EDGAR 10-K Filing

Company CIK: 1083643
Filing Year: 2021
Filename: 1083643_10-K_2021_0001564590-21-015821.json

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ITEM 1. BUSINESS
ITEM 1.BUSINESS
GENERAL
Fauquier Bankshares, Inc. (“Fauquier” or the “Company”) was incorporated under the laws of the Commonwealth of Virginia on January 13, 1984. The Company is a registered bank holding company and owns all of the voting shares of The Fauquier Bank (the “Bank”). The Company engages in its business through the Bank, a Virginia state-chartered bank that commenced operations in 1902. The Company has no significant operations other than owning the stock of the Bank.
Merger between the Company and Virginia National Bankshares Corporation (“Virginia National”).
On October 1, 2020 the Company and Virginia National announced a definitive agreement to combine in a strategic merger (the “Merger Agreement”) pursuant to which the Company will merge with and into Virginia National (the “Merger”). Upon consummation of the Merger, the holders of shares of the Company's common stock will be converted into the right to receive 0.675 shares of Virginia National common stock for each share of the Company's common stock held immediately prior to the effective date of the Merger, plus cash in lieu of fractional shares. The transaction is expected to be completed in the second quarter of 2021. The companies have received regulatory and shareholder approvals, and the transaction remains subject to other customary closing conditions.
THE FAUQUIER BANK
The Bank’s general market area principally includes Fauquier County, Prince William County and neighboring communities, and is located approximately 50 miles southwest of Washington, D.C. The Bank provides a full range of financial services, including internet banking, mobile banking, commercial, retail, insurance, wealth management, and financial planning services through eleven banking offices throughout Fauquier and Prince William counties in Virginia.
The Bank provides retail banking services to individuals and businesses. These services include various types of interest and noninterest-bearing checking accounts, money market and savings accounts, and time deposits. In addition, the Bank provides secured and unsecured commercial and real estate loans, standby letters of credit, secured and unsecured lines of credit, personal loans, residential mortgages and home equity loans, automobile and other types of consumer financing.
The Bank operates a Wealth Management Services (“WMS” or “Wealth Management”) division that began with the granting of trust powers to the Bank in 1919. The WMS division offers a full range of personalized services that include investment management, financial planning, trust, estate settlement, retirement, insurance and brokerage services.
The Bank, through its subsidiary Fauquier Bank Services, Inc., has equity ownership interests in Bankers Insurance, LLC, a Virginia independent insurance company, and Bankers Title Shenandoah, LLC, a title insurance company which are owned by a consortium of Virginia community banks. Fauquier Bank Services, Inc. also previously had an equity ownership interest in Infinex Investments, Inc., a full service broker/dealer owned by banks and banking associations in various states, whose ownership was sold by Fauquier Bank Services, Inc. in January 2019.
The revenues of the Bank are primarily derived from interest and fees received on loans, and from interest and dividends from investment securities. The principal sources of funds for the Bank’s lending activities are its deposits, repayment of loans, the sale and maturity of investment securities, and borrowings from the Federal Home Loan Bank of Atlanta (“FHLB”). Additional revenues are derived from fees for deposit and WMS related services.
LENDING ACTIVITIES
The Bank offers a range of lending services, including real estate and commercial loans, to individuals, as well as, small-to-medium sized businesses and other organizations that are located in or conduct a substantial portion of their business in the Bank’s market area. The majority of the Bank’s loans are made on a secured basis. The interest rates charged on loans vary with the degree of risk, maturity, and amount of the loan, and are further subject to competitive pressures, money market rates, availability of funds and government regulations. The Bank has no foreign loans, subprime loans or loans for highly leveraged transactions.
The Bank’s general market area for lending consists of Fauquier and Prince William Counties, Virginia and neighboring communities. There is no assurance that this area will experience economic growth. Deteriorating economic conditions, including as a result of the novel coronavirus (“COVID-19”) pandemic, as well as declines in the market value of local commercial and/or residential real estate, may have an adverse effect on the Company and the Bank.
The Bank’s loan portfolio includes the following segments: commercial and industrial, commercial real estate, construction and land, consumer and student, residential real estate and home equity lines of credit.
COMMERCIAL AND INDUSTRIAL LOANS
Commercial loans include loans for working capital, equipment purchases, SBA-backed loans including PPP loans, and various other business purposes. Business assets are the primary collateral for the Bank’s commercial loan portfolio. Commercial loans have variable or fixed rates of interest. Commercial lines of credit are typically granted on a one-year basis. Other commercial loans with terms or amortization schedules longer than one year will normally carry interest rates that vary based on financial indices and are generally payable in three to five years.
Loan originations are derived from a number of sources, including existing customers and borrowers, walk-in customers, advertising, and direct solicitation by the Bank’s loan officers. Inherent risks within this portfolio include interest rate and prepayment risks, risks resulting from uncertainties in the future value of collateral and changes in economic and industry conditions. In particular, longer maturities increase the risk that economic conditions will change and adversely affect the Bank's ability to collect. The Bank attempts to minimize loan losses by including the debtors’ cash flow as the source of repayment and, secondarily, the value of the underlying collateral. In addition, the Bank attempts to utilize shorter loan terms in order to reduce the risk of a decline in the value of such collateral.
COMMERCIAL REAL ESTATE LOANS
Loans secured by commercial real estate consist principally of commercial loans for which real estate constitutes the primary source of collateral. Commercial real estate loans generally involve a greater degree of risk because repayment may be more vulnerable to adverse conditions in the real estate market or the economy.
CONSTRUCTION AND LAND LOANS
The majority of the Bank’s construction and land loans are made to individuals to construct a primary residence. Such loans have a maximum term of twelve months, a fixed rate of interest, and loan-to-value ratios of 80% or less of the appraised value upon completion. The Bank requires that permanent financing, with the Bank or some other lender, be in place prior to closing. Construction loans are generally considered to involve a higher degree of credit risk because the risk of loss is dependent largely upon the accuracy of the initial estimate of the property’s value at completion. The Bank also provides construction loans and lines of credit to developers to acquire the necessary land, develop the site and construct the residential units. Such loans generally have maximum loan-to-value ratios of 80% of the appraised value upon completion with a fixed rate of interest. The majority of these construction loans are made to selected developers for the building of single-family dwellings on either a pre-sold or speculative basis. The Bank limits the number of unsold units under construction at one time. Loan proceeds are disbursed in stages after inspections of the project indicate that such disbursements are for costs already incurred and that have added to the value of the project.
CONSUMER AND STUDENT LOANS
The Bank’s consumer loans include loans to individuals such as auto loans, credit card loans and overdraft loans. The Bank also has U.S. Government guaranteed student loans, which were purchased through and serviced by a third-party and have a variable rate of interest.
RESIDENTIAL REAL ESTATE LOANS
The Bank’s 1-4 family residential real estate loan portfolio primarily consists of conventional loans, generally with fixed interest rates with 15 or 30-year terms, and balloon loans with fixed interest rates, and 5, 10, or 15 year maturities utilizing amortization schedules of 30 years. The majority of the Bank’s 1-4 family residential mortgage loans are secured by properties located in the Bank’s market area.
HOME EQUITY LINES OF CREDIT
Home equity lines of credit consist of conventional loans, generally with variable interest rates that are tied to the Wall Street Journal prime rate with 10 year terms. The majority of the Bank’s home equity lines of credit are secured by properties located in the Bank’s market area. The Bank allows a maximum loan-to-value ratio of 85% of the value of the property held as collateral at the time of origination.
DEPOSIT ACTIVITIES
Deposits are the major source of the Bank’s funds for lending and other investment activities. The deposits of the Bank are insured up to applicable limits by the Deposit Insurance Fund (“DIF”) of the Federal Deposit Insurance Corporation (“FDIC”). The Bank considers interest and noninterest-bearing checking accounts, savings and money market accounts, and nonbrokered time deposits under $100,000 to be core deposits. Generally, the Bank attempts to maintain the rates paid on its deposits at a competitive level. The Bank is a member of the Certificate of Deposit Account Registry Service (“CDARS”) and Insured Cash Sweep Service (“ICS”), to provide customers multi-
million dollar FDIC insurance on certificate of deposit investments and deposit sweeps through the transfer and/or exchange with other FDIC insured institutions. CDARS and ICS are registered service marks of Promontory Interfinancial Network, LLC.
INVESTMENTS
The Bank invests a portion of its assets in U.S. Government-sponsored corporation and agency obligations, state, county and municipal obligations, corporate obligations, and mutual funds. The Bank’s investments are managed in relation to loan demand and deposit growth, and are generally used to provide for the investment of excess funds, while also providing liquidity. The Bank’s restricted investments include holdings of FHLB stock and stock of the Federal Reserve Bank of Richmond (the “Reserve Bank”).
RESPONSE TO THE COVID-19 PANDEMIC
Following the outbreak of the COVID-19 pandemic in early 2020, the business environment in which the Company operates has been subject to numerous changes as a result of public health measures, economic disruption, government intervention and changes in regulation, which have affected the Company’s businesses operationally, including how it serves customers, as well as financially. The Company has implemented safe and healthy practices of social distancing and enhanced cleaning to protect employees and customers, and has increased options for certain employees to work remotely. The Company is working proactively with borrowers affected by the pandemic, including by offering short-term modifications, such as payment deferrals or interest only periods, to borrowers who are temporarily unable to make loan payments.
The federal government and federal regulatory agencies have introduced numerous initiatives in response to the pandemic. For example, the Coronavirus Aid, Relief, and Economic Security Act (the “CARES Act”), enacted on March 27, 2020, included provisions that, among other things, (i) established the Paycheck Protection Program (the “PPP”) to provide loans guaranteed by the Small Business Administration (the “SBA”) to businesses affected by the pandemic, (ii) established the Paycheck Protection Program Lending Facility (the “PPPLF”) to provide funding to eligible financial institutions through the Federal Reserve Board system to facilitate lending under the PPP, (iii) provided certain forms of economic stimulus, including direct payments to certain U.S. households, enhanced unemployment benefits, certain income tax benefits intended to assist businesses in surviving the economic crisis, and delayed the required implementation of certain new accounting standards for some entities, and (iv) provided limited regulatory relief to banking institutions. The federal banking agencies have eased certain bank capital requirements and reporting requirements in response to the pandemic, and have encouraged banking institutions to work prudently with borrowers affected by the pandemic by offering loan modifications that can improve borrowers’ capacity to service debt, increase the potential for financially stressed residential borrowers to keep their homes, and facilitate financial institutions’ ability to collect on their loans. The Consolidated Appropriations Act, 2021, enacted on December 27, 2020, expanded on some of the benefits made available under the CARES Act, including the PPP program, and provided further economic stimulus.
The Company continues to monitor and respond to developments related to the COVID-19 pandemic and will continue to find ways to improve customer service while continuing to protect customers and employees.
GOVERNMENT SUPERVISION AND REGULATION
Bank holding companies and banks are extensively regulated under both federal and state law. The following summary addresses certain provisions of federal and state laws that apply to the Company or the Bank. This summary does not purport to be complete and is qualified in its entirety by reference to the particular statutory or regulatory provisions.
EFFECT OF GOVERNMENTAL MONETARY POLICIES. The earnings and business of the Company and the Bank are affected by the economic and monetary policies of various regulatory authorities of the United States, especially the Board of Governors of the Federal Reserve System (the “Federal Reserve”). The Federal Reserve, among other things, regulates the supply of credit and money and sets interest rates in order to influence general economic conditions within the United States. The instruments of monetary policy employed by the Federal Reserve for those purposes influence in various ways the overall level of investments, loans, other extensions of credit, and deposits, and the interest rates paid on liabilities and received on assets. 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.
SARBANES-OXLEY ACT OF 2002. The Company is subject to the periodic reporting requirements of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), including the filing of annual, quarterly, and other reports with the Securities and Exchange Commission (the “SEC”). As an Exchange Act reporting company, the Company is directly affected by the Sarbanes-Oxley Act of 2002 (“SOX”), which is aimed at improving corporate governance, internal controls and reporting procedures. The Company is complying with applicable SEC and other rules and regulations implemented pursuant to SOX.
BANK HOLDING COMPANY REGULATION. The Company is a one-bank holding company, registered with the Federal Reserve under the Bank Holding Company Act of 1956 (the “BHC Act”). As such, the Company is subject to the supervision, examination, and reporting requirements of the BHC Act and the regulations of the Federal Reserve. The Company is required to furnish to the Federal Reserve an annual report of its operations at the end of each fiscal year and such additional information as the Federal Reserve may require pursuant to the BHC Act. The BHC Act generally prohibits the Company from engaging in activities other than banking or managing or controlling banks or other permissible subsidiaries and from acquiring or retaining direct or indirect control of any company engaged in any activities other than those activities determined by the Federal Reserve to be sufficiently related to banking or managing or controlling banks. With some limited exceptions, the BHC Act requires every bank holding company to obtain the prior approval of the Federal Reserve before: acquiring substantially all the assets of any bank; acquiring direct or indirect ownership or control of any voting shares of any bank if after such acquisition it would own or control more than 5% of the voting shares of such bank (unless it already owns or controls the majority of such shares); or merging or consolidating with another bank holding company. In addition, and subject to some exceptions, the BHC Act and the Change in Bank Control Act, together with the regulations promulgated thereunder, require Federal Reserve approval prior to any person or company acquiring “control” of a bank holding company.
BANK REGULATION. The Bank is chartered under the laws of the Commonwealth of Virginia and is a member of the Federal Reserve System. The Bank is subject to comprehensive regulation, examination and supervision by the Federal Reserve and the Virginia State Corporation Commission and to other laws and regulations applicable to banks. These regulations include limitations on loans to a single borrower and to the Bank’s directors, officers and employees; requirements on the opening and closing of branch offices; requirements regarding the maintenance of prescribed regulatory capital and liquidity ratios; requirements to grant credit under equal and fair conditions; and requirements to disclose the costs and terms of such credit. The FDIC insures the deposits of the Bank’s customers to the maximum extent provided by law and, as a result, the Bank is also subject to regulation by the FDIC. The Bank’s regulators have broad enforcement powers over the Bank, including the power to impose fines and other civil or criminal penalties and to appoint a receiver in order to conserve the Bank’s assets for the benefit of depositors and other creditors.
The Bank is also subject to the provisions of the Community Reinvestment Act of 1977 (“CRA”). Under the terms of the CRA, the appropriate federal bank regulatory agency is required, in connection with its examination of a bank, to assess the bank’s record in meeting the credit needs of the community served by that bank, including low-and moderate-income neighborhoods. The regulatory agency’s assessment of a bank’s record is made available to the public. Such assessment is required of any bank that has applied to (i) charter a national bank, (ii) obtain deposit insurance coverage for a newly chartered institution, (iii) establish a new branch office that will accept deposits, (iv) relocate an office, or (v) merge or consolidate with, or acquire the assets or assume the liabilities of, a federally regulated financial institution. In the case of a bank holding company applying for approval to acquire a bank or other bank holding company, the Federal Reserve will assess the record of each subsidiary bank of the applicant bank holding company, and such records may be the basis for denying the application. The Bank received a rating of “satisfactory” at its last CRA performance evaluation as of May 20, 2019.
In December 2019, the FDIC and the Office of the Comptroller of the Currency jointly proposed rules that would significantly change existing CRA regulations. The proposed rules are intended to increase bank activity in low- and moderate-income communities where there is significant need for credit, more responsible lending, greater access to banking services, and improvements to critical infrastructure. The proposals change four key areas: (i) clarifying what activities qualify for CRA credit; (ii) updating where activities count for CRA credit; (iii) providing a more transparent and objective method for measuring CRA performance; and (iv) revising CRA-related data collection, record keeping, and reporting. The Company is evaluating what impact this proposed rule may have on its operations if the rule is implemented and applicable to Federal Reserve member banks.
DIVIDENDS. Dividends from the Bank constitute the primary source of funds for dividends to be paid by the Company. There are various statutory and contractual limitations on the ability of the Bank to pay dividends, extend credit, or otherwise supply funds to the Company, including the requirement under Virginia banking laws that cash dividends only be paid out of net undivided profits and only if such dividends would not impair the capital of the Bank. The Federal Reserve also has the general authority to limit the dividends paid by bank holding companies and state member banks, if the payment of dividends is deemed to constitute an unsafe and unsound practice. The Federal Reserve has indicated that banking organizations should generally pay dividends only if (i) the organization’s net income available to common shareholders over the past year has been sufficient to fund fully the dividends and (ii) the prospective rate of earnings retention appears consistent with the organization’s capital needs, asset quality and overall financial condition. The Bank does not expect any of these laws, regulations or policies to materially impact its ability to pay dividends to the Company.
DEPOSIT INSURANCE. Each of the Bank’s depository accounts is insured by the FDIC against loss to the depositor to the maximum extent permitted by applicable law, and federal law and regulatory policy impose a number of obligations and restrictions on the Company and the Bank to reduce potential loss exposure to depositors and to the DIF. The deposit insurance assessment is based on average total
assets minus average tangible equity, as required by the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”).
The FDIC utilizes a “financial ratios method” based on the CAMELS composite ratings to determine assessment rates for small established institutions with less than $10 billion in assets, such as the Bank. The CAMELS rating system is a supervisory rating system designed to reflect financial and operational risks that a bank may face, including capital adequacy, asset quality, management capability, earnings, liquidity and sensitivity to market risk (“CAMELS”). CAMELS composite ratings set a maximum assessment for CAMELS 1 and 2 rated banks, and set minimum assessments for lower rated institutions.
During 2016, the FDIC raised the DIF’s minimum reserve ratio from 1.15% to 1.35%, as required by the Dodd-Frank Act. The FDIC imposed a 4.5 basis point annual surcharge on insured depository institutions with total consolidated assets of $10 billion or more. The rule granted credits to smaller banks, such as the Bank, for the portion of their regular assessments that contribute to increasing the reserve ratio from 1.15% to 1.35%. The minimum reserve ratio reached 1.35% in the third quarter of 2018; therefore, the Bank has not been required to pay such a surcharge thereafter.
CAPITAL REQUIREMENTS. Federal bank regulators have issued substantially similar guidelines requiring banks and bank holding companies to maintain capital at certain levels. In addition, regulators may from time to time require that a banking organization maintain capital above the minimum levels because of its financial condition or actual or anticipated growth. Failure to meet minimum capital requirements can trigger certain mandatory and discretionary actions by regulators that could have a direct material effect on the Company’s financial condition and results of operations.
The Federal Reserve and the FDIC have adopted rules to implement the Basel III capital framework as outlined by the Basel Committee on Banking Supervision (the “Basel Committee”) and certain provisions of the Dodd-Frank Act (the “Basel III Capital Rules”). For the purposes of the Basel III Capital Rules, (i) common equity Tier 1 capital consists principally of common stock (including surplus) and retained earnings; (ii) Tier 1 capital consists principally of common equity Tier 1 capital plus noncumulative preferred stock and related surplus, and certain grandfathered cumulative preferred stocks and trust preferred securities; and (iii) Tier 2 capital consists principally of Tier 1 capital plus qualifying subordinated debt and preferred stock, and limited amounts of an institution’s allowance for loan losses. Each regulatory capital classification is subject to certain adjustments and limitations, as implemented by the Basel III Capital Rules. The Basel III Capital Rules also establish risk weightings that are applied to many classes of assets held by community banks, including applying higher risk weightings to certain commercial real estate loans.
