UNITED
STATES


SECURITIES
AND EXCHANGE COMMISSION


Washington,
D.C. 20549




FORM
10-K


ANNUAL
REPORT UNDER SECTION 13 OR 15(d)


OF
THE SECURITIES EXCHANGE ACT OF 1934




For
the fiscal year ended December 31, 2009




Commission
file number 0-50765




VILLAGE
BANK AND TRUST FINANCIAL CORP.


(Exact name of registrant as
specified in its charter)




Virginia16-1694602


(State
or other jurisdiction
of                                                                            
  (I.R.S.
Employer


incorporation
or
organization)                                                                    
          Identification
No.)





15521 Midlothian Turnpike, Suite 200, Midlothian,
Virginia                       
   23113


(Address
of principal executive
offices)                                                                   
      (Zip Code)




Issuer’s telephone number 804-897-3900




Securities
registered under Section 12(b) of the Exchange Act:




Title
of each
class                                                              Name
of each exchange on which registered


Common Stock, $4.00 par
value                                                                               The
Nasdaq Stock Market




Securities
registered under Section 12(g) of the Exchange Act:


None







Indicate
by check mark if the registrant is a well-known seasoned issuer, as defined in
Rule 405 of the Securities Act.  Yes oNo
x





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





Indicate
by check mark whether the registrant (1) has filed all reports required to be
filed by Section 13 or 15(d) of the Exchange Act


during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been


subject
to such filing requirements for the past 90 days.  Yes x
No o




Indicate
by check mark if disclosure of delinquent filers pursuant to Item 405 of
Regulation S-K is not contained herein, and will not


be
contained, to the best of registrant’s knowledge, in definitive proxy or
information statements incorporated by reference in Part III


of
this Form10-K or any amendment to this Form 10-K. o




Indicate
by check mark whether the registrant is a large accelerated filer, an
accelerated filer, a non-accelerated filer, or a smaller


reporting
company. See the definition of “large accelerated filer”, “accelerated filer”
and “smaller reporting company” in Rule 12b-2


of
the Exchange Act.




Large
Accelerated Filer o                                                                                      Accelerated
Filer o


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




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


Yes o  No  x




The
aggregate market value of common stock held by non-affiliates of the registrant
as of June 30, 2009 was approximately $19,884,000




The
number of shares of common stock outstanding as of March 5, 2010 was
4,230,628.




DOCUMENTS INCORPORATED BY
REFERENCE





Portions
of the definitive Proxy Statement to be used in conjunction with the 2010 Annual
Meeting of Shareholders are incorporated


by
reference into Part III of this Form 10-K.


Village
Bank and Trust Financial Corp.
 Form
10-K
  TABLE
OF CONTENTS
  Part
I
 Item
      1.
              Business
              3Item
      1A.
              Risk
      Factors
              16Item
      1B.
              Unresolved
      Staff Comments
              24Item
      2.
              Properties
              24Item
      3.
              Legal
      Proceedings
              24Item
      4.
              Reserved
              24
  Part
II
 Item
      5.
              Market
      for Registrant’s Common Equity, Related Stockholder
                Matters
      and Issuer Purchases of Equity Securities
              25Item
      6.
              Selected
      Financial Data
              27Item
      7.
              Management’s
      Discussion and Analysis of Financial Condition
                And
      Results of Operations
              28Item
      8.
              Financial
      Statements and Supplementary Data
              52Item
      9.
              Changes
      In and Disagreements with Accountants
                on
      Accounting and Financial Disclosure
              88Item
      9A.
              Controls
      and Procedures
              88Item
      9B.
              Other
      Information
              89
  Part
III
 Item
      10.
              Directors,
      Executive Officers, and Corporate Governance
              90Item
      11.
              Executive
      Compensation
              90Item
      12.
              Security
      Ownership of Certain Beneficial Owners and
                Management
      and Related Stockholder Matters
              90Item
      13.
              Certain
      Relationships and Related Transactions,
                and
      Director Independence
              90Item
      14.
              Principal
      Accounting Fees and Services
              90
  Part
IV
 Item
      15.
              Exhibits,
      Financial Statement Schedules
              91Signatures
              
              94
  2
  PART
I
   ITEM
1.  BUSINESS
  The
disclosures set forth in this item are qualified by ITEM 1A. RISK FACTORS on
pages 17 to 24 and the section captioned “Caution About Forward-Looking
Statements” on page 29 and other cautionary statements set forth elsewhere in
this report.
  General
  Village
Bank and Trust Financial Corp. (the “Company”) was incorporated in January 2003
and was organized under the laws of the Commonwealth of Virginia as a bank
holding company whose activities consist of investment in its wholly-owned
subsidiary, Village Bank (the “Bank”).  The Bank opened to the public
on December 13, 1999 as a traditional community bank offering deposit and loan
services to individuals and businesses in the Richmond, Virginia metropolitan
area.  During 2003, the Company acquired or formed three wholly owned
subsidiaries of the Bank, Village Bank Mortgage Corporation (“Village Bank
Mortgage”), a full service mortgage banking company, Village Insurance Agency,
Inc. (“Village Insurance”), a full service property and casualty insurance
agency, and Village Financial Services Corporation (“Village Financial
Services”), a financial services company.  Currently, Village
Insurance and Village Financial Services have no ongoing
operations.
  The
Company is the holding company of and successor to the
Bank.  Effective April 30, 2004, the Company acquired all of the
outstanding stock of the Bank in a statutory share exchange
transaction.  In the transaction, the shares of the Bank’s common
stock were exchanged for shares of the Company’s common stock, par value $4.00
per share (“Common Stock”), on a one-for-one basis.  As a result, the
Bank became a wholly-owned subsidiary of the Company, the Company became the
holding company for the Bank and the shareholders of the Bank became
shareholders of the Company.  All references to the Company in this
annual report for dates or periods prior to April 30, 2004 are references to the
Bank.
  We
offer a wide range of banking and related financial services, including
checking, savings, certificates of deposit and other depository services, and
commercial, real estate and consumer loans.  We are a
community-oriented and locally managed financial institution focusing on
providing a high level of responsive and personalized services to our customers,
delivered in the context of a strong direct relationship with our
customers.  We conduct our operations from our main office/corporate
headquarters location in Chesterfield County, and we have fifteen branch
offices.
  On
October 14, 2008, Village Bank and Trust Financial Corp. and Village Bank
completed its merger with River City Bank pursuant to an Agreement and Plan of
Reorganization and Merger (the “Merger Agreement”) dated as of March 9, 2008 by
and among the Company, the Bank and River City Bank.  The merger had
previously been approved by both companies’ shareholders at their respective
annual meetings on September 30, 2008 as well as the banking
regulators.  The Merger Agreement sets forth the terms and conditions
of the Company’s merger with River City Bank through the merger of River City
Bank with and into Village Bank.  Under the terms of the Merger
Agreement, Village Bank acquired all of the outstanding shares of River City
Bank.  The shareholders of River City Bank received, for each share of
River City Bank common stock that they owned immediately prior to the effective
time of the merger, either $11 per share in cash or one share of common stock of
the Company.  Pursuant to the terms of the Merger Agreement,
shareholders of River City Bank elected to receive cash, shares of common stock
of the Company, or a combination of both, subject to allocation and proration
procedures which ensured that 20% of the total merger consideration was in cash
and 80% was in common stock of the Company.  In addition, at the
effective time of the merger, each outstanding option to purchase shares of
River City Bank common stock under any stock plans vested pursuant to its terms
and was converted into an option to acquire the number of shares of the
Company’s common stock equal to the number of shares of River City Bank common
stock underlying the option.  The Company issued approximately
1,440,000 shares in the Merger.
  3
  Business
Strategy
  Our
current business strategies include the following:
  ●
              To
      be a full service financial services provider enabling us to establish and
      maintain relationships with our
  customers.
  ●
              To
      attract customers by providing the breadth of products offered by larger
      banks while maintaining the quick response and personal service of a
      community bank.  We will continue to look for
      opportunities to expand our products and services.  In our first
      nine years of operation, we have established a diverse product line,
      including commercial, mortgage and consumer loans as well as a full array
      of deposit products and
services.
  ●
              To
      increase net income and return to shareholders through moderate loan
      growth, while controlling the cost of our deposits andnoninterestexpenses.
  ●
              To
      reduce the level of our nonperforming
      assets.  Nonperforming assets, consisting of nonaccrual
      loans and real estate acquired through foreclosure, reached record highs
      in 2009 and are having a negative affect on profitability.  We
      have committed significant resources to reduce the level of nonperforming
      assets.
  ●
              To
      expand our capacity to generatenoninterestincome
      through the sale of mortgage loans.  In 2009 our mortgage
      company hired additional mortgage loan officers which should expand our
      ability to originate mortgage
loans.
  ●
              To
      continue to emphasize commercial banking products and
      services.  Small-business commercial customers are a
      source of prime-based loans, fee income from cash management services, and
      low cost deposits, which we need to fund our growth.  We have
      been able to build a commercial business base because our staff of
      commercial bankers seeks opportunities to network within the local
      business community.  Significant additional growth in this
      banking area will depend on expanding our lending
      staff.
  Our
officers, employees and the directors live and work in our market
area.  We believe that the existing and future banking market in our
community represents an opportunity for locally owned and locally managed
community banks.  In view of the continuing trend in the financial
services industry toward consolidation into larger, sometimes impersonal,
statewide, regional and national institutions, the market exists for the
personal and customized financial services that an independent, locally owned
bank with local decision making can offer.  With the flexibility of
our smaller size and through an emphasis on relationship banking, including
personal attention and service, we can be more responsive to the individual
needs of our customers than our larger competitors.  As a community
oriented and locally managed institution, we make most of our loans in our
community and can tailor our services to meet the banking and financial needs of
our customers who live and do business in our market.
  We
provide customers with high quality, responsive and technologically advanced
banking services.  These services include loans that are priced on a
deposit-based relationship, easy access to our decision makers, and quick and
innovative action necessary to meet a customer’s banking needs.
  Location
and Market Area
  Our
overall strategy is to become the premier financial institution serving the
Richmond metropolitan area.  We recognized early on that to be
successful with this strategy, we needed to grow aggressively, expanding our
branch network to reach the most people possible.  Initially, we
focused our operations in Chesterfield County, Virginia, which, despite its
potential for business development and population growth, has beenunderserved
by community banks.  Chesterfield’s resources are very favorable for
businesses seeking a profitable and stable environment.  The county
offers superb commercial and industrial sites, an educated work force,well-designed
and developed infrastructure and a competitive tax
structure.  Chesterfield has been awarded the U.S. Senate Gold
Medallion for
  4
  Productivity
and Quality.  The county has the highest bond rating from three rating
agencies-
Standard andPoors,
Moody’s and Fitch.
  Once
we established a strong banking presence in the lucrative Chesterfield County
market with eight branches, we continued the implementation of our strategy by
expanding our franchise intoother
counties in the Richmond Metropolitan area.  In addition to
ChesterfieldCounty,
we have now opened three branches in both Hanover and Henrico Counties and one
in Powhatan County, all three along with Chesterfield have seen strong
population growth in recent years.
  At
December 31, 2009, we had fifteen full service banking offices, which were
staffed by 54 full-time employees.  Our senior staff averages more
than 25 years of professional or banking experience.  Our principal
office, which houses our executive officers and loan department, was opened in
August 2008 and is located at 15521 Midlothian Turnpike, Midlothian, Virginia
23113.  Our main telephone number is (804) 897-3900.  Our
main office which includes a branch facility and seven of our branch offices are
located inChesterfield
County,
with three branch offices in Hanover County, three in Henrico County and one in
Powhatan County.  Each branch office has been strategically located to
be convenient to business and retail customers in the growth sectors of each
County.
  Historically
the Richmond Metropolitan area has been a favorable market for us to provide
banking services.  However with the depressed economy that started in
late 2008 and was prevalent throughout 2009, this market area was negatively
impacted by the decline in the housing market, especially in Chesterfield County
where residential housing has been an economic driver in the
past.  Because a substantial part of our loan portfolio is
collateralized by residential real estate primarily in Chesterfield County, this
decline in the housing market has had a negative impact on our asset
quality.  The result has been a substantial increase in nonperforming
assets, and in turn, a negative impact on profitability.  See further
discussion of nonperforming assets under Asset
Quality in Management’s
Discussion and Analysis of Financial Condition and Results of Operations
following.
  Banking
Services
  We
receive deposits, make consumer and commercial loans, and provide other services
customarily offered by a commercial banking institution, such as business and
personal checking and savings accounts, drive-up windows, and24-hour
automated teller machines.  We have not applied for permission to
establish a trust department and offer trust services.  We are not a
member of the Federal Reserve System.  Our deposits are insured under
the Federal Deposit Insurance Act to the limits provided
thereunder.
  We
offer a full range ofshort-to-medium
term commercial and personal loans.  Commercial loans include both
secured and unsecured loans for working capital (including inventory and
receivables), business expansion (including acquisition of real estate and
improvements) and purchase of equipment and machinery.  Consumer loans
include secured and unsecured loans for financing automobiles, home
improvements, education and personal investments.  We also originate
fixed and variable rate mortgage loans and real estate construction and
acquisition loans.  Residential loans originated by our mortgage
company are usually sold in the secondary mortgage
market.
  Our
lending activities are subject to a variety of lending limits imposed by federal
and state law.  While differing limits apply in certain circumstances
based on the type of loan or the nature of the borrower (including the
borrower’s relationship to the bank), in general, for loans that are not secured
by readily marketable or other permissible collateral, we are subject to aloans-to-one
borrower limit of an amount equal to 15% of our capital and
surplus.  We may voluntarily choose to impose a policy limit on loans
to a single borrower that is less than the legal lending limit.  We
are a member of the Community Bankers’ Bank and may participate out portions of
loans when loan amounts exceed our legal lending limits or internal lending
policies.
  Lending
Activities
  Our
primary focus is on making loans to small businesses and consumers in our local
market area.  In addition, we also provide a select range of real
estate finance services.  Our primary lending
  5
  activities
are principally directed to our market area.
  LoanPortfolio.The net loan
portfolio was $457,047,000 at December 31, 2009, which compares to $464,663,000
at December 31, 2008.  The Company saw a decline in loan growth for
the first time in several years.  Loans declined by 1.6% in 2009 while
loans grew by 44% in 2008 and 36% in 2007.  The decline in loan growth
in 2009 is a direct result of the prolonged economic downturn while the majority
of the loan growth in 2008 came as a result of our merger with River City
Bank.  Our loan customers are generally located in the Richmond
metropolitan area.  We do not have any subprime loans in our loan
portfolio.
  Commercial Real Estate
Lending.We finance commercial real estate for our
clients and commercial real estate loans represent the largest segment of our
loan portfolio.  This segment of our loan portfolio has been the
largest segment since 2004 due to the significant real estate opportunities in
our market area.  We generally will finance owner-occupied commercial
real estate at an 80% loan-to-value ratio or less.  In many cases ourloan-to-value
ratio is less than 80%, which provides us with a higher level of collateral
security.  Our underwriting policies and procedures focus on the
borrower’s ability to repay the loan as well as assessment of the underlying
real estate.  Risks inherent in managing a commercial real estate loan
portfolio relate to sudden or gradual drops in property values as well as
changes in the economic climate.  We attempt to mitigate those risks
by carefully underwriting loans of this type as well as following appropriateloan-to-value
standards.  Commercial real estate loans (generally owner occupied) at
December 31, 2009 were $240,829,000, or 51.5% of the total loan
portfolio.
  Residential Mortgage
Lending.We make permanent residential mortgage loans
for inclusion in the loan portfolio.  We seek to retain in our
portfolio variable rate loans secured byone-to-four-family
residences.  However, the majority of permanent residential loans are
made by the Bank’s subsidiary, Village Bank Mortgage, which sells them to
investors in the secondary mortgage market on a pre-sold basis.  Given
the low fixed rate residential loan market in recent years, this allows us to
offer this service to our customers without retaining a significant low rate
residential loan portfolio which would be detrimental to earnings as interest
rates increase.  We originate both conforming andnon-conforming
single-family loans.
  Before
we make a loan we evaluate both the borrower’s ability to make principal and
interest payments and the value of the property that will secure the
loan.  We make first mortgage loans in amounts up to 90% of the
appraised value of the underlying real estate.  We retain some second
mortgage loans secured by property in our market area, as long as the
loan-to-value ratio combined with the first mortgage does not exceed
90%.  For conventional loans in excess of 80% loan-to-value, private
mortgage insurance is required.
  Our
currentone-to-four-family
residential adjustable rate mortgage loans have interest rates that adjust
annually after a fixed period of 1, 3 and 5 years, generally in accordance with
the rates on comparable U.S. Treasury bills plus a margin.  Our
adjustable rate mortgage loans generally limit interest rate increases to 2%
each rate adjustment period and have an established ceiling rate at the time the
loans are made of up to 6% over the original interest rate.  There are
risks resulting from increased costs to a borrower as a result of the periodic
repricing mechanisms of these loans.  Despite the benefits of
adjustable rate mortgage loans to ourasset/liability
management, they pose additional risks, primarily because as interest rates
rise; the underlying payments by the borrowers rise, increasing the potential
for default.  At the same time, the marketability of the underlying
property may be adversely affected by higher interest rates.  At
December 31, 2009, $93,657,000, or 20.0% of our loan portfolio, consisted of
residential mortgage loans.
  Real Estate Construction
Lending.This segment of our loan portfolio is
predominately residential in nature and comprised of loans with short duration,
meaning maturities of twelve months or less.  Residential houses under
construction and the underlying land for which the loan was obtained secure the
construction loans.  Construction lending entails significant risks
compared with residential mortgage lending.  These risks involve
larger loan balances concentrated with single borrowers withfunds
advanced upon the security of the land and home under construction, which is
estimated prior to the completion of the home.  Thus it is more
difficult to evaluate accurately the
  6
  total
loan funds required to complete a project and relatedloan-to-value
ratios.  To mitigate these risks we generally limit loan amounts to
80% of appraised values on pre-sold homes and 75% on speculative homes, and
obtain first lien positions on the property taken as
security.  Additionally, we offer real estate construction financing
to individuals who have demonstrated the ability to obtain a permanent
loan.  At December 31, 2009, construction loans totaled $81,688,000,
or 17.5% of the total loan portfolio.
  Commercial Business
Lending.Our commercial business lending consists of
lines of credit, revolving credit facilities, term loans, equipment loans,
stand-by letters of credit and unsecured loans.  Commercial loans are
written for any business purpose including the financing of plant and equipment,
carrying accounts receivable, general working capital, contract administration
and acquisition activities.  Our client base is diverse, and we do not
have a concentration of loans in any specific industry
segment.Commercial
business loans are generally secured by accounts receivable, equipment,
inventory and other collateral such as marketable securities, cash value of life
insurance, and time deposits.  Commercial business loans have a higher
degree of risk than residential mortgage loans, but have higher
yields.  To manage these risks, we generally obtain appropriate
collateral and personal guarantees from the borrower’s principal owners and
monitor the financial condition of business borrowers.  The
availability offunds
for the repayment of commercial business loans may substantially depend on the
success of the business itself.  Further, the collateral for
commercial business loans may depreciate over time and cannot be appraised with
as much precision as residential real estate.  All commercial loans we
make have recourse under the terms of a promissory note.  At December
31, 2009,commercial
loans totaled $39,576,000, or 8.5% of the total loan
portfolio.
  Consumer Installment
Lending.We offer various types of secured and
unsecured consumer loans.  We make consumer loans primarily for
personal, family or household purposes as a convenience to our customer base
since these loans are not the primary focus of our lending
activities.  Our general guideline is that a consumer’s total debt
service should not exceed 40% of the consumer’s gross income.  Our
underwriting standards for consumer loans include making a determination of the
applicant’s payment history on other debts and an assessment of his or her
ability to meet existing obligations and payments on the proposed
loan.  The stability of an applicant’s monthly income may be
determined by verification of gross monthly income from primary employment and
additionally from any verifiable secondary income.  Consumer loans
totaled $11,609,000 at December 31, 2009, which was 2.5% of the total loan
portfolio.
  Loan Commitments and Contingent
Liabilities.In the normal course of business, the
Company makes various commitments and incurs certain contingent liabilities
which are disclosed in the footnotes of our annual financial statements,
including commitments to extend credit.  At December 31, 2009,undisbursed
credit lines, standby letters of credit and commitments to extend credit totaled
$72,876,000.
  Credit Policies and
Administration.We have adopted a comprehensive lending
policy, which includes stringent underwriting standards for all types of
loans.  Our lending staff follows pricing guidelines established
periodically by our management team.  In an effort to manage risk, all
credit decisions in excess of the officers’ lending authority must be approved
prior to funding by a management loan committee and/or a board of
directors-level loancommittee.  Any
loans above $5,000,000 require full board of directors’
approval.  Management believes that itemploys
experienced lending officers, secures appropriate collateral and carefully
monitors the financial conditions of our borrowers and the concentration of such
loans in the portfolio.
  In
addition to the normal repayment risks, all loans in our portfolio are subject
to the state of the economy and the related effects on the borrower and/or the
real estate market.  Generally, longer-term loans have periodic
interest rate adjustments and/or call provisions.  Our senior
management monitors the loan portfolio closely to ensure that past due loans are
minimized and that potential problem loans are swiftly dealt with.  In
addition to the internal business processes employed in the credit
administration area, the Companyutilizes
an outside consulting firm to review the loan portfolio.  A detailed
annual review is performed, with an interim update occurring at least once a
year.  Results of the report are used to validate our internal loan
ratings and to provide independent
  7
  commentary
on specific loans and loan administration activities.
  Lending Limit.As of
December 31, 2009, our legal lending limit for loans to one borrower wasapproximately
$8,059,000.  However,
we generally will not extend credit to any one individual or entity in excess of
$5,000,000, and, as noted above, any amount over that must be approved by the
full Board of Directors.
  Investments
and Funding
  We
balance our liquidity needs based on loan and deposit growth via the investment
portfolio, purchased federal funds, and Federal Home Loan Bank
advances.  It is our goal to provide adequate liquidity to support our
loan growth.  Should we have excess liquidity, investments are used to
generate positive earnings.  In the event deposit growth does not
fully support our loan growth, a combination of investment sales, federal funds
and Federal Home Loan Bank advances will be used to augment our funding
position.  However, we believe that due to a continued depressed
economy as well as capital limitations, we will not see any significant growth
in our loan portfolio in 2010.  Accordingly, any growth in our
deposits will be used to increase our investment portfolio or reduce higher cost
borrowings.
  Our
investment portfolio is actively monitored and is classified as “available for
sale.”  Under such a classification, investment instruments may be
sold as deemed appropriate by management.  On a monthly basis, the
investment portfolio is marked to market via equity as required bygenerally
accepted accounting principles.  Additionally, we use the investment
portfolio to balance our asset and liability position.  We will invest
in fixed rate or floating rate instruments as necessary to reduce our interest
rate risk exposure.
  For
securities classified as available-for-sale securities, we will evaluate whether
a decline in fair value below the amortized cost basis is other than
temporary.  If the decline in fair value is judged to be other than
temporary, the cost basis of the individual security is written down to fair
value as a new cost basis and the amount of the write-down is included in
earnings.  There were no securities at December 31, 2009 where a
decline in market value was considered other than temporary.
  Competition
  We
encounter strong competition from other local commercial banks, savings and loan
associations, credit unions, mortgage banking firms, consumer finance companies,
securities brokerage firms, insurance companies, money market mutual funds and
other financial institutions.  A number of these competitors are
well-established.  Competition for loans is keen, and pricing is
important.  Most of our competitors have substantially greater
resources and higher lending limits than ours and offer certain services, such
as extensive and established branch networks and trust services, which we do not
provide at the present time.  Deposit competition also is strong, and
we may have to pay higher interest rates to attract
deposits.  Nationwide banking institutions and their branches have
increased competition in our markets, and federal legislation adopted in 1999
allows non-banking companies, such as insurance and investment firms, to
establish or acquire banks.
  The
greater Richmond metropolitan market has experienced several significant mergers
or acquisitions involving all four regional banks formerly headquartered in
central Virginia over the past fifteen years.  Additionally, other
larger banks from outside Virginia have acquired local banks.  We
believe that the Company can capitalize on the recent merger activity and
attract customers from those who are dissatisfied with the recently acquired
banks.
  At
June 30, 2009, the latest date such information is available from the FDIC, the
Bank’s deposit market share in Chesterfield County was 7.36% and 0.91% in the
Richmond MSA.
  Regulation
  We
are subject to regulations of certain federal and state agencies and receive
periodic examinations by those regulatory authorities.  As a
consequence of the extensive regulation of
  8
  commercial
banking activities, our business is susceptible to being affected by state and
federal legislation and regulations.
  General.The discussion below is only a
summary of the principal laws and regulations that comprise the regulatory
framework applicable to us.  The descriptions of these laws and
regulations, as well as descriptions of laws and regulations contained elsewhere
herein, do not purport to be complete and are qualified in their entirety by
reference to applicable laws and regulations.  In recent years,
regulatory compliance by financial institutions such as ours has placed a
significant burden on us both in costs and employee time
commitment.
  Bank Holding Company.The
Company is a bank holding company under the Federal Bank Holding Company Act of
1956, as amended, and is subject to supervision and regulation by the Board of
Governors of the Federal Reserve System (the “Federal Reserve Board”) and
Virginia State Corporation Commission (“SCC”).  As a bank holding
company, the Company is required to furnish to the Federal Reserve Board an
annual report of its operations at the end of each fiscal year and to furnish
such additional information as the Federal Reserve Board may require pursuant to
the Bank Holding Company Act.  The Federal Reserve Board, FDIC and SCC
also may conduct examinations of the Company and/or its subsidiary
bank.
  Gramm-Leach-Bliley
Act.  On
November 12, 1999, the Gramm-Leach-Bliley Act was signed into law.
Gramm-Leach-Bliley permits commercial banks to affiliate with investment
banks.  It also permits bank holding companies which elect financial
holding company status to engage in any type of financial activity, including
securities, insurance, merchant banking/equity investment and other activities
that are financial in nature.  The merchant banking provisions allow a
bank holding company to make a controlling investment in any kind of company,
financial or commercial.  These new powers allow a bank to engage in
virtually every type of activity currently recognized as financial or incidental
or complementary to a financial activity.  A commercial bank that
wishes to engage in these activities is required to be well capitalized, well
managed and have a satisfactory or better Community Reinvestment Act
rating.  Gramm-Leach-Bliley also allows subsidiaries of banks to
engage in a broad range of financial activities that are not permitted for banks
themselves.
  Sarbanes-Oxley
Act of 2002.
The Sarbanes-Oxley Act of 2002 implemented a broad range of corporate
governance, accounting and reporting measures for companies, like the Company,
that have securities registered under the Securities Exchange Act of
1934.  Specifically, the Sarbanes-Oxley Act and the various
regulations promulgated under the Act, established, among other things:
(i) new requirements for audit committees, including independence,
expertise, and responsibilities; (ii) additional responsibilities regarding
financial statements for the Chief Executive Officer and Chief Financial Officer
of the reporting company; (iii) new standards for auditors and regulation
of audits, including independence provisions that restrict non-audit services
that accountants may provide to their audit clients; (iv) increased
disclosure and reporting obligations for the reporting company and their
directors and executive officers, including accelerated reporting of stock
transactions and a prohibition on trading during pension blackout periods; and
(v) a range of new and increased civil and criminal penalties for fraud and
other violations of the securities laws.  In addition, Sarbanes-Oxley
required stock exchanges, such as NASDAQ, to institute additional requirements
relating to corporate governance in their listing rules.
  Section 404
of the Sarbanes-Oxley Act requires the Company to include in its Annual Report
on Form 10-K a report by management.  Management’s internal control
report must, among other things, set forth management’s assessment of the
effectiveness of the Company’s internal control over financial
reporting.
  Emergency
Economic Stabilization Act of 2008. In response to unprecedented
market turmoil during the third quarter of 2008, the Emergency Economic
Stabilization Act (“EESA”) of 2008 was enacted on October 3,
2008.  EESA authorizes the U.S. Treasury to provide up to $700 billion
to support the financial services industry.  Pursuant to the EESA, the
U.S. Treasury was initially authorized to use $350 billion for the Troubled
Asset Relief Program (“TARP”).  Of this amount, the U.S. Treasury
allocated $250 billion to the TARP Capital Purchase Program.  On
January 15, 2009, the second $350 billion of TARP monies was released to the
U.S. Treasury.  The Secretary’s
  9
  authority
under TARP was to expire on December 31, 2009, unless the Secretary certifies to
Congress that extension is necessary provided that his authority may not extend
beyond October 3, 2010.  On December 9, 2009, the Secretary sent such
a letter to the Congress, extending his authority under the TARP through October
3, 2010.
  On
May 1, 2009, the Company issued preferred shares and a warrant to purchase its
common shares to the U.S. Treasury as a participant in the TARP Capital Purchase
Program.  The amount of capital raised in that transaction was $14.7
million, approximately three percent of the Company’s risk-weighted
assets.  Prior to May 1, 2012, unless the parent company has redeemed
all such preferred shares or the U.S. Treasury has transferred all such
preferred shares to a third party, the consent of the U.S. Treasury will be
required for us to, among other things, pay a dividend on
the   Company’s common shares or repurchase our common shares or
outstanding preferred shares except in limited circumstances.  No
dividends may be paid on common stock unless dividends have been paid on the
senior preferred stock.  The senior preferred will not have voting
rights other than the right to vote as a class on the issuance of any preferred
stock ranking senior, any change in its terms or any merger, exchange or similar
transaction that would adversely affect its rights.  The senior
preferred will also have the right to elect two directors if dividends have not
been paid for six periods.  The Company filed a registration statement
on Form S-3 covering the warrant as required under the terms of the TARP
investment, on May 29, 2009.  The registration statement was declared
effective by the SEC on June 16, 2009.
  In
addition, until the U.S. Treasury ceases to own any of the Company’s securities
sold under the TARP Capital Purchase Program, the compensation arrangements for
our senior executive officers must comply in all respects with EESA and the
rules and regulations there under.  In compliance with such
requirements, each of our senior executive officers agreed in writing to accept
the compensation standards in existence at that time under the TARP Capital
Purchase Program and thereby cap or eliminate some of their contractual or legal
rights.
  American
Recovery and Reinvestment Act of 2009.  On February 17, 2009,
President Obama signed the American Recovery and Reinvestment Act of 2009
(“ARRA”) into law.  ARRA modified the compensation-related limitations
contained in the TARP Capital Purchase Program (the “CPP”), created additional
compensation-related limitations and directed the Secretary of the Treasury to
establish standards for executive compensation applicable to participants in
TARP.  Thus, the newly enacted compensation-related limitations are
applicable to the Company which have been added or modified by ARRA are as
follows, which provisions must be included in standards established by the U.S.
Treasury:
  ●
              No
      Severance Payments.  Under ARRA “golden parachutes” were
      redefined as any severance payment resulting from involuntary termination
      of employment, or from bankruptcy of the employer, except for payments for
      services performed or benefits accrued. Consequently under ARRA the
      Company is prohibited from making any severance payment to our “senior
      executive officers” (defined in ARRA as the five highest paid executive
      officers) and our next five most highly compensated employees during the
      CPP Covered Period.
   ●
              Recovery
      of Incentive Compensation if Based on Certain Material
      Inaccuracies.  ARRA also contains the “clawback provision”
      discussed above but extends its application to any bonus or retention
      awards and other incentive compensation paid to any of our senior
      executive officers or next 20 most highly compensated employees during the
      CPP Covered Period that is later found to have been based on materially
      inaccurate financial statements or other materially inaccurate
      measurements of performance
   ●
              No
      Compensation Arrangements That Encourage Earnings
      Manipulation.  Under ARRA, during the CPP Covered Period, the
      Company is not allowed to enter into compensation arrangements that
      encourage manipulation of the reported earnings of the Company to enhance
      the compensation of any of our
employees.
   ●
              Limits
      on Incentive Compensation.  ARRA contains a provision that
      prohibits the payment or accrual of any bonus, retention award or
      incentive compensation to any of our 5 most highly compensated employees
      during the CPP Covered Period other than awards of
    long-term
   
   10
   restricted
stock that (i) do not fully vest during the CPP Coverage Period, (ii) have a
value not greater than one-third of the total annual compensation of the awardee
and (iii) are subject to such other restrictions as determined by the Secretary
of the Treasury.  The prohibition on bonus, incentive compensation and
retention awards does not preclude payments required under written employment
contracts entered into on or prior to February 11, 2009.
   ●
              Compensation
      Committee Functions.  ARRA requires that our Compensation
      Committee be comprised solely of independent directors and that it meet at
      least semiannually to discuss and evaluate our employee compensation plans
      in light of an assessment of any risk posed to us from such compensation
      plans.
   ●
              Compliance
      Certifications.  ARRA also requires a written certification by
      our Chief Executive Officer and Chief Financial Officer of our compliance
      with the provisions of ARRA.  These certifications must be
      contained in the Company’s Annual Report on Form 10-K for the year ended
      December 31, 2009 and any subsequent year during the Capital Purchase Plan
      Covered Period the relevant U.S. Treasury regulations are
      issued.
   ●
              Treasury
      Review of Excessive Bonuses Previously Paid.  ARRA directs the
      Secretary of the Treasury to review all compensation paid to our senior
      executive officers and our next 20 most highly compensated employees to
      determine whether any such payments were inconsistent with the purposes of
      ARRA or were otherwise contrary to the public interest.  If the
      Secretary of the Treasury makes such a finding, the Secretary of the
      Treasury is directed to negotiate with the TARP Capital Purchase Program
      recipient and the subject employee for appropriate reimbursements to the
      federal government with respect to the compensation and
      bonuses.
   ●
              Say
      on Pay.  Under ARRA the SEC promulgated rules requiring a
      non-binding say on pay vote by the shareholders on executive compensation
      at the annual meeting during the CPP Covered
  Period.
   ARRA
also provides that the U.S. Treasury, after consultation with the Company’s
federal regulator, permit the Company at any time to redeem our Series A
Preferred Shares at liquidation value.  Upon such redemption, the
warrant to purchase the parent company’s common stock that was issued to the
U.S. Treasury would also be repurchased at its then current fair
value.
  On
June 10, 2009, the U.S. Treasury issued guidance on the compensation and
corporate governance standards that apply to TARP recipients, as summarized
below:
  ●
              Bonuses
      accrued or paid before the effective date of the rule adopted by the U.S.
      Treasury are not subject to the rule’s bonus payment
      limitation.  In addition, separation pay for departures that
      occurred before receipt of TARP assistance also is not subject to the
      limits of the rule (even if payments continue to be made after
      effectiveness).
  ●
              The
      term “most highly compensated employees” covers all employees, not only
      executive officers or other policy makers.  The determination of
      the most highly compensated employees is based on annual compensation for
      the prior year calculated in accordance with SEC disclosure
      rules.
  ●
              The
      rule permits salary paid in property, including stock, so long as it is
      based on a dollar amount (not a number of shares), is fully vested and
      accrues as cash salary would.  The rule also permits salary paid
      in stock units in respect of shares of the TARP recipient, or subsidiaries
      or divisions of the TARP recipient (though not below the subsidiary or
      division for which the employee directly provides
      services).  Holding periods also are
  permitted.
  ●
              Commission
      payments for sales, brokerage and asset management services for unrelated
      customers will not be subject to the bonus restrictions, but only if they
      are consistent with an existing plan of the TARP recipient in effect
      before February 17, 2009.
  11
  