The Basel III Capital Rules require banks and bank holding companies to comply with the following minimum capital ratios: (i) a ratio of common equity Tier 1 capital to risk-weighted assets of at least 4.5%, plus a 2.5% “capital conservation buffer” (effectively resulting in a minimum ratio of common equity Tier 1 to risk-weighted assets of at least 7%); (ii) a ratio of Tier 1 capital to risk-weighted assets of at least 6.0%, plus the 2.5% capital conservation buffer (effectively resulting in a minimum Tier 1 capital ratio of 8.5%); (iii) a ratio of total capital to risk-weighted assets of at least 8.0%, plus the 2.5% capital conservation buffer (effectively resulting in a minimum total capital ratio of 10.5%); and (iv) a leverage ratio of 4%, calculated as the ratio of Tier 1 capital to balance sheet exposures plus certain off-balance sheet exposures (computed as the average for each quarter of the month-end ratios for the quarter). The phase-in of the capital conservation buffer requirement began on January 1, 2016, at 0.625% of risk-weighted assets, increasing by the same amount each year until it was fully implemented at 2.5% on January 1, 2019. The capital conservation buffer is designed to absorb losses during periods of economic stress. Banking organizations with a ratio of common equity Tier 1 capital to risk-weighted assets above the minimum but below the conservation buffer face constraints on dividends, equity repurchases, and compensation based on the amount of the shortfall.
In December 2017, the Basel Committee published standards that it described as the finalization of the Basel III post-crisis regulatory reforms (the standards are commonly referred to as “Basel IV”). Among other things, these standards revise the standardized approach for credit risk (including by recalibrating risk weights and introducing new capital requirements for certain “unconditionally cancellable commitments,” such as unused credit card lines of credit) and provide a new standardized approach for operational risk capital. Under the proposed framework, these standards will generally be effective on January 1, 2022, with an aggregate output floor phasing-in through January 1, 2027. Under the current capital rules, operational risk capital requirements and a capital floor apply only to advanced approaches institutions, and not to the Company. The impact of Basel IV on the Company and the Bank will depend on the manner in which it is implemented by the federal bank regulatory agencies.
The Company meets the eligibility criteria of a small bank holding company in accordance with the Federal Reserve’s Small Bank Holding Company Policy Statement (the “SBHC Policy Statement”). On August 28, 2018, the Federal Reserve issued an interim final rule required by the Economic Growth, Regulatory Relief and Consumer Protection Act of 2018, which was signed into law on May 24, 2018 (the
“EGRRCPA”), that expands the applicability of the SBHC Policy Statement to bank holding companies with total consolidated assets of less than $3 billion (up from the prior $1 billion threshold). Under the SBHC Policy Statement, qualifying bank holding companies, such as the Company, have additional flexibility in the amount of debt they can issue and are also exempt from the Basel III Capital Rules. The SBHC Policy Statement does not apply to the Bank and the Bank must comply with the Basel III Capital Rules. The Bank must also comply with the capital requirements set forth in the “prompt corrective action” regulations pursuant to Section 38 of the Federal Deposit Insurance Act, as described below.
On September 17, 2019, the federal banking agencies jointly issued a final rule required by the EGRRCPA that permits qualifying banks and bank holding companies that have less than $10 billion in consolidated assets to elect to be subject to a 9% leverage ratio that would be applied using less complex leverage calculations (commonly referred to as the community bank leverage ratio or “CBLR”). Under the rule, which became effective on January 1, 2020, banks and bank holding companies that opt into the CBLR framework and maintain a CBLR of greater than 9% are not subject to other risk-based and leverage capital requirements under the Basel III Capital Rules and would be deemed to have met the well capitalized ratio requirements under the “prompt corrective action” framework. The CBLR will be available for banking organizations to use as of March 31, 2020 (with the flexibility for banking organizations to subsequently opt into or out of the CBLR, as applicable).
PROMPT CORRECTIVE ACTION. Federal banking agencies 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.” These terms are defined under uniform regulations issued by each of the federal banking agencies regulating these institutions. An insured depository institution which is less than adequately capitalized must adopt an acceptable capital restoration plan, is subject to increased regulatory oversight and is increasingly restricted in the scope of its permissible activities.
To be well capitalized under these regulations, a bank must have the following minimum capital ratios: (i) a common equity Tier 1 capital ratio of at least 6.5%; (ii) a Tier 1 capital to risk-weighted assets ratio of at least 8.0%; (iii) a total capital to risk-weighted assets ratio of at least 10.0%; and (iv) a leverage ratio of at least 5.0%. As of December 31, 2020, the Bank was considered “well capitalized.”
As described above, on September 17, 2019, the federal banking agencies jointly issued a final rule required by the EGRRCPA that permits qualifying banks and bank holding companies that have less than $10 billion in consolidated assets to opt into the CBLR framework. Banks opting into the CBLR framework and maintaining a CBLR of greater than 9% are deemed to have met the well capitalized ratio requirements under the “prompt corrective action” framework. The CBLR will be available for banking organizations to use as of March 31, 2020 (with the flexibility for banking organizations to subsequently opt into or out of the CBLR, as applicable).
SOURCE OF STRENGTH. Federal Reserve policy has historically required bank holding companies to act as a source of financial and managerial strength to their subsidiary banks. The Dodd-Frank Act codified this policy as a statutory requirement. Under this requirement, the Company is expected to commit resources to support the Bank, including at times when the Company may not be in a financial position to provide such resources. Any capital loans by a bank holding company to any of its subsidiary banks are subordinate in right of payment to depositors and to certain other indebtedness of such subsidiary banks. In the event of a bank holding company’s bankruptcy, any commitment by the bank holding company to a federal bank regulatory agency to maintain the capital of a subsidiary bank will be assumed by the bankruptcy trustee and entitled to priority of payment.
FEDERAL HOME LOAN BANK OF ATLANTA. The Bank is a member of the FHLB, which provides funding to their members for making housing loans as well as loans for affordable housing and community development lending. FHLB serves as a reserve or central bank for its members within its assigned region. It is funded primarily from proceeds derived from the sale of consolidated obligations of the FHLB system. It makes loans to its members (i.e., advances) in accordance with policies and procedures established by the Board of Directors of the FHLB. As a member, the Bank is required to purchase and maintain stock in the FHLB in an amount equal to at least 5% of the aggregate outstanding advances made by the FHLB to the Bank. In addition, the Bank is required to pledge collateral for outstanding advances. The borrowing agreement with the FHLB provides for the pledge by the Bank of various forms of securities and commercial and mortgage loans as collateral.
USA PATRIOT ACT. The USA PATRIOT Act 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 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 a cost of compliance, the USA PATRIOT Act has not materially affected the Bank’s products, services, or other business activities.
OFFICE OF FOREIGN ASSETS CONTROL. The U.S. Treasury Department’s Office of Foreign Assets Control (“OFAC”) is responsible for administering and enforcing economic and trade sanctions against specified foreign parties, including countries and regimes, foreign individuals and other foreign organizations and entities. OFAC publishes lists of prohibited parties that are regularly consulted by the Company in the conduct of its business in order to assure compliance. The Company is responsible for, among other things, blocking accounts of, and transactions with, prohibited parties identified by OFAC, avoiding unlicensed trade and financial transactions with such parties and reporting blocked transactions after their occurrence. Failure to comply with OFAC requirements could have serious legal, financial and reputational consequences for the Company.
MORTGAGE BANKING REGULATION. The Bank’s mortgage banking activities are subject to the rules and regulations of, and examination by the Department of Housing and Urban Development, the Federal Housing Administration, the Department of Veterans Affairs and state regulatory authorities with respect to originating, processing and selling mortgage loans. Those rules and regulations, among other things, establish standards for loan origination, prohibit discrimination, provide for inspections and appraisals of property, require credit reports on prospective borrowers and, in some cases, restrict certain loan features, and fix maximum interest rates and fees. In addition to other federal laws, mortgage origination activities are subject to the Equal Credit Opportunity Act, Truth-in-Lending Act, Home Mortgage Disclosure Act, Real Estate Settlement Procedures Act, Home Ownership Equity Protection Act, the Secure and Fair Enforcement for Mortgage Licensing Act (S.A.F.E. Act), and the regulations promulgated under these acts. These laws prohibit discrimination, require the disclosure of certain basic information to mortgagors concerning credit and settlement costs, limit payment for settlement services to the reasonable value of the services rendered and require the maintenance and disclosure of information regarding the disposition of mortgage applications based on race, gender, geographical distribution and income level.
CONSUMER LAWS AND REGULATIONS. The Bank is subject to certain consumer laws and regulations that are designed to protect consumers in transactions with banks. While the list set forth herein is not exhaustive, these laws and regulations include the Truth-in-Lending Act, the Truth-in-Savings Act, the Electronic Funds Transfer Act, the Expedited Funds Availability Act, the Equal Credit Opportunity Act, the Fair Credit Reporting Act, the Fair Housing Act, and regulations issued under such acts, among others. These laws and regulations mandate certain disclosure requirements and regulate the manner in which financial institutions must deal with customers when taking deposits, making loans to or engaging in other types of transactions with such customers.
The Dodd-Frank Act centralized responsibility for consumer financial protection by creating the Consumer Financial Protection Bureau (the “CFPB”), and giving it responsibility for implementing, examining, and enforcing compliance with federal consumer protection laws. The CFPB focuses on (i) risks to consumers and compliance with the federal consumer financial laws, (ii) the markets in which firms operate and risks to consumers posed by activities in those markets, (iii) depository institutions that offer a wide variety of consumer financial products and services, and (iv) non-depository companies that offer one or more consumer financial products or services.
The CFPB has broad rulemaking authority for a wide range of consumer financial laws that apply to all banks, including, among other things, the authority to prohibit “unfair, deceptive or abusive” acts and practices. The CFPB can issue cease-and-desist orders against banks and other entities that violate consumer financial laws. The CFPB may also institute a civil action against an entity in violation of federal consumer financial law in order to impose a civil penalty or injunction.
ABILITY-TO-REPAY AND QUALIFIED MORTGAGE RULE. The Dodd-Frank Act authorized the CFPB to establish certain minimum standards for the origination of residential mortgages, including a determination of the borrower's ability-to-repay, and allows borrowers to raise certain defenses to foreclosure if they receive any loan other than a “qualified mortgage” as defined by the Dodd-Frank Act and CFPB regulations. In general, a “qualified mortgage” is a mortgage loan without negative amortization, interest-only payments, balloon payments, or terms exceeding 30 years. In addition, to be a qualified mortgage the points and fees paid by a consumer cannot exceed 3% of the total loan amount. Qualified mortgages that are “higher-priced” (e.g. subprime loans) garner a rebuttable presumption of compliance with the ability-to-repay rules, while qualified mortgages that are not “higher-priced” (e.g. prime loans) are given a safe harbor of compliance. The Company is predominantly an originator of compliant qualified mortgages.
LOANS TO INSIDERS. The Federal Reserve Act and related regulations impose specific restrictions on loans to directors, executive officers and principal shareholders of banks. Specifically, loans to a director, an executive officer and to a principal shareholder of a bank, and some affiliated entities of any of the foregoing, may not exceed, together with all other outstanding loans to such person and affiliated
entities, the bank’s loan-to-one borrower limit. Loans in the aggregate to insiders and their related interests as a class may not exceed the Bank’s unimpaired capital and unimpaired surplus. Loans exceeding these amounts are prohibited, unless such loan is approved in advance by a majority of the board of directors of the bank with any “interested” director not participating in the voting. The FDIC has prescribed the loan amount, which includes all other outstanding loans to such person, as to which such prior board of director approval is required, as being the greater of $25,000 or 5% of capital and surplus (up to $500,000). Loans to directors, executive officers and principal shareholders are required to be made on terms and underwriting standards substantially the same as offered in comparable transactions to other persons.
CYBERSECURITY. Federal banking agencies have adopted guidelines for establishing information security standards and cybersecurity programs for implementing safeguards under the supervision of a financial institution’s board of directors. These guidelines, along with related regulatory materials, increasingly focus on risk management and processes related to information technology and the use of third-parties in the provision of financial products and services. The federal banking agencies expect financial institutions to establish lines of defense and ensure that their risk management processes also address the risk posed by compromised customer credentials, and also expect financial institutions to maintain sufficient business continuity planning processes to ensure rapid recovery, resumption and maintenance of the institution’s operations after a cyber-attack. If the financial institution fails to meet the expectations set forth in this regulatory guidance, the institution could be subject to various regulatory actions, including financial penalties, and any remediation efforts may require significant resources.
INCENTIVE COMPENSATION. Federal bank regulatory agencies issued guidance 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 Federal Reserve will review, as part of the regular, risk-focused examination process, the incentive compensation arrangements of banking organizations, such as the Bank, that are not “large, complex banking organizations.” The findings will be included in reports of examination, and deficiencies will be incorporated into the organization’s supervisory ratings. 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. As of December 31, 2020, the Company is not aware of any instances of noncompliance with the guidance.
COVID-19 RELATED REGULATORY RELIEF. In response to the COVID-19 pandemic, federal banking agencies issued a joint statement on March 22, 2020 encouraging banking institutions to work with borrowers affected by the COVID-19 pandemic, including offering short-term loan modifications to borrowers unable to meet their contractual payment obligations. Under this interagency guidance, certain loans that have been modified are exempt from being reported as past due or as troubled debt restructurings (“TDRs”). Further, the CARES Act provided additional exemptions from TDR reporting for certain loans that have been modified for reasons related to the COVID-19 pandemic. Regulatory agencies also issued an interim final rule on April 7, 2020 which provides relief in bank regulatory capital requirements that allow loans originated under the PPP to be excluded from risk-weighted assets, and to be excluded from total assets for purposes of bank leverage ratio requirements if they are pledged as collateral to the PPPLF.
Congress also enacted the Consolidated Appropriations Act, 2021, on December 27, 2020, which included (i) the Economic Aid to Hard-Hit Small Businesses, Non-profits, and Venues Act, (ii) the COVID-Related Tax Relief Act of 2020, and (iii) the Taxpayer Certainty and Disability Relief Act of 2020. These laws include significant clarifications and modifications to PPP, which had terminated on August 8, 2020. In particular, Congress revived the PPP and allocated an additional $284.45 billion in PPP funds for 2021. As a result, the SBA has modified prior guidance and promulgated new regulations and guidance to conform with and implement the new provisions during the first quarter of 2021. As a participating PPP lender, the Bank continues to monitor legislative, regulatory, and supervisory developments related thereto.
FUTURE REGULATORY UNCERTAINTY. Congress may enact legislation from time to time that affects the regulation of the financial services industry, and state legislatures may enact legislation from time to time affecting the regulation of financial institutions chartered by or operating in those states. Federal and state regulatory agencies also periodically propose and adopt changes to their regulations or change the manner in which existing regulations are applied. The substance or impact of pending or future legislation or regulation, or the application thereof, cannot be predicted, although enactment of the proposed legislation could impact the regulatory structure under which the Company and the Bank operate and may significantly increase costs, impede the efficiency of internal business processes, require an increase in regulatory capital, require modifications to business strategy, and limit the ability to pursue business opportunities in an efficient manner. A change in statutes, regulations or regulatory policies applicable to the Company or the Bank could have a material, adverse effect on the business, financial condition and results of operations of the Company and the Bank.
COMPETITION
The Company encounters strong competition both in making loans and in attracting deposits. In one or more aspects of its business, the Bank competes with other commercial banks, credit unions, finance companies, mutual funds, insurance companies, brokerage and investment banking companies, financial technology (“fintech”) companies, and other financial intermediaries. Most of these competitors, some of which are affiliated with bank holding companies, have substantially greater resources and lending limits, and may offer certain services that the Bank does not currently provide. In addition, many of the Bank’s nonbank competitors are not subject to the same level of federal regulation that governs bank holding companies and federally insured banks. Recent federal and state legislation has heightened the competitive environment in which financial institutions must conduct their business, and the potential for competition among financial institutions of all types has increased significantly. To compete, the Bank relies upon specialized services, responsive handling of customer needs, and personal contacts by its officers, directors, and staff. Large multi-branch banking institutions tend to compete based primarily on price and the number and location of branches while smaller financial institutions, like the Company, tend to compete primarily on price and personal service.
EMPLOYEES
As of December 31, 2020, the Company and the Bank employed approximately 140 full-time equivalent employees. No employee is represented by a collective bargaining unit. The Company and the Bank consider relations with employees to be good.
The Company is a small community bank and customer service is an important differentiator. The Company’s senior officers have personal relationships with many of the Company’s key customers, and attracting and retaining these senior officers is critical to the Company’s success. The Company’s compensation programs encourage performance consistent with strategic and business plans approved by the Company’s Board of Directors, while ensuring that the financial costs of current or proposed compensation and benefits are reasonable and consistent with industry standards and shareholders’ interests. See “PART III - ITEM 11. EXECUTIVE COMPENSATION” of this Annual Report on Form 10-K for a description of the types of plans and programs that Fauquier maintains for its senior officers.
AVAILABLE INFORMATION
The Company files annual, quarterly and current reports, proxy statements and other information with the SEC. The Company’s SEC filings are filed electronically and are available to the public over the internet at the SEC’s website at http://www.sec.gov. The Company’s website is https://www.tfb.bank. The Company makes its SEC filings available free of charge through this website under “About Us” “Investor Relations,” “Financial Information” “Documents” as soon as practicable after filing or furnishing the material to the SEC. Copies of documents can also be obtained free of charge by writing to the Company's secretary at 10 Courthouse Square, Warrenton, Virginia 20186 or by calling 800-638-3798. The information on the Company’s website is not incorporated into this report or any other filing the Company makes with the SEC.
The Company’s transfer agent and registrar is American Stock Transfer & Trust Company, LLC and can be contacted by writing to 6201 15th Avenue, Brooklyn, New York 11209 or by phone 800-937-5449. Their website is www.astfinancial.com.

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ITEM 1A. RISK FACTORS
ITEM 1A. RISK FACTORS
An investment in the Company’s securities involves risks and uncertainties. In addition to the other information contained in this report, including the information addressed under “Forward-Looking Statements,” investors in the Company’s securities should carefully consider the factors discussed below. These factors could materially and adversely affect the Company’s business, financial condition, liquidity, results of operations, and capital position and could cause the Company’s actual results to differ materially from its historical results or the results contemplated by the forward-looking statements contained in this report, in which case the trading price of the Company’s securities could decline.
Risk Factors Related to the COVID-19 Pandemic.
The economic impact of the COVID-19 outbreak could adversely affect our financial condition and results of operations.
In March 2020, the World Health Organization declared COVID-19 a pandemic. On March 12, 2020, the former President of the United States declared the COVID-19 outbreak in the United States a national emergency. The COVID-19 pandemic has caused significant economic dislocation in the United States as many state and local governments ordered non-essential businesses to close and residents to shelter in place at home. This has resulted in an unprecedented slow-down in economic activity and a related increase in unemployment. In response to the COVID-19 outbreak, the Federal Reserve has reduced the benchmark federal funds rate to a target range of 0% to 0.25%, and the yields on 10 and 30-year treasury notes have declined to historic lows. Various state governments and federal agencies are encouraging, or in some cases requiring, lenders to provide forbearance and other relief to borrowers (e.g., waiving late payment and other fees). The federal banking agencies have encouraged financial institutions to prudently work with affected borrowers through the issuance of an interagency statement, and federal legislation has provided relief from reporting loan classifications due to modifications related to the COVID-19 pandemic. Certain industries have been particularly hard-hit, including the travel and hospitality industry, the restaurant industry and the retail industry. Finally, the spread of COVID-19 has caused the Company to modify business practices, including branch operations, employee travel, employee work locations, and cancellation of physical participation in meetings, events and conferences. The Company may take further actions as may be required by government authorities or that we determine are in the best interests of our employees, clients and business partners.
Given the ongoing and dynamic nature of the circumstances, it is difficult to predict the full impact of the COVID-19 outbreak on the Company or its business. The extent of such impact will depend on future developments, which are highly uncertain, including when the coronavirus can be controlled and abated and when and how the economy may be reopened.
As the result of the COVID-19 pandemic and the related adverse local and national economic consequences, the Company could be subject to any of the following risks, any of which could have a material adverse effect on our business, financial condition, liquidity, and results of operations:
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demand for products and services may decline, making it difficult to grow assets and income;
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if the economy is unable to substantially reopen, and high levels of unemployment continue for an extended period of time, loan delinquencies, problem assets, and foreclosures may increase, resulting in increased charges, additions to the allowance for loan losses, and reduced income, among other impacts;
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collateral for loans, especially real estate, may decline in value, which could cause loan losses to increase;
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the allowance for loan losses may have to be increased if borrowers experience financial difficulties beyond forbearance periods, which will adversely affect net income;
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the net worth and liquidity of loan guarantors may decline, impairing their ability to honor commitments;
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as the result of the decline in the Federal Reserve’s target federal funds rate, the yield on the Company’s assets may decline to a greater extent than the decline in its cost of interest-bearing liabilities, reducing its net interest margin and spread and reducing net income;
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a material decrease in net income or a net loss over several quarters could result in a decrease in the rate of the Company’s quarterly cash dividend;
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the Company’s wealth management and trust revenues may decline with continuing market turmoil;
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the Company relies on third party vendors for certain services and the unavailability of a critical service due to the COVID-19 outbreak could have an adverse effect the Company and its operations; and
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FDIC premiums may increase if the agency experiences additional resolution costs.
Moreover, the Company’s future success and profitability substantially depends on the management skills of our executive officers. The unanticipated loss or unavailability of key employees due to the outbreak could harm our ability to operate the Company’s business or
execute its business strategy. The Company may not be successful in finding and integrating suitable successors in the event of key employee loss or unavailability.
Any one or a combination of the factors identified above could negatively impact the Company’s business, financial condition and results of operations and prospects.
As a participating lender in the PPP, the Company and the Bank are subject to additional risks of litigation from the Bank’s clients or other parties regarding the Bank’s processing of loans for the PPP and risks that the SBA may not fund some or all PPP loan guaranties.
On March 27, 2020, the former President of the United States signed the CARES Act, which included a $349 billion loan program administered through the SBA referred to as the PPP. Under the PPP, small businesses and other entities and individuals can apply for loans from existing SBA lenders and other approved regulated lenders that enroll in the program, subject to numerous limitations and eligibility criteria. The Bank is participating as a lender in the PPP. There continues to be some ambiguity in the laws, regulations and administrative guidance related to the PPP. In addition, since the opening of the PPP, several large banks have been subject to litigation regarding the process and procedures that such banks used in processing applications for the PPP. The Company and the Bank may be exposed to the risk of similar litigation, from both clients and non-clients that approached the Bank regarding PPP loans, regarding its process and procedures used in processing applications for the PPP. If any such litigation is filed against the Company or the Bank and is not resolved in a manner favorable to the Company or the Bank, it may result in significant financial liability or adversely affect the Company’s reputation. In addition, litigation can be costly, regardless of outcome. Any financial liability, litigation costs or reputational damage caused by PPP related litigation could have a material adverse impact on our business, financial condition and results of operations.
The Bank also has credit risk on PPP loans if a determination is made by the SBA that there is a deficiency in the manner in which the loan was originated, funded, or serviced by the Bank, such as an issue with the eligibility of a borrower to receive a PPP loan, which may or may not be related to the ambiguity in the laws, rules and guidance regarding the operation of the PPP. In the event of a loss resulting from a default on a PPP loan and a determination by the SBA that there was a deficiency in the manner in which the PPP loan was originated, funded, or serviced by the Bank, the SBA may deny its liability under the guaranty, reduce the amount of the guaranty, or, if it has already paid under the guaranty, seek recovery of any loss related to the deficiency from the Company or the Bank.
Risk Factors Related to the Merger Agreement with Virginia National
Combining Virginia National and the Company may be more difficult, costly or time-consuming than expected.
The success of the Merger will depend, in part, on Virginia National’s ability after the Merger to realize the anticipated benefits and cost savings from combining the businesses of Virginia National and the Company and to combine the businesses of Virginia National and the Company in a manner that permits growth opportunities and cost savings to be realized without materially disrupting the existing customer relationships of the Company or decreasing revenues due to loss of customers. If Virginia National is not able to achieve these objectives, the anticipated benefits and cost savings of the Merger may not be realized fully or at all or may take longer to realize than expected.
Virginia National and the Company have operated, and, until the completion of the Merger, will continue to operate, independently. To realize these anticipated benefits of the Merger, after the completion of the Merger, Virginia National expects to integrate the Company’s business into its own. The integration process in the Merger could result in the loss of key employees, the disruption of each party’s ongoing business, inconsistencies in standards, controls, procedures and policies that affect adversely either party’s ability to maintain relationships with customers and employees or achieve the anticipated benefits of the Merger. The loss of key employees could adversely affect Virginia National’s ability to successfully conduct its business in the markets in which the Company now operates, which could have an adverse effect on Virginia National’s financial results and the value of its common stock. If Virginia National experiences difficulties with the integration process, the anticipated benefits of the Merger may not be realized fully or at all, or may take longer to realize than expected. As with any merger of financial institutions, there also may be disruptions that cause Virginia National and the Company to lose customers or cause customers to withdraw their deposits from the Company’s or Virginia National’s banking subsidiaries, or other unintended consequences that could have a material adverse effect on Virginia National’s results of operations or financial condition after the Merger. These integration matters could have an adverse effect on the Company during this transition period and on Virginia National for an undetermined period after consummation of the Merger.
Because the market price of Virginia National common stock will fluctuate, the value of the consideration to be received by the Company’s shareholders in the Merger may change.
Pursuant to the Merger Agreement, each share of the Company’s common stock, except for certain shares of the Company’s common stock owned by the Company or Virginia National, that is issued and outstanding immediately prior to the effective time of the Merger
will be converted into the right to receive 0.6750 shares of common stock of Virginia National. The closing price of Virginia National common stock on the date that the Merger is completed may vary from the closing price of Virginia National common stock on the date the Company and Virginia National announced the signing of the Merger Agreement. Because the Merger consideration is determined by a fixed exchange ratio, at the time of the Company’s special meeting, the Company’s shareholders will not know or be able to calculate the value of the shares of Virginia National common stock they will receive upon completion of the Merger. Any change in the market price of Virginia National common stock prior to completion of the Merger may affect the value of the Merger consideration that the Company’s shareholders will receive upon completion of the Merger. Stock price changes may result from a variety of factors, including general market and economic conditions, changes in the companies’ respective businesses, operations and prospects, and regulatory considerations, among other things. Many of these factors are beyond the control of the Company and Virginia National. The Company’s shareholders should obtain current market quotations for shares of Virginia National common stock and the Company’s common stock before voting their shares at the Company’s special meeting of shareholders.
The Merger may distract management of the Company from its other responsibilities.
The Merger could cause the management of the Company to focus its time and energies on matters related to the Merger that otherwise would be directed to its business and operations. Any such distraction on the part of the Company’s management, if significant, could affect its ability to service existing business and develop new business and may adversely affect the business and earnings of the Company before the Merger, or the business and earnings of Virginia National after the Merger.
Termination of the Merger Agreement could negatively impact the Company.
Each of the Company’s and Virginia National’s obligation to consummate the Merger remains subject to a number of conditions, and there can be no assurance that all of the conditions will be satisfied, or that the Merger will be completed on the proposed terms, within the expected timeframe, or at all. Any delay in completing the Merger could cause the Company not to realize some or all of the benefits that the Company expects to achieve if the Merger is successfully completed within its expected timeframe. If the Merger Agreement is terminated, the Company’s business may be impacted adversely by the failure to pursue other beneficial opportunities due to the focus of management on the Merger, without realizing any of the anticipated benefits of completing the Merger. Additionally, if the Merger Agreement is terminated, the market price of the Company’s common stock could decline to the extent that the current market prices reflect a market assumption that the Merger will be completed. If the Merger Agreement is terminated under certain circumstances, including circumstances involving a change in recommendation by the Company's board of directors, the Company may be required to pay to Virginia National a termination fee of $2.5 million.
In addition, the Company has incurred and will incur substantial expenses in connection with the negotiation and completion of the transactions contemplated by the Merger Agreement. If the Merger is not completed, the Company would have to recognize these expenses and would have committed substantial time and resources by management, without realizing the expected benefits of the Merger. In addition, failure to consummate the Merger also may result in negative reactions from the financial markets or from the Company’s customers, vendors and employees. If the Merger is not completed, these risks may materialize and could have a material adverse effect on the Company’s stock price, business and cash flows, financial condition and results of operations.
The Merger Agreement limits the ability of the Company to pursue alternatives to the Merger.
The Merger Agreement contains “no-shop” provisions that, subject to limited exceptions, limits the ability of the Company to discuss, facilitate or commit to competing third-party proposals to acquire all or a significant part of the Company. In addition, under certain circumstances, if the Merger Agreement is terminated and the Company, subject to certain restrictions, consummates a similar transaction other than the Merger, the Company must pay to Virginia National a fee of $2.5 million. These provisions might discourage a potential competing acquiror that might have an interest in acquiring all or a significant part of the Company from considering or proposing the acquisition even if it were prepared to pay consideration, with respect to the Company, with a higher per share market price than that proposed in the Merger.
The Company will be subject to business uncertainties and contractual restrictions while the Merger is pending.
Uncertainty about the effect of the Merger on employees and customers may have an adverse effect on the Company. These uncertainties may impair the Company’s ability to attract, retain and motivate key personnel until the Merger is completed, and could cause customers and others that deal with the Company to seek to change existing business relationships with the Company. Retention of certain employees by the Company may be challenging while the Merger is pending, as certain employees may experience uncertainty about their future roles with the Company or the combined company following the Merger. If key employees depart because of issues relating to the uncertainty and difficulty of integration or a desire not to remain with the Company or the combined company following the Merger, the Company’s business, or the business of the combined company following the Merger, could be harmed. In addition, the Company has agreed to operate its business in the ordinary course prior to the closing of the Merger and from taking certain specified actions until the
Merger occurs, and the Merger Agreement restricts the Company from taking other specified actions until the merger occurs without the consent of Virginia National. These restrictions may prevent the Company from pursuing attractive business opportunities that may arise prior to the completion of the merger.
Risk Factors Related to the Company’s Lending Activities
The Company’s business is subject to various lending and other economic risks that could adversely affect its financial condition and results of operations.
The Company’s business is directly affected by general economic and market conditions; broad trends in industry and finance; legislative and regulatory changes; changes in governmental monetary and fiscal policies; and inflation, all of which are beyond the Company’s control. A deterioration in economic conditions, in particular a prolonged economic slowdown within the Company’s geographic region, could result in the following consequences which could adversely affect the Company’s business: an increase in loan delinquencies; an increase in problem assets and foreclosures; a decline in demand for products and services; and a deterioration in the value of collateral for loans.
The Company’s focus on lending to small to mid-sized community-based businesses may increase its credit risk.
Most of the Company’s commercial business and commercial real estate loans are made to small business or middle market customers. These businesses generally have fewer financial resources in terms of capital or borrowing capacity than larger entities and have a heightened vulnerability to economic conditions. Additionally, these loans may increase concentration risk as to industry or collateral securing the loans. If general economic conditions in the market areas in which the Company operates negatively impact this important customer sector, the Company’s results of operations and financial condition may be adversely affected. Moreover, a portion of these loans have been made by the Company in recent years and the borrowers may not have experienced a complete business or economic cycle. The deterioration of the borrowers’ businesses may hinder their ability to repay their loans with the Company, which could have a material adverse effect on the Company’s financial condition and results of operations.
The Company’s credit standards and on-going credit assessment processes might not protect it from significant credit losses.
The Company takes credit risk by virtue of making loans and extending loan commitments and letters of credit. Credit risk is managed through a program of underwriting standards, the review of certain credit decisions and an ongoing process of assessment of the quality of the credit already extended. In addition, the Company’s credit administration function employs risk management techniques intended to promptly identify problem loans. While these procedures are designed to provide the Company with the information needed to implement policy adjustments where necessary and to take appropriate corrective actions, there can be no assurance that such measures will be effective in avoiding future undue credit risk, and credit losses may occur in the future.
If the Company’s allowance for loan losses becomes inadequate, its financial condition and results of operations may be adversely affected.
Making loans is an essential element of the Company’s business. The risk of nonpayment is affected by a number of factors, including but not limited to: the duration of the credit; credit risks of a particular customer; changes in economic and industry conditions; and, in the case of a collateralized loan, risks resulting from uncertainties about the future value of the collateral. Although the Company seeks to mitigate risks inherent in lending by adhering to specific underwriting practices, loans may not be repaid. The Company attempts to maintain an appropriate allowance for loan losses to provide for losses in the loan portfolio. The allowance for loan losses is determined by analyzing numerous factors about the loan portfolio including historical loan losses for relevant periods of time, current trends in delinquencies and charge-offs, current economic conditions that may affect a borrower’s ability to repay and the value of collateral, changes in the size and composition of the loan portfolio and industry information. Also included are qualitative considerations with respect to the effect of potential economic events, the outcomes of which are uncertain.
Because any estimate of loan losses is subjective and the accuracy depends on the outcome of future events, charge-offs in future periods may exceed the allowance for loan losses and additional increases in the allowance for loan losses may be required. Additions to the allowance for loan losses would result in a decrease of profitability. Although management believes the allowance for loan losses is adequate to absorb losses that are inherent in the loan portfolio, the Company cannot predict such losses or that the allowance will be adequate in the future.
In addition, the adoption of Accounting Standards Update (“ASU”) No. 2016-13, as amended, could result in an increase in the allowance for loan losses as a result of changing from an “incurred loss” model, which encompasses allowances for current known and inherent losses within the portfolio, to an “expected loss” model, which encompasses allowances for losses expected to be incurred over the life of the portfolio. As a smaller reporting company, the Company has elected to defer adoption of ASU No. 2016-13 until January 1, 2023.
For information regarding recent accounting pronouncements and their effect on the Company, see “Recent Accounting Pronouncements and Other Regulatory Statements” in Note 1 “Nature of Banking Activities and Significant Accounting Policies” in the “Notes to Consolidated Financial Statements” contained in Item 8 of this Form 10 K. 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.
Nonperforming assets take significant time to resolve and adversely affect the Company’s financial condition and results of operations.
Nonperforming assets adversely affect net income in various ways. The Company does not record interest income on nonaccruing loans, which adversely affects income and increases credit administration costs. When the Company receives collateral through foreclosures and similar proceedings, it is required to mark the related loan to the then fair market value of the collateral less estimated selling costs, which may result in a loss. An increased level of nonperforming assets also increases the Company’s risk profile and may impact the capital levels regulators believe are appropriate in light of such risks. The Company utilizes various techniques such as workouts, restructurings and loan sales to manage problem assets. Increases in, or negative adjustments in, the value of these problem assets, the underlying collateral, or in the borrowers’ performance or financial condition, could adversely affect the Company’s financial condition and results of operations. In addition, the resolution of nonperforming assets requires significant commitments of time from management and staff, which can be detrimental to the performance of their other responsibilities, including generation of new loans. There can be no assurance that the Company will avoid increases in nonperforming assets in the future.
The Company’s real estate lending business can result in increased costs associated with other real estate owned (“OREO”).
Because the Company originates loans secured by real estate, the Company may have to foreclose on the collateral property and may thereafter own and operate such property. The amount that may be realized after a default is dependent upon factors outside of the Company’s control, including, but not limited to, general or local economic conditions, environmental cleanup liability, neighborhood values, interest rates, real estate tax rates, operating expenses of the mortgaged properties, and supply of and demand for properties. Certain expenditures associated with the ownership of income-producing real estate, principally real estate taxes and maintenance costs, may adversely affect the net cash flows generated by the real estate. Therefore, the cost of operating income-producing real property may exceed the rental income earned, if any, from such property, and the Company may have to advance funds in order to protect its investment or may be required to dispose of the real property at a loss.
Risks Related to the Company’s Business, Industry and Markets
Adverse changes in economic conditions in the Company’s market areas or adverse conditions in industries on which such markets are dependent could adversely affect the Company’s financial condition and results of operations.
The Company provides full service banking and other financial services in Fauquier and Prince William counties in Virginia. The Company’s loan and deposit activities are directly affected by economic conditions within these markets, as well as conditions in the industries on which those markets are economically dependent. A deterioration in local economic conditions or in the condition of an industry on which a local market depends could adversely affect such factors as unemployment rates, business formations and expansions, and housing market conditions. Adverse developments in any of these factors could result in, among other things, a decline in loan demand, a reduction in the number of creditworthy borrowers seeking loans, an increase in delinquencies, defaults and foreclosures, an increase in classified and nonaccrual loans, a decrease in the value of loan collateral, and a decline in the financial condition of borrowers and guarantors, any of which could adversely affect the Company’s financial condition and results of operations.
Competition from other financial institutions and financial intermediaries may adversely affect the Company’s profitability.
The Company faces competition in originating loans and in attracting deposits principally from other banks, mortgage banking companies, consumer finance companies, savings associations, credit unions, brokerage firms, insurance companies, fintech companies and other institutional lenders and purchasers of loans. Advancements in technology and other changes have lowered barriers to entry and made it possible for non-banks to offer products and services traditionally provided by banks. In particular, the activity of fintech companies has grown significantly over recent years and is expected to continue to grow. Fintech companies have and may continue to offer bank or bank-like products and some fintech companies have applied for bank charters. Other fintech companies have partnered with existing banks to allow them to offer deposit products to their customers. Additionally, banks and other financial institutions with larger capitalization and financial intermediaries not subject to bank regulatory restrictions have larger lending limits and are thereby able to serve the credit needs of larger clients. These institutions may be able to offer the same loan products and services that the Company offers at more competitive rates and prices. Increased competition could require the Company to increase the rates paid on deposits or lower the rates offered on loans, which could adversely affect profitability.