  ●
              The
      rule imposes a restrictive set of “best practices” on TARP recipients: (i)
      the five senior executive officers and the next 20 most highly compensated
      employees may not receive any tax “gross-up” payment of any kind,
      including payments to cover taxes due on company-provided benefits or
      separation payments; (ii) the prohibition on separation payments to the
      five senior executive officers and the next five most highly compensated
      employees is extended to payments in connection with a change in control;
      (iii) the compensation committee must review all employee compensation
      plans every six months for unnecessary risk and provide an expanded
      certification including narrative disclosure of its analysis and
      conclusions; (iv) TARP recipients must exercise their clawback rights
      unless doing so would be unreasonable; and (v) TARP recipients must adopt
      a policy reasonably designed to eliminate excessive or luxury
      expenditures.
  ●
              An
      institution will not become subject to the compensation standards merely
      as a result of acquiring a TARP recipient. In addition, if an acquiror is
      not subject to the standards immediately after the transaction, any
      employees of the acquiror (including former employees of the TARP
      recipient who become acquiror employees as a result of the transaction)
      will not be subject to the
standards.
  ●
              The
      “TARP period” during which the compensation standards apply ceases when
      the obligations arising from financial assistance cease and specifically
      excludes any period when the only outstanding obligation of a TARP
      recipient consists of U.S. Treasury warrants to purchase common
      stock.
  Comprehensive
Financial Stability Plan of 2009.  On February 10, 2009, the
Treasury Secretary announced a new comprehensive financial stability plan (the
“Financial Stability Plan”), which earmarked the second $350 billion of unused
funds originally authorized under the EESA.   The major elements
of the Financial Stability Plan included: (i) a capital assistance program that
has invested in convertible preferred stock of certain qualifying institutions,
(ii) a consumer and business lending initiative to fund new consumer loans,
small business loans and commercial mortgage asset-backed securities issuances,
(iii) a public/private investment fund intended to leverage public and private
capital with public financing to purchase up to $500 billion to $1 trillion of
legacy “toxic assets” from financial institutions, and (iv) assistance for
homeowners by providing up to $75 billion to reduce mortgage payments and
interest rates and establishing loan modification guidelines for government and
private programs.
  Regulatory
Reform.  In June 2009, the Obama administration proposed a wide
range of regulatory reforms that, if enacted, may have significant effects on
the financial services industry in the United States.  Significant
aspects of the Obama administration’s proposals included, among other things,
proposals (i) that any financial firm whose combination of size, leverage and
interconnectedness could pose a threat to financial stability be subject to
certain enhanced regulatory requirements, (ii) that federal bank regulators
require loan originators or sponsors to retain part of the credit risk of
securitized exposures, (iii) that there be increased regulation of
broker-dealers and investment advisers, (iv) for the creation of a federal
consumer financial protection agency that would, among other things, be charged
with applying consistent regulations to similar products (such as imposing
certain notice and consent requirements on consumer overdraft lines of credit),
(v) that there be comprehensive regulation of OTC derivatives, (vi) that the
controls on the ability of banking institutions to engage in transactions with
affiliates be tightened, and (vii) that financial holding companies be required
to be “well-capitalized” and “well-managed” on a consolidated
basis.
  The
Congress, state lawmaking bodies and federal and state regulatory agencies
continue to consider a number of wide-ranging and comprehensive proposals for
altering the structure, regulation and competitive relationships of the nation’s
financial institutions, including rules and regulations related to the broad
range of reform proposals set forth by the Obama administration described
above.  Separate comprehensive financial reform bills intended to
address the proposals set forth by the Obama administration were introduced in
both houses of Congress in the second half of 2009 and remain under review by
both the U.S. House of Representatives and the U.S. Senate.  In
addition, both the U.S. Treasury Department and the Basel Committee on
Banking
  12
  Supervision
(the “Basel Committee”) have issued policy statements regarding proposed
significant changes to the regulatory capital framework applicable to banking
organizations.
  We
cannot predict whether or in what form further legislation and/or regulations
may be adopted or the extent to which the Company’s business may be affected
thereby.
  Incentive
Compensation.  On October 22, 2009, the Federal Reserve Board
issued a comprehensive proposal on incentive compensation policies (the
“Incentive Compensation Proposal”) intended to ensure that the incentive
compensation policies of banking organizations do not undermine the safety and
soundness of such organizations by encouraging excessive
risk-taking.  The Incentive Compensation Proposal, which covers all
employees that have the ability to materially affect the risk profile of an
organization, either individually or as part of a group, is based upon the key
principles that a banking organization’s incentive compensation arrangements
should (i) provide incentives that do not encourage risk-taking beyond the
organization’s ability to effectively identify and manage risks, (ii) be
compatible with effective internal controls and risk management, and (iii) be
supported by strong corporate governance, including active and effective
oversight by the organization’s board of directors.  The Incentive
Compensation Proposal also contemplates a detailed review by the Federal Reserve
Board of the incentive compensation policies and practices of a number of
“large, complex banking organizations”.  Any deficiencies in
compensation practices that are identified may be incorporated into the
organization’s supervisory ratings, which can affect its ability to make
acquisitions or perform other actions.  The Incentive Compensation
Proposal provides that enforcement actions may be taken against a banking
organization if its incentive compensation arrangements or related
risk-management control or governance processes pose a risk to the
organization’s safety and soundness and the organization is not taking prompt
and effective measures to correct the deficiencies.  In addition, on
January 12, 2010, the FDIC announced that it would seek public comment on
whether banks with compensation plans that encourage risky behavior should be
charged at higher deposit assessment rates than such banks would otherwise be
charged.
  The
scope and content of the U.S. banking regulators’ policies on executive
compensation are continuing to develop and are likely to continue evolving in
the near future.  It cannot be determined at this time whether
compliance with such policies will adversely affect the ability of the Company
to hire, retain and motivate its and their key employees
  Bank
Regulation.  As a Virginia state-chartered FDIC bank that is
not a member of the Federal Reserve System, the Bank is subject to regulation,
supervision and examination by the SCC’s Bureau of Financial Institutions(“BFI”).
 The Bank is also subject to regulation, supervision and examination by the
FDIC.  Federal law also governs the activities in which we may engage,
the investments we may make and the aggregate amount of loans that may be
granted to one borrower.  Various consumer and compliance laws and
regulations also affect our operations.  Earnings are affected by
general economic conditions, management policies and the legislative and
governmental actions of various regulatory authorities, including those referred
to above.  The following description summarizes some of the laws to
which we are subject.  TheBFI
and the FDIC will conduct regular examinations, reviewing such matters as the
overall safety and soundness of the institution, the adequacy of loan loss
reserves, quality of loans and investments, management practices, compliance
with laws, and other aspects of their operations.  In addition to
these regular examinations, we mustfurnish
the FDIC with periodic reports containing afull
and accurate statement of our affairs. Supervision, regulation and examination
of banks by these agencies are intended primarily for the protection of
depositors rather than shareholders.
  Insurance of Accounts, Assessments and Regulation by
the FDIC.Our deposits are insured by the FDIC up to
the limits set forth under applicable law, currently
$250,000.  Deposits are subject to the deposit insurance assessments
of the Bank Insurance Fund(“BIF”) of
the FDIC.  The FDIC is authorized to prohibit anyBIF-insured
institution from engaging in any activity that the FDIC determines by regulation
or order to pose a serious threat to the respective insurance
fund.  Also, the FDIC may initiate enforcement actions against banks,
after first giving the institution’s primary regulatory authority an opportunity
to take such action.  The FDIC may terminate the deposit insurance of
any depository institution if it determines, after a hearing, that the
institution has
  13
  engaged
or is engaging in unsafe or unsound practices, is in an unsafe or unsound
condition to continue operations, or has violated any applicable law,
regulation, order or any condition imposed in writing
by the FDIC.  It also may suspend deposit insurance temporarily during
the hearing process for the permanent termination of insurance if the
institution has no tangible capital.  If deposit insurance is
terminated, the deposits at the institution at the time of termination, less
subsequent withdrawals, shall continue to be insured for a period from six
months to two years, as determined by the FDIC.  We are aware of no
existing circumstances that could result in termination of our deposit
insurance.
  Additionally,
on October 14, 2008, after receiving a recommendation from the boards of the
FDIC and the Federal Reserve, and consulting with the President, the Secretary
of the Treasury signed the systemic risk exception to the FDIC Act, enabling the
FDIC to establish its Temporary Liquidity Guarantee Program (“TLGP”). Under one
component of this program, the Transaction Account Guarantee Program (“TAGP”),
the FDIC temporarily provided a full guarantee on all non-interest bearing
transaction accounts held by any depositor, regardless of dollar amount, through
December 31, 2009.  The $250,000 deposit insurance coverage limit was
scheduled to return to $100,000 on January 1, 2010, but was extended by
congressional action until December 31, 2013.  The TLGP has been
extended to cover debt of FDIC-insured institutions issued through April 30,
2010, and the TAGP has been extended through June 30, 2010.  The TLGP
also guarantees all senior unsecured debt of insured depository institutions or
their qualified holding companies issued between October 14, 2008 and June 30,
2009 with a stated maturity greater than 30 days. All eligible institutions were
permitted to participate in both of the components of the TLGP without cost for
the first 30 days of the program. Following the initial 30 day grace period,
institutions were assessed at the rate of ten basis points for transaction
account balances in excess of $250,000 for the transaction account guarantee
program and at the rate of either 50, 75, or 100 basis points of the amount of
debt issued, depending on the maturity date of the guaranteed debt, for the debt
guarantee program. Institutions were required to opt-out of the TLGP if they did
not wish to participate. The Company and its applicable subsidiaries elected to
participate in both of these programs.
  Capital.The FDIC has issued
risk-based and leverage capital guidelines applicable to banking organizations
they supervise.  Under the risk-based capital requirements, we are
generally required to maintain a minimum ratio of total capital to risk-weighted
assets (including certain off-balance sheet activities, such as standby letters
of credit), of 8%.  At least half of the total capital is to be
composed of common equity, retained earnings and qualifying perpetual preferred
stock, less certain intangibles(“Tier
1 capital”).  The remainder may consist of certain subordinated debt,
certain hybrid capital instruments and other qualifying preferred stock and a
limited amount of the loan loss allowance (“Tier 2 capital” and, together with
Tier 1 capital, “total capital”).  In addition, each of the Federal
bank regulatory agencies has established minimum leverage capital ratio
requirements for banking organizations.  These requirements provide
for a minimum leverage ratio of Tier 1 capital to adjusted average quarterly
assets equal to 4% for banks and bank holding companies that meet certain
specified criteria.  All other banks and bank holding companies will
generally be required to maintain a leverage ratio of at least 100 to 200 basis
points above the stated minimum.  The risk-based capital standards of
the FDICexplicitly
identify concentrations of credit risk and the risk arising from non-traditional
activities, as well as an institution’s ability to manage these risks, as
important factors to be taken into account by the agency in assessing aninstitution’s
overall capital adequacy.  The capital guidelines also provide that an
institution’s exposure to a decline inthe
economic value of its capital due to changes in interest rates be considered by
the agency as a factor inevaluating
a bank’s capital adequacy.
  USA
Patriot Act.The
USA Patriot Act became effective on October 26, 2001 and provides for the
facilitation of information sharing among governmental entities and financial
institutions for the purpose of combating terrorism and money laundering. Among
other provisions, the USA Patriot Act permits financial institutions, upon
providing notice to the United States Treasury, to share information with one
another in order to better identify and report to the federal government
concerning activities that may involve money laundering or terrorists’
activities. The USA Patriot Act is considered a significant banking law in terms
of information disclosure regarding certain customer transactions. Certain
provisions of the USA Patriot Act impose the obligation to establish
anti-money
  14
  laundering
programs, including the development of a customer identification program, and
the screening of all customers against any government lists of known or
suspected terrorists. Although it
 does
create a reporting obligation and compliance costs, the USA Patriot Act has not
materially affected the Bank’s products, services or other business
activities.
  Reporting
Terrorist Activities.The
Office of Foreign Assets Control (OFAC), which is a division of the Department
of the Treasury, is responsible for helping to insure that United States
entities do not engage in transactions with “enemies” of the United States, as
defined by various Executive Orders and Acts of Congress.  OFAC has
sent, and will send, our banking regulatory agencies lists of names of persons
and organizations suspected of aiding, harboring or engaging in terrorist acts.
If the Bank finds a name on any transaction, account or wire transfer that is on
an OFAC list, it must freeze such account, file a suspicious activity report and
notify the FBI. The Bank has appointed an OFAC compliance officer to oversee the
inspection of its accounts and the filing of any notifications. The Bank
actively checks high-risk OFAC areas such as new accounts, wire transfers and
customer files. The Bank performs these checks utilizing software, which is
updated each time a modification is made to the lists provided by OFAC and other
agencies of Specially Designated Nationals and Blocked
Persons.
  Other Safety and Soundness
Regulations.There are a number of obligations and
restrictions imposed on depository institutions by federal law and regulatory
policy that are designed to reduce potential loss exposure to the depositors of
such depository institutions and to the FDIC insurance funds in the event the
depository institution becomes in danger of default or is in
default.  The Federal banking agencies also have broad powers under
current Federal law to take prompt corrective action to resolve problems of
insured depository institutions.  The extent of these powers depends
upon whether the institution in question is well-capitalized, adequately
capitalized, undercapitalized, significantly undercapitalized or critically
undercapitalized, as defined by the law.  Federal regulatory
authorities also have broad enforcement powers over us, including the power to
impose fines and other civil and criminal penalties, and to appoint a receiver
in order to conserve the assets of any such institution for the benefit of
depositors and other creditors.  Village Bank is currently classified
as well capitalized financial institution.
  Loans-to-OneBorrower.Under applicable laws and
regulations the amount of loans and extensions of credit which may be extended
by a bank to any one borrower, including related entities, generally may not
exceed 15% of the unimpaired capital and unimpaired surplus of the
institution.  Loans in an amount equal to an additional 10% of
unimpaired capital and unimpaired surplus also may be made to a borrower if the
loans are fully secured by readily marketable securities.  An
institution’s “unimpaired capital and unimpaired surplus” includes, among other
things, the amount of its core capital and supplementary capital included in its
total capital under Federal regulations.
  Community Reinvestment.The
requirements of the CommunityReinvestment
Act(“CRA”)
are applicable to the Company.  TheCRA
imposes on financial institutions an affirmative and ongoing obligation to meet
the credit needs of their localcommunities,
including low and moderate income neighborhoods, consistent with the safe and
sound operation of those institutions.  A financial institution’s
efforts in meeting community credit needs currently are evaluated as part of the
examination process pursuant to 12 assessment factors.  These factors
also are considered in evaluating mergers, acquisitions and applications to open
a branch or facility.
  Economic and Monetary
Policies.Our operations are affected not only by
general economic conditions, but also by the economic and monetary policies of
various regulatory authorities.  In particular, the Federal Reserve
regulates money, credit and interest rates in order to influence general
economic conditions. These policies have a significant influence on overall
growth and distribution of loans, investments and deposits and affect interest
rates charged on loans or paid for time and savings deposits.  Federal
Reserve monetary policies have had a significant effect on the operating results
of commercial banks in the past and are expected to continue to do so in the
future.
  15
   Employees
  As
of December 31, 2009, the Company and its subsidiaries had a total of 194
full-time employees and 13 part-time employees.  None of the Company’s
employees are covered by a collective bargaining agreement.  The
Company considers its relations with its employees to be good.
  Control
by Certain Shareholders
  The
Company has one shareholder who owns 8.38% of its outstanding Common
Stock.  As a group, the Board of Directors and the Company’s Executive
Officers control 16.42% of the outstanding Common Stock of the Company as of
March 1, 2009.  Accordingly, such persons, if they were to act in
concert, would not have majority control of the Bank and would not have the
ability to approve certain fundamental corporate transactions or the election of
the Board of Directors.
  Additional
Information
  The
Company files annual, quarterly and current reports, proxy statements and other
information with the Securities and Exchange Commission.  You may read
and copy any reports, statements and other information we file at the SEC’s
Public Reference Room at 450 Fifth Street, N.W., Washington, D.C. 20549. Please
call the SEC at 1-800-SEC-0330 for further information on the operations of the
Public Reference Room. Our SEC filings are also available on the SEC’s Internet
site (http://www.sec.gov).
  The
Company’s common stock trades under the symbol “VBFC” on the Nasdaq Capital
Market.  You may also read reports, proxy statements and other
information we file at the offices of the National Association of Securities
Dealers, Inc., 1735 K Street, N.W., Washington, DC 20006.
  The
Company’s Internet address is www.villagebank.com.  At that address,
we make available, free of charge, the Company’s annual report on Form 10-K,
quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to
those reports filed or furnished pursuant to Section 13(a) or 15(d) of the
Exchange Act (see “Investor Relations” section of website), as soon as
reasonably practicable after we electronically file such material with, or
furnish it to, the SEC.
  In
addition, we will provide, at no cost, paper or electronic copies of our reports
and other filings made with the SEC (except for exhibits). Requests should be
directed to C. Harril Whitehurst, Jr., Chief Financial Officer, Village Bank and
Trust Financial Corp., PO Box 330, Midlothian, VA 23113.
  The
information on the websites listed above is not and should not be considered to
be part of this annual report on Form 10-K and is not incorporated by reference
in this document.
  ITEM
1A.  RISK FACTORS
  An
investment in the parent company’s common stock is subject to risks inherent to
the Company’s business, including the material risks and uncertainties that are
described below.  Before making an investment decision, you should
carefully consider the risks and uncertainties described below together with all
of the other information included or incorporated by reference in this
report.  The risks and uncertainties described below are not the only
ones facing the Company.  Additional risks and uncertainties that
management is not aware of or focused on, or that management currently deems
immaterial, may also impair the Company’s business operations.  This
report is qualified in its entirety by these risk factors.  If any of
the following risks adversely affect the Company’s business, financial condition
or results of operations, the value of the parent company’s common stock could
decline significantly and you could lose all or part of your
investment.
     16
  The
Company’s business may be adversely affected by conditions in the financial
markets and economic conditions generally.
  Since
December 2007, the United States has experienced a recession and a slowing of
economic activity.  Business activity across a wide range of
industries and regions is greatly reduced, and local governments and many
businesses are in serious difficulty, due to the lack of consumer spending and
the lack of liquidity in the credit markets.  Unemployment has
increased significantly.
  The
financial services industry and the securities markets generally were materially
and adversely affected by significant declines in the values of nearly all asset
classes and by a serious lack of liquidity.  This was initially
triggered by declines in home prices and the values of subprime mortgages, but
spread to all mortgage and real estate asset classes, to leveraged bank loans
and to nearly all asset classes, including equities.  The global
markets have been characterized by substantially increased volatility and short
selling and an overall loss of investor confidence, initially in financial
institutions, but more recently in companies in a number of other industries and
in the broader markets.
  Market
conditions have also led to the failure or merger of a number of prominent
financial institutions.  Financial institution failures or
near-failures have resulted in further losses as a consequence of defaults on
securities issued by them and defaults under contracts entered into with such
entities as counterparties.  Furthermore, declining asset values,
defaults on mortgages and consumer loans, and the lack of market and investor
confidence, as well as other factors, have all combined to increase credit
default swap spreads, to cause rating agencies to lower credit ratings, and to
otherwise increase the cost of and decrease the availability of liquidity,
despite very significant declines in Federal Reserve borrowing rates and other
government actions.  Some banks and other lenders have suffered
significant losses and have become reluctant to lend, even on a secured basis,
due to the increased risk of default and the impact of declining asset values on
the value of collateral.  The foregoing has significantly weakened the
strength and liquidity of some financial institutions worldwide.  In
2008 and 2009, the U.S. Government, the Federal Reserve and other regulators
took numerous steps to increase liquidity and to restore investor confidence,
including investing approximately $200 billion in the equity of other banking
organizations, but asset values have continued to decline and access to
liquidity continues to be very limited.
  Although
the rate of increase in unemployment and the rate of decline in housing prices
have slowed and the consumer spending and liquidity in the credit markets have
been somewhat improved towards the end of 2009, the economic slowdown generally
continues and there can be no assurance such indicia of recovery would herald
any prolonged period of economic recovery and growth in 2010.
  The
Company’s financial performance generally, and in particular the ability of
borrowers to pay interest on and repay the principal of outstanding loans and
the value of collateral securing those loans, is highly dependent upon the
business environment in the market where the Company operates, the Richmond
Metropolitan area.  A favorable business environment is generally
characterized by, among other factors, economic growth, efficient capital
markets, low inflation, high business and investor confidence, and strong
business earnings.  Unfavorable or uncertain economic and market
conditions can be caused by: declines in economic growth, business activity, or
investor or business confidence; limitations on the availability or increases in
the cost of credit and capital; increases in inflation or interest rates;
natural disasters; or a combination of these or other
factors.  Overall, during 2009, the business environment was adverse
for many households and businesses in the United States and worldwide. The
business environment in the Richmond Metropolitan area, the United States and
worldwide may continue to deteriorate for the foreseeable
future.  There can be no assurance that these conditions will improve
in the near term.  Such conditions could adversely affect the credit
quality of the Company’s loans, results of operations and financial
condition.
     17
  Improvements
in economic indicators disproportionately affecting the financial services
industry may lag improvements in the general economy.
  Should
the stabilization of the U.S. economy lead to a general economic recovery, the
improvement of certain economic indicators, such as unemployment and real estate
asset values and rents, may nevertheless continue to lag behind the overall
economy.  These economic indicators typically affect certain
industries, such as real estate and financial services, more
significantly.  For example, improvements in commercial real estate
fundamentals typically lag broad economic recovery by 12 to 18
months.  The Company’s clients include entities active in these
industries.  Furthermore, financial services companies with a
substantial lending business are dependent upon the ability of their borrowers
to make debt service payments on loans.  Should unemployment or real
estate asset values fail to recover for an extended period of time, the Company
could be adversely affected.
  Our
results of operations are significantly affected by the ability of our borrowers
to repay their loans.
  A
significant source of risk is the possibility that losses will be sustained
because borrowers, guarantors and related parties may fail to perform in
accordance with the terms of their loan agreements.  Most of the
Company’s loans are secured but some loans are unsecured.  With
respect to the secured loans, the collateral securing the repayment of these
loans may be insufficient to cover the obligations owed under such
loans.  Collateral values may be adversely affected by changes in
economic, environmental and other conditions, including declines in the value of
real estate, changes in interest rates, changes in monetary and fiscal policies
of the federal government, widespread disease, terrorist activity, environmental
contamination and other external events.  In addition, collateral
appraisals that are out of date or that do not meet industry recognized
standards may create the impression that a loan is adequately collateralized
when it is not.  The Company has adopted underwriting and credit
monitoring procedures and policies, including regular reviews of appraisals and
borrower financial statements, that management believes are appropriate to
mitigate the risk of loss.
 
 As
of December 31, 2009, approximately 77.5% of the Company’s loan portfolio
consisted of commercial and industrial, construction and commercial real estate
loans. These types of loans are generally viewed as having more risk of default
than residential real estate loans or consumer loans.  These types of
loans are also typically larger than residential real estate loans and consumer
loans.  Because the Company’s loan portfolio contains a significant
number of commercial and industrial, construction and commercial real estate
loans with relatively large balances, the deterioration of one or a few of these
loans could cause a significant increase in non-performing loans.  An
increase in nonperforming loans could result in a net loss of earnings from
these loans, an increase in the provision for loan losses and an increase in
loan charge-offs, all of which could have a material adverse effect on the
Company’s financial condition and results of operations.  Further, if
repurchase and indemnity demands with respect to the Company’s loan portfolio
increase, its liquidity, results of operations and financial condition will be
adversely affected.
  The
Company’s allowance for loan losses may be insufficient.
  The
Company maintains an allowance for loan losses, which is a reserve established
through a provision for loan losses charged to expense, that represents
management’s best estimate of probable losses that have been incurred within the
existing portfolio of loans.  The allowance, in the judgment of
management, is necessary to reserve for estimated loan losses and risks inherent
in the loan portfolio.
  The
level of the allowance reflects management’s continuing evaluation of industry
concentrations; specific credit risks; loan loss experience; current loan
portfolio quality; present economic, political and regulatory conditions and
unidentified losses inherent in the current loan portfolio.  The
determination of the appropriate level of the allowance for loan losses
inherently involves a high degree of subjectivity and requires the Company to
make significant estimates of current credit risks and future trends, all of
which may undergo material changes.  Continuing deterioration of
economic conditions affecting borrowers, new information regarding existing
loans, identification of additional
  18
  problem
loans and other factors, both within and outside the Company’s control, may
require an increase in the allowance for loan losses.  In addition,
bank regulatory agencies periodically review the Company’s allowance for loan
losses and may require an increase in the provision for loan
 losses
or the recognition of further loan charge-offs, based on judgments different
than those of management.  Further, if charge-offs in future periods
exceed the allowance for loan losses, the Company will need additional
provisions to increase the allowance for loan losses.  Any increases
in the allowance for loan losses will result in a decrease in net income and,
possibly, capital, and may have a material adverse effect on the Company’s
financial condition and results of operations.
  Changes
in interest rates may have an adverse effect on the Company’s
profitability.
  The
operations of financial institutions such as the Company are dependent to a
large degree on net interest income, which is the difference between interest
income from loans and investments and interest expense on deposits and
borrowings.  An institution’s net interest income is significantly
affected by market rates of interest that in turn are affected by prevailing
economic conditions, by the fiscal and monetary policies of the federal
government and by the policies of various regulatory agencies.  The
Federal Reserve Board (FRB) regulates the national money supply in order to
manage recessionary and inflationary pressures.  In doing so, the FRB
may use techniques such as engaging in open market transactions of U.S.
Government securities, changing the discount rate and changing reserve
requirements against bank deposits.  The use of these techniques may
also affect interest rates charged on loans and paid on deposits.  The
interest rate environment, which includes both the level of interest rates and
the shape of the U.S. Treasury yield curve, has a significant impact on net
interest income.  Like all financial institutions, the Company’s
balance sheet is affected by fluctuations in interest
rates.  Volatility in interest rates can also result in
disintermediation, which is the flow of deposits away from financial
institutions into direct investments, such as US Government and corporate
securities and other investment vehicles, including mutual funds, which, because
of the absence of federal insurance premiums and reserve requirements, generally
pay higher rates of return than bank deposit products.  See
“Item 7: Management’s Discussion of Financial Condition and Results of
Operations” and “Item 7A: Quantitative and Qualitative Disclosure about
Market Risk”.
  Declines
in value may adversely impact the investment portfolio.
  We
have not realized any non-cash, other-than-temporary impairment charges during
2009 as a result of reductions in fair value below original cost of any
investments in our investment portfolio.  However, we could be
required to record future impairment charges on our investment securities if
they suffer any declines in value that are considered
other-than-temporary.  Considerations used to determine
other-than-temporary impairment status to individual holdings include the length
of time the stock has remained in an unrealized loss position, and the
percentage of unrealized loss compared to the carrying cost of the stock,
dividend reduction or suspension, market analyst reviews and expectations, and
other pertinent news that would affect expectations for recovery or further
decline.
  The
Company may not be able to meet the cash flow requirements of its depositors and
borrowers or meet its operating cash needs.
  Liquidity
is the ability to meet cash flow needs on a timely basis at a reasonable
cost.  The liquidity of the Company is used to service its
debt.  The liquidity of the Bank is used to make loans and leases and
to repay deposit liabilities as they become due or are demanded by
customers.  Liquidity policies and limits are established by the board
of directors.  The overall liquidity position of the Company and the
Bank are regularly monitored to ensure that various alternative strategies exist
to cover unanticipated events that could affect liquidity.  Funding
sources include Federal funds purchased, securities sold under repurchase
agreements and non-core deposits. The Bank is a member of the Federal Home Loan
Bank of Atlanta, which provides funding through advances to members that are
collateralized with mortgage-related assets.
  19
  If
the Company is unable to access any of these funding sources when needed, we
might be unable to meet customers’ needs, which could adversely impact our
financial condition, results of operations, cash flows, and level of
regulatory-qualifying capital
  Negative
perceptions associated with the Company’s continued participation in the U.S.
Treasury’s Capital Purchase Program may adversely affect its ability to retain
customers, attract investors and compete for new business
opportunities.
  Several
financial institutions which participated in the TARP Capital Purchase Program
received approval from the U.S. Treasury to exit the program during the second
half of 2009.  These institutions have, or are in the process of,
repurchasing the preferred stock and repurchasing or auctioning the warrant
issued to the U.S. Treasury as part of the program.  The Company has
not yet requested the U.S. Treasury’s approval to repurchase the preferred stock
and warrant from the U.S. Treasury.  In order to repurchase one or
both securities, in whole or in part, the Company must establish that it has
satisfied all of the conditions to repurchase and must obtain the approval of
the U.S. Treasury.  There can be no assurance that the Company will be
able to repurchase these securities from the U.S. Treasury.  The
Company’s customers, employees and counterparties in its current and future
business relationships may draw negative implications regarding the strength of
the Company as a financial institution based on its continued participation in
the program following the exit of one or more of its competitors or other
financial institutions.  Any such negative perceptions may impair the
Company’s ability to effectively compete with other financial institutions for
business or to retain high performing employees.  If this were to
occur, the Company’s business, financial condition and results of operations may
be adversely affected, perhaps materially.
  The
soundness of other financial institutions could adversely affect
us.
  Our
ability to engage in routine funding transactions could be adversely affected by
the actions and commercial soundness of other financial institutions. Financial
services institutions are interrelated as a result of trading, clearing,
counterparty or other relationships. We have exposure to many different
industries and counterparties, and we routinely execute transactions with
counterparties in the financial industry. As a result, defaults by, or even
rumors or questions about, one or more financial services institutions, or the
financial services industry generally, have led to market-wide liquidity
problems and could lead to losses or defaults by us or by other institutions.
Many of these transactions expose us to credit risk in the event of default of
our counterparty or client. In addition, our credit risk may be exacerbated when
the collateral held by us cannot be realized upon or is liquidated at prices not
sufficient to recover the full amount of the financial instrument exposure due
us. There is no assurance that any such losses would not materially and
adversely affect our results of operations.
  Changes
in economic conditions and related uncertainties may have an adverse affect on
the Company’s profitability.
  Commercial
banking is affected, directly and indirectly, by local, domestic, and
international economic and political conditions, and by governmental monetary
and fiscal policies.  Conditions such as inflation, recession,
unemployment, volatile interest rates, tight money supply, real estate values,
international conflicts and other factors beyond the Company’s control may
adversely affect the potential profitability of the Company.  Any
future rises in interest rates, while increasing the income yield on the
Company’s earnings assets, may adversely affect loan demand and the cost of
funds and, consequently, the profitability of the Company.  Any future
decreases in interest rates may adversely affect the Company’s profitability
because such decreases may reduce the amounts that the Company may earn on its
assets.  A continued recessionary climate could result in the
delinquency of outstanding loans. Management does not expect any one particular
factor to have a material effect on the Company’s results of
operations.  However, downtrends in several areas, including real
estate, construction and consumer spending, could have a material adverse impact
on the Company’s profitability.
    20
  The
supervision and regulation to which the Company is subject can be a competitive
disadvantage.
  The
operations of the Company and the Bank are heavily regulated and will be
affected by present
 and
future legislation and by the policies established from time to time by various
federal and state regulatory authorities.  In particular, the monetary
policies of the Federal Reserve have had a significant effect on the operating
results of banks in the past, and are expected to continue to do so in the
future.  Among the instruments of monetary policy used by the Federal
Reserve to implement its objectives are changes in the discount rate charged on
bank borrowings and changes in the reserve requirements on bank
deposits.  It is not possible to predict what changes, if any, will be
made to the monetary polices of the Federal Reserve or to existing federal and
state legislation or the effect that such changes may have on the future
business and earnings prospects of the Company.
  The
Company is subject to changes in federal and state tax laws as well as changes
in banking and credit regulations, accounting principles and governmental
economic and monetary policies.
  During
the past several years, significant legislative attention has been focused on
the regulation and deregulation of the financial services
industry.  Non-bank financial institutions, such as securities
brokerage firms, insurance companies and money market funds, have been permitted
to engage in activities that compete directly with traditional bank
business.
  Regulation
of the financial services industry is undergoing major changes, and future
legislation could increase our cost of doing business or harm our competitive
position.
  In
2009, many emergency government programs enacted in 2008 in response to the
financial crisis and the recession slowed or wound down, and global regulatory
and legislative focus has generally moved to a second phase of broader reform
and a restructuring of financial institution regulation. Legislators and
regulators in the United States are currently considering a wide range of
proposals that, if enacted, could result in major changes to the way banking
operations are regulated. Some of these major changes may take effect as early
as 2010, and could materially impact the profitability of our business, the
value of assets we hold or the collateral available for our loans, require
changes to business practices or force us to discontinue businesses and expose
us to additional costs, taxes, liabilities, enforcement actions and reputational
risk.
  Certain
reform proposals under consideration could result in our becoming subject to
stricter capital requirements and leverage limits, and could also affect the
scope, coverage, or calculation of capital, all of which could require us to
reduce business levels or to raise capital, including in ways that may adversely
impact our shareholders or creditors. In addition, we anticipate the enactment
of certain reform proposals under consideration that would introduce stricter
substantive standards, oversight and enforcement of rules governing consumer
financial products and services, with particular emphasis on retail extensions
of credit and other consumer-directed financial products or services. We cannot
predict whether new legislation will be enacted and, if enacted, the effect that
it, or any regulations, would have on our business, financial condition, or
results of operations.
  The
competition the Company faces is increasing and may reduce our customer base and
negatively impact the Company’s results of
operations.
  There
is significant competition among banks in the market areas served by the
Company.  In addition, as a result of deregulation of the financial
industry, the Bank also competes with other providers of financial services such
as savings and loan associations, credit unions, consumer finance companies,
securities firms, insurance companies, the mutual funds industry, full service
brokerage firms and discount brokerage firms, some of which are subject to less
extensive regulations than the Company with respect to the products and services
they provide.  Some of the Company’s competitors have greater
resources than the Corporation and, as a result, may have higher lending limits
and may offer other services not offered by our Company.  See
“Item 1: Business — Competition.”
  21
  Our
deposit insurance premium could be substantially higher in the future which
would have an adverse effect on our future
earnings.
  The
FDIC insures deposits at FDIC-insured financial institutions, including Village
Bank.  The FDIC
 charges
the insured financial institutions premiums to maintain the Deposit Insurance
Fund at a certain level.  Current economic conditions have increased
bank failures and expectations for further failures, which may result in the
FDIC making more payments from the Deposit Insurance Fund and, in connection
therewith, raising deposit premiums.  In addition, the FDIC instituted
two temporary programs to further insure customer deposits at FDIC insured
banks: deposit accounts are currently insured up to $250,000 per customer (up
from $100,000) and non-interest bearing transactional accounts at institutions
participating in the Transaction Account Guarantee Program are currently fully
insured (unlimited coverage).  These programs have placed additional
stress on the Deposit Insurance Fund.
  In
February 2009, the FDIC finalized a rule that increases premiums paid by
insured institutions and makes other changes to the assessment
system.  Due to mounting losses from failed banking institutions in
2009, the FDIC adopted an interim rule that imposed an emergency special
assessment in the second quarter of 2009 and further gave the FDIC authority to
impose additional emergency special assessments of up to 10 basis points in
subsequent quarters.  In addition, on November 12, 2009, the FDIC
adopted a rule requiring banks to prepay three years’ worth of premiums to
replenish the depleted fund.  The Company is generally unable to
control the amount of premiums that it is required to pay for FDIC
insurance.  If there are additional bank or financial institution
failures the Company may be required to pay even higher FDIC premiums than the
recently increased levels.  Further, on January 12, 2010, the FDIC
requested comments on a proposed rule tying assessment rates of FDIC-insured
institutions to the institution’s employee compensation programs.  The
exact requirements of such a rule are not yet known, but such a rule could
increase the amount of premiums the Company must pay for FDIC
insurance.  These announced increases and any future increases or
required prepayments of FDIC insurance premiums may adversely impact its
earnings.
  Concern
of customers over deposit insurance may cause a decrease in
deposits.
  With
the continuing news about bank failures, customers are increasingly concerned
about the extent to which their deposits are insured by the
FDIC.  Customers may withdraw deposits in an effort to ensure that the
amount they have on deposit with us is fully insured.  Decreases in
deposits may adversely affect our funding costs and net income.
  Fluctuations
in the stock market could negatively affect the value of the Company’s common
stock.
  The
Company’s common stock trades under the symbol “VBFC” on the Nasdaq Capital
Market. There can be no assurance that a regular and active market for the
Common Stock will develop in the foreseeable future.  See
“Item 5: Market for Registrant’s Common Equity and Related Stockholder
Matters and Issuer Purchases of Equity Securities.”  Investors in the
shares of common stock may, therefore, be required to assume the risk of their
investment for an indefinite period of time.  Current lack of investor
confidence in large banks may keep investors away from the banking sector as a
whole, causing unjustified deterioration in the trading prices of
well-capitalized community banks such as the Company.
  If
the Company fails to maintain an effective system of internal controls, it may
not be able to accurately report its financial results or prevent
fraud.  As a result, current and potential shareholders could lose
confidence in the Company’s financial reporting, which could harm its business
and the trading price of its common stock.
  The
Company has established a process to document and evaluate its internal controls
over financial reporting in order to satisfy the requirements of
Section 404 of the Sarbanes-Oxley Act of 2002 and the related regulations,
which require annual management assessments of the effectiveness of the
Company’s internal controls over financial reporting.  In this
regard,
  22
  management
has dedicated internal resources, engaged outside consultants and adopted a
detailed work plan to (i) assess and document the adequacy of internal
controls over financial reporting, (ii) take steps to improve control
processes, where appropriate, (iii) validate through testing that controls
are functioning as documented and (iv) implement a continuous reporting and
improvement process
for internal control over financial reporting.  The Company’s efforts
to comply with Section 404 of the Sarbanes-Oxley Act of 2002 and the
related regulations regarding the Company’s assessment of its internal controls
over financial reporting.  The Company’s management and audit
committee have given the Company’s compliance with Section 404 a high
priority.  The Company cannot be certain that these measures will
ensure that the Company implements and maintains adequate controls over its
financial processes and reporting in the future.  Any failure to
implement required new or improved controls, or difficulties encountered in
their implementation, could harm the Company’s operating results or cause the
Company to fail to meet its reporting obligations.  If the Company
fails to correct any issues in the design or operating effectiveness of internal
controls over financial reporting or fails to prevent fraud, current and
potential shareholders could lose confidence in the Company’s financial
reporting, which could harm its business and the trading price of its common
stock.
  The
Company is subject to a variety of operational risks, including reputational
risk, legal and compliance risk, and the risk of fraud or theft by employees or
outsiders.
  The
Company is exposed to many types of operational risks, including reputational
risk, legal and compliance risk, the risk of fraud or theft by employees or
outsiders, and unauthorized transactions by employees or operational errors,
including clerical or record-keeping errors or those resulting from faulty or
disabled computer or telecommunications systems.  Negative public
opinion can result from its actual or alleged conduct in any number of
activities, including lending practices, corporate governance and acquisitions
and from actions taken by government regulators and community organizations in
response to those activities.  Negative public opinion can adversely
affect its ability to attract and keep customers and can expose the Company to
litigation and regulatory action.
  Because
the nature of the financial services business involves a high volume of
transactions, certain errors may be repeated or compounded before they are
discovered and successfully rectified.  The Company’s necessary
dependence upon automated systems to record and process its transaction volume
may further increase the risk that technical flaws or employee tampering or
manipulation of those systems will result in losses that are difficult to
detect.  The Company also may be subject to disruptions of its
operating systems arising from events that are wholly or partially beyond its
control (for example, computer viruses or electrical or telecommunications
outages), which may give rise to disruption of service to customers and to
financial loss or liability.  The Company is further exposed to the
risk that its external vendors may be unable to fulfill their contractual
obligations (or will be subject to the same risk of fraud or operational errors
by their respective employees as the Company is) and to the risk that its (or
its vendors’) business continuity and data security systems prove to be
inadequate.  The occurrence of any of these risks could result in a
diminished ability of the Company to operate its business, potential liability
to clients, reputational damage and regulatory intervention, which could
adversely affect its business, financial condition and results of operations,
perhaps materially.
  The
Company relies on other companies to provide key components of its business
infrastructure.
  Third
parties provide key components of the Company’s business infrastructure, for
example, system support, and Internet connections and network
access.  While the Company has selected these third party vendors
carefully, it does not control their actions.  Any problems caused by
these third parties, including those resulting from their failure to provide
services for any reason or their poor performance of services, could adversely
affect its ability to deliver products and services to its customers and
otherwise conduct its business.  Replacing these third party vendors
could also entail significant delay and expense.
    23
  The
Company may have to rely on dividends from the Bank.
  The
Company is a separate and distinct legal entity from its subsidiary
bank.  Although the Company has never received any dividends from the
Bank, it is entitled to receive dividends in accordance
 with
federal and state regulations.  These federal and state regulations
limit the amount of dividends that the Bank may pay to the
Company.  In the event the Bank is unable to pay dividends to the
Company, the Company may not be able to service debt, pay obligations or pay
dividends on the Company’s common stock.  The inability of the Company
to receive dividends from the Bank could have a material adverse effect on the
Company’s business, financial condition and results of operations.
  The
Bank may not be able to remain well capitalized
  Federal
regulatory agencies are required by law to adopt regulations defining five
capital tiers: well capitalized, adequately capitalized, under capitalized,
significantly under capitalized, and critically under
capitalized.  The Bank meets the criteria to be categorized as a “well
capitalized” institution as of December 31, 2009 and 2008.  However,
the Bank may not be able to remain well capitalized for various reasons
including a change in the mix of assets or a lack of
profitability.  When capital falls below the “well capitalized”
requirement, consequences can include: new branch approval could be withheld;
more frequent examinations by the FDIC; brokered deposits cannot be renewed
without a waiver from the FDIC; and other potential limitations as described in
FDIC Rules and Regulations sections 337.6 and 303, and FDIC Act section
29.  In addition, the FDIC insurance assessment increases when an
institution falls below the “well capitalized” classification.
   ITEM
1B.  UNRESOLVED STAFF COMMENTS
  None.
   ITEM
2.  PROPERTIES
  Our
executive and administrative offices are owned by the Company and are located at
15521 Midlothian Turnpike, Midlothian, Virginia 23113 in Chesterfield County
where an 80,000 square foot corporate headquarters and operations center was
opened in August 2008.  The Company and the Bank currently occupy
approximately forty percent of the space, which includes a full service branch
location leased by the Bank.  The Company leases the other portions to
unrelated parties.  In addition to leasing the branch to the Bank, the
Bank’s wholly-owned subsidiary, Village Bank Mortgage Corporation, also leases
space in the building from the Company.
  In
addition to the branch in the corporate headquarters and operations center, the
Bank owns 9 full service branch buildings including the land on those buildings
and leases an additional five full service branch buildings.  Eight of
our branch offices are located in Chesterfield County, with three branch offices
in Hanover County, three in Henrico County and one in Powhatan
County.
  Our
properties are maintained in good operating condition and are suitable and
adequate for our operational needs.
  ITEM
3.  LEGAL PROCEEDINGS
  In
the course of its operations, the Company may become a party to legal
proceedings.  There are no material pending legal proceedings to which
the Company is a party or of which the property of the Company is
subject.
   ITEM
4.  RESERVED
   24
  PART
II
   ITEM
5.  MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS
AND ISSUER PURCHASES OF EQUITY SECURITIES
  Market
Information
  Shares
of the Company’s Common Stock trade on the Nasdaq Capital Market under the
symbol “VBFC”.  The high and low prices of shares of the Company’s
Common Stock for the periods indicated were as follows:
   High
              
              Low20081st
      quarter
              
              $
              11.47
              
              $
              9.252nd
      quarter
              
              
              10.99
              
              
              8.083rd
      quarter
              
              
              9.58
              
              
              6.114th
      quarter
              
              
              8.43
              
              
              3.3820091st
      quarter
              
              $
              5.00
              
              $
              3.772nd
      quarter
              
              
              4.95
              
              
              4.123rd
      quarter
              
              
              5.98
              
              
              3.854th
      quarter
              
              
              4.43
              
              
              2.01
   Dividends
  The
Company has not paid any dividends on its Common Stock.  We intend to
retain all of our earnings to finance the Company’s operations and we do not
anticipate paying cash dividends for the foreseeable future.  Any
decision made by the Board of Directors to declare dividends in the future will
depend on the Company’s future earnings, capital requirements, financial
condition and other factors deemed relevant by the Board.  Banking
regulations limit the amount of cash dividends that may be paid without prior
approval of the Bank’s regulatory agencies.  Such dividends are
limited to the lesser of the Bank’s retained earnings or the net income of the
previous two years combined with the current year net income.  In
addition, for as long as the U.S. Treasury holds shares of our preferred stock,
the consent of the U.S. Treasury will be required prior to the payment of any
dividends on our common stock.
  Holders
  At
March 3, 2010, there were approximately 1,634 holders of record of Common
Stock.
  For
information concerning the Company’s Equity Compensation Plans, see
“Item 12: Security Ownership of Certain Beneficial Owners and Management
and Related Stockholder Matters”.
  Recent
Sales of Unregistered Securities
  None
  Purchases
of Equity Securities
  The
Company did not repurchase any of its Common Stock during the fourth quarter of
2009.
      25
  Performance
Graph
  The
following graph shows the yearly percentage change in the Company’s cumulative
total shareholder return on its common stock from December 31, 2004 to
December 31, 2009 compared with the NASDAQ Composite Index and peer group
indexes based on asset size.
  
   Period
      EndingIndex
              12/31/04
              12/31/05
              12/31/06
              12/31/07
              12/31/08
              12/31/09Village
      Bank and Trust Financial Corp.
              100.00
              110.78
              122.41
              92.24
              38.79
              20.11NASDAQ
      Composite
              100.00
              101.37
              111.03
              121.92
              72.49
              104.31SNL
      Bank $250M-$500M
              100.00
              106.17
              110.93
              90.16
              51.49
              47.66SNL
      Bank $500M-$1B
              100.00
              104.29
              118.61
              95.04
              60.90
              58.00
  26
  ITEM
6.  SELECTED FINANCIAL DATA
   Year
      Ended December 31,2009
              
              
              2008
              
              
              2007
              
              
              2006
              
              2005Balance
      Sheet DataAt
      year-endAssets
              
              
              $  
      602,962,943
              
              
              $ 572,407,993
              
              
              $  
      393,263,999
              
              
              $ 291,217,760
              
              $214,974,952Loans,
      net of unearned income
              
              
              467,568,547
              
              
              470,722,286
              
              
              327,343,013
              
              
              241,051,025
              
              172,378,272Investment
      securities
              
              
              54,857,211
              
              
              24,300,962
              
              
              13,711,399
              
              
              12,787,644
              
              2,981,903Goodwill
              
              
              -
              
              
              7,422,141
              
              
              689,108
              
              
              689,108
              
              689,108Deposits
              
              
              498,285,124
              
              
              466,232,043
              
              
              339,297,258
              
              
              253,309,881
              
              186,752,807Borrowings
              
              
              52,593,521
              
              
              57,726,898
              
              
              24,736,569
              
              
              9,859,265
              
              9,641,810Stockholders'
      equity
              
              
              48,941,989
              
              
              46,162,574
              
              
              26,893,299
              
              
              25,644,115
              
              17,151,893Number
      of shares outstanding
              
              
              4,230,628
              
              
              4,229,372
              
              
              2,575,985
              
              
              2,562,088
              
              1,854,618Average
      for the yearAssets
              
              
              600,034,107
              
              
              442,604,327
              
              
              337,750,179
              
              
              246,562,178
              
              184,498,899Stockholders'
      equity
              
              
              56,089,455
              
              
              31,067,165
              
              
              27,798,307
              
              
              22,278,897
              
              16,410,583Weighted
      average shares outstanding
              
              
              4,230,462
              
              
              3,013,175
              
              
              2,569,529
              
              
              2,269,092
              
              1,800,061Income
      Statement DataInterest
      income
              
              
              $   33,195,973
              
              
              $ 
      29,072,146
              
              
              $   
      25,665,235
              
              
              $  
      19,019,111
              
              $ 
      11,925,133Interest
      expense
              
              
              16,407,679
              
              
              15,969,783
              
              
              13,806,715
              
              
              8,786,600
              
              4,877,376Net
      interest income
              
              
              16,788,294
              
              
              13,102,363
              
              
              11,858,520
              
              
              10,232,511
              
              7,047,757Provision
      for loan losses
              
              
              13,220,000
              
              
              2,005,633
              
              
              1,187,482
              
              
              796,006
              
              460,861Noninterest
      income
              
              
              8,285,100
              
              
              4,184,727
              
              
              2,666,956
              
              
              2,482,793
              
              2,890,316Goodwill
      impairment
              
              
              7,422,141
              
              
              -
              
              
              -
              
              
              -
              
              -Noninterest
      expense
              
              
              20,915,737
              
              
              14,572,271
              
              
              11,821,232
              
              
              9,817,089
              
              7,778,004Income
      tax expense (benefit)
              
              
              (4,973,116)
              
              
              241,097
              
              
              515,699
              
              
              702,990
              
              468,025Net
      income (loss)
              
              
              $
      (11,511,368)
              
              
              $     
      468,089
              
              
              $    
      1,001,063
              
              
              $   
      1,399,219
              
              $   
      1,231,183Per
      Share DataEarnings
      (loss) per share - basic
              
              
              $            (2.84)
              
              
              $            0.16
              
              
              $             
      0.39
              
              
              $             0.62
              
              $             0.68Earnings
      (loss) per share - diluted
              
              
              $           
      (2.84)
              
              
              $           
      0.16
              
              
              $             
      0.37
              
              
              $            
      0.59
              
              $            
      0.61Book
      value at year-end
              
              
              $              
      8.07
              
              
              $         
      10.91
              
              
              $           
      10.44
              
              
              $          
      10.01
              
              $            
      9.25Performance
      RatiosReturn
      on average assets
              
              
              (1.92)%
              
              
              0.11%
              
              
              0.30%
              
              
              0.57%
              
              0.67%Return
      on average equity
              
              
              (20.52)%
              
              
              1.51%
              
              
              3.60%
              
              
              6.28%
              
              7.50%Net
      interest margin
              
              
              3.13%
              
              
              3.25%
              
              
              3.80%
              
              
              4.48%
              
              4.15%Efficiency
      (1)
              
              
              83.42%
              
              
              84.30%
              
              
              81.38%
              
              
              77.21%
              
              78.26%Loans
      to deposits
              
              
              93.84%
              
              
              100.96%
              
              
              96.48%
              
              
              95.16%
              
              92.30%Equity
      to assets
              
              
              8.12%
              
              
              8.06%
              
              
              6.84%
              
              
              8.81%
              
              7.98%Asset
      Quality RatiosALLL
      to loans at year-end
              
              
              2.25%
              
              
              1.29%
              
              
              1.06%
              
              
              1.06%
              
              1.12%ALLL
      to nonaccrual loans
              
              
              49.37%
              
              
              71.05%
              
              
              134.20%
              
              
              91.12%
              
              105.28%Nonperforming
      assets to year-end loans
              
              
              7.95%
              
              
              2.43%
              
              
              0.87%
              
              
              1.16%
              
              1.06%Net
      charge-offs to average loans
              
              
              1.84%
              
              
              0.60%
              
              
              0.10%
              
              
              0.12%
              
              0.03%
 (1)  Efficiency
ratio is computed by dividing noninterest expense by the sum of net interest
income and noninterest income.
 The
goodwill impairment write-off is excluded in 2009 from noninterest
expense.
    27
   ITEM
7.  MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
  The
following discussion is intended to assist readers in understanding and
evaluating the financial condition, changes in financial condition and the
results of operations of the Company, consisting of the parent company and its
wholly-owned subsidiary, the Bank. This discussion should be read in conjunction
with the consolidated financial statements and other financial information
contained elsewhere in this report.
  Caution
About Forward-Looking Statements
  In
addition to historical information, this report may contain forward-looking
statements.  For this purpose, any statement, that is not a statement
of historical fact may be deemed to be a forward-looking
statement.  These forward-looking statements may include statements
regarding profitability, liquidity, allowance for loan losses, interest rate
sensitivity, market risk, growth strategy and financial and other
goals.  Forward-looking statements often use words such as “believes,”
“expects,” “plans,” “may,” “will,” “should,” “projects,” “contemplates,”
“anticipates,” “forecasts,” “intends” or other words of similar
meaning.  You can also identify them by the fact that they do not
relate strictly to historical or current facts.  Forward-looking
statements are subject to numerous assumptions, risks and uncertainties, and
actual results could differ materially from historical results or those
anticipated by such statements.
  There
are many factors that could have a material adverse effect on the operations and
future prospects of the Company including, but not limited to, changes in
interest rates, general economic conditions, the quality or composition of the
loan or investment portfolios, the level of nonperforming assets and
charge-offs, the local real estate market, volatility and disruption in national
and international financial markets, government intervention in the U.S.
financial system, demand for loan products, deposit flows, competition, and
accounting principles, policies and guidelines. Monetary and fiscal policies of
the U.S. Government could also adversely effect the Company; such policies
include the impact of any regulations or programs implemented pursuant to the
Emergency Economic Stabilization Act of 2008 (EESA), the American Recovery and
Reinvestment Act of 2009 (ARRA) and other policies of the Office of the
Comptroller of the Currency, U.S. Treasury and the Federal Reserve
Board.
  The
Company experienced significant losses during the year related to the current
economic climate.  A continuation of the turbulence in significant
portions of the global financial markets, particularly if it worsens, could
further impact the Company’s performance, both directly by affecting revenues
and the value of the Company’s assets and liabilities, and indirectly by
affecting the Company’s counterparties and the economy
generally.  Dramatic declines in the housing market in the past year
have resulted in significant write-downs of asset values by financial
institutions in the United States.  Concerns about the stability of
the U.S. financial markets generally have reduced the availability of funding to
certain financial institutions, leading to a tightening of credit, reduction of
business activity, and increased market volatility.  It is not clear
at this time what impact liquidity and funding initiatives of the Treasury and
other bank regulatory agencies that have been announced or any additional
programs that may be initiated in the future will have on the financial markets
and the financial services industry.  The extreme levels of volatility
and limited credit availability currently being experienced could continue to
affect the U.S. banking industry and the broader U.S. and global economies,
which would have an effect on all financial institutions, including the
Company.
  These
risks and uncertainties should be considered in evaluating the forward-looking
statements contained herein, and readers are cautioned not to place undue
reliance on such statements.  Any forward-looking statement speaks
only as of the date on which it is made, and the Company undertakes no
obligation to update any forward-looking statement to reflect events or
circumstances after the date on which it is made.  In addition, past
results of operations are not necessarily indicative of future
results.
   28
  Recent
Market Developments
  In
response to the financial crises affecting the banking system and financial
markets and going concern threats to investment banks and other financial
institutions, on October 3, 2008, the Emergency Economic Stabilization Act of
2008 (the “EESA”) was signed into law.  Pursuant to EESA, the United
States Department of the Treasury (the “U.S. Treasury”) was given the authority
to, among other things, purchase up to $700 billion of mortgages,
mortgage-backed securities and certain other financial instruments from
financial institutions for the purpose of stabilizing and providing liquidity to
the U.S. financial markets.
  On
October 14, 2008, the Secretary of the Department of the Treasury announced that
the U.S. Treasury will purchase equity stakes in a wide variety of banks and
thrifts.  Under the program, known as the Troubled Asset Relief
Program (“TARP”) Capital Purchase Program, from the $700 billion authorized by
EESA, the U.S. Treasury made $250 billion of capital available to U.S. financial
institutions in the form of preferred stock.  In conjunction with the
purchase of preferred stock, the U.S. Treasury received, from participating
financial institutions, warrants to purchase common stock with an aggregate
market price equal to 15% of the preferred investment. Participating financial
institutions were required to adopt the U.S.  Treasury’s standards for
executive compensation and corporate governance for the period during which the
U.S. Treasury holds equity issued under the TARP Capital Purchase
Program.  On May 1, 2009, the Company elected to participate in the
TARP Capital Purchase Program, under which the Company issued preferred shares
and a warrant to purchase common shares to the U.S. Treasury.  As of
the date of this report, the Company has not yet repurchased the preferred stock
or the warrant to purchase common stock.
  On
November 21, 2008, the Board of Directors of the FDIC adopted a final rule
relating to the Temporary Liquidity Guarantee Program (“TLG
Program”).  The TLG Program was announced by the FDIC on October 14,
2008, preceded by the determination of systemic risk by the Secretary of the
Department of Treasury (after consultation with the President), as an initiative
to counter the system-wide crisis in the nation’s financial
sector.  Under the TLG Program (as amended from time to time
thereafter) the FDIC would (i) guarantee, through the earlier of maturity or
June 30, 2012, certain newly issued senior unsecured debt issued by
participating institutions and (ii) provide full FDIC deposit insurance coverage
for noninterest bearing transaction deposit accounts, Negotiable Order of
Withdrawal (“NOW”) accounts paying less than 0.5% interest per annum and
Interest on Lawyers Trust Accounts (“IOLA”) accounts held at participating
FDIC-insured institutions.  The transaction account guarantee program
described in clause (ii) will expire on June 30, 2010. Coverage under the TLG
Program was available for the first 30 days without charge.  The fee
assessment for coverage of senior unsecured debt ranges from 50 basis points to
100 basis points per annum, depending on the initial maturity of the
debt.  The fee assessment for deposit insurance coverage is 10 basis
points per quarter on amounts in covered accounts exceeding
$250,000.
  On
February 10, 2009, the Treasury Secretary announced a new comprehensive
financial stability plan which included: (i) a capital assistance program that
has invested in convertible preferred stock of certain qualifying institutions,
(ii) a consumer and business lending initiative to fund new consumer loans,
small business loans and commercial mortgage asset-backed securities issuances,
(iii) a public-private investment fund intended to leverage public and private
capital with public financing to purchase legacy “toxic assets” from financial
institutions, and (iv) assistance for homeowners to reduce mortgage payments and
interest rates and establishing loan modification guidelines for government and
private programs.
  In
response to concerns relating to capital adequacy of large financial
institutions, the Federal Reserve Board implemented Supervisory Capital
Assessment Program (“SCAP”) under which all banking institutions with assets
over $100 billion were required to undergo a comprehensive “stress test” to
determine if they had sufficient capital to continue lending and to absorb
losses that could result from a more severe decline in the economy than
projected.  The results of the stress test were announced on May 7,
2009.  In addition, on September 3, 2009, the U.S. Treasury issued a
policy statement relating to bank capital requirements, which calls for higher
and stronger capital requirements for bank and non-bank financial firms that are
deemed to pose a risk to financial stability due to their combination of size,
leverage, interconnectedness and liquidity risk.  Also,
on
  29
  December
17, 2009, the Basel Committee issued a set of proposals relating to the capital
adequacy and liquidity risk exposures of financial institutions.
  In
order to restore the depleted Deposit Insurance Fund (“DIF”) and maintain a
sound reserve ratio, the FDIC imposed higher base assessment rates and special
one-time assessments and required prepayment of deposit insurance
premium.  The FDIC stated that, after its semi-annual reviews, it may
further increase assessment rates or take other actions to bring the DIF’s
reserve ratio back to a desirable level.
  In
June of 2009, the Obama administration proposed a wide range of regulatory
reforms that included, among other things, proposals (i) that any financial firm
whose combination of size, leverage and interconnectedness could pose a threat
to financial stability be subject to certain enhanced regulatory requirements,
(ii) that federal bank regulators require loan originators or sponsors to retain
part of the credit risk of securitized exposures, (iii) that there be increased
regulation of broker-dealers and investment advisers, (iv) for the creation of a
federal consumer financial protection agency that would, among other things, be
charged with applying consistent regulations to similar products (such as
imposing certain notice and consent requirements on consumer overdraft lines of
credit), (v) that there be comprehensive regulation of OTC derivatives, (vi)
that the controls on the ability of banking institutions to engage in
transactions with affiliates be tightened, and (vii) that financial holding
companies be required to be “well-capitalized” and “well-managed” on a
consolidated basis.
  On
October 22, 2009, the Federal Reserve Board issued a comprehensive proposal on
incentive compensation policies intended to ensure that the incentive
compensation policies of banking organizations do not undermine the safety and
soundness of such organizations by encouraging excessive risk-taking. The
proposal covers all employees that have the ability to materially affect the
risk profile of an organization, either individually or as part of a
group.
  General
  The
Company was organized under the laws of the Commonwealth of Virginia to engage
in commercial and retail banking.  The Bank opened to the public on
December 13, 1999 as a traditional community bank offering deposit and loan
services to individuals and businesses in the Richmond, Virginia metropolitan
area.  During 2003, the Company acquired or formed three wholly owned
subsidiaries of the Bank, Village Bank Mortgage Corporation (“Village Bank
Mortgage”), a full service mortgage banking company, Village Insurance Agency,
Inc. (“Village Insurance”), a full service property and casualty insurance
agency, and Village Financial Services Corporation (“Village Financial
Services”), a financial services company.  On October 14, 2008, the
Company completed its merger with River City Bank pursuant to an Agreement and
Plan of Reorganization and Merger, dated as of March 9, 2008, by and among the
Company, the Bank and River City Bank.  The merger had previously been
approved by both companies’ shareholders at their respective annual meetings on
September 30, 2008 as well as the banking regulators.
  We
offer a wide range of banking and related financial services, including
checking, savings, certificates of deposit and other depository services, and
commercial, real estate and consumer loans.  We are a
community-oriented and locally managed financial institution focusing on
providing a high level of responsive and personalized services to our customers,
delivered in the context of a strong direct relationship with our
customers.  We conduct our operations from our main office/corporate
headquarters location and fourteen branch offices.
  The
Company’s primary source of earnings is net interest income, and its principal
market risk exposure is interest rate risk.  The Company is not able
to predict market interest rate fluctuations and its asset/liability management
strategy may not prevent interest rate changes from having a material adverse
effect on the Company’s results of operations and financial
condition.
  Although
management endeavors to minimize the credit risk inherent in the Company’s loan
portfolio, it must necessarily make various assumptions and judgments about the
collectibility of the loan portfolio based on its experience and evaluation of
economic conditions.  If such assumptions
  30
  or
judgments prove to be incorrect, the current allowance for loan losses may not
be sufficient to cover loan losses and additions to the allowance may be
necessary, which would have a negative impact on net income.
  There
is intense competition in all areas in which the Company conducts its business.
The Company competes with banks and other financial institutions, including
savings and loan associations, savings banks, finance companies, and credit
unions.  Many of these competitors have substantially greater
resources and lending limits and provide a wider array of banking
services.  To a limited extent, the Company also competes with other
providers of financial services, such as money market mutual funds, brokerage
firms, consumer finance companies and insurance
companies.  Competition is based on a number of factors, including
prices, interest rates, services, availability of products and geographic
location.
  The
Company had a net loss of $11,511,000 in 2009 as compared to net income of
$468,000 in 2008 and of $1,001,000 in 2007.  The single most
significant factor in our declining earnings the last two years has been the
recessionary economy.
  Total
assets increased to $602,963,000 at December 31, 2009 from $572,408,000 at
December 31, 2008 and $393,264,000 at December 31, 2007, representing increases
of 5% in 2009 and 46% in 2008.  The growth in total assets in 2008 is
attributable to our merger with River City Bank, which added approximately
$157.7 million in assets at the time of merger.  The growth in 2009
was primarily a result of an increase in investment securities of $30,556,000,
funded by an increase in deposits of $32,053,000.
  Much
of our internal growth has been driven by lending on real estate.  As
a result, the material decline in real estate values experienced in 2009 had a
significant adverse effect on the growth and profitability of the
Company.  At December 31, 2009, 89.0% of our loan portfolio was
collateralized by real estate.  Declines in real estate values can
reduce projected cash flows from commercial properties and the ability of
borrowers to use home equity to support borrowings and increase the
loan-to-value ratios of loans previously made by us, thereby weakening
collateral coverage and increasing the possibility of a loss in the event of
default.  In addition, delinquencies, foreclosures and losses
generally increase during economic slowdowns or recessions.
  The
following presents management’s discussion and analysis of the financial
condition of the Company at December 31, 2009 and 2008, and results of
operations for the Company for the years ended December 31, 2009, 2008 and
2007.  This discussion should be read in conjunction with the
Company’s audited Financial Statements and the notes thereto appearing elsewhere
in this Annual Report.
  Income
Statement Analysis
  Net
interest income, which represents the difference between interest earned on
interest-earning assets and interest incurred on interest-bearing liabilities,
is the Company’s primary source of earnings.  Net interest income can
be affected by changes in market interest rates as well as the level and
composition of assets, liabilities and shareholders’ equity.  Net
interest spread is the difference between the average rate earned on
interest-earning assets and the average rate paid on interest-bearing
liabilities.  The net yield on interest-earning assets (“net interest
margin”) is calculated by dividing tax equivalent net interest income by average
interest-earning assets.  Generally, the net interest margin will
exceed the net interest spread because a portion of interest-earning assets are
funded by various noninterest-bearing sources, principally noninterest-bearing
deposits and shareholders’ equity.
  We
recorded a net loss of $11,511,000, or $2.84 per fully diluted share, in 2009,
compared to net income of $468,000, or $0.16 per fully diluted share, in 2008,
and $1,001,000, or $0.37 per fully diluted share, in 2007.  The
decline in our profitability in 2009 was attributable to four significant
increases in expenses from 2008 to 2009 as follows:
  31
  
 2009
              
              2008
              
              IncreaseProvision
      for loan losses
              
              $13,220,000
              
              $2,005,633
              
              $11,214,367Goodwill
      impairment
              
              7,422,141
              
              -
              
              7,422,141Expenses
      related toforeclosed
      real estate
              
              1,475,338
              
              165,455
              
              1,309,883FDIC
      insurance premium
              
              1,366,612
              
              400,394
              
              966,218$20,912,609
   All
of these increases in expenses are attributable primarily to the recessionary
economy that dominated 2009.  The increases in the provision for loan
losses and in expenses related to foreclosed real estate reflect the
difficulties that many of our borrowers experienced with their ability to repay
our loans to them.  The write-off of goodwill was based on our annual
evaluation of the value of goodwill which was performed by an independent third
party.  Goodwill was considered fully impaired at December 31, 2009
primarily because the value of the Company’s stock, and thus its overall value,
declined significantly in 2009 as did many other banks’ stock.  The
increase in the FDIC insurance premium was related to the losses the FDIC
incurred in 2009 in closing 140 banks as it sought to restore the DIF to a
desirable level.  Total assets of failed banks in 2009 totaled $170.9
billion with the loss to the DIF of $4.6 billion.
  The
decline in earnings from $1,001,000 in 2007 to $468,000 in 2008 was attributable
to a decline in our net interest margin from 3.80% for 2007 to 3.27% for 2008,
as well as an increase in the provision for loan losses of $818,000, from
$1,187,000 in 2007 to $2,005,000 in 2008.  The decline in our net
interest margin is attributable to declining interest rates and our acquisition
of River City Bank which had a lower net interest margin.  The
increase in the provision for loan losses was a result of deteriorating asset
quality.
  Net
interest income
  Net
interest income is our primary source of earnings and represents the difference
between interest and fees earned on interest-earning assets and the interest
paid on interest-bearing liabilities.  The level of net interest
income is affected primarily by variations in the volume and mix of those assets
and liabilities, as well as changes in interest rates when compared to previous
periods of operation.
  Growth
in loans and deposits has resulted in net interest income increasing from
$11,859,000 in 2007, to $13,102,000 in 2008 and to $16,788,000 in
2009.  However, net interest income as a percentage of average assets
has steadily declined the last two years, from 3.5% in 2007 to 3.0% in 2008 and
to 2.8% in 2009.  The growth in net interest income has not kept pace
with the growth of the Company.  This is attributable to a declining
net interest margin, from 3.80% in 2007 to 3.27% in 2008 and to 3.13% in
2009.  This declining interest margin resulted from declines in
short-term interest rates that started in 2007 and continued into
2008.  A significant portion of our loan portfolio, the primary source
of revenue to Village Bank, has interest rates that adjust according to the
direction of short-term interest rates.  Accordingly, as short-term
rates were reduced by the Federal Reserve, the income from our loan portfolio
was reduced.  While the reduction of short-term interest rates also
reduced the rates we pay on deposits, our largest expense, the reduction in
interest rates paid on deposits was slower than the reduction of interest rates
on our loan portfolio as our deposits generally do not reprice as quickly as our
loans.  Consequently, our net interest income, the primary source of
our earnings, was negatively impacted as short-term interest rates were reduced
by the Federal Reserve.
  Although
the year to year comparison reflects a declining net interest margin, we are
starting to experience a turnaround in this decline.  During 2009, the
average interest rate we paid on deposits declined by 1.42%.  This
decline outpaced the decline in the average interest rate earned on loans of
..67%, which had a positive impact on our net interest margin.  While
the net interest margin of 3.13% for the full year of 2009 was lower than the
net interest margin of 3.27% for 2008, it increasedfrom 3.29% for the month of
December 2008 to 3.38% for the month of December 2009.  If short-term
interest rates remain stable in 2010, we expect further declines in the average
rate paid on
  32
  
 deposits
and an improving net interest margin.
  Average
interest-earning assets increased by $135,350,000, or 34%, in 2009 and by
$88,383,000, or 28%, in 2008.  These increases in interest-earning
assets were due primarily to the growth of our loan
portfolio.  However, the average yield on interest-earning assets
decreased to 6.19% in 2009 from 7.26% in 2008 and 8.22% in 2007.  Many
of our loans are indexed to short-term rates affected by the Federal Reserve's
decisions about short-term interest rates, and, accordingly, as the Federal
Reserve increases or decreases short-term rates, the yield on interest-earning
assets is affected.  As the Federal Reserve decreased interest rates
starting in 2007 and continuing through 2008, decreasing short-term interest
rates by 5% over twelve months, the average yield on our interest-earning assets
decreased.
  Our
average interest-bearing liabilities increased by $120,065,000, or 31%, in 2009
and by $96,873,000, or 34%, in 2008.  These increases in average
interest-bearing liabilities were due to strong growth in average deposits of
$111,034,000 in 2009 and $70,321,000 in 2008 as well as borrowings of
$19,990,000 in 2008. The average cost of interest-bearing liabilities decreased
to 3.27% in 2009, from 4.18% in 2008 and 4.84% in 2007.  The
significant decrease in our cost of funds in 2009 and 2008 was a result of
decreases in short-term interest rates by the Federal Reserve in 2007 and
2008.  As with our interest-earning assets, the declines in the
short-term interest rates by the Federal Reserve also reduced the interest rates
we pay on interest-bearing liabilities in 2008, however, the reduction in
interest rates on our interest-bearing liabilities has been slower than the
reduction of interest rates on our interest-earning assets as the liabilities
generally do not reprice as quickly as the assets.  Consequently, our
net interest income, the primary source of our earnings, is negatively impacted
as long as short-term interest rates continue to be reduced by the Federal
Reserve.  See “Interest rate sensitivity” on page 48 for further
discussion of the repricing of assets and liabilities.
  The
following table illustrates average balances of total interest-earning assets
and total interest-bearing liabilities for the periods indicated, showing the
average distribution of assets, liabilities, shareholders' equity and related
income, expense and corresponding weighted-average yields and
rates.  The average balances used in these tables and other
statistical data were calculated using daily average balances.  We
have no tax exempt assets for the periods presented.
   33
  