Weakness in the secondary residential mortgage loan markets will adversely affect noninterest income.
One of the components of the Company’s strategic plan is to generate noninterest income from loans originated for sale into the secondary market. Interest rates, low housing inventory, cash buyers, new mortgage lending regulations and other market conditions could have an adverse effect on loan originations across the industry which would reduce our noninterest income.
The Company relies on deposits obtained from customers in the Company’s market area to provide liquidity and to support growth.
The Company’s business strategies are based on access to funding from local customer deposits. Deposit levels may be affected by a number of factors, including interest rates paid by competitors, general interest rate levels, returns available to customers on alternative investments and general economic conditions. If deposit levels fall, the Company could lose a relatively low-cost source of funding and interest expense would likely increase as alternative funding to replace lost deposits may be necessary. If local customer deposits are not sufficient to fund the Company’s normal operations and growth, the Company will look to outside sources, such as borrowings from the FHLB, which is a secured funding source. The Company’s ability to access borrowings from the FHLB will be dependent upon whether and the extent to which collateral to secure FHLB borrowings can be provided. The Company may also look to federal funds purchased and brokered deposits. The Company may also seek to raise funds through the issuance of shares of its common stock, or other equity or equity-related securities, or debt securities including subordinated notes as additional sources of liquidity. If the Company is unable to access funding sufficient to support business operations and growth strategies or is only able to access such funding on unattractive terms, the Company may not be able to implement its business strategies which may negatively affect financial performance.
Risk Factors Related to the Company’s Operations and Technology
The Company relies on dividends from the Bank for substantially all of its revenue.
The Company is a bank holding company that conducts substantially all of its operations through the Bank. As a result, the Company relies on dividends from the Bank for substantially all of its revenues. There are various regulatory restrictions on the ability of the Bank to pay dividends or make other payments to the Company, and the Company’s right to participate in a distribution of assets upon the Bank’s liquidation or reorganization is subject to the prior claims of the Bank’s creditors. If the Bank is unable to pay dividends to the Company, the Company may not be able to service its outstanding borrowings and other debt, pay its other obligations or pay a cash dividend to the holders of the Company’s common stock, and the Company’s business, financial condition and results of operations may be adversely affected. Further, although the Company has historically paid cash dividends to holders of its common stock, these holders are not entitled to receive dividends and regulatory or economic factors may cause the Company’s Board of Directors to consider, among other actions, the reduction of dividends paid on the Company’s common stock even if the Bank continues to pay dividends to the Company.
The Company’s risk management framework may not be effective in mitigating risk and loss.
The Company maintains an enterprise risk management program that is designed to identify, quantify, monitor, report and control the risks it faces including, but not limited to, interest rate, credit, liquidity, operational, reputation, legal, compliance, economic and litigation risk. Although the risk management program is assessed on an ongoing basis, the Company gives no assurance that the risk management framework and related controls will effectively mitigate the risks listed above or limit losses that may occur. If the Company’s risk management program or controls do not function effectively, the Company’s financial condition and results of operations may be adversely affected.
The Company’s operations may be adversely affected by cybersecurity risks.
In the ordinary course of business, the Company collects and stores sensitive data, including proprietary business information and personally identifiable information of its customers and employees in systems and on networks. The secure processing, maintenance, and use of this information is critical to operations and the Company’s business strategy. The Company has invested in accepted technologies, and continually reviews processes and practices that are designed to protect its networks, computers, and data from damage or unauthorized access. Despite these security measures, the Company’s computer systems and infrastructure may be vulnerable to attacks by hackers or breached due to employee error, malfeasance or other disruptions. A breach of any kind could compromise systems and the information stored there could be accessed, damaged or disclosed. A breach in security could result in legal claims, regulatory penalties, disruption in operations, and damage to the Company’s reputation, which could adversely affect its business and financial condition. Furthermore, as cyber threats continue to evolve and increase, the Company may be required to expend significant additional financial and operational resources to modify or enhance its protective measures, or to investigate and remediate any identified information security vulnerabilities.
In addition, multiple major U.S. retailers have experienced data systems incursions reportedly resulting in the thefts of credit and debit card information, online account information and other financial or privileged data. Retailer incursions affect cards issued and deposit
accounts maintained by many banks, including the Bank. Although the Company’s systems are not breached in retailer incursions, these events can cause it to reissue a significant number of cards and take other costly steps to avoid significant theft loss to the Company and its customers. In some cases, the Company may be required to reimburse customers for the losses they incur. Other possible points of intrusion or disruption not within the Company’s control include internet service providers, electronic mail portal providers, social media portals, distant-server (cloud) service providers, electronic data security providers, telecommunications companies, and smart phone manufacturers. Additionally, in recent years banking regulators have focused on the responsibilities of financial institutions to supervise vendors and other third-party service providers. The Company may have to dedicate significant resources to manage risks and regulatory burdens, including the Company’s data processing and cybersecurity service providers.
Furthermore, because some of our employees are working remotely from their homes due to the COVID-19 pandemic, there is an increased risk of disruption to our operations because they are utilizing residential networks and infrastructure which may not be as secure as in our office environment.
Business counterparties, over which the Company may have limited or no control, may experience disruptions that could adversely affect the Company.
Multiple major U.S. retailers and a major consumer credit reporting agency have experienced data systems incursions in recent years reportedly resulting in the thefts of credit and debit card information, online account information, and other personal and financial data of hundreds of millions of individuals. Retailer incursions may affect debit cards issued and deposit accounts maintained by many banks. Although the Company is not aware of any instance in which the Bank’s systems have been breached in a retailer incursion, these events can cause the Bank to reissue a significant number of cards and take other costly steps to avoid significant theft loss to the Bank and its customers. In some cases, the Bank may be required to reimburse customers for losses they incur. Credit reporting agency intrusions affect the Bank’s customers and can require these customers and the Bank to increase monitoring and take remedial action to prevent unauthorized account activity or access. Other possible points of intrusion or disruption outside the Company’s control include internet service providers, electronic mail portal providers, social media portals, distant-server (or “cloud”) service providers, electronic data security providers, telecommunications companies and smart phone manufacturers.
The Company is technology dependent and an inability to invest in technological improvements may adversely affect its financial condition and results of operations.
The financial services industry is undergoing rapid technological changes with frequent introductions of new technology-driven products and services, which may require substantial capital expenditures to modify or adapt existing products and services. In addition to enhancing customer service, the effective use of technology increases efficiency and results in reduced costs, although a financial institution’s initial investment in a technology product or service may represent a significant incremental cost. The Company’s future success will depend, in part, upon the ability to create synergies in operations through the use of technology and to facilitate the ability of customers to engage in financial transactions in a manner that enhances the customer experience. The Company cannot assure that technological improvements will increase operational efficiency or that the Company will be able to effectively implement new technology-driven products and services or be successful in marketing these products and services to customers, which may cause the Company to lose market share or incur additional expense.
Failure to maintain effective systems of internal and disclosure control could have a material adverse effect on the Company’s financial condition and results of operations.
Effective internal and disclosure controls are necessary to provide reliable financial reports and effectively prevent fraud and to operate successfully as a public company. As part of the Company’s ongoing monitoring of internal control, it may discover material weaknesses or significant deficiencies in its internal control that require remediation. A “material weakness” is a deficiency, or a combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of a company’s annual or interim financial statements will not be prevented or detected on a timely basis. Any failure to maintain effective controls or to timely effect any necessary improvement of the Company’s internal and disclosure controls could, among other things, result in losses from fraud or error, harm the Company’s reputation or cause investors to lose confidence in the Company’s reported financial information, all of which could have a material adverse effect on the Company’s financial condition and results of operations.
The Company relies heavily on its management team and the unexpected loss of key officers may adversely affect operations.
The Company believes that growth and future success will depend in large part on the skills and experience of its executive officers and on their relationships with the communities it serves. The loss of the services of one or more of these officers could disrupt operations and impair the Company’s ability to implement its business strategy, which could adversely affect the Company’s financial condition and results of operations.
The success of the Company’s business strategies depends on its ability to identify and recruit individuals with experience and relationships in its primary markets.
The successful implementation of the Company’s business strategy will require the Company to continue to attract, hire, motivate and retain skilled personnel to develop new customer relationships as well as new financial products and services. The market for qualified management personnel is competitive. In addition, the process of identifying and recruiting individuals with the combination of skills and attributes required to carry out the Company’s strategy is often lengthy, and the Company may not be able to effectively integrate these individuals into its operations. The Company’s inability to identify, recruit and retain talented personnel to manage its operations effectively and in a timely manner could limit growth, which could materially adversely affect the Company’s business.
The Company’s corporate culture has contributed to its success, and if the Company cannot maintain this culture, the Company could lose the beneficial aspects fostered by this culture, which could harm business.
The Company believes that a critical contributor to its success has been its corporate culture, which focuses on building personal relationships with its customers. As the Company grows, and more complex organizational management structures are required, the Company may find it increasingly difficult to maintain the beneficial aspects of this corporate culture, which could negatively affect the Company’s future success.
Risks Related to Market Interest Rates
The Company is subject to interest rate risk and fluctuations in interest rates may negatively affect its financial performance.
The Company’s profitability depends, in part, on its net interest margin, which is the difference between the interest earned on loans, securities and other interest-earning assets, and interest paid on deposits and borrowings divided by total interest-earning assets. Changes in interest rates will affect the Company’s net interest margin in diverse ways, including the pricing of loans and deposits, the levels of prepayments and asset quality. The Company is unable to predict actual fluctuations of market interest rates because many factors influencing interest rates are beyond the Company’s control. Management believes that the Company’s current interest rate exposure is manageable and does not indicate any significant exposure to interest rate changes. The Company expects continued pressure on its net interest margin due to continued low market rates and intense competition for loans and deposits from both local and national financial institutions. Continued pressure on net interest margin could adversely affect the Company’s financial condition and results of operations.
The Bank may be required to transition from the use of the London Interbank Offered Rate (“LIBOR”) index in the future.
In 2017, the United Kingdom’s Financial Conduct Authority announced that after 2021 it would no longer compel banks to submit the rates required to calculate LIBOR. On November 30, 2020, the ICE Benchmark Administration Limited, the administrator of the LIBOR, announced that it would consult on its plan to cease the publication of one-week and two-month LIBOR immediately after December 31, 2021 and to cease the publications of the remaining tenors of LIBOR (one, three, six, and 12-month) immediately after June 30, 2023. The Federal Reserve, the Office of the Comptroller of the Currency, and the FDIC also issued a statement encouraging banks to transition away from LIBOR as soon as practicable. It is unclear whether new methods of calculating LIBOR will be established such that it continues to exist after 2021. As a result, the continuation of LIBOR on the current basis cannot and will not be guaranteed after 2021. At this time, it is impossible to predict whether and to what extent banks will continue to provide submissions for the calculation of LIBOR. Similarly, it is impossible to predict whether LIBOR will continue to be viewed as an acceptable market benchmark, what rate or rates may become accepted alternatives to LIBOR, or what effects any such changes in views or alternatives may have on the markets for LIBOR-indexed financial instruments.
Regulators, industry groups, and others have, among other things, published recommended replacement language for LIBOR-linked financial instruments, identified recommended alternatives for certain LIBOR rates (e.g., the Secured Overnight Financing Rate), and proposed implementations of the recommended alternatives in floating rate instruments. There is not yet any consensus on what recommendations and proposals will be broadly accepted.
The Company has loans and other financial instruments with attributes that are either directly or indirectly dependent on LIBOR. The transition from LIBOR could create additional costs and additional risk. Since proposed alternative rates are calculated differently, payments under contracts referencing new rates will differ from those referencing LIBOR. The transition could change the Company’s market risk profiles, requiring changes to risk and pricing models, valuation tools, product design and hedging strategies. Furthermore, failure to adequately manage this transition process with customers could adversely impact the Company’s reputation. Although the Company is currently unable to assess what the ultimate impact of the transition from LIBOR will be, failure to adequately manage the transition could have an adverse effect on the Company’s financial condition and results of operations.
Risks Related to the Regulation of the Company
Compliance with laws, regulations and supervisory guidance, both new and existing, may adversely affect the Company’s financial condition and results of operations.
The Company is subject to numerous laws, regulations and supervision from both federal and state agencies. Failure to comply with these laws and regulations could result in financial, structural and operational penalties, including receivership. In addition, establishing systems and processes to achieve compliance with these laws and regulations may increase costs and/or place limits on pursuing certain business opportunities.
The legislative and regulatory environment is beyond the Company’s control, may change rapidly and unpredictably and may negatively influence profitability and capital levels. The Company’s success depends on its ability to maintain compliance with both existing and new laws and regulations.
Future legislation, regulation and government policy could affect the banking industry as a whole, including the Company’s results of operations, in ways that are difficult to predict. In addition, the Company’s results of operations could be adversely affected by changes in the way in which existing statutes and regulations are interpreted or applied by courts and government agencies.
The CFPB may increase the Company’s regulatory compliance burden and could affect consumer financial products and services that the Company offers.
The CFPB is reshaping the consumer financial laws through rulemaking and enforcement of the Dodd-Frank Act’s prohibitions against unfair, deceptive and abusive consumer finance products or practices, which are directly affecting the business operations of financial institutions offering consumer financial products or services. This agency’s broad rulemaking authority includes identifying practices or acts that are unfair, deceptive or abusive in connection with any consumer financial transaction, financial product or service. Although the CFPB has jurisdiction over banks with $10 billion or greater in assets, rules, regulations and policies issued by the CFPB may also apply to the Company by virtue of the adoption of such policies and best practices by the Federal Reserve and the FDIC. Further, the CFPB may include its own examiners in regulatory examinations by the Company’s primary regulators. The total costs and limitations related to this additional regulatory agency and the limitations and restrictions that will be placed upon the Company with respect to consumer products and services have yet to be determined in their entirety. However, these costs, limitations and restrictions are producing, and may continue to produce, significant, material effects on the Company’s financial condition and results of operations.
Regulatory capital standards, including the Basel III Capital Rules, require the Company and the Bank to maintain higher levels of capital and liquid assets, which could adversely affect the Company’s profitability and return on equity.
The Basel III Capital Rules and related changes to the standardized calculations of risk-weighted assets are complex and created additional compliance burdens, especially for community banks. The Basel III Capital Rules require bank holding companies and their subsidiaries to maintain significantly more capital as a result of higher required capital levels and more demanding regulatory capital risk weightings and calculations. While the Company is exempt from these capital requirements under the SBHC Policy Statement, the Bank is not exempt and must comply. The Bank must also comply with the capital requirements set forth in the “prompt corrective action” regulations pursuant to Section 38 of the Federal Deposit Insurance Act. Satisfying capital requirements may require the Company or the Bank to limit its banking operations, retain net income or reduce dividends to improve regulatory capital levels, which could negatively affect its business, financial condition and results of operations. The EGRRCPA amended the Dodd-Frank Act to, among other things, provide relief from certain of these requirements. The Company does not expect the EGRRCPA and the related rulemakings to materially reduce the impact of capital requirements on its business.
The Company’s earnings are significantly affected by the fiscal and monetary policies of the federal government and its agencies.
The policies of the Federal Reserve affect the Company significantly. The Federal Reserve regulates the supply of money and credit in the United States. Its policies directly and indirectly influence the rate of interest earned on loans and paid on borrowings and interest-bearing deposits and can also affect the value of financial instruments. Those policies determine, to a significant extent, the cost of funds for lending and investing. Changes in those policies are beyond the Company’s control and are difficult to predict. Federal Reserve policies can also affect the Company’s borrowers, potentially increasing the risk that they may fail to repay their loans. This could adversely affect the borrower’s earnings and ability to repay a loan, which could have a material adverse effect on the Company’s financial condition and results of operations.
The Company’s deposit insurance premiums could increase in the future, which may adversely affect future financial performance.
The FDIC insures deposits at FDIC insured financial institutions, including the Bank. The FDIC charges insured financial institutions premiums to maintain the DIF at a certain level. Economic conditions that began with the financial crisis of 2008 increased the rate of bank failures through 2014, requiring the FDIC to make payments for insured deposits from the DIF and prepare for future payments from the DIF. A depository institution’s deposit insurance assessment is calculated based on the institution’s total assets less tangible equity, rather than the previous base of total deposits. The Bank’s FDIC insurance premiums could increase in future periods if the Bank’s asset size increases, if the FDIC raises base assessment rates, or if the FDIC takes other actions to replenish the DIF.
General Risk Factors
Changes in accounting standards and management’s selection of accounting methods, including assumptions and estimates, could materially affect the Company’s financial statements.
From time to time, the SEC and Financial Accounting Standards Board (the “FASB”) change the financial accounting and reporting standards that govern the preparation of the Company’s financial statements. These changes can be hard to predict and can materially affect how the Company records and reports its financial condition and results of operations. In some cases, the Company could be required to apply a new or revised standard retroactively, resulting in changes to previously reported financial results, or a cumulative charge to retained earnings. In addition, management is required to use certain assumptions and estimates in preparing financial statements, including determining the fair value of certain assets and liabilities, among other items. If the assumptions or estimates are incorrect, the Company may experience unexpected material consequences.
The Company’s common stock price may be volatile, which could result in losses to investors.
The Company’s common stock price has been volatile in the past, and several factors could cause the price to fluctuate in the future. These factors include, but are not limited to, actual or anticipated variations in earnings, changes in analysts’ recommendations or projections, operations and stock performance of other peer companies, and reports of trends and concerns and other issues related to the financial services industry. Fluctuations in the Company’s common stock price may be unrelated to performance. General market declines or market volatility in the future, especially in the financial institutions sector, could adversely affect the price of the Company’s common stock, and the current market price may not be indicative of future market prices.
Future sales of the Company’s common stock by shareholders or the perception that those sales could occur may cause the Company’s common stock price to decline.
Although the Company’s common stock is listed for trading on the Nasdaq Capital Market, the trading volume may be lower than that of other larger financial institutions. A public trading market having the desired characteristics of depth, liquidity and orderliness depends on the presence in the marketplace of willing buyers and sellers of the common stock at any given time. This presence depends on the individual decisions of investors and general economic and market conditions over which the Company has no control. Given the potential for lower relative trading volume, significant sales of the common stock in the public market, or the perception that those sales may occur, could cause the trading price of the Company’s common stock to decline or to be lower than it otherwise might be in the absence of these sales or perceptions.
Future issuances of the Company’s common stock could adversely affect the market price and could be dilutive.