 Average
      Balance Sheets(In
      thousands)Year
      Ended December 31, 2009
              
              Year
      Ended December 31, 2008
              
              Year
      Ended December 31, 2007Interest
              
              Annualized
              
              
              
              Interest
              
              Annualized
              
              
              
              Interest
              
              AnnualizedAverage
              
              Income/
              
              Yield
              
              Average
              
              Income/
              
              Yield
              
              Average
              
              Income/
              
              YieldBalance
              
              Expense
              
              Rate
              
              Balance
              
              Expense
              
              Rate
              
              Balance
              
              Expense
              
              RateLoansCommercial
              
              $47,607
              
              $2,959
              
              6.22%
              
              $39,275
              
              $2,034
              
              5.18%
              
              $21,791
              
              $1,795
              
              8.24%Real
      estate - residential
              
              89,386
              
              5,802
              
              6.49%
              
              61,416
              
              5,291
              
              8.62%
              
              42,461
              
              3,418
              
              8.05%Real
      estate - commercial
              
              230,621
              
              15,591
              
              6.76%
              
              160,019
              
              10,968
              
              6.85%
              
              120,797
              
              9,722
              
              8.05%Real
      estate - construction
              
              99,103
              
              6,038
              
              6.09%
              
              105,732
              
              8,965
              
              8.48%
              
              92,886
              
              8,707
              
              9.37%Consumer
              
              10,642
              
              788
              
              7.40%
              
              7,779
              
              657
              
              8.45%
              
              6,488
              
              582
              
              8.97%Gross
      loans
              
              477,359
              
              31,178
              
              6.53%
              
              374,221
              
              27,915
              
              7.46%
              
              284,423
              
              24,224
              
              8.52%Investment
      securities
              
              33,174
              
              1,458
              
              4.40%
              
              12,125
              
              699
              
              5.76%
              
              16,471
              
              847
              
              5.14%Loans
      held for sale
              
              10,305
              
              533
              
              5.17%
              
              3,721
              
              225
              
              6.05%
              
              2,368
              
              155
              
              6.55%Federal
      funds and other
              
              15,034
              
              27
              
              0.18%
              
              10,455
              
              233
              
              2.23%
              
              8,877
              
              439
              
              4.95%Total
      interest earning assets
              
              535,872
              
              33,196
              
              6.19%
              
              400,522
              
              29,072
              
              7.26%
              
              312,139
              
              25,665
              
              8.22%Allowance
      for loan losses
              
              (8,367)
              
              
              
              
              
              (4,309)
              
              
              
              
              
              (2,956)Cash
      and due from banks
              
              15,998
              
              
              
              
              
              8,179
              
              
              
              
              
              5,169Premises
      and equipment, net
              
              27,880
              
              
              
              
              
              23,951
              
              
              
              
              
              13,901Other
      assets
              
              28,651
              
              
              
              
              
              14,261
              
              
              
              
              
              9,497Total
      assets
              
              $600,034
              
              
              
              
              
              $442,604
              
              
              
              
              
              $337,750Interest
      bearing depositsInterest
      checking
              
              26,530
              
              443
              
              1.67%
              
              $12,735
              
              $159
              
              1.25%
              
              $10,454
              
              $104
              
              0.99%Money
      market
              
              69,267
              
              1,242
              
              1.79%
              
              28,215
              
              561
              
              1.99%
              
              21,618
              
              726
              
              3.36%Savings
              
              7,009
              
              85
              
              1.21%
              
              6,891
              
              193
              
              2.80%
              
              3,669
              
              42
              
              1.14%Certificates
              
              347,698
              
              12,664
              
              3.64%
              
              291,629
              
              13,435
              
              4.61%
              
              233,408
              
              12,078
              
              5.17%Total
      deposits
              
              450,504
              
              14,434
              
              3.20%
              
              339,470
              
              14,348
              
              4.23%
              
              269,149
              
              12,950
              
              4.81%BorrowingsLong-tern
      debt - trustpreferred
      securities
              
              8,764
              
              392
              
              4.47%
              
              8,764
              
              508
              
              5.80%
              
              6,173
              
              447
              
              7.24%FHLB
      advances
              
              26,348
              
              970
              
              4.22%
              
              20,620
              
              834
              
              4.22%
              
              7,945
              
              340
              
              4.22%Other
      borrowings
              
              16,337
              
              612
              
              1.77%
              
              13,034
              
              280
              
              1.77%
              
              1,748
              
              70
              
              1.77%Total
      interest bearing liabilities
              
              501,953
              
              16,408
              
              3.27%
              
              381,888
              
              15,970
              
              4.18%
              
              285,015
              
              13,807
              
              4.84%Noninterest
      bearing deposits
              
              39,626
              
              
              
              
              
              27,657
              
              
              
              
              
              22,686Other
      liabilities
              
              2,366
              
              
              
              
              
              1,992
              
              
              
              
              
              2,251Total
      liabilities
              
              543,945
              
              
              
              
              
              411,537
              
              
              
              
              
              309,952Equity
      capital
              
              56,089
              
              
              
              
              
              31,067
              
              
              
              
              
              27,798Total
      liabilities and capital
              
              $600,034
              
              
              
              
              
              $442,604
              
              
              
              
              
              $337,750Net
      interest income beforeprovision
      for loan losses
              
              
              
              $16,788
              
              
              
              
              
              $13,102
              
              
              
              
              
              $11,858Interest
      spread - average yieldon
      interest earning assets,less
      average rate oninterest
      bearing liabilities
              
              
              
              
              
              2.93%
              
              
              
              
              
              3.08%
              
              
              
              
              
              3.38%Net
      interest margin(net
      interest incomeexpressed
      as a percentageof
      average earning assets)
              
              
              
              
              
              3.13%
              
              
              
              
              
              3.27%
              
              
              
              
              
              3.80%
  Interest
income and interest expense are affected by changes in both average interest
rates and average volumes of interest-earning assets and interest-bearing
liabilities.  The following table analyzes changes in net interest
income attributable to changes in the volume of interest-sensitive assets and
liabilities compared to changes in interest rates.  Nonaccrual loans
are included in average loans outstanding. The changes in interest due to both
rate and volume have been allocated to changes due to volume and changes due to
rate in proportion to the relationship of the absolute dollar amounts of the
changes in each.
  34
  
 Rate/Volume
      Analysis(In
      thousands)2009
      vs. 2008
              
              2008
      vs. 2007Increase
      (Decrease)
              
              Increase
      (Decrease)Due
      to Changes in
              
              Due
      to Changes inVolume
              
              Rate
              
              Total
              
              Volume
              
              Rate
              
              TotalInterest
      incomeLoans
              
              $6,333
              
              $(2,762)
              
              $3,571
              
              $5,297
              
              $(1,606)
              
              $3,691Investment
      securities
              
              879
              
              (120)
              
              759
              
              (273)
              
              125
              
              (148)Fed
      funds sold and other
              
              187
              
              (393)
              
              (206)
              
              169
              
              (305)
              
              (136)Total
      interest income
              
              7,399
              
              (3,275)
              
              4,124
              
              5,193
              
              (1,786)
              
              3,407Interest
      expenseDepositsInterest
      checking
              
              217
              
              66
              
              283
              
              24
              
              31
              
              55Money
      market accounts
              
              731
              
              (48)
              
              683
              
              489
              
              (654)
              
              (165)Savings
      accounts
              
              3
              
              (110)
              
              (107)
              
              57
              
              94
              
              151Certificates
      of deposit
              
              8,613
              
              (9,386)
              
              (773)
              
              2,423
              
              (1,066)
              
              1,357Total
      deposits
              
              9,564
              
              (9,478)
              
              86
              
              2,993
              
              (1,595)
              
              1,398BorrowingsLong-term
      debt
              
              -
              
              (116)
              
              (116)
              
              18
              
              43
              
              61FHLB
      Advances
              
              201
              
              (65)
              
              136
              
              512
              
              (18)
              
              494Other
      borrowings
              
              332
              
              -
              
              332
              
              210
              
              -
              
              210Total
      interest expense
              
              10,097
              
              (9,659)
              
              438
              
              3,733
              
              (1,570)
              
              2,163Net
      interest income
              
              $(2,698)
              
              $6,384
              
              $3,686
              
              $1,460
              
              $(216)
              
              $1,244Note:
      the combined effect on interest due to changes in both volume and rate,
      which cannot beseparately
      identified, has been allocated proportionately to the change due to volume
      and thechange
      due to rate.
   Provision
for loan losses
  The
amount of the loan loss provision is determined by an evaluation of the level of
loans outstanding, the level of non-performing loans, historical loan loss
experience, delinquency trends, underlying collateral values, the amount of
actual losses charged to the reserve in a given period and assessment of present
and anticipated economic conditions.
  The
level of the allowance reflects changes in the size of the portfolio or in any
of its components as well as management’s continuing evaluation of industry
concentrations, specific credit risks, loan loss experience, current loan
portfolio quality, present economic, and political and regulatory
conditions.  Portions of the allowance may be allocated for specific
credits; however, the entire allowance is available for any credit that, in
management’s judgment, should be charged off.  While management
utilizes its best judgment and information available, the ultimate adequacy of
the allowance is dependent upon a variety of factors beyond the Company’s
control, including the performance of the Company’s loan portfolio, the economy,
changes in interest rates and the view of the regulatory authorities toward loan
classifications.
  Profitability
has been negatively impacted the last two years by increasing provisions for
loan losses.  The provision for loan losses increased from $1,187,000
in 2007 to $2,006,000 in 2008 and to $13,220,000 in 2009.  These
increases in the provision for loan losses are attributable to the growth in our
loan portfolio and a deterioration in asset quality as the depressed economy has
negatively impacted the ability of our borrowers to repay us.  The
deterioration in asset quality has occurred primarily in loans secured by real
estate.  Loans secured by real estate represent 89% of our total loan
portfolio at December 31, 2009.
  35
  
  We
believe that the level of the provision for loan losses experienced in 2009 will
not be repeated in 2010, as the economy is showing some signs of recovery which
should help the ability of borrowers to repay loans.  However, no
assurances can be given that the provision for loan losses in 2010 will not
equal or exceed that in 2009.
  Noninterest
income
  Noninterest
income includes service charges and fees on deposit accounts, fee income related
to loan origination, and gains and losses on sale of mortgage loans and
securities held for sale. Over the last three years the most significant
noninterest income item has been gain on loan sales generated by Village Bank
Mortgage, representing 57% in both 2007 and 2008 and 70% in 2009 of total
noninterest income.  Noninterest income amounted to $2,667,000 in
2007, $4,185,000 in 2008 and $8,285,000 in 2009.
  The
increase in noninterest income in 2009 of $4,100,000 is primarily attributable
to an increase in gain on sale of loans of $3,447,000 and increased service
charges and fees on transactional deposit accounts of $452,000.  The
gain on sale of loans resulted from an increase in loan production by our
mortgage company, from $100 million in loan closings in 2008 to $252 million in
2009.  Despite the depressed economic conditions in 2009, the mortgage
company was able to increase loan production due to the addition of new loan
officers.  Management expects the mortgage company to further increase
loan production in 2010 due to declining mortgage loan interest rates that will
allow more borrowers to qualify for loans and provide refinance opportunities
for existing home owners.  Service charges and fees increased because
transactional deposits grew by $108,215,000, or 132%, in 2009 as a result of
maturing time deposits moving to money market accounts.
  The
increase in noninterest income in 2008 of $1,518,000 is primarily attributable
to increased service charges and fees on transactional deposit accounts of
$412,000 and an increase in gain on sale of loans of
$868,000.  Transactional deposits grew by $26,112,000, or 47%, in 2008
as a result of the maturing of our branch network coupled with the addition of
the deposits of River City Bank, resulting in the increase in service charges
and fees.  The gain on sale of loans resulted from an increase in loan
production by our mortgage company, from $67 million in loan closings in 2007 to
$100 million in 2008.
  Noninterest
expense
  Noninterest
expense includes all expenses of the Company with the exception of interest
expense on deposits and borrowings, provision for loan losses and income
taxes.  Some of the primary components of noninterest expense are
salaries and benefits, and occupancy and equipment costs.  Over the
last three years, the most significant noninterest expense item has been
salaries and benefits, representing 58%, 55% and 50% of noninterest expense
(excluding the write-off of goodwill in 2009) in 2007, 2008 and 2009,
respectively.  Noninterest expense increased from $11,821,000 in 2007,
to $14,572,000 in 2008 and to $28,338,000 in 2009.  In 2009 the
write-off of all goodwill of $7,422,141 was included in noninterest
expense.  This was a one time expense as we no longer have any
goodwill.
  The
increase in noninterest expense of $13,766,000 in 2009 resulted from the
goodwill write-off of $7,422,000 as well as increases in expenses related to
foreclosed assets of $1,310,000 and the FDIC insurance premium of
$966,000.  Other growth related increases in noninterest expense in
2009 were increases in salaries and benefits of $2,500,000, occupancy of
$493,000, loan underwriting expense of $430,000, data processing of $159,000 and
equipment of $126,000.
  The
increases in noninterest expense of $2,751,000 in 2008 resulted from the
addition of new branches and the growth in the Company overall as well as the
merger with River City Bank.  Growth related increases in noninterest
expense in 2008 were increases in salaries and benefits of $1,133,000,
professional and outside services of $372,000, occupancy of $364,000, loan
underwriting expense of $271,000 and the FDIC insurance premium of
$225,000.
  36
  Income
taxes
  Tax
expense (benefit) amounted to $(4,973,000), $241,000 and $516,000 in 2009, 2008
and 2007, respectively.  The $5,241,000 decline in income tax expense
in 2009 is related to the loss of $(16,484,000) and $275,000 decline in 2008
were attributable to the lower taxable income.
  Commercial
banking organizations conducting business in Virginia are not subject to
Virginia income taxes.  Instead, they are subject to a franchise tax
based on bank capital.  The Bank recorded a franchise tax expense of
$355,000, $180,000 and $210,000 for 2009, 2008 and 2007,
respectively.
  Balance
Sheet Analysis
  Investment
securities
  At
December 31, 2009 and 2008, all of our investment securities were classified as
available-for-sale.  Investment securities classified as available for
sale may be sold in the future, prior to maturity. These securities are carried
at fair value.  Net aggregate unrealized gains or losses on these
securities are included, net of taxes, as a component of shareholders’
equity.  Given the generally high credit quality of the portfolio,
management expects to realize all of its investment upon market recovery or, the
maturity of such instruments and thus believes that any impairment in value is
interest rate related and therefore temporary.  Available for sale
securities included net unrealized gains of $97,000 at December 31, 2009 and net
unrealized losses of $26,000 at December 31, 2008.  As of December 31,
2009, management does not have the intent to sell any of the securities
classified as available for sale and management believes that it is more likely
than not that the Company will not have to sell any such securities before a
recovery of cost.
  The
following table presents the composition of our investment portfolio at the
dates indicated.
  37
  
 Investment
      Securities Available-for-Sale(Dollars
      in thousands)Unrealized
              
              EstimatedPar
              
              Amortized
              
              Gain
              
              Fair
              
              AverageValue
              
              Cost
              
              (Loss)
              
              Value
              
              YieldDecember
      31, 2009US
      Government AgenciesOne
      to five years
              
              $ 
      9,000
              
              $ 
      9,315
              
              $   
      (66)
              
              $ 
      9,249
              
              2.32%Five
      to ten years
              
              3,000
              
              3,029
              
              32
              
              3,061
              
              4.50%More
      than ten years
              
              34,250
              
              35,284
              
              75
              
              35,359
              
              5.22%Total
              
              46,250
              
              47,628
              
              41
              
              47,669
              
              4.61%Mortgage-backed
      securitiesOne
      to five years
              
              389
              
              435
              
              (37)
              
              398
              
              4.40%Five
      to ten years
              
              471
              
              471
              
              29
              
              500
              
              5.24%More
      than ten years
              
              3,141
              
              3,227
              
              53
              
              3,280
              
              5.53%Total
              
              4,001
              
              4,133
              
              45
              
              4,178
              
              5.39%MunicipalsMore
      than ten years
              
              1,000
              
              1,026
              
              1
              
              1,027
              
              5.28%Other
      investmentsMore
      than five years
              
              2,000
              
              1,973
              
              10
              
              1,983
              
              5.65%Total
      investment securities
              
              $53,251
              
              $
      54,760
              
              $  
        97
              
              $
      54,857
              
              4.72%December
      31, 2008US
      Government AgenciesWithin
      one year
              
              $    
      360
              
              $    
      360
              
              $    
      (4)
              
              $     
      356
              
              4.50%More
      than five years
              
              16,546
              
              16,095
              
              564
              
              16,659
              
              5.73%Total
              
              16,906
              
              16,455
              
              560
              
              17,015
              
              5.70%Mortgage-backed
      securitiesOne
      to five years
              
              874
              
              905
              
              (23)
              
              $882
              
              4.47%More
      than five years
              
              4,603
              
              4,694
              
              (76)
              
              4,618
              
              5.42%5,477
              
              5,599
              
              (99)
              
              5,500
              
              5.27%Other
      investmentsMore
      than five years
              
              2,000
              
              1,970
              
              (184)
              
              1,786
              
              5.65%Total
      investment securities
              
              $
      24,383
              
              $
      24,024
              
              $ 
      277
              
              $
      24,301
              
              5.60%
  Loans
  A
management objective is to maintain the quality of the loan
portfolio.  The Company seeks to achieve this objective by maintaining
rigorous underwriting standards coupled with regular evaluation of the
creditworthiness of and the designation of lending limits for each
borrower.  The portfolio strategies include seeking industry and loan
size diversification in order to minimize credit exposure and originating loans
in markets with which the Company is familiar.
  The
Company’s real estate loan portfolios, which represent approximately 89% of all
loans, are secured by mortgages on real property located principally in the
Commonwealth of Virginia.  Sources of repayment are from the
borrower’s operatingprofits,
cash flows and liquidation of pledged collateral.  The Company’s
commercial loan portfolio represents approximately 8.5% of all
loans.  Loans in this category are typically made to individuals,
small and medium-sized businesses and range between $250,000 and $2.5
million.  Based on underwriting standards, commercial
and
  38
  industrial
loans may be secured in whole or in part by collateral such as liquid assets,
accounts receivable, equipment, inventory, and real property.  The
collateral securing any loan may depend on the type of loan and may vary in
value based on market conditions.  The remainder of our loan portfolio
is in consumer loans which represent 2.5% of the total.
  The
following tables present the composition of our loan portfolio at the dates
indicated and maturities of selected loans at December 31, 2009.
   Loan
      Portfolio, Net(In
      thousands)December
      31,2009
              
              2008
              
              2007
              
              2006
              
              2005Commercial
              $  
      39,576
              
              $  
      52,438
              
              $   
      23,152
              
              $  
      17,889
              
              $  
      14,121Real
      estate - residential
              93,657
              
              84,612
              
              51,281
              
              36,408
              
              30,043Real
      estate - commercial
              240,830
              
              220,400
              
              140,176
              
              100,039
              
              66,274Real
      estate - construction
              81,688
              
              103,161
              
              106,556
              
              80,324
              
              56,146Consumer
              11,609
              
              10,307
              
              6,611
              
              6,730
              
              6,161Total
      loans
              467,360
              
              470,918
              
              327,776
              
              241,390
              
              172,745Less:  unearned
      income, net
              209
              
              (196)
              
              (433)
              
              (339)
              
              (367)Less:  Allowance
      for loan losses
              (10,522)
              
              (6,059)
              
              (3,469)
              
              (2,553)
              
              (1,931)Total
      loans, net
              $ 
      457,047
              
              $
      464,663
              
              $  323,874
              
              $
      238,498
              
              $
      170,447
   Maturities
      of Selected LoansDecember
      31, 2009(In
      thousands)Fixed
      Rate
              
              Variable
      RateWithin
              
              1
      to 5
              
              After
              
              
              
              1
      to 5
              
              After
              
              
              
              Total1
      Year
              
              Years
              
              5
      Years
              
              Total
              
              Years
              
              5
      Years
              
              Total
              
              MaturitiesCommercial
              
              $19,657
              
              $13,451
              
              $6,309
              
              $19,760
              
              $    159
              
              $         -
              
              $      159
              
              $39,576Real
      estateCommercial
              
              37,346
              
              80,191
              
              93,119
              
              173,310
              
              28,155
              
              2,019
              
              30,174
              
              240,830Construction
              
              67,283
              
              10,211
              
              3,911
              
              14,122
              
              283
              
              -
              
              283
              
              81,688Residential
              
              53,433
              
              6,466
              
              33,328
              
              39,794
              
              430
              
              -
              
              430
              
              93,657
  Allowance
for loan losses
  The
allowance for loan losses is an estimate of the losses that may be sustained in
our loan portfolio.  An allowance for loan losses is established
through a provision for loan losses based upon industry standards, known risk
characteristics, management’s evaluation of the risk inherent in the loan
portfolio and changes in the nature and volume of loan activity.  Such
evaluation considers among other factors, the estimated market value of the
underlying collateral, and current economic conditions.
  The
level of the allowance for loan losses is determined by an ongoing detailed
analysis of risk and loss potential within the portfolio as a
whole.  Outside of our own analysis, our reserve adequacy and
methodology are reviewed on a regular basis by an independent firm and bank
regulators.
  The
overall allowance for loan losses is equivalent to approximately 2.25% of total
loans net of deferred fees.  The schedule below, Allocation
of the Allowance for Loan Losses, reflects the pro rata allocation by the
different loan types.  The methodology as to how the allowance was
derived is
  39
  a
combination of specific allocations and percentage allocations of the
unallocated portion of the allowance for loan losses, as discussed
below.  The Company has developed a comprehensive risk weighting
system based on individual loan characteristics that enables the Company to
allocate the composition of the allowance for loan losses by types of
loans.
  The
methodology as to how the allowance was derived is detailed
below.  Unallocated amounts included in the allowance for loan losses
have been applied to the loan classifications on a percentage
basis.
  Adequacy
of the reserve is assessed, and appropriate expense and charge-offs are taken,
no less frequently than at the close of each fiscal quarter end.  The
methodology by which we systematically determine the amount of our reserve is
set forth by the board of directors in our Loan Policy.  Under this
Policy, management is charged with ensuring that each loan is individually
evaluated and the portfolio characteristics are evaluated to arrive at an
appropriate aggregate reserve.  The results of the analysis are
documented, reviewed and approved by the board of directors no less than
quarterly. The following elements are considered in this analysis: individual
loan risk ratings, lending staff changes, loan review and board oversight, loan
policies and procedures, portfolio trends with respect to volume, delinquency,
composition/concentrations of credit, risk rating migration, levels of
classified credit, off-balance sheet credit exposure, any other factors
considered relevant from time to time (the “general reserve”); loss estimates on
specific problem credits (the “specific reserve”), and, finally, an “unallocated
reserve” to cover any unforeseen factors as a result of current economic
conditions.  Each of the reserve components, general, specific and
unallocated are discussed in further detail below.
  With
respect to the general reserve, all loans are graded or “Risk Rated”
individually for loss potential at the time of origination and as warranted
thereafter, but no less frequently than quarterly. Loss potential factors are
applied based upon a blend of the following criteria: our own direct experience;
our collective management experience in administering similar loan portfolios in
the market; and peer data contained in statistical releases issued by the
FDIC.  Management’s collective experience at this company and other
banks is the most heavily weighted criterion, and the weighting is subjective
and varies by loan type, amount, collateral, structure, and repayment terms.
Prevailing economic conditions generally and within each individual borrower’s
business sector are considered, as well as any changes in the borrower’s own
financial position and, in the case of commercial loans, management structure
and business operations.
  When
deterioration develops in an individual credit, the loan is placed on a “Watch
List” and the loan is monitored more closely.  All loans on the watch
list are evaluated for specific loss potential based upon either an evaluation
of the liquidated value of the collateral or cash flow
deficiencies.  If management believes that, with respect to a specific
loan, an impaired source of repayment, collateral impairment or a change in a
debtor’s financial condition presents a heightened risk of non-performance of a
particular loan, a portion of the reserve may be specifically allocated to that
individual loan.  The aggregation of this loan by loan loss analysis
comprises the specific reserve.
  The
unallocated reserve is maintained to absorb risk factors outside of the general
and specific reserves.  To arrive at the unallocated reserve, the loan
portfolio is “shocked” or downgraded by a certain percentage based on
management’s subjective assessment of the state of the economy.  The
depressed economy in 2008 and 2009 has resulted in an increase in the percentage
downgrade of the loan portfolio.
  The
allowance for loan losses was $10,522,000, $6,059,000 and $3,469,000 at December
31, 2009, 2008 and 2007, respectively.  The ratio of the allowance for
loan losses to gross loans was 2.25% at December 31, 2009, 1.29% at December 31,
2008, and 1.06% December 31, 2007.  The increase in the allowance for
loan losses in 2009 reflects a higher level of problem loans, management’s
concern about the uncertainty in the economy and the current nationwide credit
crisis.  The increase in 2008 is attributable to the increase in loans
outstanding, primarily as a result of the merger with River City Bank, and a
deterioration of asset quality.  We believe the amount of the
allowance for loan losses at December 31, 2009 is adequate to absorb the losses
that can reasonably be anticipated from the loan portfolio at that
date.
  40
   The
following table presents an analysis of the changes in the allowance for loan
losses for the periods indicated.
   Analysis
      of Allowance for Loan Losses(In
      thousands)Year
      Ended December 31,2009
              
              2008
              
              2007
              
              2006
              
              2005Beginning
      balance
              
              $  
         6,059
              
              $
           3,469
              
              $   
       2,553
              
              $    
      1,931
              
              $  
         1,514Provision
      for loan losses
              
              13,220
              
              2,006
              
              1,187
              
              796
              
              461Charge-offsCommercial
      and industrial
              
              $ 
        (1,273)
              
              $ 
          (468)
              
              (31)
              
              (183)
              
              -Real
      estate - residential
              
              -
              
              (202)
              
              (120)
              
              -
              
              -Real
      estate - commercial
              
              (783)
              
              (96)
              
              -
              
              -
              
              -Real
      estate - construction
              
              (5,779)
              
              (1,475)
              
              (66)
              
              -
              
              -Consumer
              
              (932)
              
              (2)
              
              (54)
              
              (72)
              
              (46)(8,767)
              
              (2,243)
              
              (271)
              
              (255)
              
              (46)RecoveriesCommercial
      and industrial
              
              -
              
              7
              
              -
              
              -
              
              -Real
      estate - residential
              
              -
              
              2
              
              -
              
              -
              
              -Real
      estate - commercial
              
              -
              
              -
              
              -
              
              74
              
              -Real
      estate - construction
              
              3
              
              395
              
              -
              
              -
              
              -Consumer
              
              7
              
              19
              
              -
              
              7
              
              210
              
              423
              
              -
              
              81
              
              2Net
      charge-offs
              
              (8,757)
              
              (1,820)
              
              (271)
              
              (174)
              
              (44)Acquisition
      of River City Bank
              
              -
              
              2,404
              
              -
              
              -
              
              -Ending
      balance
              
              $
        10,522
              
              $ 
         6,059
              
              $  
         3,469
              
              $ 
          2,553
              
              $  
         1,931Loans
      outstanding at end of year (1)
              
              $
      467,569
              
              $
      470,722
              
              $
      327,343
              
              $ 
      241,051
              
              $ 
      172,378Ratio
      of allowance for loan losses asa
      percent of loans outstanding atend
      of year
              
              2.25%
              
              1.29%
              
              1.06%
              
              1.06%
              
              1.12%Average
      loans outstanding for the year (1)
              
              $
      477,359
              
              $
      374,221
              
              $
      284,423
              
              $
      205,978
              
              $
      150,432Ratio
      of net charge-offs to average loansoutstanding
      for the year
              
              1.84%
              
              0.60%
              
              0.10%
              
              0.12%
              
              0.03%(1)  Loans
      are net of unearned income.
   Charge-offs
increased significantly from $2,243,000 in 2008 to $8,767,000 in
2009.  This increase in charge-offs was primarily attributable to
loans for real estate acquisition, development and construction in Chesterfield
County, our primary lending market.  The elevated charge-off levels
experienced in the current year warrant the heightened level of provisioning in
2009 and justify management’s use of a higher historical charge-off factor when
considering the losses currently inherent in the loan portfolio during the
calculation of the allowance for loan losses.  Due to the state of the
economy, the duration of the loss history used in calculating the allowance was
shortened during 2009 to better reflect current market conditions.
  We
have allocated the allowance for loan losses according to the amount deemed to
be reasonably necessary to provide for the possibility of losses being incurred
within each of the categories of loans.  The allocation of the
allowance as shown in the table below should not be interpreted as an indication
that losses in future years will occur in the same proportions or that the
allocation indicates future loss trends.  Furthermore, the portion
allocated to each loan category is not the total amount available for future
losses that might occur within such categories since the total allowance is
a
  41
  general
allowance applicable to the entire portfolio.
   Allocation
      of the Allowance for Loan Losses(In
      thousands)December
      31, 2009
              
              December
      31, 2008
              
              December
      31, 2007
              
              December
      31, 2006
              
              December
      31, 2005Total
              
              %
              
              Total
              
              %
              
              Total
              
              %
              
              Total
              
              %
              
              Total
              
              %Commercial
              
              $
          710
              
              6.7%
              
              $   
      1,664
              
              27.5%
              
              $   
       479
              
              13.8%
              
              $   
      377
              
              14.8%
              
              $   
      568
              
              29.5%Real
      estateResidential
              
              1,515
              
              14.4%
              
              1,142
              
              18.8%
              
              712
              
              20.5%
              
              512
              
              20.1%
              
              358
              
              18.5%Commercial
              
              3,500
              
              33.3%
              
              2,166
              
              35.7%
              
              1,204
              
              34.7%
              
              884
              
              34.5%
              
              444
              
              23.0%Construction
              4,442
              
              42.2%
              
              965
              
              15.9%
              
              989
              
              28.5%
              
              694
              
              27.2%
              
              485
              
              25.1%Consumer
              
              355
              
              3.4%
              
              122
              
              2.0%
              
              85
              
              2.5%
              
              86
              
              3.4%
              
              76
              
              3.9%Total
              
              $
      10,522
              
              100.0%
              
              $  
      6,059
              
              100.0%
              
              $
      3,469
              
              100.0%
              
              $
      2,553
              
              100.0%
              
              $
      1,931
              
              100.0%
   Historically,
commercial real estate loans have had the largest allocation of the allowance
for loan losses as this type of loan has represented the largest category in our
loan portfolio (52% in 2009 and 47% in 2008).  However, in 2009, the
largest allocation of the allowance for loan losses changed to real estate
construction loans.  This is a result of our experience with loan
charge-offs in 2009 as charge-offs on real estate construction loans were
$5,779,000, or 66%, of the total charge-offs of $8,767,000.  The
allocation of the allowance for loan losses to commercial real estate loans
continues to be a significant percentage due to the high concentration of this
loan type in our loan portfolio.  In addition to our charge-off
experience in 2009, the recessionary conditions and the deterioration of
national and local housing trends noted during 2009 and 2008 also support this
shift in the allocation.
  Asset
quality
  The
following table summarizes asset quality information at the dates
indicated:
   Asset
      Quality(In
      thousands)
  December
      31,
  2009
              
              2008
              
              2007
              
              2006
              
              2005Nonaccrual
      loans
              $        
      25,913
              
              $         
      8,528
              
              $   
      2,585
              
              $    
      2,801
              
              $    1,834Restructured
      loans
              -
              
              -
              
              -
              
              -
              
              -Foreclosed
      properties
              11,279
              
              2,932
              
              270
              
              -
              
              -Total
      nonperforming assets
              $        
      37,192
              
              $       11,460
              
              $   
      2,855
              
              $    
      2,801
              
              $   
      1,834Loans
      past due 90 days and still accruing(not
      included in nonaccrual loans above)
              $          
      4,787
              
              $        
      6,197
              
              $  
      1,219
              
              $ 
        6,520
              
              $   
      4,932Nonperforming
      assets to loans at end of year (1)
              7.95%
              
              2.43%
              
              0.87%
              
              1.16%
              
              1.06%Nonperforming
      assets to total assets
              6.17%
              
              2.00%
              
              0.73%
              
              0.96%
              
              0.85%Allowance
      for loan losses to nonaccrual loans
              40.6%
              
              71.0%
              
              134.2%
              
              91.1%
              
              105.3%(1)  Loans
      are net of unearned income.
   Interest
is accrued on outstanding loan principal balances, unless the Company considers
collection to be doubtful.  Commercial and unsecured consumer loans
are designated as non-accrual when the
  42
  Company
considers collection of expected principal and interest
doubtful.  Mortgage loans and most other types of consumer loans past
due 90 days or more may remain on accrual status if management determines that
concern over our ability to collect principal and interest is not
significant.  When loans are placed in non-accrual status, previously
accrued and unpaid interest is reversed against interest income in the current
period and interest is subsequently recognized only to the extent cash is
received.  Interest accruals are resumed on such loans only when in
the judgment of management, the loans are estimated to be fully collectible as
to both principal and interest.
  Of
the total nonaccrual loans of $25,913,000 at December 31, 2009 that were
considered impaired, seventeen loans totaling $17,525,000 had specific
allowances for loan losses totaling $5,522,000.  This compares to
$8,528,000 in nonaccrual loans at December 31, 2008 of which three loans
totaling $1,369,000 had specific allowances for loan losses of $235,000 at
December 31, 2008.  The increase in nonaccrual loans is due to the
recessionary economy and is the primary factor in the higher overall allowance
for loan losses at December 31, 2009.The
increased level of classified loans impacted the level of allocations required
based upon historical loss experience resulting in increased provisioning and
allowance levels.
  If
the loans classified as nonaccrual had been current in accordance with the
original terms the gross amount of interest income that would have been earned
in 2009 and 2008 was $569,000 and $95,000 respectively.  Twelve loans
totaling $4,787,000 at December 31, 2009 were past due 90 days or more and
interest was still being accrued as such amounts were considered
collectible.
  Deposits
  The
following table gives the composition of our deposits at the dates
indicated.
   Deposits(In
      thousands)December
      31, 2009
              