The Company may issue additional shares of common stock or securities that are convertible into or exchangeable for, or that represent the right to receive, shares of the Company’s common stock. Issuances of a substantial number of shares of common stock, or the expectation that such issuances might occur, could adversely affect the market price of the shares of common stock and could be dilutive to shareholders. Any decision the Company makes to issue common stock in the future will depend on market conditions and other factors, and the Company cannot predict or estimate the amount, timing, or nature of possible future issuances. Accordingly, the Company’s shareholders bear the risk that future issuances could reduce the market price of the common stock and dilute their stock holdings in the Company.
The Company’s dividends may not be sustained.
Although the Company has historically paid cash dividends to holders of its common stock, holders of common stock are not entitled to receive dividends. Financial, regulatory or economic factors may cause the Company’s Board of Directors to consider, among other actions, the suspension or reduction of dividends paid on the Company’s common stock. Furthermore, the Company is a bank holding company that conducts substantially all of its operations through its subsidiaries, including the Bank. As a result, the Company relies on dividends from the Bank for substantially all of its revenues. There are various regulatory restrictions on the ability of the Bank to pay
dividends or make other payments to the Company. If the Bank is unable to pay dividends to the Company, the Company may not be able to pay a cash dividend to the holders of the Company’s common stock.

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ITEM 1B. UNRESOLVED STAFF COMMENTS
ITEM 1B. UNRESOLVED STAFF COMMENTS
Not applicable.

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ITEM 2. PROPERTIES
ITEM 2. PROPERTIES
The following describes the location and general character of the physical properties of the Company.
The Bank owns two buildings located in the Town of Warrenton at 10 Courthouse Square, Warrenton, Virginia. These buildings house the Company’s executive offices and the Bank’s main office, loan operations, information technology and Wealth Management.
The Bank owns a building located in the Town of Warrenton at 87 W. Lee Highway, Warrenton, Virginia which houses a retail banking branch and the Bank’s deposit operations department.
The Bank owns four retail banking branches located in Fauquier County: 6464 Main Street, The Plains, Virginia; 5119 Lee Highway, New Baltimore, Virginia; 3543 Catlett Road, Catlett, Virginia; and 6207 Station Drive, Bealeton, Virginia.
The Bank owns two retail banking branches located in Prince William County: 7485 Limestone Drive, Gainesville, Virginia; and 8780 Centreville Road, Manassas, Virginia.
The Bank leases three retail banking branches located in Prince William County: 15240 Washington Street, Haymarket, Virginia; 10260 Bristow Center Drive, Bristow, Virginia; and 8091 Sudley Road, Manassas, Virginia.
The Company believes all of its properties are in good operating condition and are adequate for its present and anticipated future needs.

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ITEM 3. LEGAL PROCEEDINGS
ITEM 3. LEGAL PROCEEDINGS
In the ordinary course of business, the Company and the Bank are parties to various legal proceedings. There is no pending or threatened legal proceedings to which the Company or the Bank is a party or to which the property of either the Company or the Bank is subject that, in the opinion of management, may materially impact the financial condition of either entity.

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ITEM 4. MINE SAFETY DISCLOSURE
ITEM 4. MINE SAFETY DISCLOSURES
Not applicable.
PART II

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ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY
ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
Market Information and Holders
The Company’s common stock trades on the Nasdaq Capital Market (“Nasdaq”) under the symbol “FBSS”. As of March 26, 2021, there were 3,807,659 shares outstanding of the Company’s common stock, which is the Company’s only class of stock outstanding. These shares were held by approximately 313 holders of record. As of March 26, 2021, the market price of the Company’s common stock was $20.70.
Dividends
The Company declared a quarterly cash dividend of $0.125 per share in 2020. The Company declared a quarterly cash dividend of $0.12 per share in the first, second and third quarters of 2019. In the fourth quarter of 2019, the Company declared a quarterly cash dividend of $0.125 per share.
The Company’s future dividend policy is subject to the discretion of the Board of Directors and will depend upon a number of factors, including future earnings, financial condition, cash and capital requirements, and general business conditions. The Company’s ability to pay cash dividends will depend upon the Bank’s ability to pay dividends to the Company. Transfers of funds from the Bank to the Company in the form of loans, advances and cash dividends are restricted by federal and state banking laws and regulations.
Stock Repurchases
On an annual basis, the Company’s Board of Directors authorizes the number of shares of common stock that can be repurchased. On January 16, 2020, the Board of Directors authorized the Company to repurchase up to 113,512 shares (3% of the shares of common stock outstanding on January 1, 2020) beginning January 1, 2020. During the year ended December 31, 2020, 2,007 shares of common stock were repurchased at an average price of $19.21 per share. No shares were repurchased during the fourth quarter of 2020.

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ITEM 6. SELECTED FINANCIAL DATA
ITEM 6. SELECTED FINANCIAL DATA
The selected consolidated financial data set forth below should be read in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and the consolidated financial statements and accompanying notes included elsewhere in this report. The historical results are not necessarily indicative of results to be expected for any future period.
For the Year Ended December 31,
(Dollars in thousands, except per share data)
EARNINGS STATEMENT DATA:
Interest income
$
28,312
$
29,170
$
26,698
$
23,320
$
21,574
Interest expense
2,541
4,520
3,233
2,049
1,843
Net interest income
25,771
24,650
23,465
21,271
19,731
Provision for (recovery of) loan losses
1,773
(508
)
Net interest income after provision for (recovery of) loan losses
23,998
24,304
22,958
20,751
20,239
Noninterest income
5,474
5,895
5,236
5,468
5,296
Gain on sale and call of securities
-
Noninterest expense
23,520
22,454
22,151
20,844
20,925
Income before income taxes
6,944
7,824
6,881
5,375
4,611
Income taxes
1,067
1,004
2,879
Net income
$
5,877
$
6,820
$
6,135
$
2,496
$
3,674
PER SHARE DATA:
Net income per share, basic
$
1.55
$
1.80
$
1.63
$
0.66
$
0.98
Net income per share, diluted
$
1.55
$
1.80
$
1.62
$
0.66
$
0.98
Cash dividends
$
0.50
$
0.485
$
0.48
$
0.48
$
0.48
Weighted average shares outstanding, basic
3,793,366
3,783,322
3,772,421
3,764,690
3,753,757
Weighted average shares outstanding, diluted
3,798,816
3,790,718
3,779,366
3,773,010
3,763,929
Book value
$
19.08
$
17.74
$
15.90
$
14.92
$
14.51
BALANCE SHEET DATA:
Total assets
$
867,173
$
722,171
$
730,805
$
644,613
$
624,445
Loans, net
609,879
544,999
544,188
497,705
458,608
Securities, including restricted investments
84,683
81,799
74,124
73,699
51,755
Deposits
766,119
622,155
635,638
570,023
546,157
Shareholders' equity
72,461
67,122
60,007
56,142
54,451
PERFORMANCE RATIOS:
Net interest margin(1)
3.46
%
3.74
%
3.81%
3.66%
3.50%
Return on average assets
0.73
%
0.96
%
0.92%
0.39%
0.60%
Return on average equity
8.31
%
10.64
%
10.64%
4.44%
6.82%
Dividend payout
32.26
%
26.94
%
29.63%
72.44%
49.07%
Efficiency ratio (GAAP)
72.96
%
73.32
%
74.99%
77.95%
83.61%
ASSET QUALITY RATIOS:
Allowance for loan losses to total loans
1.11
%
0.95
%
0.94%
1.01%
0.98%
Allowance for loan losses to nonperforming loans
67.41
%
102.57
%
78.65%
56.43%
38.72%
Nonperforming assets to total assets
1.87
%
0.89
%
1.09%
1.60%
2.10%
Nonaccrual loans to total loans
0.20
%
0.18
%
0.36%
0.63%
0.76%
Net charge-offs (recoveries) to average loans
0.02
%
0.05
%
0.08%
(0.01%)
(0.19%)
CAPITAL RATIOS:
Leverage
8.54
%
9.40
%
9.39%
9.17%
9.23%
Common equity Tier 1 capital ratio
12.67
%
12.58
%
11.89%
11.43%
12.22%
Tier 1 capital ratio
12.67
%
12.58
%
11.89%
11.43%
12.22%
Total capital ratio
13.87
%
13.54
%
12.85%
12.41%
13.17%
(1)
Net interest margin is calculated as fully taxable equivalent net interest income divided by average earning assets and represents the Company’s net yield on its earning assets.

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ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS
ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS
This report contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These forward-looking statements include, but are not limited to, statements about (i) the benefits, expenses and expected completion date of the merger between Virginia National and Fauquier; (ii) Fauquier’s plans, objectives, expectations and intentions and other statements contained in this report that are not historical facts; and (iii) other statements identified by words such as “may”, “assumes”, “approximately”, “will”, “expects”, “anticipates”, “intends”, “plans”, “believes”, “seeks”, “estimates”, “targets”, “projects”, or words of similar meaning generally intended to identify forward-looking statements. These forward-looking statements are based upon the current beliefs and expectations of the management of Fauquier and are inherently subject to significant business, economic and competitive uncertainties and contingencies, many of which are beyond the control of the Company. In addition, these forward-looking statements are subject to various risks, uncertainties and assumptions with respect to future business strategies and decisions that are subject to change and difficult to predict with regard to timing, extent, likelihood and degree of occurrence. As a result, although Fauquier believes that its expectations with respect to forward-looking statements are based upon reasonable assumptions within the bounds of its existing knowledge of its business and operations, actual results may differ materially from any projected future results performance or achievements expressed or implied by such forward-looking statements.
The following factors, among others, could cause actual results to differ materially from the anticipated results or other expectations expressed in the forward-looking statements: (1) the businesses of Virginia National and Fauquier may not be combined successfully, or such combination may take longer, be more difficult, time-consuming or costly to accomplish than expected; (2) the expected growth opportunities or cost savings from the Merger may not be fully realized or may take longer to realize than expected; (3) deposit attrition, operating costs, customer losses and business disruption following the Merger, including adverse effects on relationships with employees and customers, may be greater than expected; (4) the regulatory approvals required for the Merger may not be obtained on the proposed terms or on the anticipated schedule; (5) the shareholders of Virginia National or Fauquier may fail to approve the Merger; (6) economic, legislative or regulatory changes, including changes in accounting standards, may adversely affect the businesses in which Virginia National and Fauquier are engaged; (7) the interest rate environment may further compress margins and adversely affect net interest income; (8) results may be adversely affected by continued diversification of assets and adverse changes to credit quality; (9) competition from other financial services companies in Virginia National’s and Fauquier’s markets could adversely affect operations; (10) an economic slowdown could adversely affect credit quality and loan originations; (11) general economic conditions, including unemployment levels and slowdowns in economic growth, and particularly related to further and sustained economic impacts of the COVID-19 pandemic; (12) monetary and fiscal policies of the U.S. Government, including policies of the U.S. Department of Treasury and the Federal Reserve; (13) cyber threats, attacks or events; (14) accounting principles, policies and guidelines and elections made by Fauquier thereunder; (15) competition from other financial institutions and financial-intermediaries; (16) the novel COVID-19 pandemic is adversely affecting Virginia National, Fauquier, and their respective customers, employees and third-party service providers; the adverse impacts of the pandemic on their respective business, financial position, operations and prospects have been material, and it is not possible to accurately predict the extent, severity or duration of the pandemic or when normal economic and operation conditions will return; (17) potential claims, damages and fines related to litigation or government actions, including litigation or actions arising from Fauquier or Virginia National’s participation in and administration of programs related to COVID-19, including, among other things, the PPP under the CARES Act, as subsequently extended; and (18) other factors that may affect future results of Virginia National and Fauquier, including: changes in asset quality and credit risk; the inability to sustain revenue and earnings growth; changes in interest rates and capital markets; inflation; customer borrowing, repayment, investment and deposit practices; the impact, extent and timing of technological changes; capital management activities; and other actions of the bank regulatory agencies and legislative and regulatory actions and reforms. Additional factors that could cause actual results to differ materially from those expressed in the forward-looking statements are discussed in Fauquier’s reports (such as Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q and Current Reports on Form 8-K) filed with the SEC and available on the SEC’s Internet site (http://www.sec.gov).
Readers are cautioned not to rely too heavily on the forward-looking statements contained in this report. Forward-looking statements speak only as of the date they are made and Fauquier does not undertake any obligation to update, revise or clarify these forward-looking statements, whether as a result of new information, future events or otherwise.
CRITICAL ACCOUNTING POLICIES
GENERAL. The Company’s financial statements are prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”). The financial information contained within the Company’s statements is, to a significant extent, based on measures of the financial effects of transactions and events that have already occurred. A variety of factors could affect the ultimate value
that is obtained either when earning income, recognizing an expense, recovering an asset or relieving a liability. The Company uses historical loss factors as one factor in determining the inherent loss that may be present in its loan portfolio. Actual losses could differ significantly from the historical factors that the Company uses in its estimates. In addition, GAAP itself may change from one previously acceptable accounting method to another method. Although the economics of the Company’s transactions would be the same, the timing of the recognition of the Company’s transactions could change.
ALLOWANCE FOR LOAN LOSSES. The Company establishes the allowance for loan losses through charges to earnings in the form of a provision for loan losses. Loan losses are charged against the allowance when it is believed that the collection of the principal is unlikely. Subsequent recoveries of losses previously charged against the allowance are credited to the allowance. The allowance represents an amount that, in management’s judgment, will be adequate to absorb probable losses inherent in the loan portfolio. Management’s judgment in determining the level of the allowance is based on evaluations of the collectability of loans while taking into consideration such factors as trends in delinquencies and charge-offs for relevant periods of time, changes in the nature and volume of the loan portfolio, current economic conditions that may affect a borrower’s ability to repay and the value of collateral, overall portfolio quality and review of specific potential losses. This evaluation is inherently subjective because it requires estimates that are susceptible to significant revision as more information becomes available. Note 1 to the Consolidated Financial Statements presented in Item 8, Financial Statements and Supplementary Data provides additional information related to the allowance for loan losses.
The Company employs an independent outsourced loan review function, which annually substantiates and/or adjusts internally generated risk ratings. This independent review function reports directly to the Company’s Board of Directors’ audit committee, and the results of this review are factored into the calculation of the allowance for loan losses.
OTHER-THAN-TEMPORARY IMPAIRMENT (“OTTI”) FOR SECURITIES. Impairment of securities occurs when the fair value of a security is less than its amortized cost. For debt securities, impairment is considered other-than-temporary and recognized in its entirety in net income if either (i) the Company intends to sell the security or (ii) it is more-likely-than-not that the Company will be required to sell the security before recovery of its amortized cost basis. If, however, the Company does not intend to sell the security and it is not more-likely-than-not that the Company will be required to sell the security before recovery, the Company must determine what portion of the impairment is attributable to a credit loss, which occurs when the amortized cost basis of the security exceeds the present value of the cash flows expected to be collected from the security. If there is no credit loss, there is no OTTI. If there is a credit loss, OTTI exists, and the credit loss must be recognized in net income and the remaining portion of impairment must be recognized in other comprehensive income (loss). For equity securities, impairment is considered to be other-than-temporary based on the Company’s ability and intent to hold the investment until recovery of fair value. OTTI of an equity security results in a write-down that must be included in net income. The Company regularly reviews each investment security for OTTI based on criteria that includes the extent to which cost exceeds market price, the duration of that market decline, the financial health of and specific prospects for the issuer, the best estimate of the present value of cash flows expected to be collected from debt securities, the intention with regard to holding the security to maturity and the likelihood that the Company would be required to sell the security before recovery.
IMPACT OF COVID-19
On March 11, 2020, the World Health Organization declared COVID-19 a pandemic as a result of the global spread of the illness. In response to the outbreak, federal and state authorities in the U.S. introduced various measures to try to limit or slow the spread of COVID-19, including travel restrictions, nonessential business closures, stay-at-home orders and strict social distancing.
To the extent the economic impacts of COVID-19 continue for a prolonged period and conditions stagnate or worsen, the Company’s provision for loan losses, net interest income and overall profitability may be adversely affected.
Business Continuity
The Company remains committed to adhering to health and safety-related requirements and best practices across all locations by taking proactive and disciplined steps to promote safety and overall wellbeing of employees, clients, shareholders and communities. The Company’s Enterprise Risk Management framework, which is overseen by the Board of Directors, the Company’s Business Continuity Plan and the Bank’s Incident Response Plan remain integral parts of monitoring day to day business activities. The Company has not furloughed nor does the Company expect to furlough any employees. Management continues to closely monitor business activities and has or will adjust accordingly as the health and safety of all constituents continues to be the priority.
Paycheck Protection Program
On March 27, 2020, the CARES Act was enacted to, among other provisions, provide emergency assistance for individuals, families and businesses affected by COVID-19. The CARES Act included the creation of the PPP through the SBA. Loans provided by the Bank through the PPP may be forgiven based on the borrowers’ compliance with the terms of the program. The SBA provides a 100% guaranty to the lender of principal and interest, unless the lender violates an obligation under the agreement. As loan losses are expected to be immaterial, if any at all, due to the SBA guaranty, there is no provision allocated for PPP loans within the allowance for loan loss calculation. The Company disbursed $53.1 million in PPP loans to 549 borrowers and has forgiven 223 PPP loans with an aggregate principal balance of $22.6 million in aggregate principal loan balances through December 31, 2020. During the first quarter of 2021, the Company disbursed $28.6 million in PPP loans to 346 borrowers and has forgiven 126 PPP loans with an aggregate principal balance of $9.2 million.
The following table summarizes the details of the Company’s PPP loans:
(Dollars in thousands)
December 31, 2020
PPP loans originated
$
53,082
PPP loans forgiven
$
22,555
Average PPP loans outstanding
$
34,672
PPP average loan size outstanding
$
PPP interest income
$
PPP fee income, net
$
PPP outstanding unearned fees
$
PPP weighted average processing fee
4.00
%
Average yield on PPP loans
3.54
%
Short-term Loan Modifications
Under the provisions of the CARES Act, the Company established a short-term loan modification program, allowing the deferral of scheduled payments for a 90-day period beginning in April 2020. Modifications made on a good faith basis in response to COVID-19 to borrowers who were current prior to any relief were not considered trouble debt restructurings (“TDRs”). Borrowers who were considered current were ones whose loans were less than 30 days past due on their contractual payments at the time the modification was entered. The CARES Act and interagency guidance provided financial institutions the option to temporarily suspend certain accounting requirements related to TDRs with respect to loan modifications, including the deferral of scheduled payments. The following table summarizes loans modifications and loan payment deferrals, by loan segment, as of December 31, 2020.