              December
      31, 2008
              
              December
      31, 2007Amount
              
              %
              
              Amount
              
              %
              
              Amount
              
              %Demand
      accounts
              
              $ 
      38,521
              
              7.7%
              
              $  34,483
              
              7.4%
              
              $ 
      22,223
              
              6.6%Interest
      checking accounts
              
              36,441
              
              7.3%
              
              17,427
              
              3.7%
              
              10,518
              
              3.1%Money
      market accounts
              
              115,167
              
              23.1%
              
              30,003
              
              6.4%
              
              22,060
              
              6.5%Savings
      accounts
              
              8,901
              
              1.8%
              
              5,388
              
              1.2%
              
              3,373
              
              1.0%Time
      deposits of $100,000 and over
              
              119,352
              
              24.0%
              
              148,173
              
              31.8%
              
              101,987
              
              30.1%Other
      time deposits
              
              179,903
              
              36.1%
              
              230,758
              
              49.5%
              
              178,136
              
              52.7%Total
              
              $498,285
              
              100.0%
              
              $466,232
              
              100.0%
              
              $338,297
              
              100.0%
   Total
deposits increased by 7%, 37% and 34% in 2009, 2008 and 2007,
respectively.  Although total deposits did not increase significantly
in 2009, the composition did change.  Transactional deposit accounts
(demand, interest checking, money market and savings accounts) increased to
39.9% of total deposits compared to 18.7% and 17.2% at December 31, 2008 and
2007, respectively.  This increase in transactional deposit accounts
was the result of the Bank offering attractive interest rates on money market
accounts to encourage customers with maturing certificates of deposit to
transfer those funds to money market accounts as well as improved deposit
gathering efforts by our branch personnel.
  The
variety of deposit accounts offered by the Company has allowed us to be
competitive in obtaining funds and has allowed us to respond with flexibility
to, although not to eliminate, the threat of disintermediation (the flow of
funds away from depository institutions such as banking institutions into direct
investment vehicles such as government and corporate securities).  Our
ability to attract and retain deposits, and our cost of funds, has been, and
will continue to be, significantly affected by money market
conditions.
  43
  The
following table is a schedule of average balances and average rates paid for
each deposit category for the periods presented:
   Average
      Deposits and Rates Paid(In
      thousands)Year
      Ended December 31,2009
              
              2008
              
              2007Account
      Type
              
              Amount
              
              Rate
              
              Amount
              
              Rate
              
              Amount
              
              RateNoninterest-bearing
      demand accounts
              
              $39,626
              
              -
              
              $27,657
              
              -
              
              $22,686
              
              -Interest-bearing
      depositsInterest
      checking accounts
              
              26,530
              
              1.67%
              
              12,735
              
              1.25%
              
              10,454
              
              0.99%Money
      market accounts
              
              69,267
              
              1.79%
              
              28,215
              
              1.99%
              
              21,618
              
              3.36%Savings
      accounts
              
              7,009
              
              1.21%
              
              6,891
              
              2.81%
              
              3,669
              
              1.16%Time
      deposits of $100,000 and over
              
              121,440
              
              3.72%
              
              100,840
              
              4.90%
              
              81,828
              
              5.23%Other
      time deposits
              
              226,258
              
              3.60%
              
              190,789
              
              4.44%
              
              151,580
              
              5.14%Total
      interest-bearing deposits
              
              450,504
              
              3.20%
              
              339,470
              
              4.23%
              
              269,149
              
              4.81%Total
      average deposits
              
              $490,130
              
              
              
              $367,127
              
              
              
              $291,835
   The
following table is a schedule of maturities for time deposits of $100,000 or
more at December 31, 2009.
   Maturities
      of Time Deposits of $100,000 or More(In
      thousands)Due
      within three months
              
              $33,478Due
      after three months through six months
              
              10,509Due
      after six months through twelve months
              
              29,689Over
      twelve months
              
              45,676$119,352
   Borrowings
  We
utilize borrowings to supplement deposits when they are available at a lower
overall cost to us or they can be invested at a positive rate of
return.
  As
a member of the Federal Home Loan Bank of Atlanta (“FHLB”), the Bank is required
to own capital stock in the FHLB and is authorized to apply for borrowings from
the FHLB.  Each FHLB credit program has its own interest rate, which
may be fixed or variable, and range of maturities.  The FHLB may
prescribe the acceptable uses to which the advances may be put, as well as on
the size of the advances and repayment provisions.  Borrowings from
the FHLB were $29,000,000 and $25,000,000 at December 31, 2009 and 2008
respectively.  The FHLB advances are secured by the pledge of
residential mortgage loans and our FHLB stock.  Available borrowings
at December 31, 2009 were approximately $9.5 million.
  Federal
funds purchased represent unsecured borrowings from other banks and generally
mature daily.  We did not have any purchased federal funds at December
31, 2009 or 2008.
  On
September 12, 2007, the Company entered into a promissory note payable to
Community Bankers’ Bank for $11,000,000 bearing interest at thirty day LIBOR
plus 2.375% and maturing September 12, 2009.  The modification of the
note was effective July 1, 2009 converting to 6.60% with principal and interest
payments of $68,906 fixed for 60 months, then converting to the five year T-Bill
rate plus 2.40% adjusted every sixty months thereafter.  Proceeds
advanced under the
  44
  promissory
note were used to finance the construction of the Company’s new principal
administrative offices in Chesterfield County which was completed in July
2008.  The balances outstanding were $9,943,873 and $10,021,871 at
December 31, 2009 and 2008 respectively, and included in other
borrowings.
  Contractual
obligations and other commitments
  The
Company is a party to financial instruments with off-balance sheet risk in the
normal course of business to meet the financing needs of its customers and to
reduce its own exposure to fluctuations in interest rates.  These
financial instruments include commitments to extend credit and standby letters
of credit.  These instruments involve elements of credit risk and
interest rate risk in excess of the amount recognized in the consolidated
balance sheets.  The contractual amounts of these instruments reflect
the extent of the Company’s involvement in particular classes of financial
instruments.
  The
Company’s exposure to credit loss in the event of nonperformance by the other
party to the financial instruments for commitments to extend credit and letters
of credit written is represented by the contractual amount of these
instruments.  The Company uses the same credit policies in making
commitments and conditional obligations as it does for on-balance sheet
instruments.  Unless noted otherwise, the Company does not require
collateral or other security to support financial instruments with credit
risk.
  Commitments
to extend credit are agreements to lend to a customer as long as there is no
violation of any condition established in the contract.  Commitments
generally have fixed expiration dates or other termination clauses and may
require payment of a fee.  Since many of the commitments may expire
without being completely drawn upon, the total commitment amounts do not
necessarily represent future cash requirements.
  Capital
resources
  Stockholders’
equity at December 31, 2009 was $48,942,000, compared to $46,163,000 at December
31, 2008 and $26,893,000 at December 31, 2007.  On May 1, 2009,
the Company received a $14,738,000 investment by the United States Department of
the Treasury under its Capital Purchase Program (the TARP
Program).  The TARP Program is a voluntary program designed to provide
capital for healthy banks to improve the flow of funds from banks to their
customers.  Under the TARP Program, the Company issued to the Treasury
$14,738,000 of preferred stock and warrants to purchase 499,030 shares of the
Company’s common stock at a purchase price of $4.43 per share. The preferred
stock issued by the Company under the TARP Capital Purchase Program carries a 5%
dividend for each of the first 5 years of the investment, and 9% thereafter,
unless the shares are redeemed by the Company.  The increase in equity
in 2009 of $2,779,000 is primarily due to the receipt of the capital investment
under the TARP Program of $14,738,000, offset by the net loss of $11,511,000 for
the year, and the dividends paid to the U.S. Treasury on the TARP investment of
$494,600.
  During
the third quarter of 2008, the Company took steps to increase the capital
position of both the Company and the Bank in connection with the planned merger
with River City Bank.  Such actions were taken, in part, to allow the
FDIC to consider the merger application on an expedited/delegated
basis.  In that regard, the Company issued 59,885 shares of common
stock and received proceeds of $500,000 as a result of the exercise of
previously issued options to its directors, all of which was contributed to the
Bank as capital.  In addition, the Company obtained a loan for
$2,250,000 from Virginia Community Bank of which it contributed $2,000,000 to
the Bank as capital.  And lastly, the Company issued 106,250 shares of
common stock to the Company’s largest shareholder for proceeds of $850,000, all
of which was contributed to the Bank as capital.  The merger with
River City Bank resulted in an additional $5,764,000 in common stock and
$10,505,000 of surplus.  All of the above transactions contributed to
the $19,270,000 increase in equity during 2008.   The balance
outstanding on the loan at December 31, 2009 was $2,000,000 and included in
other borrowings.
  45
  During
the first quarter of 2005, the Company issued $5.2 million in Trust Preferred
Capital Notes to increase its regulatory capital and to help fund its expected
growth in 2005.  During the third quarter of 2007, the Company issued
$3.6 million in Trust Preferred Capital Notes to partially fund the construction
of an 80,000 square foot headquarters building completed in July
2008.  The Trust Preferred Capital Notes may be included in Tier 1
capital for regulatory capital adequacy determination purposes up to 25% of Tier
1 capital after its inclusion.  See Note 15 of the Notes
to Consolidated Financial Statements for a more detailed discussion of
the Trust Preferred Capital Notes.
  The
following table presents the composition of regulatory capital and the capital
ratios at the dates indicated for the Company.
   Analysis
      of Capital(In
      thousands)As
      of December 31,2009
              
              2008
              
              2007Tier
      1 capitalPreferred
      stock
              
              $       59Common
      stock
              
              16,922
              
              $
      16,917
              
              $  10,304Additional
      paid-in capital
              
              40,569
              
              25,737
              
              13,726Retained
      earnings (deficit)
              
              (8,648)
              
              3,454
              
              2,986Warrant
      Surplus
              
              732Discount
      on preferred stock
              
              (636)Qualifying
      trust preferred securities
              
              8,764
              
              8,764
              
              8,764Total
      equity
              
              57,762
              
              54,872
              
              35,780Less:
      goodwill
              
              -
              
              (7,422)
              
              (689)Total
      Tier 1 capital
              
              57,762
              
              47,450
              
              35,091Tier
      2 capitalAllowance
      for loan losses
              
              6,310
              
              6,059
              
              3,469Total
      Tier 2 capital
              
              6,310
              
              6,059
              
              3,469Total
      risk-based capital
              
              64,072
              
              53,509
              
              38,560Risk-weighted
      assets
              
              $500,602
              
              $500,689
              
              $378,020Capital
      ratiosTier
      1 capital to risk-weighted assets
              
              11.5%
              
              9.4%
              
              9.3%Total
      capital to risk-weighted assets
              
              12.8%
              
              10.6%
              
              10.2%Leverage
      ratio (Tier 1 capital toaverage
      assets)
              
              9.4%
              
              8.4%
              
              16.4%Equity
      to total assets
              
              8.1%
              
              8.1%
              
              6.8%
   Federal
regulatory agencies are required by law to adopt regulations defining five
capital tiers: well capitalized, adequately capitalized, under capitalized,
significantly under capitalized, and critically under
capitalized.  The Bank meets the criteria to be categorized as a “well
capitalized” institution as of December 31, 2009 and 2008.  When
capital falls below the “well capitalized” requirement, consequences can
include: new branch approval could be withheld; more frequent examinations by
the FDIC; brokered deposits cannot be renewed without a waiver from the FDIC;
and other potential limitations as described in FDIC Rules and Regulations
sections 337.6 and 303, and FDIC Act section 29.  In addition, the
FDIC insurance assessment increases when an institution falls below the “well
capitalized” classification.
  46
   Liquidity
  Liquidity
provides us with the ability to meet normal deposit withdrawals, while also
providing for the credit needs of customers.  We are committed to
maintaining liquidity at a level sufficient to protect depositors, provide for
reasonable growth, and fully comply with all regulatory
requirements.
  At
December 31, 2009, cash, cash equivalents and investment securities
available-for-sale totaled $75,519,000, or 12.5 % of total assets.
  At
December 31, 2009, we had commitments to originate $72,876,000 of
loans.  Fixed commitments to incur capital expenditures were less than
$25,000 at December 31, 2009.  Certificates of deposit scheduled to
mature in the 12-month period ending December 31, 2009 total
$184,051,000.  We believe that a significant portion of such deposits
will remain with us.  We further believe that deposit growth, loan
repayments and other sources of funds will be adequate to meet our foreseeable
short-term and long-term liquidity needs.
  Interest
Rate Sensitivity
  An
important element of asset/liability management is the monitoring of our
sensitivity to interest rate movements.  In order to measure the
effects of interest rates on our net interest income, management takes into
consideration the expected cash flows from the securities and loan portfolios
and the expected magnitude of the repricing of specific asset and liability
categories.  We evaluate interest sensitivity risk and then formulate
guidelines to manage this risk based on management’s outlook regarding the
economy, forecasted interest rate movements and other business
factors.  Our goal is to maximize and stabilize the net interest
margin by limiting exposure to interest rate changes.
  Contractual
principal repayments of loans do not necessarily reflect the actual term of our
loan portfolio.  The average lives of mortgage loans are substantially
less than their contractual terms because of loan prepayments and because of
enforcement of due-on-sale clauses, which gives us the right to declare a loan
immediately due and payable in the event, among other things, the borrower sells
the real property subject to the mortgage and the loan is not
repaid.  In addition, certain borrowers increase their equity in the
security property by making payments in excess of those required under the terms
of the mortgage.
  The
sale of fixed rate loans is intended to protect us from precipitous changes in
the general level of interest rates. The valuation of adjustable rate mortgage
loans is not as directly dependent on the level of interest rates as is the
value of fixed rate loans.  As with other investments, we regularly
monitor the appropriateness of the level of adjustable rate mortgage loans in
our portfolio and may decide from time to time to sell such loans and reinvest
the proceeds in other adjustable rate investments.
  The
data in the following table reflects repricing or expected maturities of various
assets and liabilities at December 31, 2009.  The gap analysis
represents the difference between interest-sensitive assets and liabilities in a
specific time interval.  Interest sensitivity gap analysis presents a
position that existed at one particular point in time, and assumes that assets
and liabilities with similar repricing characteristics will reprice at the same
time and to the same degree.
  47
  
 Village
      Bank and Trust Financial Corp.Interest
      Rate Sensitivity GAP AnalysisDecember
      31, 2009(In
      thousands)Within
      3
              
              3
      to 6
              
              6
      to 12
              
              13
      to 36
              
              More
      thanMonths
              
              Months
              
              Months
              
              Months
              
              36
      Months
              
              TotalInterest
      Rate Sensitive AssetsLoans
      (1)Fixed
      rate
              
              $ 
      41,620
              
              $ 
      13,432
              
              $ 
      22,143
              
              $ 
      26,716
              
              $ 
      154,846
              
              $ 
      258,757Variable
      rate
              
              135,345
              
              3,332
              
              8,093
              
              14,808
              
              47,025
              
              208,603Investment
      securities
              
              -
              
              -
              
              162
              
              78
              
              54,617
              
              54,857Loans
      held for sale
              
              7,506
              
              -
              
              -
              
              -
              
              -
              
              7,506Federal
      funds sold
              
              6,777
              
              -
              
              -
              
              -
              
              -
              
              6,777Total
      rate sensitive assets
              
              191,248
              
              16,764
              
              30,398
              
              41,602
              
              256,488
              
              536,500Cumulative
      rate sensitive assets
              
              191,248
              
              208,012
              
              238,410
              
              280,012
              
              536,500Interest
      Rate Sensitive LiabilitiesInterest
      checking (2)
              
              -
              
              -
              
              -
              
              36,441
              
              -
              
              36,441Money
      market accounts
              
              115,166
              
              -
              
              -
              
              -
              
              -
              
              115,166Savings
      (2)
              
              -
              
              -
              
              -
              
              8,901
              
              -
              
              8,901Certificates
      of deposit
              
              88,654
              
              29,044
              
              69,612
              
              100,666
              
              11,279
              
              299,255FHLB
      advances
              
              -
              
              15,000
              
              -
              
              14,000
              
              -
              
              29,000Trust
      Preferred Securities
              
              -
              
              -
              
              -
              
              -
              
              8,764
              
              8,764Federal
      funds purchased
              
              -
              
              -
              
              -
              
              -
              
              -
              
              -Other
      borrowings
              
              2,928
              
              2,041
              
              84
              
              266
              
              9,511
              
              14,830Total
      rate sensitive liabilities
              
              206,748
              
              46,085
              
              69,696
              
              160,274
              
              29,554
              
              512,357Cumulative
      rate sensitive liabilities
              
              206,748
              
              252,833
              
              322,529
              
              482,803
              
              512,357Rate
      sensitivity gap for period
              
              $(15,500)
              
              $(29,321)
              
              $(39,298)
              
              $(118,672)
              
              $
      226,934
              
              $ 
      24,143Cumulative
      rate sensitivity gap
              
              $(15,500)
              
              $(44,821)
              
              $(84,119)
              
              $(202,791)
              
              $  
      24,143Ratio
      of cumulative gap to total assets
              
              (2.6)%
              
              (7.4)%
              
              (14.0)%
              
              (33.6)%
              
              4.0%Ratio
      of cumulative rate sensitiveassets
      to cumulative rate sensitiveliabilities
              
              92.5%
              
              82.3%
              
              73.9%
              
              58.0%
              
              104.7%Ratio
      of cumulative gap to cumulativerate
      sensitive assets
              
              (8.1)%
              
              (21.5)%
              
              (35.3)%
              
              (72.4)%
              
              4.5%(1)
      Includes nonaccrual loans of approximately $21,313,000, which are spread
      throughout the categories.(2)
      Management believes that interest checking and savings accounts are
      generally not sensitive to changes in interestrates
      and therefore has placed such deposits in the "13 to 36 months"
      category.
  At
December 31, 2009, our liabilities that reprice within one year exceeded assets
that reprice within one year by $84,119,000 and therefore we were in a
liability-sensitive position.  A negative gap can adversely affect
earnings in periods of increasing interest rates.  This negative
position is due primarily to the short maturity of certificates of deposit as
well as an increase in money market accounts.
  Critical
Accounting Policies
  The
accounting and reporting policies followed by the Company conform, in all
material respects, to U.S. generally accepted accounting principles (“U.S.
GAAP”) which, effective for all interim and annual periods ending after
September 15, 2009, principally consist of the Financial Standards Board
Accounting Standards Codification (“FASB Codification”).  FASB
Codification Topic 105: Generally
Accepted Accounting Principles establishes the FASB codification as the
source of authoritative accounting principles recognized by the FASB to be
applied by nongovernmental entities in the preparation of financial statements
in conformity with generally accepted accounting principles.  Rules
and interpretive releases of the Securities and Exchange Commission (“SEC”)
under authority of federal securities laws are also sources of authoritative
guidance for SEC registrants.  All guidance contained in the FASB
Codification carries an equal level of authority.  All
non-grandfathered, non SEC accounting literature not included in the FASB
Codification is superseded and deemed non-authoritative.  In preparing
the consolidated financial statements,
  48
  management
has made estimates, assumptions and judgments based on information available as
of the date of the financial statements; accordingly, as this information
changes, the financial statements may reflect different estimates, assumptions
and judgments.  Certain policies inherently have greater reliance on
the use of estimates, assumptions and judgments and, as such, have a greater
possibility of producing results that could be materially different than
originally reported.  Estimates, assumptions and judgments are
necessary when assets and liabilities are required to be recorded at fair value,
when a decline in the value of an asset not carried on the financial statements
at fair value warrants an impairment write-down or valuation allowance to be
established, or when an asset or liability must be recorded contingent upon a
future event.  Carrying assets and liabilities at fair value
inherently results in more financial statement volatility.  The fair
values and the information used to record valuation adjustments for certain
assets and liabilities are based either on quoted market prices or are provided
by other third-party sources, when readily available.  Management
evaluates its estimates and assumptions on an ongoing basis using historical
experience and other factors, including the current economic environment, which
management believes to be reasonable under the circumstances.  The
Company adjusts such estimates and assumptions when the Company believes facts
and circumstances dictate.  Illiquid credit markets, volatile equity,
foreign currency and energy markets and declines in consumer spending have
combined to increase the uncertainty inherent in such estimates and
assumptions.  As future events and their effects cannot be determined
with precision, actual results could differ significantly from these
estimates.  Changes in those estimates resulting from continuing
changes in the economic environment will be reflected in the financial
statements in the future periods.
  The
financial condition and results of operations presented in the financial
statements, accompanying notes to the financial statements and management's
discussion and analysis are, to a large degree, dependent upon the Company's
accounting policies.  The selection and application of these
accounting policies involve judgments, estimates, and uncertainties that are
susceptible to change. Presented below is discussion of those accounting
policies that management believes are the most important accounting policies to
the portrayal and understanding of our financial condition and results of
operations.  These critical accounting policies require management's
most difficult, subjective and complex judgments about matters that are
inherently uncertain.  In the event that different assumptions or
conditions were to prevail, and depending upon the severity of such changes, the
possibility of materially different financial condition or results of operations
is a reasonable likelihood.  See also Note 1 of the Notes
to Consolidated Financial Statements.
  Allowance
for loan losses
  We
monitor and maintain an allowance for loan losses to absorb an estimate of
probable losses inherent in the loan portfolio.  We maintain policies
and procedures that address the systems of controls over the following areas of
maintenance of the allowance:  the systematic methodology used to
determine the appropriate level of the allowance to provide assurance they are
maintained in accordance with accounting principles generally accepted in the
United States of America; the accounting policies for loan charge-offs and
recoveries; the assessment and measurement of impairment in the loan portfolio;
and the loan grading system.
  The
allowance reflects management’s best estimate of probable losses within the
existing loan portfolio and of the risk inherent in various components of the
loan portfolio, including loans identified as impaired as required by FASB
Codification Topic 310: Receivables.  Loans
evaluated individually for impairment include non-performing loans, such as
loans on non-accrual, loans past due by 90 days or more, restructured loans and
other loans selected by management.  The evaluations are based upon
discounted expected cash flows or collateral valuations.  If the
evaluation shows that a loan is individually impaired, then a specific reserve
is established for the amount of impairment.
  Loans
are grouped by similar characteristics, including the type of loan, the assigned
loan classification and the general collateral type.  A loss rate
reflecting the expected loss inherent in a group of loans is derived based upon
estimates of default rates for a given loan grade, the predominant collateral
type for the group and the terms of the loan.  The resulting estimate
of losses for groups of loans is adjusted for relevant environmental factors and
other conditions of the portfolio of loans and leases,
including:  borrower and industry concentrations; levels and trends
in
  49
  delinquencies,
charge-offs and recoveries; changes in underwriting standards and risk
selection; level of experience, ability and depth of lending management; and
national and local economic conditions.
  The
amounts of estimated impairment for individually evaluated loans and groups of
loans are added together for a total estimate of loan losses.  This
estimate of losses is compared to our allowance for loan losses as of the
evaluation date and, if the estimate of losses is greater than the allowance, an
additional provision to the allowance would be made.  If the estimate
of losses is less than the allowance, the degree to which the allowance exceeds
the estimate is evaluated to determine whether the allowance falls outside a
range of estimates.  If the estimate of losses is below the range of
reasonable estimates, the allowance would be reduced by way of a credit to the
provision for loan losses.  We recognize the inherent imprecision in
estimates of losses due to various uncertainties and variability related to the
factors used, and therefore a reasonable range around the estimate of losses is
derived and used to ascertain whether the allowance is too high.  If
different assumptions or conditions were to prevail and it is determined that
the allowance is not adequate to absorb the new estimate of probable losses, an
additional provision for loan losses would be made, which amount may be material
to the financial statements.
  Goodwill
  Goodwill
represents the cost in excess of the fair value of net assets acquired
(including identifiable intangibles) in transactions accounted for as business
combinations. Goodwill has an indefinite useful life and is evaluated for
impairment annually, or more frequently if events and circumstances indicate
that the asset might be impaired. An impairment loss is recognized to the extent
that the carrying amount exceeds the asset’s fair value. The goodwill impairment
analysis is a two-step test. The first, used to identify potential impairment,
involves comparing each reporting unit’s estimated fair value to its carrying
value, including goodwill. If the estimated fair value of a reporting unit
exceeds its carrying value, goodwill is considered not to be impaired. If the
carrying value exceeds estimated fair value, there is an indication of potential
impairment and the second step is performed to measure the amount of
impairment.  If required, the second step involves calculating an
implied fair value of goodwill for each reporting unit for which the first step
indicated impairment. The implied fair value of goodwill is determined in a
manner similar to the amount of goodwill calculated in a business combination,
by measuring the excess of the estimated fair value of the reporting unit, as
determined in the first step, over the aggregate estimated fair values of the
individual assets, liabilities and identifiable intangibles as if the reporting
unit was being acquired in a business combination. If the implied fair value of
goodwill exceeds the carrying value of goodwill assigned to the reporting unit,
there is no impairment. If the carrying value of goodwill assigned to a
reporting unit exceeds the implied fair value of the goodwill, an impairment
charge is recorded for the excess. The Company’s annual goodwill impairment
evaluation in 2009 resulted in a goodwill impairment charge of $7,422,000 which
was recorded to noninterest expense for the year ended December 31, 2009. Of the
total $7,422,000 in goodwill, $6,733,000 related to the acquisition of River
City Bank and $689,000 related to the acquisition of the mortgage
company.  This impairment charge, representing the full amount of
goodwill on the consolidated balance sheet, was primarily due to a significant
decline in the market value of the Company’s common stock during 2009 to below
tangible book value for an extended period of time.  Other intangible
assets include premiums paid for acquisitions of core deposits and other
identifiable intangible assets. Intangible assets other than goodwill, which are
determined to have finite lives, are amortized based upon the estimated economic
benefits received.
  Income
taxes
  Deferred
income tax assets and liabilities are determined using the liability (or balance
sheet) method.  Under this method, the net deferred tax asset or
liability is determined based on the tax effects of the temporary differences
between the book and tax bases of the various balance sheet assets and
liabilities and gives current recognition to changes in tax rates and
laws.  Deferred taxes are reduced by a valuation allowance when, in
the opinion of management, it is more likely than not that some portion or all
of the deferred tax assets will not be realized.  Management is also
required to identify, estimate and disclose positions they have taken where the
income tax treatment of the
  50
  position
taken is not 100% certain.  Our evaluation of the deductibility or
taxability of items included in the Company’s tax returns has not resulted in
the identification of any material, uncertain tax positions.
  New
accounting standards
  In
May 2009, the FASB issued guidance on subsequent events that standardizes
accounting for and disclosures of events that occur after the balance sheet date
but before financial statements are issued or are available to be issued. As a
public entity, the Company is required to evaluate subsequent events through the
date its financial statements are issued. Accordingly, the Company has completed
an evaluation of subsequent events through November 13, 2009. These rules
became effective for the Company during its interim period ending after
June 15, 2009, and did not have a material impact on its consolidated
financial statements.
  In
June 2009, the FASB issued standards on accounting for transfers of financial
assets, removing the concept of qualifying special-purpose entities as an
accounting criteria that had provided an exception to consolidation, and
provided additional guidance on requirements for consolidation. This guidance is
effective for annual periods ending after November 15, 2009, and did not
have a material impact on the Company’s consolidated financial
statements.
  New
authoritative accounting guidance under ASC Topic 715, “Compensation—Retirement
Benefits,” provides guidance related to an employer’s disclosures about plan
assets of defined benefit pension or other post-retirement benefit plans. Under
ASC Topic 715, disclosures should provide users of financial statements with an
understanding of how investment allocation decisions are made, the factors that
are pertinent to an understanding of investment policies and strategies, the
major categories of plan assets, the inputs and valuation techniques used to
measure the fair value of plan assets, the effect of fair value measurements
using significant unobservable inputs on changes in plan assets for the period
and significant concentrations of risk within plan assets. The new authoritative
accounting guidance under ASC Topic 715 became effective for the Company’s
consolidated financial statements for the year-ended December 31, 2009 and the
required disclosures are reported in Note 17 - Retirement Plans.
  Additional
new authoritative accounting guidance under ASC Topic 715,
“Compensation—Retirement Benefits,” requires the recognition of a liability and
related compensation expense for endorsement split-dollar life insurance
policies that provide a benefit to an employee that extends to post-retirement
periods.  Under ASC Topic 715, life insurance policies purchased for
the purpose of providing such benefits do not effectively settle an entity’s
obligation to the employee. Accordingly, the entity must recognize a liability
and related compensation expense during the employee’s active service period
based on the future cost of insurance to be incurred during the employee’s
retirement. The Company does not have any split-dollar life insurance
policies.
  To
conform with Securities and Exchange Commission (“SEC”) requirements, the FASB
repealed the requirement that SEC registrants disclose the date through which an
evaluation of subsequent events has been conducted as required under FASB ASC
Update 2010-09 “Subsequent Events”.
  New
authoritative accounting guidance under ASC Topic 860, “Transfers and
Servicing,” amends prior accounting guidance to enhance reporting about
transfers of financial assets, including securitizations, and where companies
have continuing exposure to the risks related to transferred financial assets.
The new authoritative accounting guidance eliminates the concept of a
“qualifying special-purpose entity” and changes the requirements for
derecognizing financial assets. The new authoritative accounting guidance also
requires additional disclosures about all continuing involvements with
transferred financial assets including information about gains and losses
resulting from transfers during the period. The new authoritative accounting
guidance under ASC Topic 860 will be effective January 1, 2010 and is not
expected to have a significant impact on the Company’s consolidated financial
statements.
  51
   Impact
of inflation and changing prices
  The
Company’s financial statements included herein have been prepared in accordance
with generally accepted accounting principles in the United States, which
require the Company to measure financial position and operating results
primarily in terms of historical dollars.  Changes in the relative
value of money due to inflation or recession are generally not
considered.  The primary effect of inflation on the operations of the
Company is reflected in increased operating costs.  In management’s
opinion, changes in interest rates affect the financial condition of a financial
institution to a far greater degree than changes in the inflation
rate.  While interest rates are greatly influenced by changes in the
inflation rate, they do not necessarily change at the same rate or in the same
magnitude as the inflation rate.  Interest rates are highly sensitive
to many factors that are beyond the control of the Company, including changes in
the expected rate of inflation, the influence of general and local economic
conditions and the monetary and fiscal policies of the United States government,
its agencies and various other governmental regulatory authorities.
  