December 31, 2020
(Dollars in thousands)
Balance
Loan
Deferrals
Loan Modifications
Loan Deferrals and Modifications to
Total Loans
Commercial and industrial
$
68,390
$
$
-
0.02
%
Commercial real estate
200,690
2,576
0.45
%
Construction and land
73,966
-
-
-
Consumer
6,355
-
-
-
Student
6,971
-
-
-
Residential real estate
230,885
-
0.01
%
Home equity lines of credit
29,492
-
-
-
Total
$
616,749
$
$
2,576
0.49
%
Borrowers whose industries are expected to be stressed by COVID-19, include, but are not limited to, religious organizations, hospitality, childcare and restaurants. The following table summarizes these industries as it relates to the Company’s loan portfolio at December 31, 2020:
(Dollars in thousands)
December 31, 2020
Loan Category
Balance
Percent of
Total Loans
Religious Organizations
$
25,625
4.15
%
Hospitality
15,691
2.54
%
Childcare
14,407
2.34
%
Restaurants
11,189
1.81
%
$
66,912
10.85
%
Net interest income
While net interest income was significantly impacted by the lower interest rate environment during 2020, the Company’s interest income benefited from PPP loans and related processing fees. PPP loans carry a fixed rate of 1.0% with a two-year contractual maturity. For the year ended December 31, 2020, PPP loans contributed approximately $1.2 million to the Company’s net interest income, with the average yield of 3.54%.
EXECUTIVE OVERVIEW
This discussion is intended to focus on certain financial information regarding the Company and the Bank and may not contain all the information that is important to the reader. The purpose of this discussion is to provide the reader with a more thorough understanding of the Company’s financial statements. As such, this discussion should be read carefully in conjunction with the consolidated financial statements and accompanying notes contained elsewhere in this report.
The Company’s primary financial objectives are to maximize earnings and to deploy capital in profitable growth initiatives that will enhance long-term shareholder value. The Company monitors the following financial performance metrics towards achieving these goals: (i) return on average assets (“ROA”), (ii) return on average equity (“ROE”), and (iii) growth in earnings. The Company also actively manages capital through growth and dividends, while considering the need to maintain a strong regulatory capital position.
Future trends regarding net interest income are dependent on the absolute level of market interest rates, the shape of the yield curve, the amount of lost income from nonperforming assets, loan prepayments, the mix and amount of various deposit types, and many other factors, as well as the overall volume of interest-earning assets. Many of these factors are individually difficult to predict, and when factored together, the uncertainty of future trends compounds.
For the year ended December 31, 2020, the Company’s ROE and ROA were 8.31% and 0.73%, respectively, compared to 10.64% and 0.96%, respectively, for the year ended December 31, 2019.
Total assets were $867.2 million on December 31, 2020 compared to $722.2 million on December 31, 2019. Net loans were $609.9 million on December 31, 2020 compared to $545.0 million on December 31, 2019. Total deposits were $766.1 million on December 31, 2020 compared to $622.2 million on December 31, 2019, respectively. Low cost transaction deposits (demand and interest checking accounts) increased to $449.2 million on December 31, 2020, from $366.0 on December 31, 2019.
The Company had net income of $5.9 million, or $1.55 per diluted share, in 2020 compared to $6.8 million, or $1.80 per diluted share for 2019. Net interest margin was 3.46% for the year ended December 31, 2020 compared to 3.74% for the year ended December 31, 2019. Net interest income for the year ended December 31, 2020 was $25.8 million compared to $24.7 million for the year ended December 31, 2019.
On October 1, 2020, the Company and Virginia National announced the Merger Agreement pursuant to which the Company and Virginia National will engage in the “Merger. Upon consummation of the Merger, the holders of shares of the Company's common stock will be converted into the right to receive 0.675 shares of Virginia National common stock for each share of the Company's common stock held immediately prior to the effective date of the Merger, plus cash in lieu of fractional shares. The transaction is expected to be completed in the second quarter of 2021. The companies have received regulatory and shareholder approvals, and the transaction remains subject to other customary closing conditions.
The following table presents a quarterly summary of consolidated net income for the last two years.
For the Quarter Ended
For the Quarter Ended
(Dollars in thousands, except per share data)
December 31,
September 30,
June 30,
March 31,
December 31,
September 30,
June 30,
March 31,
Interest income
$
7,406
$
6,841
$
7,008
$
7,057
$
7,350
$
7,362
$
7,279
$
7,179
Interest expense
1,108
1,171
1,195
1,046
Net interest income
6,904
6,294
6,384
6,189
6,242
6,191
6,084
6,133
Provision for loan losses
-
Net interest income after provision for loan losses
6,737
5,949
5,473
5,839
6,151
6,191
5,879
6,083
Gains on sales of securities available for sale, net
-
-
-
-
-
-
-
Other noninterest income
1,438
1,478
1,216
1,342
1,484
1,610
1,400
1,480
Noninterest expense
7,357
5,670
4,889
5,605
5,808
5,419
5,509
5,718
Income before income taxes
1,810
1,757
1,800
1,576
1,827
2,382
1,770
1,845
Income tax expense
Net income
$
1,356
$
1,547
$
1,578
$
1,396
$
1,572
$
2,052
$
1,564
$
1,632
Net income per share, basic
$
0.36
$
0.41
$
0.42
$
0.37
$
0.42
$
0.54
$
0.41
$
0.43
Net income per share, diluted
$
0.36
$
0.41
$
0.42
$
0.37
$
0.42
$
0.54
$
0.41
$
0.43
RESULTS OF OPERATIONS
NET INTEREST INCOME
2020 COMPARED WITH 2019
Net interest income increased to $25.8 million for the year ended December 31, 2020 from $24.7 million for the same period of 2019. The net interest margin was 3.46% for the year ended December 31, 2020 compared to 3.74% for the same period in 2019.
Interest income decreased while average earning assets increased from $660.8 million in 2019 to $747.4 million in 2020. The decrease of 63 basis points (“bp”) in the average yield on assets from 4.43% in 2019 to 3.80% in 2020 was primarily the result of:
•
Average loans increased $60.0 million from $544.9 million in 2019 to $604.9 million in 2020. The tax-equivalent yield on loans decreased to 4.33% in 2020 compared to 4.84% in 2019. Together, interest and fee income from loans decreased $206,000 for 2020 compared with 2019. While average loan balances increased as a result of organic loan growth as well as approximately $34.7 million of average outstanding loan balances related to PPP loans, loan yields decreased as a result of the lower interest rate environment and the fixed rate of 1% on PPP loans.
•
Average securities increased $9.2 million from $74.8 million in 2019 to $84.0 million in 2020. The tax-equivalent yield on securities decreased to 2.52% in 2020 compared to 2.81% in 2019. Tax-equivalent interest and dividend income on securities remained relatively unchanged at $2.1 million for 2020 and 2019.
Total interest expense decreased $2.0 million from $4.5 million in 2019 to $2.5 million in 2020, resulting in the average rate on total interest-bearing liabilities decreasing from 0.88% in 2019 to 0.46% in 2020, and cost of funds decreasing from 0.71% in 2019 to 0.35% in 2020. As described below, the decreases in the cost of funds were the result of the Company’s response to interest rate trends and the reduction of rates on certain interest-bearing transaction accounts, and lower funding costs on FHLB advances. The decrease in interest expense from 2019 to 2020 was due primarily to the following:
•
Average interest-bearing deposits increased $50.8 million from $481.9 million in 2019 to $532.8 million in 2020. The average rate paid on interest-bearing deposits decreased from 0.75% in 2019 to 0.39% in 2020. This resulted in a decrease in interest paid on deposits of $1.5 million from $3.6 million in 2019 to $2.1 million in 2020. The increase in interest-bearing deposit balances was primarily the result of organic deposit growth from new and existing personal and business clients.
•
Average FHLB advances decreased $6.3 million from $27.6 million in 2019 to $21.3 million in 2020. Interest expense on FHLB advances decreased $421,000 from $712,000 in 2019 to $291,000 in 2020.
The Company believes that, given the current interest rate environment, net interest income and the net interest margin could decrease in future periods.
2019 COMPARED WITH 2018
Net interest income increased to $24.7 million for the year ended December 31, 2019 from $23.5 million for the same period of 2018. The net interest margin was 3.74% for the year ended December 31, 2019 compared to 3.81% for the same period in 2018.
Interest income increased as the result of an overall increase in average earning assets from $619.1 million in 2018 to $660.8 million in 2019, a direct result of management’s emphasis on growing the loan and securities portfolios. The increase of 10 bps in the average yield on assets from 4.33% in 2018 to 4.43% in 2019 was primarily the result of:
•
Average loans increased $27.2 million from $517.7 million in 2018 to $544.9 million in 2019. The tax-equivalent yield on loans increased to 4.84% in 2019 compared to 4.69% in 2018. Together, interest and fee income from loans increased $2.1 million for 2019 compared with 2018.
•
Average securities increased $184,000 from $74.6 million in 2018 to $74.8 million in 2019. The tax-equivalent yield on investments remained unchanged at 2.81% in 2019 compared to 2018. Tax-equivalent interest and dividend income on securities decreased $11,000 from 2018 to 2019.
Total interest expense increased $1.3 million from $3.2 million in 2018 to $4.5 million in 2019, resulting in the average rate on total interest-bearing liabilities increasing from 0.67% in 2018 to 0.88% in 2019, due primarily to the following:
•
Average interest-bearing deposits increased $27.8 million from $454.0 million in 2018 to $481.9 million in 2019. The average rate paid on interest-bearing deposits increased from 0.54% in 2018 to 0.75% in 2019. This resulted in an increase in interest paid on deposits of $1.1 million from $2.4 million in 2018 to $3.6 million in 2019.
•
Average FHLB advances increased $4.3 million from $23.3 million in 2018 to $27.6 million in 2019. Interest expense on FHLB advances increased $171,000 from $541,000 in 2018 to $712,000 in 2019.
The following table sets forth, on a tax-equivalent basis, information relating to the Company’s average balance sheet and reflects the average yield on assets and average cost of liabilities for the years ended December 31, 2020, 2019 and 2018 and the average yields and rates paid for the periods indicated. These yields and costs are derived by dividing income or expense by the average daily balances of assets and liabilities, respectively, for the periods presented.
December 31, 2020
December 31, 2019
December 31, 2018
(Dollars in thousands)
Average
Income/
Average
Average
Income/
Average
Average
Income/
Average
Assets
Balances
Expense
Rate
Balances
Expense
Rate
Balances
Expense
Rate
Loans
Taxable
$
603,810
$
26,192
4.34
%
$
543,111
$
26,398
4.86
%
$
514,958
$
24,291
4.72
%
Nonaccrual (2)
1,125
-
-
1,834
-
-
2,770
-
-
Total loans
604,935
26,192
4.33
%
544,945
26,398
4.84
%
517,728
24,291
4.69
%
Securities
Taxable
65,949
1,554
2.38
%
60,847
1,631
2.71
%
60,560
1,622
2.68
%
Tax-exempt (1)
18,041
3.02
%
13,956
3.25
%
14,059
3.37
%
Total securities
83,990
2,099
2.52
%
74,803
2,085
2.81
%
74,619
2,096
2.81
%
Deposits in other banks
58,460
0.23
%
41,077
1.90
%
26,777
1.53
%
Federal funds sold
-
0.35
%
-
2.31
%
-
1.59
%
Total earning assets
747,399
28,426
3.80
%
660,839
29,265
4.43
%
619,138
26,797
4.33
%
Less: Allowance for loan losses
(6,149
)
(5,429
)
(5,317
)
Total nonearning assets
59,367
57,000
50,848
Total Assets
$
800,617
$
712,410
$
664,669
Liabilities and Shareholders' Equity
Deposits
Demand
$
159,668
$
121,910
$
117,422
Interest-bearing
NOW
252,648
$
0.20
%
230,081
$
1,028
0.45
%
231,819
$
0.39
%
Money market
105,218
0.40
%
78,097
0.83
%
59,400
0.52
%
Savings
102,862
0.09
%
87,478
0.32
%
89,103
0.26
%
Time deposits
72,095
1,057
1.47
%
86,205
1,641
1.90
%
73,717
1,009
1.37
%
Total interest-bearing deposits
532,823
2,064
0.39
%
481,861
3,595
0.75
%
454,039
2,447
0.54
%
Federal funds purchased
-
1.05
%
2.90
%
2,044
2.26
%
FHLB advances
21,324
1.37
%
27,611
2.58
%
23,315
2.32
%
Junior subordinated debt
4,124
4.50
%
4,124
4.83
%
4,124
4.83
%
Total interest-bearing liabilities
558,272
2,541
0.46
%
514,090
4,520
0.88
%
483,522
3,233
0.67
%
Other liabilities
11,968
12,331
6,088
Shareholders' equity
70,709
64,079
57,637
Total Liabilities and Shareholders' Equity
$
800,617
$
712,410
$
664,669
Net interest income (tax-equivalent basis)
$
25,885
3.35
%
$
24,745
3.55
%
$
23,564
3.66
%
Less: tax equivalent adjustment
Net interest income
$
25,771
$
24,650
$
23,465
Interest expense as a percent of average earning assets
0.34
%
0.68
%
0.52
%
Net interest margin
3.46
%
3.74
%
3.81
%
(1)
Income and rates on nontaxable assets are computed on a tax-equivalent basis using a federal tax rate of 21%.
(2)
Nonaccrual loans are included in the average balance of total loans and total earning assets.
RATE/VOLUME ANALYSIS
The following table sets forth certain information regarding changes in interest income and interest expense for the periods indicated. For each category of interest-earning asset and interest-bearing liability, information is provided on changes attributable to changes in volume (change in volume multiplied by old rate); and changes in rates (change in rate multiplied by old volume). Changes in rate-volume, which cannot be separately identified, are allocated proportionately between changes in rate and changes in volume.
2020 Compared to 2019
2019 Compared to 2018
Due to
Due to
Due to
Due to
(In thousands)
Change
Volume
Rate
Change
Volume
Rate
Interest Income
Loans
Taxable
$
(206
)
$
2,953
$
(3,159
)
$
2,107
$
1,328
$
Securities
Taxable
(77
)
(213
)
Tax-exempt (1)
(42
)
(20
)
(3
)
(17
)
Deposits in other banks
(647
)
(978
)
Total interest income
(839
)
3,553
(4,392
)
2,468
1,551
Interest Expense
NOW
(535
)
(636
)
(7
)
Money market
(225
)
(449
)
Savings
(187
)
(236
)
(4
)
Time deposits
(584
)
(269
)
(315
)
Federal funds purchased
(14
)
(14
)
-
(32
)
(35
)
FHLB advances
(421
)
(163
)
(258
)
Junior subordinated debt
(13
)
-
(13
)
-
-
-
Total interest expense
(1,979
)
(72
)
(1,907
)
1,287
Net interest income
$
1,140
$
3,625
$
(2,485
)
$
1,181
$
1,229
$
(48
)
(1)
Income and rates on nontaxable assets are computed on a tax-equivalent basis using a federal tax rate of 21%.
NONINTEREST INCOME
December 31,
Increase (Decrease) 2020 vs. 2019
Increase (Decrease) 2019 vs. 2018
(Dollars in thousands)
Amount
Percent
Amount
Percent
Noninterest Income
Trust and estate fees
$
2,249
$
1,743
$
1,542
$
29.0
%
$
13.0
%
Brokerage fees
23.0
%
151.7
%
Service charges on deposit accounts
1,118
1,522
1,706
(404
)
(26.5
)%
(184
)
(10.8
)%
Interchange fee income, net
1,215
1,305
1,252
(90
)
(6.9
)%
4.2
%
Bank-owned life insurance
(6
)
(1.6
)%
1.4
%
Gain on sale/call of securities available for sale, net
1155.7
%
(759
)
(90.6
)%
Gain on sale of mortgage loans held for sale, net
24.6
%
86.5
%
Other income
(111
)
(548
)
(125.4
)%
176.6
%
$
6,466
$
5,974
$
6,074
$
8.2
%
$
(100
)
(1.6
)%
2020 COMPARED WITH 2019
Total noninterest income increased $492,000 from $6.0 million in 2019 to $6.5 million in 2020. The following were the primary changes in noninterest income:
•
Trust, estate and brokerage fees increased as a result of an increase in assets under management for both trust and investment management accounts and brokerage accounts. Assets under management were $530.8 million at December 31, 2020 compared to $455.0 million at December 31, 2019.
•
Service charges on deposit accounts continued to decline as a result of the decline in non-sufficient funds (“NSF”) fees which is directly related to customer behavior. NSF fees were $978,000 in 2020 compared to $1.5 million in 2019.
•
During 2020, the net gain on the sale of securities available for sale was the result of a portfolio reallocation to align with the Company’s investment goals. During 2019, the gain on calls of securities available for sale was the result of two calls of trust preferred securities that went to auction and were settled at their par value.
•
Other income decreased primarily as a result of several factors. Automated teller machine (“ATM”) surcharge income decreased $81,000 when compared to 2019, due to the Company outsourcing this activity. Losses on the disposal of these ATMs totaled $177,000 during 2020. Partnership income, which is primarily derived from the Bank’s ownership interest in Bankers Insurance, LLC, increased $112,000 when compared to 2019. The increase in this income was partially offset by an increase of $172,000 in pass-through losses from the Bank’s investment in qualified affordable housing projects.
2019 COMPARED WITH 2018
Total noninterest income decreased $100,000 from $6.1 million in 2018 to $6.0 million in 2019. The following were the primary changes in noninterest income:
•
Trust, estate and brokerage fees increased as a result of increased brokerage production and increased assets under management. Assets under management were $455.0 million at December 31, 2019 compared to $325.5 million at December 31, 2018.
•
Service charges on deposit accounts continued to decline due to customer behavior and increased mobile banking usage.
•
The decrease in the net gains on the sale of securities available for sale in 2019 was due to the Company’s portfolio reallocation to align with its investment goals and the gain on calls of securities available for sale in 2018 which was the result of two calls of trust preferred securities that went to auction and were settled at their par value.
•
The net gain on mortgage loans held for sale increased as a result of increased loans sold on the secondary market. Loans originated for sale on the secondary market were $5.4 million in 2019 compared to $2.0 million in 2018.
•
Other income increased as a result of decreased net losses on partnerships of $32,000, gains from the sale of property of $139,000, income received from the sale of an equity ownership interest of $39,000 and income of $69,000 received from contract negotiations with a new broker/dealer which is recognized over the life of the contract.
NONINTEREST EXPENSE
December 31,
Increase (Decrease) 2020 vs. 2019
Increase (Decrease) 2019 vs. 2018
(Dollars in thousands)
Amount
Percent
Amount
Percent
Noninterest Expenses
Salaries and benefits
$
12,103
$
12,084
$
12,108
$
0.2
%
$
(24
)
(0.2
)%
Occupancy
2,409
2,352
2,331
2.4
%
0.9
%
Furniture and equipment
1,050
1,012
(274
)
(26.1
)%
3.8
%
Marketing and business development
(161
)
(24.8
)%
6.2
%
Legal, audit and consulting
1,129
1,054
1,015
7.1
%
3.8
%
Data processing
1,432
1,381
1,292
3.7
%
6.9
%
Federal Deposit Insurance Corporation assessment
104.2
%
(179
)
(48.5
)%
Merger related expenses
1,231
-
-
1,231
-
-
0.0
%
Prepayment penalty on early debt extinguishment
-
-
(268
)
-
-
Other operating expenses
3,565
3,427
3,414
4.0
%
0.4
%
$
23,520
$
22,454
$
22,151
$
1,066
4.7
%
$
1.4
%
2020 COMPARED WITH 2019
Total noninterest expense increased $1.1 million from $22.5 million in 2019 to $23.5 million in 2020. Management continued to strive for increased efficiencies through process improvements and expense monitoring. The following were the primary changes in noninterest expense:
•
Furniture and equipment expenses decreased primarily due to a decrease in depreciation associated with the ATMs, as noted above in noninterest income, that were removed due to the Bank’s outsourcing this activity. Depreciation expense for furniture and equipment was $113,000 for 2020 compared to $323,000 for 2019.
•
Marketing expenses decreased by $92,000 primarily due to timing differences in marketing campaigns. Business development activities decreased $60,000, as a result of the COVID-19 pandemic.
•
FDIC deposit insurance assessment increased as a result of the Small Bank Assessment Credit of $162,000 that was received in 2019. This credit is the portion of the Company’s assessment that contributed to the growth in the DIF reserve ratio from 1.15% to 1.35%.
•
Merger expenses of $1.2 million are related to the Merger with Virginia National, announced on October 1, 2020. The Company expects to continue to incur merger expenses until the Merger with Virginia National is completed, which is currently expected to occur in the second quarter of 2021.
2019 COMPARED WITH 2018
Total noninterest expense increased $303,000 from $22.2 million in 2018 to $22.5 million in 2019. Management continued to strive for increased efficiencies through process improvements and expense monitoring. The following were the primary changes in noninterest expense:
•
While the Company’s personnel expenses were its largest noninterest expense, total salary and benefit expenses remained relatively flat.
•
Occupancy, furniture and equipment expenses remained relatively unchanged.
•
Marketing and business development expenses increased slightly as a result of advertising campaigns, business development opportunities and community support.
•
Consulting expense, which includes legal and auditing fees, remained relatively unchanged.
•
FDIC deposit insurance assessment decreased as a result of the Small Bank Assessment Credit. This credit is the portion of the Company’s assessment that contributed to the growth in the DIF reserve ratio from 1.15% to 1.35%.
•
The Company incurred prepayment penalties on the early extinguishment of $13.0 million of FHLB advances.
•
Other operating expenses remained relatively unchanged.
INCOME TAXES
Income tax expense for 2020 was $1.1 million, resulting in an effective tax rate of 15.4%, compared with $1.0 million or 12.8%, in 2019 and $746,000, or 10.8%, in 2018. Income tax expense and the effective tax rate differed from the statutory federal income tax rate of 21% primarily due to the Bank’s investment in tax-exempt securities, income from bank-owned life insurance and community development tax credits. Community development tax credits were $479,000, $552,000, and $504,000 for 2020, 2019 and 2018, respectively.
ASSET QUALITY
Loans that are separately identified as impaired are measured based on the present value of expected future cash flows or, alternatively, the observable market price of the loans or the fair value of the collateral. However, for those loans that are collateral dependent and for which management has determined foreclosure is probable, impairment is based on the net realizable value of the collateral.
A loan is considered impaired when there is an identified weakness which makes it probable that the collection of all principal and interest according to the contractual terms of the loan agreement will not be made. Factors involved in determining if a loan is impaired include, but are not limited to, expected future cash flows, financial condition of the borrower, and current economic conditions. Loans that are considered doubtful or loss generally qualify as impaired loans.
Nonperforming assets, in most cases, consist of nonaccrual loans, TDRs, OREO, and loans that are greater than 90 days past due and accruing interest.
As mentioned above, in response to COVID-19, the Company established a short-term loan modification program, which included the deferral of scheduled payments for a 90-day period. Borrowers who were considered current were ones whose loans were less than 30 days past due on their contractual payments at the time the modification was entered. As of December 31, 2020, there was one loan modification totaling $2.6 million and 5 loans in payment deferral totaling $518,000. These additional deferrals remained within the CARES Act and the March 2020 interagency guidance and were not considered TDRs.
The following table sets forth certain information with respect to the Company’s nonperforming assets at the dates indicated:
At December 31,
(Dollars in thousands)
Nonaccrual loans
$
1,245
$
$
1,993
$
3,180
$
3,523
TDR loans still accruing
8,363
2,471
3,361
4,182
5,305
Loans 90+ days past due and accruing
1,636
1,227
1,665
2,859
Total nonperforming loans
10,192
5,096
6,581
9,027
11,687
OREO, net
1,356
1,356
1,356
1,356
1,356
Total nonperforming assets
$
11,548
$
6,452
$
7,937
$
10,383
$
13,043
Allowance for loan losses to total loans
1.11
%
0.95
%
0.94
%
1.00
%
1.00
%
Nonaccrual loans to total loans
0.20
%
0.18
%
0.36
%
0.60
%
0.80
%
Allowance for loan losses to nonperforming loans
67.41
%
102.57
%
78.65
%
56.40
%
38.70
%
Nonperforming loans to total loans
1.65
%
0.93
%
1.20
%
1.80
%
2.50
%
Nonperforming assets to total assets
1.33
%
0.89
%
1.09
%
1.60
%
2.10
%
Nonperforming assets totaled $11.5 million or 1.33% of total assets at December 31, 2020 and $6.5 million or 0.89% of total assets at December 31, 2019. The ratio of allowance for loan losses as a percentage of nonperforming loans was 67.41% and 102.57% at December 31, 2020 and 2019, respectively. Factors contributing to these changes are:
•
Nonaccrual loans were $1.2 million and $1.0 million at December 31, 2020 and 2019, respectively. Changes in nonaccrual loans during 2020 was the result of the principal curtailment for one commercial real estate loans totaling $632,000, offset by the addition of one commercial and industrial loan totaling $509,000 and one residential real estate loan totaling $379,000.
•
OREO remained unchanged at $1.4 million, consisting of one 47-acre tract of undeveloped property.
•
Loans greater than 90 or more days past due and still accruing interest totaled $584,000 and $1.6 million at December 31, 2020 and 2019, respectively. Included are $583,000 and $1.2 million in student loans at December 31, 2020 and 2019 that were greater than 90 days past due and still accruing interest. Student loans that are past due continue to accrue interest due to the 98% guarantee by the U.S. Department of Education.
•
There were five loans in the portfolio totaling $8.4 million that were identified as TDRs (non-COVID related) at December 31, 2020 compared to five loans at $2.5 million at December 31, 2019. One commercial and industrial loan was modified and identified as a TDR during 2020. There were no loans modified and identified as TDRs during 2019. At December 31, 2020, all TDRs were current and performing in accordance with their modified terms.
ANALYSIS OF LOAN LOSS EXPERIENCE
The allowance for loan losses is maintained at a level which, in management’s judgment, is adequate to absorb credit losses inherent in the loan portfolio. Management periodically evaluates the collectability of the loan portfolio, credit concentrations, trends in historical loan loss experience, impaired loans, and current economic conditions in determining the adequacy of the allowance. The allowance is increased by the provision for loan losses, which is charged to expense, and reduced by charge-offs, net of recoveries. Because of uncertainties inherent in the estimation process, management’s estimate of credit losses inherent in the loan portfolio and the related allowance remains subject to change. Additions to the allowance, recorded as the provision for loan losses on the Company’s statements of operations, are made, as needed, to maintain the allowance at an appropriate level based on management’s analysis. The amount of the provision is a function of the level of loans outstanding, the level and nature of impaired and nonperforming loans, historical loan loss experience, the amount of loan losses actually charged-off or recovered during a given period and current national and local economic conditions. There can be no assurances, however, that future losses will not exceed estimated amounts, or that increased amounts of provisions for loan losses will not be required in future periods.
The allowance for loan losses was $6.9 million or 1.11% of total loans at December 31, 2020 compared to $5.2 million or 0.95% of total loans at December 31, 2019. The provision for loan losses was $1.8 million and $346,000 for the years ended December 31, 2020 and 2019, respectively. The increase in the allowance for loan losses was due primarily to the increase in qualitative factors related to COVID-19 and the current economic conditions, including, but not limited to, the increased unemployment rate for the Commonwealth of Virginia. The allowance for loan losses was not impacted by PPP loans during the year ended December 31, 2020 due to the 100% SBA guaranty for loans funded under this program.
While Management believes that adequate loan loss reserves existed as of December 31, 2020, Management also recognizes that the full impact of COVID-19 may have a continued adverse effect on the credit quality of the Company’s loan portfolio subsequent to 2020.
Impaired loans were $9.6 million and $3.6 million at December 31, 2020 and 2019, respectively. Reserves allocated to impaired loans were $72,000 and $229,000 at December 31, 2020 and 2019, respectively. There are no loans other than those disclosed above either as nonperforming or impaired, where information known about the borrower has caused management to have serious doubts about the borrower’s ability to repay.
The following table summarizes the Bank’s loan loss experience for the periods indicated:
Years ended December 31,
(Dollars in thousands)
Allowance for loan losses, January 1,
$
5,227
$
5,176
$
5,094
$
4,525
$
4,193
Charged-off loans:
Commercial and industrial
Commercial real estate
-
-
Construction and land
-
-
-
-
Consumer
Student
Residential real estate
-
-
Home equity lines of credit
-
-
-
-
Total loans charged-off
Recoveries:
Commercial and industrial
1,527
Commercial real estate
Construction and land
-
-
-
-
-
Consumer
Student
-
-
-
-
-
Residential real estate
-
-
-
Home equity lines of credit
-
-
Total loan recoveries
1,564
Net charge-offs (recoveries)
(49
)
(840
)
Provision for (recovery of) loan losses
1,773
(508
)
Allowance for loan losses, December 31,
$
6,870
$
5,227
$
5,176
$
5,094
$
4,525
Ratio of net charge-offs (recoveries) to average loans
0.02
%
0.05
%
0.08
%
(0.01
)%
(0.19
)%
The following table allocates the allowance for loan losses to each loan portfolio segment. The allowance has been allocated according to the amount deemed to be reasonably necessary to provide for the possibility of losses being incurred, although the entire allowance balance is available to absorb any actual charge-offs that may occur.
At December 31,
Allowance for Loan Losses
Percentage of Total Loans
Allowance for Loan Losses
Percentage of Total Loans
Allowance for Loan Losses
Percentage of Total Loans
Allowance for Loan Losses
Percentage of Total Loans
Allowance for Loan Losses
Percentage of Total Loans
(Dollars in thousands)
Commercial and industrial
$
11.09
%
$
4.98
%
$
4.86
%
$
4.90
%
$
5.50
%
Commercial real estate
2,334
32.54
%
1,788
33.06
%
1,738
34.18
%
1,609
35.20
%
1,569
35.70
%
Construction and land
1,080
11.99
%
11.86
%
13.00
%
10.70
%
10.70
%
Consumer
1.03
%
1.08
%
1.01
%
1.00
%
0.70
%
Student
1.13
%
1.48
%
1.67
%
2.10
%
2.80
%
Residential real estate
1,839
37.44
%
1,596
40.95
%
1,311
37.49
%
37.20
%
35.10
%
Home equity lines of credit
4.78
%
6.59
%
7.79
%
8.90
%
9.50
%
Unallocated
-
-
-
-
-
$
6,870
100.00
%
$
5,227
100.00
%
$
5,176
100.00
%
$
5,094
100.00
%
$
4,525
100.00
%
COMPARISON OF FINANCIAL CONDITION AT DECEMBER 31, 2020 AND 2019
SUMMARY
A financial institution’s primary sources of revenue are generated by its earning assets and sales of financial assets, while its major expenses are produced by the funding of those assets with interest-bearing liabilities, provisions for loan losses and compensation to employees. Effective management of these sources and uses of funds is essential in attaining a financial institution’s maximum profitability while maintaining an acceptable level of risk.
At December 31, 2020, the Company had total assets of $867.2 million compared to $722.2 million at December 31, 2019. The significant components of the Company’s consolidated balance sheets are discussed below.
SECURITIES
At December 31, 2020, 2019 and 2018, the carrying values of securities available for sale at fair value were:
Available for Sale
(Dollars in thousands)
Obligations of U.S. Government corporations and agencies
$
59,210
$
63,941
$
56,409
Obligations of states and political subdivisions
23,638
15,842
14,580
Corporate bonds
-
-
Total
$
82,848
$
79,783
$
71,884
The following is a schedule of estimated maturities, or call date if more probable, or next rate repricing adjustment date, and related weighted average yields of securities at December 31, 2020:
Due in one year or less
Due after
One through Five years
Due after
Five through Ten years
Due after Ten years
Total
(Dollars in thousands)
Amount
Yield
Amount
Yield
Amount
Yield
Amount
Yield
Amount
Yield
Securities available for sale:
Obligations of U.S. Government corporations and agencies
$
2,016
1.37
%
$
8,118
2.59
%
$
5,409
1.54
%
$
43,667
1.84
%
$
59,210
1.90
%
Obligations of states and political subdivisions
5.28
%
4.58
%
4,060
3.13
%
19,222
2.78
%
23,638
2.87
%
Total securities
$
2,071
1.48
%
$
8,419
2.66
%
$
9,469
2.22
%
$
62,889
2.13
%
$
82,848
2.18
%
Excluding obligations of U.S. Government corporations and agencies, there were no securities from a single issuer exceeding 10% of shareholders’ equity.
LOAN PORTFOLIO
Loans are made mainly to customers located within the Company’s primary market area. Loan pricing strategies and product offerings are continually modified in an effort to increase lending activity without sacrificing the existing credit quality standards. At December 31, 2020 and 2019, net loans were 70.33% and 75.46% of total assets, respectively, and were the largest category of the Company’s earning assets. Loans are shown on the balance sheets net of unearned discounts and the allowance for loan losses. Interest is computed by methods that result in level rates of return on principal. Loans are charged-off when deemed by management to be uncollectible, after taking into consideration such factors as the current financial condition of the customer and the underlying collateral and guarantees.
Total loans on the balance sheet are comprised of the following portfolio segments at the dates indicated:
At December 31,
(Dollars in thousands)
Commercial and industrial loans
$
68,390
$
27,404
$
26,721
$
24,413
$
25,735
Commercial real estate
200,690
181,898
187,797
176,827
165,271
Construction and land
73,966
65,231
71,409
54,162
49,777
Consumer
6,355
5,958
5,562
5,068
3,100
Student
6,971
8,151
9,158
10,677
13,006
Residential real estate
230,885
225,316
205,945
187,104
162,383
Home equity lines of credit
29,492
36,268
42,772
44,548
43,861
Total loans
$
616,749
$
550,226
$
549,364
$
502,799
$
463,133
At December 31, 2020, there were no loan concentrations to commercial borrowers engaged in similar activities that exceeded 10% of total loans. Based on regulatory guidelines, the Bank is required to monitor the commercial real estate loan portfolio for: (i) concentrations above 100% of Tier 1 capital for construction and land loans and; (ii) concentrations above 300% for permanent investor real estate loans. As of December 31, 2020, the Company was well below these thresholds.
The following is a schedule of maturities and sensitivities of loans subject to changes in interest rates as of December 31, 2020:
(Dollars in thousands)
Within One Year
One Year through Five Years
After Five Years
Total
Commercial and industrial
$
8,487
$
52,498
$
7,405
$
68,390
Commercial real estate
27,948
96,382
76,360
200,690
Construction and land
48,192
25,198
73,966
$
84,627
$
174,078
$
84,341
$
343,046
For maturities over one year:
Floating and adjustable rate loans
$
14,938
$
32,271
$
47,209
Fixed rate loans
159,140
52,070
211,210
$
174,078
$
84,341
$
258,419
DEPOSITS
Deposits totaled $766.1 million and $622.2 million at December 31, 2020 and 2019, respectively.
The average daily amounts of deposits and rates paid on deposits is summarized for the periods indicated in the following table:
Year Ended December 31,
(Dollars in thousands)
Amount
Rate
Amount
Rate
Amount
Rate
Demand
$
159,668
$
121,910
$
117,422
Interest-bearing:
NOW
252,648
0.20
%
230,081
0.45
%
231,819
0.39
%
Money market
105,218
0.40
%
78,097
0.83
%
59,400
0.52
%
Savings
102,862
0.09
%
87,478
0.32
%
89,103
0.26
%
Time deposits
72,095
1.47
%
86,205
1.90
%
73,717
1.37
%
Total interest-bearing deposits
532,823
0.39
%
481,861
0.75
%
454,039
0.54
%
Total deposits
$
692,491
$
603,771
$
571,461
The following is a schedule of maturities of time deposits in amounts of $100,000 or more at December 31, 2020:
December 31, 2020
(Dollars in thousands)
Within
Three Months
Three through Six Months
Six through Twelve Months
Over Twelve Months
Total
$100,000 to $250,000
$
8,849
$
7,100
$
8,379
$
2,889
$
27,217
Over $250,000
1,832
4,525
5,190
1,478
13,025
Total
$
10,681
$
11,625
$
13,569
$
4,367
$
40,242
BORROWINGS
Amounts and weighted average rates for long-and short-term borrowings as of December 31, 2020, 2019 and 2018 are as follows:
December 31, 2020
December 31, 2019
December 31, 2018
(Dollars in thousands)
Amount
Rate
Amount
Rate
Amount
Rate
FHLB advances
$
12,606
2.06
%
$
16,695
2.21
%
$
23,780
2.66
%
At December 31, 2020, the weighted average life of FHLB advances was approximately 2.99 years.
In 2019, the Company sought to reduce its cost of interest-bearing liabilities by reducing the balance of its FHLB advances from $23.8 million at December 31, 2018, to $16.7 million at December 31, 2019. The reduction of FHLB advances included early repayments of $13.0 million on December 31, 2019, resulting in prepayment penalties totaling $268,000.
LIQUIDITY
Liquidity management involves meeting the present and future financial obligations of the Company with the sale or maturity of assets or with the occurrence of additional liabilities. Liquidity needs are met with cash on hand, deposits in other banks, federal funds sold and unencumbered securities classified as available for sale. At December 31, 2020, liquid assets totaled $193.0 million, or 22.26% of total assets and 24.29% of total liabilities. Securities provide a constant source of liquidity through paydowns and maturities. The Company maintains short-term borrowing arrangements, namely federal funds lines of credit, with larger financial institutions as an additional source of liquidity and the Bank’s membership with the FHLB also provides a source of borrowings with numerous rate and term structures. Management monitors the liquidity position regularly and attempts to maintain a position which utilizes available funds most efficiently. As a result, management believes that the Company maintains overall liquidity sufficient to satisfy its depositors’ requirements and meet its customers’ credit needs.
CAPITAL
Shareholders’ equity totaled $72.5 million at December 31, 2020 compared with $67.1 million at December 31, 2019. The amount of equity reflects management’s desire to increase shareholders’ return on equity while maintaining a strong capital base.