 ITEM
8.  FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
  The
consolidated financial statements and related footnotes of the Company are
presented below.
                           52
  Report
of Independent Registered Public Accounting Firm
   Board
of Directors
 Village
Bank and Trust Financial Corp.
 Midlothian,
Virginia
   We
have audited the accompanying consolidated balance sheets of Village Bank and
Trust Financial Corp. and Subsidiary as of December 31, 2009 and 2008, and the
related consolidated statements of income, stockholders’ equity and cash flows
for each of the three years in the period ended December 31,
2009.  These consolidated financial statements are the responsibility
of the Company’s management.  Our responsibility is to express an
opinion on these consolidated financial statements based on our
audits.
  We
conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States).  Those standards require
that we plan and perform the audits to obtain reasonable assurance about whether
the financial statements are free of material misstatement.  The
Company is not required to have, nor were we engaged to perform, an audit of its
internal control over financial reporting.  Our audits included
consideration of internal control over financial reporting as a basis for
designing audit procedures that are appropriate in the circumstances, but not
for the purpose of expressing an opinion on the effectiveness of the Company’s
internal control over financial reporting.  Accordingly, we express no
such opinion.  An audit also includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial
statements.  An audit also includes assessing the accounting
principles used and significant estimates made by management, as well as
evaluating the overall financial statement presentation.  We believe
that our audits provide a reasonable basis for our opinion.
  In
our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the consolidated financial position of Village
Bank and Trust Financial Corp. and Subsidiary as of December 31, 2009 and 2008,
and the consolidated results of its operations and its cash flows for each of
the three years in the period ended December 31, 2009, in conformity with
accounting principles generally accepted in the United States of
America.
      /s/BDO
Seidman, LLP
   Richmond,
Virginia
 March
30, 2010
    
  53
  
 Village
      Bank and Trust Financial Corp. and SubsidiaryConsolidated
      Balance SheetsDecember
      31, 2009 and 20082009
              
              2008AssetsCash
      and due from banks
              
              $ 
      13,884,581
              
              $ 
      13,107,245Federal
      funds sold
              
              6,777,239
              
              13,493,584Investment
      securities available for sale
              
              54,857,211
              
              24,300,962Loans
      held for sale
              
              7,506,252
              
              4,325,746LoansOutstandings
              
              467,359,664
              
              470,918,182Allowance
      for loan losses
              
              (10,521,931)
              
              (6,059,272)Deferred
      fees and costs
              
              208,883
              
              (195,896)457,046,616
              
              464,663,014Premises
      and equipment, net
              
              27,799,084
              
              28,173,518Accrued
      interest receivable
              
              3,366,718
              
              3,499,793Goodwill
              
              -
              
              7,422,141Bank
      owned life insurance
              
              5,431,002
              
              5,099,022Other
      real estate owned
              
              11,278,532
              
              2,932,101Other
      assets
              
              15,015,708
              
              5,390,867$602,962,943
              
              $572,407,993Liabilities
      and Stockholders' EquityLiabilitiesDeposits
              
              $498,285,124
              
              $466,232,043Federal
      home loan bank advances
              
              29,000,000
              
              25,000,000Long-term
      debt- trust preferred securities
              
              8,764,000
              
              8,764,000Other
      borrowings
              
              14,829,521
              
              23,962,898Accrued
      interest payable
              
              501,069
              
              1,014,534Other
      liabilities
              
              2,641,410
              
              1,271,944Total
      liabilities
              
              554,021,124
              
              526,245,419Stockholders'
      equityPreferred
      stock, $4 par value, $1,000 liquidation preference,1,000,000
      shares authorized, 14,738 shares issued and outstanding
              
              58,952
              
              -Common
      stock, $4 par value - 10,000,000 shares authorized;4,230,628
      shares issued and outstanding at December 31, 20094,229,372
      shares issued and outstanding at December 31, 2008
              
              16,922,512
              
              16,917,488Additional
      paid-in capital
              
              40,568,771
              
              25,737,048Retained
      earnings
              
              (8,647,731)
              
              3,453,788Warrant
              
              732,479
              
              -Discount
      on preferred stock
              
              (636,959)
              
              -Accumulated
      other comprehensive income (loss)
              
              (56,205)
              
              54,250Total
      stockholders' equity
              
              48,941,819
              
              46,162,574$602,962,943
              
              $572,407,993See
      accompanying notes to consolidated financial statements.
   54
  
 Village
      Bank and Trust Financial Corp. and SubsidiaryConsolidated
      Statements of IncomeYears
      Ended December 31, 2009, 2008 and 20072009
              
              2008
              
              2007Interest
      incomeLoans
              
              $   31,711,644
              
              $   28,140,129
              
              $  24,379,103Investment
      securities
              
              1,457,694
              
              698,790
              
              847,364Federal
      funds sold
              
              26,635
              
              233,227
              
              438,768Total
      interest income
              
              33,195,973
              
              29,072,146
              
              25,665,235Interest
      expenseDeposits
              
              14,433,943
              
              14,348,287
              
              12,949,807Borrowed
      funds
              
              1,973,736
              
              1,621,496
              
              856,908Total
      interest expense
              
              16,407,679
              
              15,969,783
              
              13,806,715Net
      interest income
              
              16,788,294
              
              13,102,363
              
              11,858,520Provision
      for loan losses
              
              13,220,000
              
              2,005,633
              
              1,187,482Net
      interest income after provisionfor
      loan losses
              
              3,568,294
              
              11,096,730
              
              10,671,038Noninterest
      incomeService
      charges and fees
              
              1,612,769
              
              1,160,500
              
              748,695Gain
      on sale of loans
              
              5,828,006
              
              2,381,023
              
              1,513,318(Gain)
      loss on sale of equipment
              
              (43,637)
              
              57,827
              
              -Rental
      income
              
              187,786
              
              4,183
              
              -Other
              
              700,176
              
              581,194
              
              404,943Total
      noninterest income
              
              8,285,100
              
              4,184,727
              
              2,666,956Noninterest
      expenseSalaries
      and benefits
              
              10,476,065
              
              7,976,472
              
              6,842,990Occupancy
              
              1,757,939
              
              1,264,757
              
              900,913Equipment
              
              877,205
              
              751,698
              
              659,014Supplies
              
              495,562
              
              464,900
              
              353,573Professional
      and outside services
              
              1,726,130
              
              1,544,895
              
              1,173,135Advertising
      and marketing
              
              308,598
              
              315,985
              
              439,749OREO
      expense
              
              1,475,338
              
              165,455
              
              -FDIC
      assessment
              
              1,366,612
              
              464,395
              
              175,763Other
      operating expense
              
              2,432,286
              
              1,623,714
              
              1,276,095Goodwill
      impairment
              
              7,422,141
              
              -
              
              -Total
      noninterest expense
              
              28,337,876
              
              14,572,271
              
              11,821,232Net
      income (loss) before income taxes
              
              (16,484,482)
              
              709,186
              
              1,516,762Income
      tax (benefit) expense
              
              (4,973,114)
              
              241,097
              
              515,699Net
      income (loss)
              
              (11,511,368)
              
              468,089
              
              1,001,063Preferred
      stock dividends
              
              494,631
              
              -
              
              -Net
      Income (loss) available toCommon
      shareholders
              
              $(12,005,999)
              
              $ 
      468,089
              
              $
      1,001,063Earnings
      (loss) per share, basic
              
              $    
            (2.84)
              
              $  
           0.16
              
              $   
            0.39Earnings
      (loss) per share, diluted
              
              $  
              (2.84)
              
              $ 
            0.16
              
              $   
            0.37See
      accompanying notes to consolidated financial statements.
    55
   Village
      Bank and Trust Financial Corp. and SubsidiaryConsolidated
      Statements of Stockholders' Equityand
      Comprehensive IncomeYears
      Ended December 31, 2009, 2008 and 2007AccumulatedAdditional
              
              Retained
              
              
              
              Discount
      on
              
              OtherPreferred
              
              Common
              
              Paid-in
              
              Earnings
              
              
              
              Preferred
              
              ComprehensiveStock
              
              Stock
              
              Capital
              
              (Deficit)
              
              Warrant
              
              Stock
              
              Income
      (loss)
              
              TotalBalance,
      December 31, 2006
              
              $                
      -
              
              $  
      10,248,352
              
              $  
      13,588,888
              
              $    
      1,984,634
              
              $               
      -
              
              $                      
      -
              
              $            
      (177,759)
              
              $   
      25,644,115Issuance
      of common stock
              
              -
              
              55,588
              
              77,646
              
              -
              
              -
              
              -
              
              -
              
              133,234Stock
      based compensation
              
              -
              
              -
              
              59,735
              
              -
              
              -
              
              -
              
              -
              
              59,735Minimum
      pension adjustment(net
      of income taxes of $4,419)
              
              -
              
              -
              
              -
              
              -
              
              -
              
              -
              
              8,579
              
              8,579Net
      income
              
              -
              
              -
              
              -
              
              1,001,063
              
              -
              
              -
              
              -
              
              1,001,063Change
      in unrealized gain(loss)
      on securitiesavailable
      for sale (net ofincome
      taxes of $23,992)
              
              -
              
              -
              
              -
              
              -
              
              -
              
              -
              
              46,573
              
              46,573Total
      comprehensive income
              
              -
              
              -
              
              -
              
              -
              
              -
              
              -
              
              -
              
              1,047,636Balance,
      December 31, 2007
              
              -
              
              10,303,940
              
              13,726,269
              
              2,985,697
              
              -
              
              -
              
              (122,607)
              
              26,893,299Issuance
      of common stock
              
              -
              
              849,652
              
              950,712
              
              -
              -
              -
              
              -
              
              -
              
              1,800,364Stock
      issued in acquisition of
              
              
              
              
              
              
              
              
              
              
              
              
              
              -
              
              -River
      City Bank
              
              -
              
              5,763,896
              
              10,504,700
              
              -
              
              -
              
              -
              
              
              
              16,268,596Stock
      based compensation
              
              -
              
              -
              
              555,367
              
              -
              
              -
              
              -
              
              -
              
              555,367Minimum
      pension adjustment(net
      of income taxes of $2,917)
              
              -
              
              -
              
              -
              
              -
              
              -
              
              -
              
              8,580
              
              8,580Net
      income
              
              -
              
              -
              
              -
              
              468,091
              
              -
              
              -
              
              -
              
              468,091Change
      in unrealized gain(loss)
      on securities(net
      of incom taxes of $57,214)
              -
              
              -
              
              -
              
              -
              
              -
              
              -
              
              168,277
              
              168,277Total
      comprehensive income
              
              -
              
              -
              
              -
              
              -
              
              -
              
              -
              
              -
              
              636,368Balance,
      December 31, 2008
              
              -
              
              16,917,488
              
              25,737,048
              
              3,453,788
              
              -
              
              -
              
              54,250
              
              46,162,574Issuance
      of preferred stock
              
              58,952
              
              -
              
              14,679,048
              
              -
              
              732,479
              
              (732,479)
              
              -
              
              14,738,000Amortization
      of preferred stockdiscount
              
              -
              
              -
              
              -
              
              (95,520)
              
              -
              
              95,520
              
              -
              
              -Preferred
      stock dividend
              
              -
              
              -
              
              -
              
              (494,631)
              
              -
              
              -
              
              -
              
              (494,631)Issuance
      of common stock
              
              -
              
              5,024
              
              (5,024)
              
              -
              
              -
              
              -
              
              -
              
              -Stock
      based compensation
              
              -
              
              -
              
              157,699
              
              -
              
              -
              
              -
              
              -
              
              157,699Minimum
      pension adjustment(net
      of income taxes of $2,917)
              
              -
              
              -
              
              -
              
              -
              
              -
              
              -
              
              8,580
              
              8,580Net
      loss
              
              -
              
              -
              
              -
              
              (11,511,368)
              
              -
              
              -
              
              -
              
              (11,511,368)Change
      in unrealized gain(loss)
      on securities(net
      of incom taxes of $61,321)
              -
              
              -
              
              -
              
              -
              
              -
              
              -
              
              (119,035)
              
              (119,035)Total
      comprehensive income
              
              -
              
              -
              
              -
              
              -
              
              -
              
              -
              
              -
              
              (11,621,823)Balance,
      December 31, 2009
              
              $  
        58,952
              
              $  
      16,922,512
              
              $  
      40,568,771
              
              $  
      (8,647,731)
              
              $  
      732,479
              
              $       
      (636,959)
              
              $              
      (56,205)
              
              $  
      48,941,819  See
      accompanying notes to consolidated financial statements.
 56
  Village
      Bank and Trust Financial Corp. and SubsidiaryConsolidated
      Statements of Cash FlowsYears
      Ended December 31, 2009, 2008 and 20072009
              
              2008
              
              2007Cash
      Flows from Operating ActivitiesNet
      income (loss)
              
              $             (11,511,368)
              
              $              468,089
              
              $           1,001,063Adjustments
      to reconcile net income to netcash
      provided by (used in) operating activities:Depreciation
      and amortization
              
              1,250,315
              
              798,965
              
              673,110Deferred
      income taxes
              
              (3,031,268)
              
              (291,679)
              
              (236,072)Provision
      for loan losses
              
              13,220,000
              
              2,005,633
              
              1,187,482Write-down
      of other real estate owned
              
              1,329,991
              
              -
              
              -Write-off
      of goodwill
              
              7,422,141
              
              -
              
              -Gain
      on securities
              
              (329,183)
              
              (23,194)
              
              -Gain
      on loans sold
              
              (5,828,006)
              
              (2,381,023)
              
              (1,513,318)(Gain)
      loss on sale of premises and equipment
              
              43,353
              
              (57,827)
              
              -Gain
      on sale of other real estate owned
              
              (46,173)
              
              -
              
              -Stock
      compensation expense
              
              157,699
              
              555,367
              
              59,735Proceeds
      from sale of other real estate owned
              
              2,875,478
              
              -
              
              -Proceeds
      from sale of mortgage loans
              
              255,007,702
              
              101,624,820
              
              68,667,081Origination
      of mortgage loans for sale
              
              (252,360,202)
              
              (100,079,657)
              
              (67,494,471)Amortization
      of premiums and accrection of discounts on securities, net
              
              337,251
              
              (31,098)
              
              37,759(Increase)
      decrease in interest receivable
              
              133,075
              
              (43,355)
              
              (451,491)Increase
      in bank owned life insurance
              
              (331,980)
              
              (1,108,511)
              
              (1,382,788)Increase
      in other assets
              
              (6,523,672)
              
              (1,945,210)
              
              (751,544)Increase
      (decrease) in interest payable
              
              (513,465)
              
              (178,382)
              
              157,994Increase
      (decrease) in other liabilities
              
              1,369,466
              
              262,945
              
              (501,892)Net
      cash used in operating activities
              
              2,671,154
              
              (424,117)
              
              (547,352)Cash
      Flows from Investing ActivitiesPurchases
      of available for sale securities
              
              (46,117,779)
              
              -
              
              (23,532,491)Maturities
      and calls of available for sale securities
              
              15,373,106
              
              16,619,003
              
              22,641,205Net
      increase in loans
              
              (18,109,329)
              
              (32,209,599)
              
              (86,562,804)Purchases
      of premises and equipment
              
              (1,023,928)
              
              (8,954,314)
              
              (8,080,207)Proceeds
      from sale of premises and equipment
              
              104,693
              
              1,144,595
              
              -Acquisition
      net of cash required
              
              -
              
              (57,175)
              
              -Net
      cash used in investing activities
              
              (49,773,237)
              
              (23,457,490)
              
              (95,534,297)Cash
      Flows from Financing ActivitiesIssuance
      of preferred stock
              
              14,738,000
              
              -
              
              -Issuance
      of common stock
              
              -
              
              1,800,364
              
              133,234Net
      increase (decrease)  in deposits
              
              32,053,081
              
              (3,277,260)
              
              85,987,377Federal
      Home Loan Bank borrowings
              
              4,000,000
              
              13,000,000
              
              8,000,000Proceeds
      from issuance of trust preferred securities
              
              -
              
              -
              
              3,609,000Net
      increase (decrease) in other borrowings
              
              (9,133,377)
              
              16,844,328
              
              3,268,539Dividends
      on preferred stock
              
              (494,631)
              
              -
              
              -Net
      cash provided by financing activities
              
              41,163,073
              
              28,367,432
              
              100,998,150Net
      (decrease) increase in cash and cash equivalents
              
              (5,939,009)
              
              4,485,825
              
              4,916,501Cash
      and cash equivalents, beginning of period
              
              26,600,829
              
              22,115,004
              
              17,198,503Cash
      and cash equivalents, end of period
              
              $               20,661,820
              
              $          26,600,829
              
              $        22,115,004Supplemental
      Schedule of Non Cash ActivitiesReal
      estate owned assets acquired in settlement of loans
              
              $               12,505,727
              
              $            1,337,306
              
              $                        -See
      accompanying notes to consolidated financial statements.
  57
  Village
Bank and Trust Financial Corp. and Subsidiary
 Notes
to Consolidated Financial Statements
 Years
Ended December 31, 2009, 2008 and 2007
   Note
1.                      Summary
of Significant Accounting Policies
  The
accounting and reporting policies of Village Bank and Trust Financial Corp. and
subsidiary (the “Company”) conform to accounting principles generally accepted
in the United States of America and to general practice within the banking
industry.  The following is a description of the more significant of
those policies:
  Business
 The
Company is the holding company of and successor to the Village Bank (the
”Bank”).  Effective April 30, 2004, the Company acquired all of the
outstanding stock of the Bank in a statutory share exchange
transaction.  In the transaction, the shares of the Bank’s common
stock were exchanged for shares of the Company’s common stock, par value $4.00
per share (“Common Stock”), on a one-for-one basis.  As a result, the
Bank became a wholly owned subsidiary of the Company, the Company became the
holding company for the Bank and the shareholders of the Bank became
shareholders of the Company.
  The
Bank opened to the public on December 13, 1999 as a traditional community bank
offering deposit and loan services to individuals and businesses in the
Richmond, Virginia metropolitan area.  During 2003, the Bank acquired
or formed three wholly owned subsidiaries, Village Bank Mortgage Corporation
(“Village Mortgage”), a full service mortgage banking company, Village Insurance
Agency, Inc. (“Village Insurance”), a full service property and casualty
insurance agency, and Village Financial Services Corporation (“Village Financial
Services”), a financial services company.  Through these subsidiaries,
the Bank provides a broad array of financial services to its
customers.
  On
October 14, 2008, the Company completed its merger with River City Bank pursuant
to an Agreement and Plan of Reorganization and Merger, dated as of March 9,
2008, by and among the Company, the Bank and River City Bank.  The
merger had previously been approved by both companies’ shareholders at their
respective annual meetings on September 30, 2008 as well as the banking
regulators.
  The
Company is subject to intense competition from existing bank holding companies,
commercial banks and savings banks which have been in business for many years
and have established customer bases.  Competition also comes from a
variety of other non-bank businesses that offer financial
services.  Many of these competitors operate in the same geographic
market where the Company operates, are well-known with long-standing
relationships with businesses and individuals in the communities, and are
substantially larger with greater resources than the Company.
  The
Bank is also subject to regulations of certain federal and state agencies and
undergoes periodic examinations by those regulatory authorities.  As a
consequence of the extensive regulation of commercial banking activities, the
Bank’s business is susceptible to being affected by state and federal
legislation and regulations.
  The
majority of the Company’s real estate loans are collateralized by properties in
markets in the Richmond, Virginia metropolitan area.  Accordingly, the
ultimate collectibility of those loans collateralized by real estate is
particularly susceptible to changes in market conditions in the Richmond
area.
  58
  Basis
of Presentation and Consolidation
 The
consolidated financial statements include the accounts of the Company, the Bank
and the Bank’s subsidiaries.  All material intercompany balances and
transactions have been eliminated in consolidation.
  Use
of estimates
 The
preparation of the consolidated financial statements in conformity with
accounting principles generally accepted in the United States of America
requires management to make estimates and assumptions that affect the reported
amounts of assets and liabilities and disclosure of contingent assets and
liabilities as of the dates of the statements of financial condition and
revenues and expenses during the reporting period.  Actual results
could differ significantly from those estimates.  A material estimate
that is particularly susceptible to significant change in the near term relates
to the determination of the allowance for loan losses.
  Investment
securities
 At
the time of purchase, debt securities are classified into the following
categories: held-to-maturity, available-for-sale or trading.  Debt
securities that the Company has both the positive intent and ability to hold to
maturity are classified as held-to-maturity.  Held-to-maturity
securities are stated at amortized cost adjusted for amortization of premiums
and accretion of discounts on purchase using a method that approximates the
effective interest method.  Investments classified as trading or
available-for-sale are stated at fair market value.  Changes in fair
value of trading investments are included in current earnings while changes in
fair value of available-for-sale investments are excluded from current earnings
and reported, net of taxes, as a separate component of stockholders’
equity.  Presently, the Company does not maintain a portfolio of
trading securities.
  A
decline in the market value of any available-for-sale or held-to-maturity
security below cost that is deemed other than temporary results in a charge to
earnings and the corresponding establishment of a new cost basis for the
security.  No such declines have occurred.
  Interest
income is recognized when earned.  Realized gains and losses for
securities classified as available-for-sale and held-to-maturity are included in
earnings and are derived using the specific identification method for
determining the cost of securities sold.
  Loans
held for sale
 The
Company, through the Bank’s mortgage banking subsidiary, Village Bank Mortgage,
originates residential mortgage loans for sale in the secondary
market.  Mortgage loans originated and intended for sale in the
secondary market are carried at the lower of cost or estimated fair value on an
individual loan basis as determined by outstanding commitments from
investors.  The Company requires a firm purchase commitment from a
permanent investor before a loan can be closed, thus limiting interest rate
risk.  Net unrealized losses, if any, are recognized through a
valuation allowance by charges to income.
  Residential
mortgage loans held for sale are sold to the permanent investor with the
mortgage servicing rights released.  Gains or losses on sales of
mortgage loans are recognized based on the difference between the selling price
and the carrying value of the related mortgage loans sold.  This
difference arises primarily as a result of the value of the mortgage servicing
rights.
  Once
a residential mortgage loan is sold to a permanent investor, the Company has no
further involvement or retained interest in the loan.  There are
limited circumstances in which the permanent investor can contractually require
the Company to repurchase the loan.  The Company makes no provision
for any such recourse related to loans sold as history has shown repurchase of
loans under these circumstances has been remote.
  59
  Loans
 Loans
are stated at the principal amount outstanding, net of unearned
income.  Loan origination fees and certain direct loan origination
costs are deferred and amortized to interest income over the life of the loan as
an adjustment to the loan’s yield over the term of the loan.
  Interest
is accrued on outstanding principal balances, unless the Company considers
collection to be doubtful.  Commercial and unsecured consumer loans
are designated as non-accrual when payment is delinquent 90 days or at the point
which the Company considers collection doubtful, if earlier.  Mortgage
loans and most other types of consumer loans past due 90 days or more may remain
on accrual status if management determines that such amounts are
collectible.  When loans are placed in non-accrual status, previously
accrued and unpaid interest is reversed against interest income in the current
period and interest is subsequently recognized only to the extent cash is
received.  Interest accruals are resumed on such loans only when in
the judgment of management, the loans are estimated to be fully collectible as
to both principal and interest.
  The
Company, through the Bank’s mortgage banking subsidiary, Village Bank Mortgage,
enters into commitments to originate residential mortgage loans in which the
interest rate on the loan is determined prior to funding, termed rate lock
commitments.  Such rate lock commitments on mortgage loans to be sold
in the secondary market are considered to be derivatives.  The period
of time between issuance of a loan commitment and closing and sale of the loan
generally ranges from 30 to 45 days.  The Company protects itself from
changes in interest rates during this period by requiring a firm purchase
agreement from a permanent investor before a loan can be closed.  As a
result, the Company is not exposed to losses nor will it realize gains or losses
related to its rate lock commitments due to changes in interest
rates.
  The
market value of rate lock commitments and best efforts contracts is not readily
ascertainable with precision because rate lock commitments and best efforts
contracts are not actively traded in stand-alone markets.  The Company
determines the fair value of rate lock commitments and best efforts contracts by
measuring the change in the value of the underlying asset while taking into
consideration the probability that the rate lock commitments will
close.  Due to high correlation between rate lock commitments and best
efforts contracts, no significant gains or losses have occurred on the rate lock
commitments.
  Allowance
for loan losses
 The
allowance for loan losses is established as losses are estimated to have
occurred through a provision for loan losses charged to
earnings.  Loan losses are charged against the allowance when
management believes the uncollectibility of a loan balance is
probable.  Subsequent recoveries, if any, are credited to the
allowance.
  The
allowance represents an amount that, in management’s judgment, will be adequate
to absorb any losses on existing loans that may become
uncollectible.  Management’s judgment in determining the adequacy of
the allowance is based on evaluations of the collectibility of loans while
taking into consideration such factors as changes in the nature and volume of
the loan portfolio, current economic conditions which may affect a borrower’s
ability to repay, overall portfolio quality, and review of specific potential
losses.  This evaluation is inherently subjective, as it requires
estimates that are susceptible to significant revision as more information
becomes available.
  The
allowance consists of general, specific and unallocated
components.  The general component covers non-classified loans and is
based on historical loss experience adjusted for qualitative
factors.  The specific component relates to loans that we have
concluded, based on the value of collateral, guarantees and any other pertinent
factors, have known losses.  For such loans that are also classified
as impaired, an allowance is established when the discounted cash flows (or
collateral value or observable market price) of the impaired loan is lower than
the carrying value of
  60
  that
loan.  An unallocated component is maintained to cover uncertainties
that could affect management’s estimate of probable losses. The unallocated
component of the allowance reflects the margin of imprecision inherent in the
underlying assumptions used in the methodologies for estimating specific and
general losses in the portfolio.
  A
loan is considered impaired when, based on current information and events, it is
probable that the Company will be unable to collect the scheduled payments of
principal or interest when due according to the contractual terms of the loan
agreement.  Factors considered by management in determining impairment
include payment status, collateral value, and the probability of collecting
scheduled principal and interest payments when due.  Loans that
experience insignificant payment delays and payment shortfalls generally are not
classified as impaired.  Management determines the significance of
payment delays and payment shortfalls on a case-by-case basis, taking into
consideration all of the circumstances surrounding the loan and the borrower,
including the length of the delay, the reasons for the delay, the borrower’s
prior payment record, and the amount of the shortfall in relation to the
principal and interest owed.  Impairment is measured on a loan by loan
basis for commercial and construction loans by either the present value of the
expected future cash flows discounted at the loan’s effective interest rate, the
loan’s obtainable market price, or the fair value of the collateral if the loan
is collateral dependent.
  Large
groups of smaller balance homogeneous loans are collectively evaluated for
impairment. Accordingly, the Company does not separately identify individual
consumer and residential loans for impairment disclosures.
  Premises
and equipment
 Land
is carried at cost.  Premises and equipment are carried at cost less
accumulated depreciation and amortization.  Depreciation of buildings
and improvements is computed using the straight-line method over the estimated
useful lives of the assets of 39 years.  Depreciation of equipment is
computed using the straight-line method over the estimated useful lives of the
assets ranging from 3 to 7 years.  Amortization of premises (leasehold
improvements) is computed using the straight-line method over the term of the
lease or estimated lives of the improvements, whichever is shorter.
  Goodwill
 Goodwill
represents the cost in excess of the fair value of net assets acquired
(including identifiable intangibles) in transactions accounted for as business
combinations.  Goodwill has an indefinite useful life and is evaluated
for impairment annually, or more frequently if events and circumstances indicate
that the asset might be impaired.  An impairment loss is recognized to
the extent that the carrying amount exceeds the asset’s fair
value.  The goodwill impairment analysis is a two-step test. The
first, used to identify potential impairment, involves comparing each reporting
unit’s estimated fair value to its carrying value, including
goodwill.  If the estimated fair value of a reporting unit exceeds its
carrying value, goodwill is considered not to be impaired.  If the
carrying value exceeds estimated fair value, there is an indication of potential
impairment and the second step is performed to measure the amount of
impairment.  If required, the second step involves calculating an
implied fair value of goodwill for each reporting unit for which the first step
indicated impairment.  The implied fair value of goodwill is
determined in a manner similar to the amount of goodwill calculated in a
business combination, by measuring the excess of the estimated fair value of the
reporting unit, as determined in the first step, over the aggregate estimated
fair values of the individual assets, liabilities and identifiable intangibles
as if the reporting unit was being acquired in a business
combination.  If the implied fair value of goodwill exceeds the
carrying value of goodwill assigned to the reporting unit, there is no
impairment.  If the carrying value of goodwill assigned to a reporting
unit exceeds the implied fair value of the goodwill, an impairment charge is
recorded for the excess.
  The
Company’s annual goodwill impairment evaluation in 2009 resulted in a goodwill
impairment charge of $7,422,000 which was recorded to noninterest expense for
the year ended December 31,
  61
  2009.  Of
the total $7,422,000 in goodwill, $6,733,000 related to the acquisition of River
City Bank and $689,000 related to the acquisition of the mortgage
company.  This impairment charge, representing the full amount of
goodwill on the consolidated balance sheet, was primarily due to a significant
decline in the market value of the Company’s common stock during 2009 to below
tangible book value for an extended period of time.  Other intangible
assets include premiums paid for acquisitions of core deposits and other
identifiable intangible assets.  Intangible assets other than
goodwill, which are determined to have finite lives, are amortized based upon
the estimated economic benefits received.
  Income
taxes
 Deferred
income taxes are recognized for the tax consequences of “temporary differences”
by applying enacted tax rates applicable to future years to differences between
the financial statement carrying amounts and the tax bases of existing assets
and liabilities.  The effect on recorded deferred income taxes of a
change in tax laws or rates is recognized in income in the period that includes
the enactment date.  To the extent that available evidence about the
future raises doubt about the realization of a deferred income tax asset, a
valuation allowance is established.  A tax position is recognized as a
benefit only if it is “more likely than not” that the tax position would be
sustained in a tax examination, with a tax examination being presumed to
occur.  The amount recognized is the largest amount of tax benefit
that is greater than 50% likely of being realized on examination.  For
tax positions not meeting the “more likely than not” test, no tax benefit is
recorded.  The primary temporary differences are the allowance for
loan losses and depreciation and amortization.  The Company has not
identified any material uncertain tax positions.  As such, the
disclosures required by GAAP pertaining to uncertain tax positions have been
omitted.
  Consolidated
statements of cash flows
 For
purposes of reporting cash flows, cash and cash equivalents include cash on
hand, due from banks (including cash items in process of collection),
interest-bearing deposits with banks and federal funds
sold.  Generally, federal funds are purchased and sold for one-day
periods.  Cash flows from loans originated by the Bank and deposits
are reported net.  The Company paid interest of $16,921,000,
$15,543,000 and $13,649,000 in 2009, 2008, and 2007,
respectively.  The Company paid income taxes of $290,000, $260,400 and
$800,400 in 2009, 2008 and 2007, respectively.  Non-cash investing
activities included loans converted to real estate owned of $8,942,000,
$1,337,000 and $0 in 2009, 2008 and 2007.respectively.
  Comprehensive
income
 Comprehensive
income is defined to include all changes in equity except those resulting from
investments by owners and distributions to owners.  Total
comprehensive income (loss) consists of net income (loss) and other
comprehensive income (loss).  The Company’s other comprehensive income
(loss) and accumulated other comprehensive income (loss) are comprised of
unrealized gains and losses on certain investments in debt securities and
amortization of the unfunded pension liability.  At December 31, 2009
the accumulated other comprehensive income was comprised of unrealized gains on
securities available for sale of $63,862 and unfunded pension liability of
$120,067.
  Earnings
per common share
 Basic
earnings (loss) per common share represent net income available to common
stockholders, which represents net income (loss) less dividends paid or payable
to preferred stock shareholders, divided by the weighted-average number of
common shares outstanding during the period.  For diluted earnings per
common share, net income available to common shareholders is divided by the
weighted average number of common shares issued and outstanding for each period
plus amounts representing the dilutive effect of stock options and warrants, as
well as any adjustment to income that would result from the assumed
issuance.  The effects of stock options and warrants are excluded from
the computation of diluted earnings per common share in periods in which the
effect
  62
  would
be antidilutive.  Stock options and warrants are antidilutive if the
underlying average market price of the stock that can be purchased for the
period is less than the exercise price of the option or
warrant.  Potential common shares that may be issued by the Company
relate solely to outstanding stock options and warrants and are determined using
the treasury stock method.
  Stock
incentive plan
 The
Company's shareholders approved the Company's 2000 stock incentive plan which
authorizes the issuance of up to 455,000 shares of common stock (increased from
255,000 shares by amendment to the Incentive Plan approved by the Company’s
shareholders at its 2006 annual meeting on May 23, 2006) to assist the Company
in recruiting and retaining key personnel.  The incentive plan
includes issuances of stock options and awards of 444,590 common shares. 
The expiration date on options granted is ten years with a three year vesting
schedule.  See Note 15 for more information on the stock incentive
plan.
  Fair
values of financial instruments
 The
fair value of an asset or liability is the price that would be received to sell
that asset or paid to transfer that liability in an orderly transaction between
market participants. A fair value measurement assumes that the transaction to
sell the asset or transfer the liability occurs in the principal market for the
asset or liability or, in the absence of a principal market, the most
advantageous market for the asset or liability. The price in the principal (or
most advantageous) market used to measure the fair value of the asset or
liability shall not be adjusted for transaction costs. An orderly transaction is
a transaction that assumes exposure to the market for a period prior to the
measurement date to allow for marketing activities that are usual and customary
for transactions involving such assets and liabilities; it is not a forced
transaction. Market participants are buyers and sellers in the principal market
that are independent, knowledgeable, able to transact and willing to
transact.  The Bank uses the following methods and assumptions in
estimating fair values of financial instruments:
  Cash
and cash equivalents – The carrying amount of cash and cash equivalents
approximates fair value.
  Investment
securities – The fair value of investment securities held-to-maturity and
available-for-sale is estimated based on bid quotations received from
independent pricing services.  The carrying amount of other
investments approximates fair value.
  Loans
– For variable rate loans that reprice frequently and have no significant change
in credit risk, fair values are based on carrying values.  For all
other loans, fair values are calculated by discounting the contractual cash
flows using estimated market discount rates which reflect the credit and
interest rate risk inherent in the loans, or by using the current rates at which
similar loans would be made to borrowers with similar credit ratings and for the
same remaining maturities.
  Deposits
– The fair value of deposits with no stated maturity, such as demand, interest
checking and money market, and savings accounts, is equal to the amount payable
on demand at year-end.  The fair value of certificates of deposit is
based on the discounted value of contractual cash flows using the rates
currently offered for deposits of similar remaining
maturities.
  Borrowings
– The fair value of FHLB borrowings is based on the discounted value of
contractual cash flows using the rates currently offered for borrowings of
similar remaining maturities.  The carrying amounts of federal funds
purchased approximate their fair values.  Other borrowings are
short-term in nature and the carrying amounts approximate fair
value.
  Accrued
interest – The carrying amounts of accrued interest receivable and
payable approximate fair value.
  
  63
  Off-balance-sheet instruments – The fair value
of off-balance-sheet lending commitments is equal to the amount of commitments
outstanding at December 31, 2009 of $72,876,000.  This is based onthe
fact that the Bank generally does not offer lending commitments or standby
letters of credit to its customers for long periods, and therefore, the
underlying rates of the commitments approximate market rates.
  New
accounting pronouncements
  In
May 2009, the FASB issued guidance on subsequent events that standardizes
accounting for and disclosures of events that occur after the balance sheet date
but before financial statements are issued or are available to be issued. As a
public entity, the Company is required to evaluate subsequent events through the
date its financial statements are issued. Accordingly, the Company has completed
an evaluation of subsequent events through November 13, 2009. These rules
became effective for the Company during its interim period ending after
June 15, 2009, and did not have a material impact on its consolidated
financial statements.
  In
June 2009, the FASB issued standards on accounting for transfers of financial
assets, removing the concept of qualifying special-purpose entities as an
accounting criteria that had provided an exception to consolidation, and
provided additional guidance on requirements for consolidation. This guidance is
effective for annual periods ending after November 15, 2009, and did not
have a material impact on the Company’s consolidated financial
statements.
  New
authoritative accounting guidance under ASC Topic 715, “Compensation—Retirement
Benefits,” provides guidance related to an employer’s disclosures about plan
assets of defined benefit pension or other post-retirement benefit plans. Under
ASC Topic 715, disclosures should provide users of financial statements with an
understanding of how investment allocation decisions are made, the factors that
are pertinent to an understanding of investment policies and strategies, the
major categories of plan assets, the inputs and valuation techniques used to
measure the fair value of plan assets, the effect of fair value measurements
using significant unobservable inputs on changes in plan assets for the period
and significant concentrations of risk within plan assets. The new authoritative
accounting guidance under ASC Topic 715 became effective for the Company’s
consolidated financial statements for the year-ended December 31, 2009 and the
required disclosures are reported in Note 17 - Retirement Plans.
  Additional
new authoritative accounting guidance under ASC Topic 715,
“Compensation—Retirement Benefits,” requires the recognition of a liability and
related compensation expense for endorsement split-dollar life insurance
policies that provide a benefit to an employee that extends to post-retirement
periods.  Under ASC Topic 715, life insurance policies purchased for
the purpose of providing such benefits do not effectively settle an entity’s
obligation to the employee. Accordingly, the entity must recognize a liability
and related compensation expense during the employee’s active service period
based on the future cost of insurance to be incurred during the employee’s
retirement. The Company does not have any split-dollar life insurance
policies.
  To
conform with Securities and Exchange Commission (“SEC”) requirements, the FASB
repealed the requirement that SEC registrants disclose the date through which an
evaluation of subsequent events has been conducted as required under FASB ASC
Update 2010-09 “Subsequent Events”.
  New
authoritative accounting guidance under ASC Topic 860, “Transfers and
Servicing,” amends prior accounting guidance to enhance reporting about
transfers of financial assets, including securitizations, and where companies
have continuing exposure to the risks related to transferred financial assets.
The new authoritative accounting guidance eliminates the concept of a
“qualifying special-purpose entity” and changes the requirements for
derecognizing financial assets. The new authoritative accounting guidance also
requires additional disclosures about all continuing  64
 involvements
with transferred financial assets including information about gains and losses
resulting from transfers during the period. The new authoritative accounting
guidance under ASC Topic 860will be effective January 1, 2010 and is not
expected to have a significant impact on the Company’s consolidated financial
statements.
  Note
2.                      Business
Combination
  On
September 30, 2008 the Company acquired River City Bank for approximately
$20,720,000.  The total consideration included approximately
$16,269,000 of common stock, representing approximately 1,441,000 shares, and
cash of $3,962,244 paid to stockholders of River City Bank.  The
transaction requires no future contingent consideration payments.  The
merger of the Company and River City Bank resulted in a combined company with
approximately $572 million in assets and increases the Company’s market presence
in Henrico County and establishes a presence in Hanover County continuing our
goal of expanding our franchise into other counties in the Richmond metropolitan
area.
  Goodwill
of $6.7 million recorded in this transaction was subsequently determined to be
impaired at December 31, 2009 and an impairment of goodwill was recorded as of
that date.  The Company also recorded $809,318 in core deposits
intangibles which is being amortized over eight years using the straight line
method.  The balance of the intangible was $687,000 and $785,000 at
December 31, 2009 and 2008, respectively.  Amortization expense of $98,000
and $24,000 was included in other operating expense at December 31, 2009 and
2008, respectively.  Amortization expense of $98,000 per year will be
recognized through 2016.
  Note
3.                      Investment
securities available-for-sale
  The
amortized cost and estimated fair value of investment securities
available-for-sale as of December 31, 2009 and 2008 are as follows:
   Gross
              
              GrossAmortized
              
              Unrealized
              
              Unrealized
              
              EstimatedCost
              
              Gains
              
              Losses
              
              Fair
      ValueDecember
      31, 2009U.S.
      Government agencies
              
              $
      47,627,779
              
              $  301,365
              
              $
      (259,967)
              
              $47,669,177Mortgage-backed
      securities
              
              4,133,353
              
              91,937
              
              (46,983)
              
              4,178,307Municipals
              
              1,026,422
              
              233
              
              -
              
              1,026,655Other
      investments
              
              1,972,896
              
              10,175
              
              -
              
              1,983,071Total
              
              $
      54,760,450
              
              $  403,710
              
              $
      (306,950)
              
              $54,857,210December
      31, 2008U.S.
      Government agencies
              
              $
      16,454,727
              
              $  565,175
              
              $     (4,873)
              
              $17,015,029Mortgage-backed
      securities
              
              5,599,176
              
              7,607
              
              (106,818)
              
              5,499,965Other
      investments
              
              1,969,943
              
              -
              
              (183,975)
              
              1,785,968Total
              
              $
      24,023,846
              
              $  572,782
              
              $
      (295,666)
              
              $24,300,962
   Investment
securities with book values of approximately $6,000,000 and $12,000,000 at
December 31, 2009 and 2008, respectively, were pledged to secure municipal
deposits.
  
  65
  Investment
securities available for sale that have an unrealized loss position at December
31, 2009 and December 31, 2008 are detailed below:
 Securities
      in a loss
              
              Securities
      in a lossPosition
      for less than
              
              Position
      for more than12
      Months
              
              12
      Months
              
              TotalFair
              
              Unrealized
              
              Fair
      Value
              
              Unrealized
              
              Fair
              
              UnrealizedDecember
      31, 2009
              
              Value
              
              Losses
              
              (Loss)
              
              Losses
              
              Value
              
              Losses(In
      Thousands)Investment
      Securitiesavailable
      for saleUS
      Government Agencies
              
              $   19,542
              
              $       (264)
              
              $                -
              
              $               -
              
              $   19,542
              
              $     (264)Total
              
              $   19,542
              
              $       (264)
              
              $                -
              
              $               -
              
              $   19,542
              
              $     (264)
  Securities
      in a loss
              
              Securities
      in a lossPosition
      for less than
              
              Position
      for more than12
      Months
              
              12
      Months
              
              TotalFair
              
              Unrealized
              
              Fair
      Value
              
              Unrealized
              
              Fair
              
              UnrealizedValue
              
              Losses
              
              (Loss)
              
              Losses
              
              Value
              
              LossesDecember
      31, 2008(In
      Thousands)Investment
      Securitiesavailable
      for saleUS
      Government Agencies
              
              $   1,350
              
              $          (9)
              
              $             -
              
              $                -
              
              $    1,350
              
              $         (9)Mortgage-backed
      securities
              
              3,044
              
              (40)
              
              
              
              
              
              3,044
              
              (40)Other
      investments
              
              1,786
              
              (184)
              
              -
              
              -
              
              1,786
              
              (184)Total
              
              $   6,180
              
              $      (233)
              
              $             -
              
              $                -
              
              $    6,180
              
              $    (233)
  Management
does not believe that any individual unrealized loss as of December 31, 2009 is
other than a temporary impairment.  These unrealized losses are
primarily attributable to changes in interest rates.  The Company has
the ability to hold these securities for a time necessary to recover the
amortized cost or until maturity when full repayment would be
received.
  The
amortized cost and estimated fair value of investment securities
available-for-sale as of December 31, 2009, by contractual maturity, are as
follows:
   Amortized
              
              EstimatedCost
              
              Fair
      ValueOne
      to five years
              
              $   9,749,636
              
              $   9,647,303Five
      to ten years
              
              5,473,345
              
              5,544,527More
      than ten years
              
              39,537,469
              
              39,665,380Total
              
              $
      54,760,450
              
              $
      54,857,210
   During
2009 and 2008, investment securities available-for-sale totaling $15,373,000 and
$16,336,000 respectively, were called or matured with no net
losses.
  Note
4.                      Loans
  Loans
classified by type as of December 31, 2009 and 2008 are as
follows:
  66
  
 2009
              
              2008Commercial
              
              $   39,576,219
              
              $  52,438,487Real
      estate - residential
              
              93,656,979
              
              84,611,678Real
      estate - commercial
              
              240,829,484
              
              220,399,707Real
      estate - construction
              
              81,688,330
              
              103,161,425Consumer
              
              11,608,652
              
              10,306,885Total
      loans
              
              467,359,664
              
              470,918,182Deferred
      loan cost (unearned income), net
              
              208,883
              
              (195,896)Less:  Allowance
      for loan losses
              
              (10,521,931)
              
              (6,059,272)$  457,046,616
              
              $
      464,663,014
  Gains
on the sale of loans totaling approximately $5,828,000, $2,381,000 and
$1,513,000 were realized during the years ended December 31, 2009, 2008 and
2007, respectively.
  Twelve
loans totaling $4,787,000 at December 31, 2009 were past due 90 days or more yet
interest was still being accrued.
  The
following is a summary of loans directly or indirectly with executive officers
or directors of the Company for the years ended December 31, 2009 and
2008:
  2009
              
              2008Beginning
      balance
              
              $  9,985,486
              
              $   5,434,997Additions
              
              8,131,630
              
              10,178,165Reductions
              
              (8,392,325)
              
              (5,627,676)Ending
      balance
              
              $  9,724,791
              
              $   9,985,486
   Executive
officers and directors also had unused credit lines totaling $3,864,000 and
$4,411,000 at December 31, 2009 and 2008, respectively.  All loans and
credit lines to executive officers and directors were made in the ordinary
course of business at the Company’s normal credit terms, including interest rate
and collateralization prevailing at the time for comparable transactions with
other persons.
  Note
5.                      Allowance
for loan losses
  Activity
in the allowance for loan losses in 2009, 2008 and 2007 was as
follows:
  2009
              
              2008
              
              2007Beginning
      balance
              
              $   6,059,272
              
              $  3,469,274
              
              $  2,552,608Provision
      for loan losses
              
              13,220,000
              
              2,005,633
              
              1,187,482River
      City Bank, acquisition
              
              -
              
              2,403,551Charge-offs
              
              (8,767,522)
              
              (2,242,761)
              
              (271,016)Recoveries
              
              10,181
              
              423,575
              
              200Ending
      balance
              
              $
      10,521,931
              
              $  6,059,272
              
              $  3,469,274
   67
  As
of December 31, 2009, 2008 and 2007, the Company had impaired loans of
$25,913,000, $1,369,000 and $959,000, respectively, which were on nonaccrual
status.  These loans had valuation allowances of $5,522,000, $235,000
and $200,000 as of December 31, 2009, 2008 and 2007,
respectively.  The Company does not record interest income on impaired
loans.  Interest income that would have been recorded had impaired
loans been performing would have been $569,000, $95,000 and $93,000 for 2009,
2008 and 2007, respectively.
  Note
6.                      Premises
and equipment
  The
following is a summary of premises and equipment as of December 31, 2009 and
2008:
   2009
              
              2008Land
              
              $    6,318,761
              
              $   6,318,761Buildings
      and improvements
              
              21,556,836
              
              20,747,905Furniture,
      fixtures and equipment
              
              4,404,084
              
              4,858,610Total
      premises and equipment
              
              32,279,681
              
              31,925,276Less:
      Accumulated depreciation and amortization
              
              (4,480,597)
              
              (3,751,758)Premises
      and equipment, net
              
              $  27,799,084
              
              $  28,173,518
   Depreciation
and amortization of premises and equipment for 2009, 2008 and 2007 amounted to
$1,250,000, $799,000 and $673,000 respectively.
  Note
7.                      Investment
in bank owned life insurance
  The
Bank is owner and designated beneficiary on life insurance policies in the face
amount of $15,391,000 covering certain of its directors and executive
officers.  The earnings from these policies are used to offset
expenses related to retirement plans.  The cash surrender value of
these policies at December 31, 2009 and 2008 was $5,431,000 and $5,099,000,
respectively.
  Note
8.                      Deposits
  Deposits
as of December 31, 2009 and 2008 were as follows:
   2009
              
              2008Demand
      accounts
              
              $   38,520,878
              
              $   34,483,360Interest
      checking accounts
              
              36,441,259
              
              17,427,061Money
      market accounts
              
              115,166,477
              
              30,002,756Savings
      accounts
              
              8,901,299
              
              5,387,828Time
      deposits of $100,000 and over
              
              119,352,471
              
              148,172,837Other
      time deposits
              
              179,902,740
              
              230,758,201Total
              
              $
      498,285,124
              
              $
      466,232,043
   The
following are the scheduled maturities of time deposits as of December 31,
2009:
  68
  
 Greater
      thanLess
      Than
              
              or
      Equal toYear
      Ending December 31,
              
              $100,000
              
              $100,000
              
              Total2010
              
              $   110,375,362
              
              $   73,676,055
              
              $   184,051,4172011
              
              45,409,688
              
              30,042,971
              
              75,452,6592012
              
              13,827,040
              
              8,601,274
              
              22,428,3142013
              
              4,185,381
              
              2,705,386
              
              6,890,7672014
              
              6,105,269
              
              4,326,785
              
              10,432,054$  179,902,740
              
              $  119,352,471
              
              $  299,255,211
   Deposits
held at the Company by related parties, which include officers, directors,
greater than 5% shareholders and companies in which directors of the Board have
a significant ownership interest, approximated $6,660,000 and $3,915,000 at
December 31, 2008 and 2009, respectively.
  Note
9.                      Borrowings
  The
Company uses both short-term and long-term borrowings to supplement deposits
when they are available at a lower overall cost to the Company or they can be
invested at a positive rate of return.
  On
September 12, 2007, the Company entered into a promissory note payable to
Community Bankers’ Bank for $11,000,000.  The note was modified on
July 1, 2009 and bears interest at a fixed interest rate of 6.60% with principal
and interest payments of $68,906 for 60 months, then converts to the five year
T-Bill rate plus 2.40%, adjusted every sixty months thereafter.  The
note matures on July 1, 2029 and the balance at December 31, 2009 and
2008 was 9,943,873 and $10,021,871, respectively..  Proceeds
advanced under the promissory note were used to finance the construction of the
Company’s new principal administrative offices in Chesterfield County which was
completed in July 2008.
  On
September 24, 2008 the Company obtained a note payable from Virginia Community
Bank for $2,250,000 bearing interest at 5% payable quarterly and matured
September 24, 2009.  At maturity, the note was reduced to $2,000,000
and extended to April 23, 2010.  The balance at December 31, 2009 and
2008 was 2,000,000 and $2,250,000, respectively..
  As
a member of the Federal Home Loan Bank of Atlanta, the Bank is required to own
capital stock in the FHLB and is authorized to apply for advances from the
FHLB.  The Company held $2,308,000 in FHLB stock at December 31, 2009
which is held at cost and included in other assets.  Each FHLB credit
program has its own interest rate, which may be fixed or variable, and range of
maturities.  The FHLB may prescribe the acceptable uses to which the
advances may be put, as well as on the size of the advances and repayment
provisions.  The FHLB borrowings are secured by the pledge of U.S.
Government agency securities, FHLB stock and qualified single family first
mortgage loans.  The FHLB advances held at December 31, 2009 mature
$5,000,000 on April 09, 2010, $10,000,000 on June 28, 2010, $5,000,000 on April
11, 2011, $5,000,000 April 9, 2012 and $4,000,000 on August 27,
2013.
  The
Company uses federal funds purchased and repurchase agreements for short-term
borrowing needs.  Federal funds purchased represent unsecured
borrowings from other banks and generally mature daily.  Securities
sold under agreements to repurchase are classified as borrowings and generally
mature within one to four days from the transaction date.  Securities
sold under agreements to repurchase are reflected at the amount of cash received
in connection with the transaction.  The Company may be required to
provide additional collateral based on the fair value of the underlying
securities.  There were no securities sold under agreements to
repurchase at December 31, 2009 and $9,425,000 at
  69
  December
31, 2008.
  The Company
also has securities sold under agreements to repurchase, which are secured
transactions with customers and generally mature the day following the date
sold.  The carrying value of these repurchase agreements was $2,885,648 and
$2,266,027 at December 31, 2009 and 2008, respectively.
  Information
related to borrowings is as follows:
   Year
      Ended December 31,2009
              
              2008Maximum
      outstanding during the yearFHLB
      advances
              
              $  29,000,000
              
              $  25,000,000Federal
      funds purchased
              
              373,000
              
              29,405,248Community
      Bankers' Bank
              
              10,003,958
              
              6,962,518Balance
      outstanding at end of yearFHLB
      advances
              
              29,000,000
              
              25,000,000Virginia
      Community Bank
              
              2,000,000
              
              2,250,000Community
      Bankers' Bank
              
              9,943,873
              
              10,021,871Average
      amount outstanding during the yearFHLB
      advances
              
              26,347,945
              
              20,620,438Federal
      funds purchased
              
              3,726
              
              2,329,358Community
      Bankers' Bank
              
              10,003,958
              
              6,962,518Average
      interest rate during the yearFHLB
      advances
              
              3.68%
              
              4.04%Federal
      funds purchased
              
              0.61%
              
              1.78%Community
      Bankers' Bank
              
              4.77%
              
              2.94%Average
      interest rate at end of yearFHLB
      advances
              
              3.57%
              
              3.41%Federal
      funds purchased
              
              -
              
              -Community
      Bankers' Bank
              
              2.82%
              
              2.82%Virginia
      Community Bank
              
              5.00%
              
              5.05%
   Note
10.                      Income
taxes
  The
following summarizes the tax effects of temporary differences which compose net
deferred tax assets and liabilities at December 31, 2009, 2008 and
2007:
   70
 2009
              
              2008
              
              2007Deferred
      tax assetsNet
      operating loss carryforward
              
              $   1,235,858
              
              $                 -
              
              $                -Allowance
      for loan losses
              
              3,577,456
              
              1,771,460
              
              1,099,684Pension
      expense
              
              61,864
              
              66,279
              
              70,695Goodwill
              
              -
              
              -
              
              6,781Total
      deferred tax assets
              
              4,875,178
              
              1,837,739
              
              1,177,160Deferred
      tax liabilitiesDepreciation
              
              384,183
              
              467,219
              
              235,447Amortization
      of intangibles
              
              98,066
              
              19,613
              
              -Goodwill
              
              28,741
              
              33,857Other,
      net
              
              24,780
              
              110,428
              
              26,771Total
      deferred tax liabilities
              
              535,770
              
              631,117
              
              262,217Net
      deferred tax asset
              
              $
      4,339,408
              
              $
      1,206,622
              
              $   914,943
  The
net deferred tax asset is included in other assets on the balance
sheet.
  The
income tax expense (benefit) charged to operations for the years ended December
31, 2009, 2008 and 2007 consists of the following:
  2009
              
              2008
              
              2007Current
      tax expense (benefit)
              
              $(1,941,846)
              
              $  532,776
              
              $  778,775Deferred
      tax expense (benefit)
              
              (3,031,268)
              
              (291,679)
              
              (263,076)Provision
      (benefit) for income taxes
              
              $(4,973,114)
              
              $
      241,097
              
              $
      515,699
  A
reconciliation of income taxes computed at the federal statutory income tax rate
to total income taxes is as follows for the years ended December 31, 2009, 2008
and 2007:
  2009
              
              2008
              
              2007Net
      income (loss) before income taxes
              
              $(16,484,489)
              
              $   709,186
              
              $  1,516,762Computed
      "expected" tax expense
              
              $  (5,604,727)
              
              $   241,123
              
              $     515,699Goodwill
      impairment
              
              2,523,528
              
              -
              
              -Cash
      surrender value of life insurance
              
              (55,684)
              
              (36,894)
              
              (28,148)Nondeductible
      expenses
              
              15,495
              
              19,504
              
              17,580Net
      operating loss carryforward
              
              (1,851,726)
              
              -
              
              -Other
              
              -
              
              17,363
              
              10,568Provision
      for income taxes
              
              $  (4,973,114)
              
              $   241,097
              
              $    515,699
  Commercial
banking organizations conducting business in Virginia are not subject to
Virginia income taxes.  Instead, they are subject to a franchise tax
based on bank capital.  The Company recorded franchise tax expense of
$355,000, $180,000 and $210,000 for 2009, 2008 and 2007, respectively, which is
included in other operating expenses.
  71
   Note
11.                      Earnings
(loss) per share
  The
following table presents the basic and diluted earnings per share
computations:
 
 Year
      Ended December 31,2009
              
              2008
              
              2007NumeratorNet
      income (loss)
              
              $
      (11,511,368)
              
              $   468,089
              
              $
      1,001,063Preferred
      stock dividend
              
              (494,631)
              
              -Net
      income (loss) available tocommon
      stockholders
              
              $
      (12,005,999)
              
              $   468,089
              
              $
      1,001,063DenominatorWeighted
      average shares outstanding - basic
              
              4,230,462
              
              3,013,175
              
              2,569,529Dilutive
      effect of common stock options
              
              -
              
              19,895
              
              125,480Weighted
      average shares outstanding - diluted
              
              4,230,462
              
              3,033,070
              
              2,695,009Earnings
      (loss) per share - basic and dilutedEarnings
      (loss) per share - basic
              
              $            (2.84)
              
              $       0.16
              
              $         0.39Effect
      of dilutive common stock options
              
              -
              
              -
              
              (0.02)Earnings
      (loss) per share - diluted
              
              $            (2.84)
              
              $       0.16
              
              $        0.37
  Outstanding
options and warrants to purchase common stock (see Notes 13 and 14) were
considered in the computation of diluted earnings per share for the years
presented.  Stock options for 336,005, 333,955 and 4,000 shares of
common stock were not included in computing diluted earnings per share in 2009,
2008 and 2007, respectively, because their effects were anti-dilutive. Warrants
for 4,196,202 and 1,500,000 shares of common stock were not included in
computing earnings per share in 2009 and 2008, because their effects were also
anti-dilutive.
  Note
12.                      Lease
commitments
  Certain
premises and equipment are leased under various operating
leases.  Total rent expense charged to operations was $435,000,
$455,000 and $406,000 in 2009, 2008 and 2007, respectively.  At
December 31, 2009, the minimum total rental commitment under such non-cancelable
operating leases was as follows:
  2010
              
              $ 
        441,000
              
              $ 
         440,8362011
              
              419,000
              
              418,7802012
              
              431,000
              
              430,8132013
              
              446,000
              
              445,7042014
              
              437,000
              
              436,890Thereafter
              
              396,000
              
              395,775$
      2,570,000
              
              $
      2,568,797
  Note
13.                      Commitments
and contingencies
  The
Company is a party to financial instruments with off-balance-sheet risk in the
normal course of business to meet the financial needs of its
customers.  These financial instruments include commitments to extend
credit and standby letters of credit.  These instruments involve, to
varying degrees, elements of credit and interest-rate risk in excess of the
amounts recognized in the
  72
  financial
statements.  The contract amounts of these instruments reflect the
extent of involvement that the Company has in particular classes of
instruments.
  The
Company’s exposure to credit loss in the event of non-performance by the other
party to the financial instrument for commitments to extend credit, and to
potential credit loss associated with letters of credit issued, is represented
by the contractual amount of those instruments.  The Company uses the
same credit policies in making commitments and conditional obligations as it
does for loans and other such on-balance sheet instruments.
  At
December 31, 2009, the Company had outstanding the following approximate
off-balance-sheet financial instruments whose contract amounts represent credit
risk:
   ContractAmountUndisbursed
      credit lines
              
              $  49,621,000Commitments
      to extend or originate credit
              
              19,078,000Standby
      letter of credit
              
              4,177,000Total
      commitments to extend credit
              
              $  72,876,000
   Commitments
to extend credit are agreements to lend to a customer as long as there is no
violation of any condition established in the contract.  Commitments
generally have fixed expiration dates or other termination clauses and may
require the payment of a fee.  Historically, many commitments expire
without being drawn upon; therefore, the total commitment amounts shown in the
above table are not necessarily indicative of future cash
requirements.  The Company evaluates each customer’s creditworthiness
on a case-by-case basis.  The amount of collateral obtained, as deemed
necessary by the Company upon extension of credit, is based on management’s
credit evaluation of the customer.  Collateral held varies but may
include personal or income-producing commercial real estate, accounts
receivable, inventory and equipment.
  Concentrations
of credit risk – All of the Company’s loans, commitments to extend
credit, and standby letters of credit have been granted to customers in the
Company’s market area.  Although the Company is building a diversified
loan portfolio, a substantial portion of its clients’ ability to honor contracts
is reliant upon the economic stability of the Richmond, Virginia area, including
the real estate markets in the area.  The concentrations of credit by
type of loan are set forth in Note 4.  The distribution of commitments
to extend credit approximates the distribution of loans
outstanding.
  Note
14.                      Stockholders’
equity and regulatory matters
  The
acquisition of River City Bank was consummated as of October 1, 2008 and
resulted in an addition of $5,464,000 of common stock.  The company
also issued 106,250 shares of common stock to the Company’s largest shareholder
for proceeds of $850,000 during the fourth quarter of 2008.
  The
Organizational Investors Warrant Plan made available 140,000 warrants for grant
to the Company’s initial (organizational) investors for certain risks associated
with the establishment of the Bank.  The warrants have an exercise
price of $10 per share (which approximates the fair value per share of common
stock at issuance date) and expired on April 30, 2008.  Prior to
expiration, warrants to purchase 47,000 shares were exercised resulting in
$475,000 in additional capital.
  73
  On
May 1, 2009, as part of the Capital Purchase Program established by the U.S.
Department of the Treasury (the “Treasury”) under the Emergency Economic
Stabilization Act of 2008 (“EESA”), the Company entered into a Letter Agreement
and Securities Purchase Agreement—Standard Terms (collectively, the “Purchase
Agreement”) with the Treasury, pursuant to which the Company sold
(i) 14,738 shares of the Company’s Fixed Rate Cumulative Perpetual
Preferred Stock, Series A, par value $4.00 per share, having a liquidation
preference of $1,000 per share (the “Preferred Stock”) and (ii) a warrant
(the “Warrant”) to purchase 499,029 shares of the Company’s common stock at an
initial exercise price of $4.43 per share, subject to certain anti-dilution and
other adjustments, for an aggregate purchase price of $14,738,000 in
cash.  The fair value of the preferred stock was estimated using
discounted cash flow methodology at an assumed market equivalent rate of 13%,
with 20 quarterly payments over a five year period, and was determined to be
$10,208,000.  The fair value of the warrant was estimated using the
Black-Scholes option pricing model, with assumptions of 25% volatility, a
risk-free rate of 2.03%, a yield of 6.162% and an estimated life of 5 years, and
was determined to be $534,000.  The aggregate fair value for both the
preferred stock and common stock warrants was determined to be $10,742,000 with
95% of the aggregate attributable to the preferred stock and 5% attributable to
the common stock warrant.  Therefore, the $14,738,000 issuance was
allocated with $14,006,000 being assigned to the preferred stock and $732,000
being allocated to the common stock warrant.  The difference between
the $14,738,000 face value of the preferred stock and the amount allocated of
$14,006,000 to the preferred stock is being accreted as a discount on the
preferred stock using the effective interest rate method over five
years.
  The
Preferred Stock will qualify as Tier 1 capital and will pay cumulative dividends
at a rate of 5% per annum for the first five years, and thereafter at a
rate of 9% per annum.  The Preferred Stock is generally
non-voting, other than on certain matters that could adversely affect the
Preferred Stock.
  The
Warrant is immediately exercisable.  The Warrant provides for the
adjustment of the exercise price and the number of shares of common stock
issuable upon exercise pursuant to customary anti-dilution provisions, such as
upon stock splits or distributions of securities or other assets to holders of
common stock, and upon certain issuances of common stock at or below a specified
price relative to the then-current market price of common stock.  The
Warrant expires ten years from the issuance date. If, on or prior to
December 31, 2009, the Company receives aggregate gross cash proceeds of
not less than the purchase price of the Preferred Stock from one or more
“Qualified Equity Offerings” announced after October 13, 2008, the number
of shares of common stock issuable pursuant to the Treasury’s exercise of the
Warrant will be reduced by one-half of the original number of shares, taking
into account all adjustments, underlying the Warrant.  Pursuant to the
Purchase Agreement, the Treasury has agreed not to exercise voting power with
respect to any shares of common stock issued upon exercise of the
Warrant.
  The
Bank is subject to various regulatory capital requirements administered by the
federal and state banking agencies.  Failure to meet minimum capital
requirements can initiate certain mandatory, and possible additional
discretionary, actions by regulators that, if undertaken, could have a direct
material effect on the Bank’s financial statements.  Under the capital
adequacy guidelines and the regulatory framework for prompt corrective action,
the Bank must meet specific capital guidelines that involve quantitative
measures of the Bank’s assets, liabilities, and certain off-balance-sheet items
as calculated under regulatory accounting practices.  The Bank’s
capital amounts and classification are also subject to qualitative judgments by
the regulators about components, risk weightings, and other
factors.
  Quantitative
measures are established by regulation to ensure capital adequacy require the
Bank to maintain minimum amounts and ratios (set forth in the table below) of
total and Tier 1 Capital (as defined in the regulations) to risk-weighted
assets, and of Tier 1 Capital to average assets (the Leverage
ratio).  Management believes that as of December 31, 2009, the Bank
meets all capital adequacy requirements to which it is subject.
  74
   Federal
regulatory agencies are required by law to adopt regulations defining five
capital tiers: well capitalized, adequately capitalized, under capitalized,
significantly under capitalized, and critically under
capitalized.  The Bank meets the criteria to be categorized as an
“well capitalized” institution as of December 31, 2009.
  The
capital amounts and ratios at December 31, 2009 and 2008 for the Company and the
Bank are presented in the table below:
   For
      CapitalActual
              
              Adequacy
      Purposes
              
              To
      be Well CapitalizedAmount
              
              Ratio
              
              Amount
              
              Ratio
              
              Amount
              
              RatioDecember
      31, 2009Total
      capital (to risk-weighted
      assets)Consolidated
              
              $64,072,000
              
              12.80%
              
              $40,048,000
              
              8.00%
              
              $50,060,000
              
              10.00%Village
      Bank
              
              54,796,000
              
              11.33%
              
              38,705,000
              
              8.00%
              
              48,382,000
              
              10.00%Tier
      1 capital (to risk-weighted
      assets)Consolidated
              
              57,762,000
              
              11.54%
              
              20,024,000
              
              4.00%
              
              30,036,000
              
              6.00%Village
      Bank
              
              48,693,000
              
              10.06%
              
              19,353,000
              
              4.00%
              
              29,029,000
              
              6.00%Leverage
      ratio (Tier 1capital
      to averageassets)Consolidated
              
              57,762,000
              
              9.39%
              
              24,607,000
              
              4.00%
              
              30,759,000
              
              5.00%Village
      Bank
              
              48,693,000
              
              8.24%
              
              23,643,000
              
              4.00%
              
              29,554,000
              
              5.00%December
      31, 2008Total
      capital (to risk-weighted
      assets)Consolidated
              
              $53,245,000
              
              10.63%
              
              $40,055,000
              
              8.00%
              
              $50,069,000
              
              10.00%Village
      Bank
              
              49,834,000
              
              10.27%
              
              38,835,000
              
              8.00%
              
              48,544,000
              
              10.00%Tier
      1 capital (to risk-weighted
      assets)Consolidated
              
              47,186,000
              
              9.42%
              
              20,028,000
              
              4.00%
              
              30,041,000
              
              6.00%Village
      Bank
              
              43,775,000
              
              9.02%
              
              19,418,000
              
              4.00%
              
              29,126,000
              
              6.00%Leverage
      ratio (Tier 1capital
      to averageassets)Consolidated
              
              47,186,000
              
              8.40%
              
              21,959,000
              
              4.00%
              
              27,449,000
              
              5.00%Village
      Bank
              
              43,775,000
              
              8.20%
              
              21,344,000
              
              4.00%
              
              26,681,000
              
              5.00%
  In
addition, banking regulations limit the amount of cash dividends that may be
paid without prior approval of the Bank’s regulatory agencies.  Such
dividends are limited to the lesser of the Bank’s retained earnings or the net
income of the previous two years combined with the current year net
income.
  75
   Note
15.                      Stock
incentive plan
 
 In
accordance with accounting standards the Company measures the cost of employee
services received in exchange for an award of equity instruments based on the
grant-date fair value of the award (with limited exceptions).  That cost is
recognized over the period during which an employee is required to provide
service in exchange for the award rather than disclosed in the financial
statements.  During the years ended December 31, 2009, 2008 and 2007 the
Company granted 3,000, 150,680 and 1,000 stock options, respectively, and the
total expense of these grants to be recognized over the three year vesting
period was $8,151, and $7,638 in 2009 and 2007, respectively.  The stock
options to acquire 150,680 shares granted during 2008 are related to the
purchase of River City Bank and the value of these options of $489,481 was
included as part of the purchase price.
 
 The
following table summarizes options outstanding under the stock incentive plan at
the indicated dates:
   Year
      Ended December 31,2009
              
              2008Weighted
              
              
              
              
              
              
              
              WeightedAverage
              
              
              
              
              
              
              
              AverageExercise
              
              Fair
      Value
              
              Intrinsic
              
              
              
              Exercise
              
              Fair
      Value
              
              IntrinsicOptions
              
              Price
              
              Per
      Share
              
              Value
              
              Options
              
              Price
              
              Per
      Share
              
              ValueOptions
      outstanding,beginning
      of period
              
              333,955
              
              $    9.63
              
              $  4.77
              
              
              
              247,410
              
              $  10.06
              
              $  4.69Granted
              
              3,000
              
              4.45
              
              2.86
              
              
              
              150,680
              
              8.49
              
              4.86Forfeited
              
              (950)
              
              10.78
              
              5.90
              
              
              
              (4,250)
              
              12.23
              
              5.14Exercised
              
              -
              
              -
              
              -
              
              
              
              (59,885)
              
              8.36
              
              4.64
              
              $  20,923Options
      outstanding,end
      of period
              
              336,005
              
              $    9.58
              
              $  4.75
              
              $             -
              
              333,955
              
              $    9.63
              
              $  4.77
              
              $            -Options
      exercisable,end
      of period
              
              300,900
              
              
              
              
              
              
              
              252,100Year
      Ended December 31,2007WeightedAverageExercise
              
              Fair
      Value
              
              IntrinsicOptions
              
              Price
              
              Per
      Share
              
              ValueOptions
      outstanding,beginning
      of period
              
              251,910
              
              $  10.22
              
              $   4.67Granted
              
              1,000
              
              13.96
              
              8.04Forfeited
              
              -
              
              -
              
              -Exercised
              
              (5,500)
              
              8.74
              
              4.07
              
              $     96,246Options
      outstanding,end
      of period
              
              247,410
              
              $  10.26
              
              $  4.70
              
              $1,295,438Options
      exercisable,end
      of period
              
              229,910
   The
fair value of each option granted is estimated on the date of grant using the
Black-Sholes option
    76
  pricing
model with the following assumptions used for grants for the years
indicated:
  Year
      Ended December 31,2009
              
              2008
              
              2007Risk-free
      interest rate
              
              3.46%
              
              2.88%
              
              4.81%Dividend
      yield
              
              0%
              
              0%
              
              0%Expected
      weighted average term
              
              7
      years
              
              7
      years
              
              7
      yearsVolatility
              
              50%
              
              50%
              
              50%
  The
following table summarizes information about stock options outstanding at
December 31, 2009:
  Outstanding
              
              ExercisableWeightedAverageRemaining
              
              Weighted
              
              
              
              WeightedYears
      of
              
              Average
              
              
              
              AverageRange
      of
              
              Number
      of
              
              Contractual
              
              Exercise
              
              Number
      of
              
              ExerciseExercise
      Prices
              
              Options
              
              Life
              
              Price
              
              Options
              
              Price$7.68
      - $9.24
              
              144,030
              
              4.7
              
              $    7.19
              
              126,175
              
              $    7.28$11.20
      - $13.96
              
              191,975
              
              6.4
              
              11.57
              
              174,475
              
              10.40336,005
              
              5.7
              
              9.69
              
              300,650
              
              9.09
  During
the first quarter of 2007, the Company granted to certain officers 5,725
restricted shares of common stock and 5,725 performance shares of common stock
with a weighted average fair market value of $15.95 at the date of
grant.  During the second quarter an additional 175 restricted shares
of common stock and 175 performance shares of common stock were granted with a
weighted average fair market value of $16.75 at the date of
grant.  These restricted stock awards have three-year graded vesting
and the performance shares cliff vest at the end of three years.  The
number of performance shares that ultimately vest is dependent upon achieving
specific performance targets.  Prior to vesting, these shares are
subject to forfeiture to us without consideration upon termination of employment
under certain circumstances.  During the first quarter of 2009, we
granted to certain officers 26,592 restricted shares of common stock with a
weighted average fair market value of $4.60 at the date of
grant.  These restricted stock awards have three-year graded
vesting.  Prior to vesting, these shares are subject to forfeiture to
us without consideration upon termination of employment under certain
circumstances.  The total number of shares underlying non-vested
restricted stock and performance share awards was 27,219 and 8,709 at December
31, 2009 and 2008, respectively.
  The
fair value of the stock is calculated under the same methodology as stock
options and the expense is recognized over the vesting
period.  Unamortized stock-based compensation related to nonvested
share based compensation arrangements granted under the Incentive Plan as of
December 31, 2009and 2008 was $324,051 and $173,031, respectively.  Of
the $324,051 of unamortized compensation at December 31, 2009, $91,055 relates
to performance based restricted stock awards.  The time based
unamortized compensation of $232,966 is expected to be recognized over a
weighted average period of 2.0 years.  The total fair value of shares
vested during the years ended December 31, 2009, 2008 and 2007 was $157,851
$65,886 and $59,735, respectively.  There were 1,092 and 350
forfeitures of restricted stock awards in 2009 and 2008, respectively, and none
in 2007.
  Stock-based
compensation expense was $157,699 and $555,367 for the years ended December
31,
  77
  2009
and 2008, respectively.
  Stock-based
compensation expense was $157,699, $65,887 and $59,734 for the years ended
December 31, 2009, 2008 and 2007, respectively.
  Note
16.                      Trust
preferred securities
  During
the first quarter of 2005, Southern Community Financial Capital Trust I, a
wholly-owned subsidiary of the Company, was formed for the purpose of issuing
redeemable securities.  On February 24, 2005, $5.2 million of Trust
Preferred Capital Notes were issued through a pooled
underwriting.  The securities have a LIBOR-indexed floating rate of
interest (three-month LIBOR plus 2.15%) which adjusts, and is payable,
quarterly. The interest rate was 2.40% and 4.97% at December 31, 2009 and 2008,
respectively.  The securities may be redeemed at par beginning on
March 15, 2010 and each quarter after such date until the securities mature on
March 15, 2035.  The principal asset of the Trust is $5.2 million of
the Company’s junior subordinated debt securities with like maturities and like
interest rates to the Trust Preferred Capital Notes.
  During
the third quarter of 2007, Village Financial Statutory Trust II, a wholly –owned
subsidiary of the Company, was formed for the purpose of issuing redeemable
securities.  On September 20, 2007, $3.6 million of Trust Preferred
Capital Notes were issued through a pooled underwriting.  The
securities have a five year fixed interest rate of 6.29% payable quarterly,
converting after five years to a LIBOR-indexed floating rate of interest
(three-month LIBOR plus 1.4%) which adjusts and is also payable
quarterly.  The securities may be redeemed at par at any time
commencing in December 2012 until the securities mature in 2037.  The
principal asset of the Trust is $3.6 million of the Company’s junior
subordinated securities with like maturities and like interest rates to the
Trust Preferred Capital Notes.
  The
Trust Preferred Capital Notes may be included in Tier 1 capital for regulatory
capital adequacy determination purposes up to 25% of Tier 1 capital after its
inclusion.  The portion of the Trust Preferred Capital Notes not
considered as Tier 1 capital may be included in Tier 2 capital.
  The
obligations of the Company with respect to the issuance of the Trust Preferred
Capital Notes constitute a full and unconditional guarantee by the Company of
the Trust’s obligations with respect to the Trust Preferred Capital
Notes.  Subject to certain exceptions and limitations, the Company may
elect from time to time to defer interest payments on the junior subordinated
debt securities, which would result in a deferral of distribution payments on
the related Trust Preferred Capital Notes and require a deferral of common
dividends.
  Note
17.                      Retirement
plans
  401K
Plan:  The Bank provides a qualified 401K plan to all eligible
employees which is administered through the Virginia Bankers Association
Benefits Corporation.  Employees are eligible to participate in the
plan after three months of employment.  Eligible employees may,
subject to statutory limitations, contribute a portion of their salary to the
plan through payroll deduction.  Due to the recent economic conditions
the Bank ceased it matching program in 2009 and does not anticipate making ay
contributions in 2010. Prior to 2009 the Bank provided a matching contribution
of $.50 for every $1.00 the participant contributes up to the first 4% of their
salary.  Participants were fully vested in their own contributions and
vested equally over three years of service in the Bank’s matching
contributions.  Total contributions to the plan for the years ended
December 31, 2008, and 2007 were $107,918 and $98,705
respectively.
  Supplemental
Executive Retirement Plan:  The Bank established the Village
Bank Supplemental Executive Retirement Plan (the “SERP”) on January 1, 2005 to
provide supplemental retirement income to certain executive officers as
designated by the Personnel Committee and approved by the Board of
Directors.  The SERP is an unfunded employee pension plan under the
provisions of ERISA.  An eligible employee, once designated by the
Committee and approved by the Board of
  78
  Directors
in writing to participate in the SERP, becomes a participant in the SERP 60 days
following such approval (unless an earlier participation date is
approved).  There are currently five executive officers who
participate in the SERP.  The retirement benefit to be received by a
participant is determined by the Committee and approved by the Board of
Directors and is payable in equal monthly installments over a 15 year period,
commencing on the first day of the month following a participant’s retirement or
termination of employment, provided the participant has been employed by the
Bank for a minimum of 10 years (6 years in the case of one
participant).  The Personnel Committee, in its sole discretion, may
choose to treat a participant who has experienced a termination of employment on
or after attaining age 65 but prior to completing his service requirement as
having completed his service requirement.  At December 31, 2009 and
2008, the Bank’s liability under the SERP was $963,122 and $328,880,
respectively, and expense for the years ended December 31, 2009, 2008 and 2007
was to $266,829, $112,459 and $166,495, respectively.  The increase in
cash surrender value of the BOLI related to the participants was $331,980,
$81,101 and $62,410 for the years ended December 31, 2009, 2008 and 2007,
respectively.
  Directors’
Deferral Plan:  The Bank established the Village Bank Outside
Directors Deferral Plan (the “Directors Deferral Plan”) on January 1, 2005 under
which non-employee Directors of Village Bank have the opportunity to defer
receipt of all or a portion of certain compensation until retirement or
departure from the Board of Directors.  Deferral of compensation under
the Directors Deferral Plan is voluntary by non-employee Directors and to
participate in the plan a director must file a deferral election as provided in
the plan.  A Director shall become an active participant with respect
to a plan year (as defined in the plan) only if he is expected to have
compensation during the plan year and he timely files a deferral
election.  A separate account is established for each participant in
the plan and each account shall, in addition to compensation deferred at the
election of the participant, be credited with interest on the balance of the
account, the rate of such interest to be established by the Board of Directors
in its sole discretion at the beginning of each plan year.  At
December 31, 2009 and 2008, the Bank’s liability under the Directors Deferral
Plan was $367,413 and $263,472, respectively, and expense for the years ended
December 31, 2009, 2008 and 2007 was $103,941, $82,599 and $74.607,
respectively.
  Note
18.  Fair Value
  Effective
January 1, 2008, the Company adopted the provisions of FASB Codification Topic
820: Fair
Value Measurements which defines fair value, establishes a framework for
measuring fair value under U.S GAAP, and expands disclosures about fair value
measurements.
  The
fair value of an asset or liability is the price that would be received to sell
that asset or paid to transfer that liability in an orderly transaction between
market participants. A fair value measurement assumes that the transaction to
sell the asset or transfer the liability occurs in the principal market for the
asset or liability or, in the absence of a principal market, the most
advantageous market for the asset or liability. The price in the principal (or
most advantageous) market used to measure the fair value of the asset or
liability shall not be adjusted for transaction costs. An orderly transaction is
a transaction that assumes exposure to the market for a period prior to the
measurement date to allow for marketing activities that are usual and customary
for transactions involving such assets and liabilities; it is not a forced
transaction. Market participants are buyers and sellers in the principal market
that are independent, knowledgeable, able to transact and willing to
transact.
  FASB
Codification Topic 820: Fair Value Measurements and Disclosures establishes a hierarchy
for valuation inputs that gives the highest priority to quoted prices in active
markets for identical assets or liabilities and the lowest priority to
unobservable inputs.  The fair values hierarchy is as
follows:
  79
  ●
              Level
      1 Inputs— Quoted prices (unadjusted) for identical assets or liabilities
      in active markets that the entity has the ability to access as of the
      measurement date.
  ●
              Level
      2 Inputs— Significant other observable inputs other than Level 1
      prices such as quoted prices for similar assets or liabilities; quoted
      prices in markets that are not active; or other inputs that are observable
      or can be corroborated by observable market
  data.
  ●
              Level
      3 Inputs- Significant unobservable inputs that reflect a company’s
      own assumptions about the assumptions that market participants would use
      in pricing an asset or
liability.
  The
Company used the following methods to determine the fair value of each type of
financial instrument:
  Investment
securities: The fair values for investment securities are determined by
quoted prices for similar assets or liabilities (Level 2).
  Residential
loans held for sale: The fair value of loans held for sale is determined
using quoted prices for a similar asset, adjusted for specific attributes of
that loan (Level 2).
  Impaired
loans: The fair values of impaired loans are measured for impairment
using the fair value of the collateral for collateral-dependent loans on a
nonrecurring basis. Collateral may be in the form of real estate or business
assets including equipment, inventory and accounts receivable. The use of
discounted cash flow models and management’s best judgment are significant
inputs in arriving at the fair value measure of the underlying collateral and
are therefore classified within (Level 3).
  Real
estate owned: Real estate owned assets are adjusted to fair value upon
transfer of the loans to foreclosed assets. Subsequently, real estate owned
assets are carried at net realizable value. Fair value is based upon independent
market prices, appraised values of the collateral or management’s estimation of
the value of the collateral. When the fair value of the collateral is based on
an observable market price or a current appraised value, the Company records the
foreclosed asset as nonrecurring Level 2.  When an appraised value is
not available or management determines the fair value of the collateral is
further impaired below the appraised value and there is no observable market
price, the Company records the foreclosed asset as nonrecurring Level 3.
  Assets
and liabilities measured at fair value under Topic 820 on a recurring and
non-recurring basis, including financial assets and liabilities for which the
Company has elected the fair value option, are summarized
below:
  80
  
 Fair
      Value Measurementat
      December 31, 2009 Using(In
      Thousands)Carrying
      Value
              
              Quoted
      Prices in Active Markets for Identical Assets (Level 1)
              
              Other  Observable
      Inputs (Level 2)
              
              Significant
      Unobservable Inputs (Level 3)Financial
      Assets-RecurringUS
      Government Agencies
              
              $       47,669
              
              
              
              $         47,669MBS
              
              4,178
              
              
              
              4,178Municipals
              
              1,027
              
              
              
              1,027Other
      available for sale (1)
              
              1,983
              
              
              
              1,983Financial
      Assets-Non-RecurringImpaired
      loans
              
              25,913
              
              
              
              
              
              $        25,913Real
      estate owned
              
              11,279
              
              
              
              
              
              11,279Residential
      loans held for sale
              
              7,506
              
              
              
              7,506(1)
      Excludes restricted stock.Fair
      Value Measurementat
      December 31, 2008 Using(In
      Thousands)Carrying
      Value
              
              Quoted
      Prices in Active Markets for Identical Assets (Level 1)
              
              Other  Observable
      Inputs (Level 2)
              
              Significant
      Unobservable Inputs (Level 3)Financial
      Assets-RecurringUS
      Government Agencies
              
              $       17,045
              
              
              
              $        17,045MBS
              
              5,470
              
              
              
              5,470Other
      available for sale (1)
              
              1,786
              
              
              
              1,786Financial
      Assets-Non-RecurringImpaired
      loans
              
              8,528
              
              
              
              
              
              $        8,528Real
      estate owned
              
              2,932
              
              
              
              
              
              2,932Residential
      loans held for sale
              
              4,326
              
              
              
              4,326(1)
      Excludes restricted stock.
   The
following tables present the changes in the Level 3 fair value category for the
year ended December 31, 2009.
  81
  
 Impaired
              
              Real
      EstateLoans
              
              Owned
              
              Total
      Assets(in
      thousands)Balance
      at December 31, 2007
              
              $  2,585
              
              $     270
              
              $    2,855Total
      realized and unrealized gains (losses)Included
      in earnings
              
              -
              
              -
              
              -Included
      in other comprehensive income
              
              -
              
              -
              
              -Net
      transfers in and/or out of Level 3
              
              5,943
              
              2,662
              
              8,605Balance
      at December 31, 2008
              
              8,528
              
              2,932
              
              11,460Total
      realized and unrealized gains (losses)Included
      in earnings
              
              -
              
              46
              
              46Included
      in other comprehensive income
              
              -
              
              -
              
              -Net
      transfers in and/or out of Level 3
              
              17,385
              
              8,301
              
              25,686Balance
      at December 31, 2009
              
              $  25,913
              
              $
      11,279
              
              $  25,732
   In
general, fair value of securities is based upon quoted market prices, where
available. If such quoted market prices are not available, fair value is based
upon market prices determined by an outside, independent entity that primarily
uses as inputs, observable market-based parameters. Fair value of loans held for
sale is based upon internally developed models that primarily use as inputs,
observable market-based parameters. Valuation adjustments may be made to ensure
that financial instruments are recorded at fair value. These adjustments may
include amounts to reflect counterparty credit quality, the Company’s
creditworthiness, among other things, as well as unobservable parameters. Any
such valuation adjustments are applied consistently over time. The Company
valuation methodologies may produce a fair value calculation that may not be
indicative of net realizable value or reflective of future fair values. While
management believes the Company’s valuation methodologies are appropriate and
consistent with other market participants, the use of different methodologies or
assumptions to determine the fair value of certain financial instruments could
result in a different estimate of fair value at the reporting date.
  Cash
and cash equivalents – The carrying amount of cash and cash equivalents
approximates fair value.
  Investment
securities – The fair value of investment securities held-to-maturity and
available-for-sale is estimated based on bid quotations received from
independent pricing services.  The carrying amount of other
investments approximates fair value.
  Loans
– For variable rate loans that reprice frequently and have no significant change
in credit risk, fair values are based on carrying values.  For all
other loans, fair values are calculated by discounting the contractual cash
flows using estimated market discount rates which reflect the credit and
interest rate risk inherent in the loans, or by using the current rates at which
similar loans would be made to borrowers with similar credit ratings and for the
same remaining maturities.
  Deposits
– The fair value of deposits with no stated maturity, such as demand, interest
checking and money market, and savings accounts, is equal to the amount payable
on demand at year-end.  The fair value of certificates of deposit is
based on the discounted value of contractual cash flows using the rates
currently offered for deposits of similar remaining
maturities.
  Borrowings
– The fair value of FHLB borrowings is based on the discounted value of
contractual cash flows using the rates currently offered for borrowings of
similar remaining maturities.  The carrying amounts of federal funds
purchased approximate their fair values.  Other borrowings
are
  82
  short-term
in nature and the carrying amounts approximate fair value.
  Accrued
interest – The carrying amounts of accrued interest receivable and
payable approximate fair value.
  Off-balance-sheet
instruments – The fair value of off-balance-sheet lending commitments is
equal to the amount of commitments outstanding at December 31, 2009 of
$72,876,000.  This is based on the fact that the Bank generally does
not offer lending commitments or standby letters of credit to its customers for
long periods, and therefore, the underlying rates of the commitments approximate
market rates.
  2009
              
              2008Carrying
              
              Estimated
              
              Carrying
              
              EstimatedValue
              
              Fair
      Value
              
              Value
              
              Fair
      ValueFinancial
      assetsCash
      and cash equivalents
              
              $  20,661,820
              
              $  20,661,820
              
              $  26,612,829
              
              $  26,612,829Investment
      securities available for sale
              54,857,211
              
              54,857,211
              
              24,300,962
              
              24,300,962Loans
      held for sale
              
              7,506,252
              
              7,506,252
              
              4,325,746
              
              4,325,746Loans
              
              457,046,616
              
              466,271,730
              
              464,663,014
              
              506,263,603Accrued
      interest receivable
              
              3,366,718
              
              3,366,718
              
              3,499,793
              
              3,499,793Financial
      liabilitiesDeposits
              
              498,285,124
              
              500,979,984
              
              466,232,043
              
              442,567,544FHLB
      borrowings
              
              29,000,000
              
              29,011,904
              
              25,000,000
              
              24,977,639Trust
      preferred securities
              
              8,764,000
              
              8,764,000
              
              8,764,000
              
              8,764,000Other
      borrowings
              
              14,829,521
              
              14,829,521
              
              23,962,898
              
              23,962,898Accrued
      interest payable
              
              501,069
              
              501,069
              
              1,014,534
              
              1,014,534Off-balance-sheet
      instrumentsUndisbursed
      credit lines
              
              
              
              49,621,000
              
              
              
              70,659,000Commitments
      to extend or originatecredit
              
              
              
              19,078,000
              
              
              
              14,109,000Standby
      letters of credit
              
              
              
              4,177,000
              
              
              
              4,124,000
    83
  Note
19.                      Parent
corporation only financial statements
   Village
      Bank and Trust Financial Corp.(Parent
      Corporation Only)Balance
      SheetsDecember
      31, 2009 and 20082009
              
              2008AssetsCash
      and due from banks
              
              $    2,835,334
              
              $       721,617Investment
      in subsidiaries
              
              48,669,651
              
              51,404,282Investment
      in special purpose subsidiary
              
              264,000
              
              264,000Premises
      and equipment, net
              
              14,564,323
              
              14,588,892Prepaid
      expenses and other assets
              
              7,184,697
              
              1,263,948$  73,518,005
              
              $  68,242,739Liabilities
      and Stockholders' EquityLiabilitiesLong-term
      debt - trust preferred securities
              
              $    8,764,000
              
              $    8,764,000Payable
      to subsidiary
              
              3,203,546
              
              700,737Other
      Borrowings
              
              11,943,873
              
              12,271,871Other
      liabilities
              
              664,767
              
              343,557Total
      liabilities
              
              24,576,186
              
              22,080,165Stockholders'
      equityPreferred
      stock
              
              58,952
              
              -Common
      stock
              
              16,922,512
              
              16,917,488Additional
      paid-in capital
              
              40,568,771
              
              25,737,048Retained
      earnings (deficit)
              
              (8,647,731)
              
              3,453,788Warrant
      surplus
              
              732,479Discount
      on preferred stock
              
              (636,959)
              
              -Accumulated
      other comprehensive
              
              
              
              -Income
      (loss)
              
              (56,205)
              
              54,250Total
      stockholders' equity
              
              48,941,819
              
              46,162,574$  73,518,005
              
              $   68,242,739
   84
  
 Village
      Bank and Trust Financial Corp.(Parent
      Corporation Only)Statement
      of OperationsYears
      Ended December 31, 2009, 2008 and 20072009
              
              2008
              
              2007Noninterest
      incomeRental
      Income
              
              $    
      881,496
              
              $  265,515
              
              $               -Total
      noninterest income
              
              881,496
              
              265,515
              
              -ExpensesInterest
              
              978,634
              
              $  708,020
              
              $   447,381Occupancy
              
              636,053
              
              232,612
              
              11,700Equipment
              
              19,767
              
              7,140
              
              -Advertising
      and marketing
              
              717
              
              4,468
              
              -Supplies
              
              51,426
              
              52,951
              
              33,850Legal
              
              22,126
              
              897
              
              15,029Audit
      and accounting
              
              6,719
              
              -
              
              -Other
      outside services
              
              39,676
              
              17,050
              
              6,389Insurance
              
              15,195
              
              6,065
              
              -Telephone
              
              -
              
              44,942
              
              -Other
              
              52,452
              
              21,788
              
              -Total
      expenses
              
              1,822,765
              
              1,095,933
              
              514,349Net
      loss before undistributed equity in subsidiary
              
              (941,269)
              
              (830,418)
              
              (514,349)Undistributed
      equity in subsidiary
              
              (12,782,126)
              
              1,016,165
              
              1,340,533Net
      income before income taxes
              
              (13,723,395)
              
              185,747
              
              826,184Income
      taxes (benefit)
              
              (2,212,027)
              
              (282,342)
              
              (174,879)Net
      income (loss)
              
              $(11,511,368)
              
              $   468,089
              
              $  1,001,063
   85
  
 Village
      Bank and Trust Financial Corp.(Parent
      Corporation Only)Statement
      of Cash FlowsYears
      Ended December 31, 2009, 2008 and 20072009
              
              2008
              
              2007Cash
      Flows from Operating ActivitiesNet
      income
              
              $(11,511,368)
              
              $    468,089
              
              $   1,001,063Adjustments
      to reconcile net income to net cashprovided
      by operating activitiesStock
      compensation expense
              
              -Depreciation
      and amortization
              
              392,150
              
              9,012
              
              -Undistributed
      earnings of subsidiary
              
              12,782,126
              
              (1,016,165)
              
              (1,340,533)Increase/Decrease
      in other assets
              
              (5,920,749)
              
              293,101
              
              1,004,831Increase
      in other liabilities
              
              2,823,769
              
              1,335,642
              
              (473,426)Net
      cash provided by operations
              
              (1,434,072)
              
              1,089,679
              
              191,935Cash
      Flows from Investing ActivitiesPayments
      for investments in and advances to subsidiaries
              (10,000,000)
              
              (20,108,076)
              
              -Purchase
      of premises and equipment
              
              (367,581)
              
              (7,913,499)
              
              (6,684,405)Net
      cash used in operations
              
              (10,367,581)
              
              (28,021,575)
              
              (6,684,405)Cash
      Flows from Financing ActivitiesProceeds
      from issuance of preferred stock
              
              14,738,000
              
              -
              
              -Proceeds
      from issuance of long-term debt
              
              -
              
              -
              
              3,609,000Proceeds
      from issuance of common stock
              
              -
              
              18,068,960
              
              133,234Net
      increase (decrease) in other borrowings
              
              (327,998)
              
              9,435,781
              
              2,836,090Dividends
      on preferred stock
              
              (494,632)Net
      cash provided by operations
              
              13,915,370
              
              27,504,741
              
              6,578,324Net
      increase in cash
              
              2,113,717
              
              572,845
              
              85,854Cash,
      beginning of period
              
              721,617
              
              148,772
              
              62,918Cash,
      end of period
              
              $  2,835,334
              
              $  721,617
              
              $  148,772
   86
  Note
20.                      Selected
quarterly financial data (unaudited)
  Condensed
quarterly financial data is shown as follows:
   First
              
              Second
              
              Third
              
              FourthQuarter
              
              Quarter
              
              Quarter
              
              Quarter2009Interest
      income
              
              $    8,353,428
              
              $    8,427,816
              
              $    8,334,206
              
              $    8,080,523Interest
      expense
              
              4,446,762
              
              4,259,921
              
              4,009,344
              
              3,691,652Net
      interest income beforeprovision
      for loan losses
              
              3,906,666
              
              4,167,895
              
              4,324,862
              
              4,388,871Provision
      for loan losses
              
              1,100,000
              
              3,100,000
              
              6,000,000
              
              3,020,000Gain
      on sale of loans
              
              943,116
              
              1,509,971
              
              1,842,129
              
              1,532,790Fees
      and other noninterestincome
              
              513,270
              
              525,773
              
              552,101
              
              874,951Goodwill
      impairment
              
              -
              
              -
              
              -
              
              7,422,141Noninterest
      expenses
              
              4,376,899
              
              5,803,529
              
              4,916,631
              
              5,818,683Income
      tax (benefit)
              
              (38,708)
              
              (917,962)
              
              (1,427,260)
              
              (2,589,186)Net
      loss
              
              (75,139)
              
              (1,781,928)
              
              (2,770,279)
              
              (6,884,027)Loss
      per shareBasic
              
              $         (0.02)
              
              $          (0.45)
              
              $         (0.70)
              
              $         (1.80)Diluted
              
              $         (0.02)
              
              $          (0.45)
              
              $         (0.70)
              
              $         (1.80)2008Interest
      income
              
              $  6,758,711
              
              $   6,869,527
              
              $  6,725,218
              
              $  8,718,690Interest
      expense
              
              3,973,172
              
              3,681,656
              
              3,628,988
              
              4,685,967Net
      interest income beforeprovision
      for loan losses
              
              2,785,539
              
              3,187,871
              
              3,096,230
              
              4,032,723Provision
      for loan losses
              
              249,354
              
              498,024
              
              514,827
              
              743,428Gain
      on sale of loans
              
              426,517
              
              608,344
              
              717,830
              
              628,332Fees
      and other noninterestincome
              
              331,874
              
              373,782
              
              579,737
              
              611,661Noninterest
      expenses
              
              3,153,167
              
              3,400,998
              
              3,547,443
              
              4,564,010Income
      tax expense
              
              48,078
              
              92,131
              
              112,719
              
              (11,831)Net
      income (loss)
              
              93,331
              
              178,844
              
              218,808
              
              (22,891)Earnings
      (loss) per shareBasic
              
              $          0.04
              
              $           0.07
              
              $           0.08
              
              $         (0.01)Diluted
              
              $          0.04
              
              $           0.07
              
              $           0.08
              
              $         (0.01)
       87
  ITEM
9.  CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
  None.
   ITEM
9A.  CONTROLS AND PROCEDURES
  Attached
as exhibits to this Form 10-K are certifications of the Company’s Chief
Executive Officer (CEO) and Chief Financial Officer (CFO), which are
required in accordance with Rule 13a-14 of the Securities Exchange Act of
1934, as amended (the Exchange Act). This “Controls and Procedures” section
includes information concerning the controls and controls evaluation referred to
in the certifications.
  Conclusion
Regarding the Effectiveness of Disclosure Controls and
Procedures
  As
of the end of the period covered by this report, the Company carried out an
evaluation, under the supervision and with the participation of the Company’s
management, including the Company’s Chief Executive Officer and Chief Financial
Officer, of the effectiveness of the design and operation of the Company’s
disclosure controls and procedures pursuant to the Securities Exchange Act of
1934, as amended.  Based upon that evaluation, the Company’s Chief
Executive Officer and Chief Financial Officer concluded that the Company’s
disclosure controls and procedures are effective in recording, processing,
summarizing and timely reporting to management information relating to the
Company (including its consolidated subsidiaries) required to be included in the
Company’s reports that it files or submits under the Exchange Act.
  The
Company’s management is also responsible for establishing and maintaining
adequate internal control over financial reporting.  There were no
changes in the Company’s internal control over financial reporting identified in
connection with the evaluation of it that occurred during the Company’s last
fiscal quarter that materially affected, or are reasonably likely to materially
affect, internal control over financial reporting.
   88
  Report
on Management’s Assessment of Internal Control over Financial
Reporting
  Management
of the Company is responsible for establishing and maintaining adequate internal
control over financial reporting.  Internal control is designed to
provide reasonable assurance regarding the reliability of financial reporting
and the preparation of financial statements for external purposes in accordance
with accounting principles generally accepted in the United States of
America.  Management regularly monitors its internal control over
financial reporting and takes appropriate action to correct any deficiencies
that may be identified.
  Management
assessed the Company’s internal control over financial reporting as of
December 31, 2009.  This assessment was based on criteria
established in Internal
Control—Integrated Framework issued by the Committee of Sponsoring
Organizations of the Treadway Commission. Based on this assessment, management
concluded that the Company maintained effective internal control over financial
reporting as of December 31, 2009.
  Because
of its inherent limitations, internal control over financial reporting may not
prevent or detect misstatements.  Further, because of changes in
conditions, internal control effectiveness may vary over time.
  This
annual report does not include an attestation report of the Company’s registered
public accounting firm regarding internal control over financial
reporting.  Management’s report was not subject to attestation by the
Company’s registered public accounting firm pursuant to temporary rules of the
Securities and Exchange Commission that permit the Company to provide only
management’s report in this annual report.
   /s/  Thomas
W. Winfree
 President
and Chief Executive Officer
   /s/  C.
Harril Whitehurst, Jr.
 Senior
Vice President and Chief Financial Officer
   March
26, 2010
 Date
   ITEM
9B.  OTHER INFORMATION
  None.
  89
  PART
III
   ITEM
10.  DIRECTORS, EXECUTIVE OFFICERS, AND CORPORATE
GOVERNANCE
  The
information required to be disclosed in this Item 10 is contained in the
Company’s Proxy Statement for the 2010 Annual Meeting of Shareholders and is
incorporated herein by reference.
   ITEM
11.  EXECUTIVE COMPENSATION
  The
information required to be disclosed in this Item 11 is contained in the
Company’s Proxy Statement for the 2010 Annual Meeting of Shareholders and is
incorporated herein by reference.
   ITEM
12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED
STOCKHOLDER MATTERS
  The
information required to be disclosed in this Item 12 is contained in the
Company’s Proxy Statement for the 2010 Annual Meeting of Shareholders and is
incorporated herein by reference.
   ITEM
13.  CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR
INDEPENDENCE
  The
information required to be disclosed in this Item 13 is contained in the
Company’s Proxy Statement for the 2010 Annual Meeting of Shareholders and is
incorporated herein by reference.
   ITEM
14.  PRINCIPAL ACCOUNTING FEES AND SERVICES
  The
information required to be disclosed in this Item 14 is contained in the
Company’s Proxy Statement for the 2010 Annual Meeting of Shareholders and is
incorporated herein by reference.
     90
  PART
IV
   ITEM
15.  EXHIBITS, FINANCIAL STATEMENT SCHEDULES
  (a)(1)
Financial Statements
 The
following consolidated financial statements and reports are included in Part II,
Item 8, of this report on Form 10K.
  Report
of Independent Registered Public Accounting Firm (BDO Seidman)
 Consolidated
Balance Sheets – December 31, 2009 and 2008
 Consolidated
Statements of Income – Years Ended December 31, 2009, 2008 and 2007
Consolidated Statements of Changes in Stockholders’ Equity and
 Comprehensive Income – Years Ended
December 31, 2009, 2008 and 2007
 Consolidated
Statements of Cash Flows – Years Ended December 31, 2009, 2008 and
2007
 Notes
to Consolidated Financial Statements
  (a)(2)
Financial Statement Schedules
 All
schedules are omitted since they are not required, are not applicable, or the
required information is shown in the consolidated financial statements or notes
thereto.
  (a)(3)
Exhibits
 The
following exhibits are filed as part of this Form 10-K and this list includes
the Exhibit Index.
 
  Exhibit
 NumberDescription
  2.1
              Agreement
      and Plan of Reorganization and Merger by and among Village Bank and Trust
      Financial Corp., Village Bank and River City Bank dated as of March 9,
      2008 incorporated by reference from Annex A to the joint proxy
      statement/prospectus included in the Registration Statement on Form S-4/A
      filed with the Securities and Exchange Commission on August 5, 2008.
  3.1
              Articles
      of Incorporation of Village Bank and Trust Financial Corp. restated in
      electronic format only as of May 18,
2005.
  3.2
              Articles
      of Amendment to the Company’s Articles of Incorporation, designating the
      terms of the Fixed Rate Cumulative Perpetual Preferred Stock, Series A,
      incorporated by reference to Exhibit 3.1 of the Current Report on Form 8-K
      filed with the Securities and Exchange Commission on May 6,
      2009
  3.3
              Bylaws
      of Village Bank and Trust Financial Corp., incorporated by reference to
      Exhibit 3.1 of the Current Report on Form 8-K filed with the Securities
      and Exchange Commission on December 10,
2007.
  4.1
              Form
      of Certificate for Fixed Rate Cumulative Perpetual Preferred Stock, Series
      A, incorporated by reference to Exhibit 4.1 of the Current Report on Form
      8-K filed with the Securities and Exchange Commission on May 6,
      2009.
   91
  4.2
              Warrant
      to Purchase Shares of Common Stock, dated May 1, 2009, incorporated by
      reference to Exhibit 4.2 of the Current Report on Form 8-K filed with the
      Securities and Exchange Commission on May 6,
  2009.
  10.1
              Incentive
      Plan, as amended and restated May 23, 2006, incorporated by reference to
      Exhibit 10.1 of the Quarterly Report on Form 10-QSB for the period ended
      June 30, 2006.*
  10.2
              Organizational
      Investors Warrant Plan, incorporated by reference to Exhibit 10.2 of the
      Annual Report on Form 10-KSB for the year ended December 31,
      2004.
  10.3
              Shareholder
      Loan Referral Warrant Plan, incorporated by reference to Exhibit 10.3 of
      the Annual Report on Form 10-KSB for the year ended December 31,
      2004.
  10.4
              Executive
      Employment Agreement, effective as of April 1, 2001, between Thomas W.
      Winfree and Southern Community Bank & Trust, incorporated by reference
      to Exhibit 10.4 of the Annual Report on Form 10-KSB for the year ended
      December 31, 2004.*
  10.5
              Form
      of Incentive Stock Option Agreement, incorporated by reference to Exhibit
      10.5 of the Annual Report on Form 10-KSB for the year ended December 31,
      2004.*
  10.6
              Form
      of Non-Employee Director Non-Qualified Stock Option Agreement,
      incorporated by reference to Exhibit 10.6 of the Annual Report on Form
      10-KSB for the year ended December 31, 2004.
*
  10.7
              Letter
      Agreement, dated as of May 1, 2009, by and between Village Bank and Trust
      Financial Corp. and the United States Department of the Treasury,
      incorporated by reference to Exhibit 10.1 of the Current Report on Form
      8-K filed with the Securities and Exchange Commission on May 6,
      2009.
  10.8
              Side
      Letter Agreement, dated as of May 1, 2009, by and between Village Bank and
      Trust Financial Crop. and the United States Department of the Treasury,
      incorporated by reference to Exhibit 10.2 of the Current Report of Form
      8-K filed with the Securities and Exchange Commission on May 6,
      2009.
  10.9
              Form
      of Senior Executive Officer Waiver, incorporated by reference to Exhibit
      10.3 of the Current Report on Form 8-K filed with the Securities and
      Exchange Commission on May 6,
2009.*
  10.10
              Form
      of Senior Executive Officer Consent Letter, incorporated by reference to
      Exhibit 10.4 of the Current Report on Form 8-K filed with the Securities
      and Exchange Commission on May 6,
2009.*
  21
              Subsidiaries
      of Village Bank and Trust Financial
Corp.
  31.1
              Section
      302 Certification by Chief Executive
Officer.
  31.2
              Section
      302 Certification by Chief Financial
Officer.
  92
   32
              Section
      906 Certification.
  99.1
              TARP
      Certification by Chief Executive
Officer.
  99.2
              TARP
      Certification by Chief Financial
Officer.
   _____________________________
 *
      Management contracts and compensatory plans and
    arrangements.
    93
  SIGNATURES
  Pursuant
to the requirements of Section 13 or 15(d) 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.
   VILLAGE
BANK AND TRUST FINANCIAL CORP.
    Date:  March
26,
2010                                     By:/s/ Thomas W. Winfree
 Thomas
W. Winfree
 President
and Chief Executive Officer
   In
accordance with the Exchange Act, this report has been signed below by the
following persons on behalf of the registrant and in the capacities and on the
dates indicated.
  Signature
              Title
              Date/s/ Thomas W.
      Winfree
                Thomas
      W. Winfree
              President
      and Chief Executive
                Officer
      and Director
                (Principal
      Executive Officer)
              March
      26, 2010/s/
      C. Harril Whitehurst, Jr.
                C.
      Harril Whitehurst, Jr.
              Senior
      Vice President and Chief Financial Officer (Principal Financial and
      Accounting Officer)
              March
      26, 2010/s/
      R. T. Avery, III
                R.T.
      Avery, III
              Director
              March
      26, 2010/s/
      Donald J. Balzer, Jr.
                Donald
      J. Balzer, Jr.
              Director
      and
                Vice
      Chairman of the Board
              March
      26, 2010/s/
      Craig D. Bell
                Craig
      D. Bell
              Director
      and
                Chairman
      of the Board
              March
      26, 2010/s/
      William B. Chandler
                William
      B. Chandler
              Director
              March
      26, 2010/s/
      R. Calvert Esleeck, Jr.
                R.
      Calvert Esleeck, Jr.
              Director
              March
      26, 2010/s/
      George R. Whittemore
                George
      R. Whittemore
              Director
              March
      26, 2010  94
 /s/
      Michael L. Toalson
                Michael
      L. Toalson
              Director
              March
      26, 2010/s/
      O. Woodland Hogg, Jr.
                O.
      Woodland Hogg, Jr.
              Director
              March
      26, 2010/s/
      Michael A. Katzen
                Michael
      A. Katzen
              Director
              March
      26, 2010/s/
      Charles E. Walton
                Charles
      E. Walton
              Director
              March
      26, 2010/s/
      John T. Wash, Sr.
                John
      T. Wash, Sr.
              Director
              March
      26, 2010
                               95