The Company and the Bank are subject to various regulatory capital requirements administered by banking agencies. Failure to meet minimum capital requirements can trigger certain mandatory and discretionary actions by regulators that could have a direct material effect on the Company’s financial condition and results of operations. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Bank must meet specific capital guidelines that involve quantitative measures of their assets, liabilities, and certain off-balance sheet items as calculated under regulatory accounting practices. In addition to the regulatory risk-based capital, the Company must maintain a capital conservation buffer of additional total capital and common equity Tier 1 capital as required by the Basel III Capital Rules. The phase-in of the capital conservation buffer requirement began on January 1, 2016, at 0.625% of risk-weighted assets, increasing by the same amount each year until it was fully implemented at 2.5% on January 1, 2019. Management believes that the Bank satisfies all capital adequacy requirements to which they are subject as of December 31, 2020 and 2019.
As of December 31, 2020 and December 31, 2019, the Company qualified as a small bank holding company under SBHC Policy Statement and, as a result, the Company was exempt from the Basel III Capital Rules. See the discussion under the heading “Government Supervision and Regulation” in Item 1 of this Annual Report on Form 10-K for more information.
As of December 31, 2020, the Bank is considered “well capitalized” as defined by regulatory authorities. The following table provides information on the regulatory capital ratios for the Bank at December 31, 2020 and 2019.
(Dollars in thousands)
December 31, 2020
December 31, 2019
Tier 1 Capital:
Common equity
$
75,588
$
70,312
Unrealized (gain) loss on securities available for sale, net
(2,643
)
(1,294
)
Unrealized benefit obligation for supplemental retirement plans
(31
)
(155
)
Total Common equity tier 1 capital
72,914
68,863
Tier 2 Capital:
Allowable allowance for loan losses
6,870
5,227
Total Capital:
$
79,784
$
74,090
Risk-Weighted Assets:
$
575,302
$
547,202
Regulatory Capital Ratios:
Leverage Ratio
8.54
%
9.40
%
Common Equity Tier 1 Capital Ratio
12.67
%
12.58
%
Tier 1 Capital Ratio
12.67
%
12.58
%
Total Capital Ratio
13.87
%
13.54
%
CONTRACTUAL OBLIGATIONS
The following table sets forth information relating to the Company’s contractual obligations as of December 31, 2020.
(Dollars in thousands)
Payments due by period
Contractual Obligations:
Total
Less than One Year
Two through
Three Years
Four through
Five Years
More than Five Years (1)
Debt obligations
$
16,730
$
-
$
2,606
$
10,000
$
4,124
Data processing obligations
2,494
-
2,494
-
-
Lease obligations
5,277
-
1,320
1,353
2,604
Total
$
24,501
$
-
$
6,420
$
11,353
$
6,728
(1)
Includes $4.1 million of junior subordinated debt with varying put provisions with a mandatory redemption September 21, 2036.
OFF-BALANCE SHEET ARRANGEMENTS
The Company’s off-balance sheet arrangements consist of interest rate swap agreements, commitments to extend credit and letters of credit. Refer to Note 15 “Financial Instruments with Off-Balance Sheet Risk” and Note 16 “Derivative Instruments and Hedging Activities” of the Notes to Consolidated Financial Statements for further discussion on the specific arrangements and elements of credit and interest rate risk inherent to the arrangements. These arrangements increase the degree of both credit and interest rate risk beyond that which is recognized through the financial assets and liabilities on the consolidated balance sheets.
IMPACT OF INFLATION AND CHANGING PRICES
The consolidated financial statements and the accompanying notes presented elsewhere in this document have been prepared in accordance with GAAP, which require the measurement of financial position and operating results in terms of historical dollars without considering
the change in the relative purchasing power of money over time and due to inflation. Unlike most industrial companies, virtually all the assets and liabilities of the Company and the Bank are monetary in nature. The impact of inflation is reflected in the increased cost of operations. As a result, interest rates have a greater impact on the Company’s performance than inflation. Interest rates do not necessarily move in the same direction or to the same extent as the prices of goods and services.
RECENT ACCOUNTING PRONOUNCEMENTS
Recent accounting pronouncements affecting the Company are described in Item 8. “Financial Statements and Supplementary Data” under the heading Note 1 “Nature of Banking Activities and Significant Accounting Policies-Recent Significant Accounting Pronouncements and Other Regulatory Statements.”

---

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Market risk is the risk of loss in a financial instrument arising from adverse changes in market rates or prices such as interest rates, foreign currency exchange rates, commodity prices and equity prices. The Company’s primary market risk exposure is interest rate risk, though it should be noted that the assets under management by Wealth Management are affected by equity price risk. The ongoing monitoring and management of this risk is an important component of the Company’s asset/liability management process, which is governed by policies established by its Board of Directors. The Company has established a management Asset/Liability Committee (“ALCO”) that oversees and develops guidelines and strategies that govern the Company’s asset/liability management activities, based upon estimated market risk sensitivity, policy limits and overall market interest rate levels and trends.
Interest rate risk represents the sensitivity of earnings to changes in market interest rates. As interest rates change, the interest income and expense streams associated with the Company’s financial instruments also change, affecting net interest income, the primary component of the Company’s earnings. ALCO uses the results of a detailed and dynamic simulation model to quantify the estimated exposure of net interest income to sustained interest rate changes.
The simulation model captures the impact of changing interest rates on the interest income received and interest expense paid on all assets and liabilities reflected on the Company’s balance sheets. The simulation model’s sensitivity analysis is compared to ALCO policy limits, which specify a maximum tolerance level for net interest income exposure over a one-year horizon, assuming no balance sheet growth, given upward and downward shifts in interest rates. The following reflects the range of the Company’s estimated net interest income sensitivity analysis during 2020 and 2019.
Rate Change
- 100 bps
(3.20
)%
(5.30
)%
+ 100 bps
4.40
%
2.50
%
+ 200 bps
7.90
%
4.10
%
Asset sensitivity indicates that in a rising interest rate environment the Company’s net interest income would increase and in a decreasing interest rate environment the Company’s net interest income would decrease. Liability sensitivity indicates that in a rising interest rate environment the Company’s net interest income would decrease and in a decreasing interest rate environment the Company’s net interest income would increase. Based on the analysis above, from a net interest income perspective, the Company was asset sensitive at December 31, 2020 and December 31, 2019.
While these numbers are subjective based upon the parameters used within the model, management believes that the current interest rate exposure is manageable and does not indicate any significant exposure to interest rate changes.
The preceding sensitivity analysis does not represent the Company’s forecast and should not be relied upon as being indicative of expected operating results. These hypothetical estimates are based upon numerous assumptions, including the nature and timing of interest rate levels including yield curve shape, prepayments on loans and securities, deposit decay rates, pricing decisions on loans and deposits, reinvestment or replacement of asset and liability cash flows. While assumptions are developed based upon current economic and local market conditions, the Company cannot make any assurances about the predictive nature of these assumptions, including how customer preferences or competitor influences might change.
Also, as market conditions vary from those assumed in the sensitivity analysis, actual results will also differ due to factors such as prepayment and refinancing levels likely deviating from those assumed, the varying impact of interest rate change, caps or floors on adjustable rate assets, the potential effect of changing debt service levels on customers with adjustable rate loans, depositor early
withdrawals and product preference changes, and other internal and external variables. Furthermore, the sensitivity analysis does not reflect actions that ALCO might take in response to or anticipation of changes in interest rates.

---

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
FAUQUIER BANKSHARES, INC. AND SUBSIDIARIES
CONSOLIDATED FINANCIAL REPORT
December 31, 2020
CONTENTS
CONSOLIDATED FINANCIAL STATEMENTS
Consolidated balance sheets
Consolidated statements of operations
Consolidated statements of comprehensive income
Consolidated statements of changes in shareholders’ equity
Consolidated statements of cash flows
Notes to consolidated financial statements
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Shareholders
Fauquier Bankshares, Inc.
Warrenton, Virginia
Opinion on the Financial Statements
We have audited the accompanying consolidated balance sheets of Fauquier Bankshares, Inc. and Subsidiaries (the “Company”) as of December 31, 2020 and 2019, and the related consolidated statements of operations, comprehensive income, changes in shareholders' equity, and cash flows for each of the three years in the period ended December 31, 2020 and the related notes (collectively referred to as the “consolidated financial statements”). In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 2020 and 2019, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2020, in conformity with accounting principles generally accepted in the United States of America.
Basis for Opinion
These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on the Company’s consolidated financial statements based on our audits. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. As part of our audits, we are required to obtain an understanding of internal control over financial reporting, 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.
Our audits included performing procedures to assess the risks of material misstatement of the consolidated financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the consolidated financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion.
Critical Audit Matter
The critical audit matter communicated below is a matter arising from the current period audit of the consolidated financial statements that were communicated or required to be communicated to the audit committee and that (1) relate to accounts or disclosures that are material to the consolidated financial statements and (2) involved our especially challenging, subjective, or complex judgments. The communication of critical audit matters does not alter in any way our opinion on the consolidated financial statements, taken as a whole, and we are not, by communicating the critical audit matter below, providing separate opinion on the critical audit matter or on the accounts or disclosures to which it relates.
Allowance for Loan Losses
Description of the Matter
As described in Note 1 (Nature of Banking Activities and Significant Accounting Policies) and Note 3 (Loans and Allowance for Loan Losses) to the consolidated financial statements, the Company maintains an allowance for loan losses that represents management’s estimate of the probable losses inherent in the Company’s loan portfolio. Auditing management’s estimate used in determining the allowance for the loan portfolio involved a high degree of subjectivity in evaluating management’s determination of the factors and assumptions used in the allowance estimate. At December 31, 2020, the allowance for loans losses was $6,870,000.
We identified the determination and application of the various allowance calculation inputs and assumptions as a critical audit matter because of the extent of auditor judgment applied and significant audit effort to evaluate the significant subjective and complex judgments made by management related to these elements.
How We Addressed the Matter in Our Audit
We obtained an understanding and evaluated the design of controls over the Company’s allowance process for the loan portfolio. Controls included, among others, those over the risk rating process, the identification of indicators of impairment, management’s review and approval of the calculations used to determine the allowance, including the underlying data and data inputs and outputs of those calculations, and management’s evaluation and review of the qualitative adjustments, including the reasonable and supportable forecast qualitative adjustment.
To test the Company’s allowance estimate, we tested the underlying data used in the estimate calculation to determine it was accurate, complete and relevant. Included in this were loan reviews to test the accuracy of loan grades and specific reserve calculations, as well as testing the allowance calculation model for computational accuracy. Further, we evaluated management’s basis for qualitative adjustments in relation to changes in economic conditions. Our procedures included evaluating management’s inputs and assumptions by comparing the information to internal and external source data including, among others, historical loss data and economic data utilized by the Company. In addition, we evaluated the overall allowance amount and whether the amount appropriately reflects losses incurred in the loan portfolios as of the consolidated balance sheet date. We also reviewed subsequent events and transactions and considered whether they corroborate or contradict the Company’s conclusion.
/s/ Brown, Edwards & Company, L.L.P
BROWN, EDWARDS & COMPANY, L.L.P
We have served as the Company’s auditor since 2017.
Harrisonburg, Virginia
March 26, 2021
Fauquier Bankshares, Inc. and Subsidiaries
Consolidated Balance Sheets
As of December 31, 2020 and 2019
(In thousands, except share and per share data)
December 31,
December 31,
Assets
Cash and due from banks
$
15,728
$
9,124
Interest-bearing deposits in other banks
108,825
37,203
Federal funds sold
Securities available for sale, at fair value
82,848
79,783
Restricted investments
1,835
2,016
Mortgage loans held for sale
Loans
616,749
550,226
Allowance for loan losses
(6,870
)
(5,227
)
Loans, net
609,879
544,999
Premises and equipment, net
16,529
17,492
Accrued interest receivable
2,305
1,984
Other real estate owned, net
1,356
1,356
Bank-owned life insurance
14,321
13,961
Other assets
13,159
13,992
Total assets
$
867,173
$
722,171
Liabilities
Deposits:
Noninterest-bearing checking
$
182,653
$
123,492
Interest-bearing:
Checking
266,501
242,531
Savings and money market accounts
243,573
182,007
Time deposits
73,392
74,125
Total interest-bearing
583,466
498,663
Total deposits
766,119
622,155
Federal Home Loan Bank advances
12,606
16,695
Junior subordinated debt
4,124
4,124
Other liabilities
11,863
12,075
Total liabilities
794,712
655,049
Shareholders’ Equity
Common stock, par value $3.13, and additional paid-in capital; authorized: 8,000,000 shares; issued and outstanding: 3,798,561 and 3,783,724 shares including 8,621 and 20,352 unvested shares, respectively
16,369
15,964
Retained earnings
53,767
49,787
Accumulated other comprehensive income, net
2,325
1,371
Total shareholders’ equity
72,461
67,122
Total liabilities and shareholders’ equity
$
867,173
$
722,171
See accompanying Notes to Consolidated Financial Statements.
Fauquier Bankshares, Inc. and Subsidiaries
Consolidated Statements of Operations
Years Ended December 31, 2020, 2019 and 2018
(In thousands, except per share data)
Interest Income
Interest and fees on loans
$
26,192
$
26,398
$
24,291
Interest and dividends on securities:
Taxable interest income
1,389
1,465
1,487
Tax-exempt interest
Dividends
Interest on deposits in other banks
Total interest income
28,312
29,170
26,698
Interest Expense
Interest on deposits
2,064
3,595
2,447
Interest on federal funds purchased
-
Interest on Federal Home Loan Bank advances
Interest on Junior subordinated debt
Total interest expense
2,541
4,520
3,233
Net interest income
25,771
24,650
23,465
Provision for loan losses
1,773
Net interest income after provision for loan losses
23,998
24,304
22,958
Noninterest Income
Trust and estate fees
2,249
1,743
1,542
Brokerage fees
Service charges on deposit accounts
1,118
1,522
1,706
Interchange fee income, net
1,215
1,305
1,252
Bank-owned life insurance
Gain on sale/call of securities available for sale, net
Gain on sale of mortgage loans held for sale, net
Other income
(111
)
Total noninterest income
6,466
5,974
6,074
Noninterest Expenses
Salaries and benefits
12,103
12,084
12,108
Occupancy
2,409
2,352
2,331
Furniture and equipment
1,050
1,012
Marketing and business development
Legal, audit and consulting
1,129
1,054
1,015
Data processing
1,432
1,381
1,292
Federal Deposit Insurance Corporation assessment
Merger related expenses
1,231
-
-
Prepayment penalty on early debt extinguishment
-
-
Other operating expenses
3,565
3,427
3,414
Total noninterest expenses
23,520
22,454
22,151
Income before income taxes
6,944
7,824
6,881
Income tax expense
1,067
1,004
Net Income
$
5,877
$
6,820
$
6,135
Earnings per share, basic
$
1.55
$
1.80
$
1.63
Earnings per share, diluted
$
1.55
$
1.80
$
1.62
Dividends per share
$
0.50
$
0.485
$
0.48
See accompanying Notes to Consolidated Financial Statements.
Fauquier Bankshares, Inc. and Subsidiaries
Consolidated Statements of Comprehensive Income
Years Ended December 31, 2020, 2019 and 2018
(In thousands)
Net income
$
5,877
$
6,820
$
6,135
Other comprehensive income (loss), net of tax:
Change in fair value of securities available for sale, net of tax,
$(567), $(586), and $43, respectively
2,133
2,204
(161
)
Reclassification adjustment for gain on securities available for sale, net of tax,
$208, $17, and $176, respectively
(784
)
(62
)
(662
)
Change in fair value of interest rate swap, net of tax, $72, $66, and $(36), respectively
(271
)
(250
)
Change in unrecognized benefit obligation for Supplemental Executive Retirement Plan,
net of tax, $33, $(4) and $(4), respectively
(124
)
Total other comprehensive income (loss), net of tax, $(254), $(507), and $179, respectively
1,909
(673
)
Total comprehensive income
$
6,831
$
8,729
$
5,462
See accompanying Notes to Consolidated Financial Statements.
Fauquier Bankshares, Inc. and Subsidiaries
Consolidated Statements of Changes in Shareholders’ Equity
Years Ended December 31, 2020, 2019 and 2018
(In thousands, except share and per share data)
Common Stock
and Additional Paid-In Capital
Retained Earnings
Accumulated Other Comprehensive Income (Loss)
Total
Balance, December 31, 2017
$
15,526
$
40,491
$
$
56,142
Net income
-
6,135
-
6,135
Other comprehensive loss, net of tax effect of $179
-
-
(673
)
(673
)
Cash dividends ($0.48 per share)
-
(1,813
)
-
(1,813
)
Amortization of unearned compensation, restricted stock awards
-
-
Reclassification of net unrealized gains on equity securities from
Accumulated other comprehensive income (loss)
-
(10
)
-
Issuance of common stock - unvested shares (7,333 shares)
-
-
-
-
Issuance of common stock - vested shares (4,194 shares)
-
-
Repurchase of common stock (368 shares)
(8
)
-
-
(8
)
Balance, December 31, 2018
$
15,742
$
44,803
$
(538
)
$
60,007
Balance, December 31, 2018
$
15,742
$
44,803
$
(538
)
$
60,007
Net income
-
6,820
-
6,820
Other comprehensive income, net of tax effect of $(507)
-
-
1,909
1,909
Cash dividends ($0.485 per share)
-
(1,836
)
-
(1,836
)
Amortization of unearned compensation, restricted stock awards
-
-
Issuance of common stock - unvested shares (7,956 shares)
-
-
-
-
Issuance of common stock - vested shares (4,149 shares)
-
-
Forfeiture of common stock - unvested shares (1,210 shares)
-
-
-
-
Repurchase of common stock (960 shares)
(21
)
-
-
(21
)
Balance, December 31, 2019
$
15,964
$
49,787
$
1,371
$
67,122
Balance, December 31, 2019
$
15,964
$
49,787
$
1,371
$
67,122
Net income
-
5,877
-
5,877
Other comprehensive income, net of tax of $(254)
-
-
Cash dividends ($0.50 per share)
-
(1,897
)
-
(1,897
)
Amortization of unearned compensation, restricted stock awards
-
-
Issuance of common stock - unvested shares (7,889 shares)
-
-
-
-
Issuance of common stock - vested shares (4,293 shares)
-
-
Issuance of common stock - performance-based restricted stock units (4,662 shares)
-
-
Repurchase of common stock - unvested shares (2,007 shares)
(24
)
-
-
(24
)
Balance, December 31, 2020
$
16,369
$
53,767
$
2,325
$
72,461
See accompanying Notes to Consolidated Financial Statements.
Fauquier Bankshares, Inc. and Subsidiaries
Consolidated Statements of Cash Flows
Years Ended December 31, 2020, 2019 and 2018
(In thousands)
Cash Flows from Operating Activities
Net income
$
5,877
$
6,820
$
6,135
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization
1,086
1,256
1,255
Provision for loan losses
1,773
Loss on disposal of premises and equipment, net
-
-
(Gain) loss on interest rate swaps, net
(5
)
Deferred tax (benefit) expense
(487
)
Gains on sales/calls of securities available for sale
(992
)
(79
)
(838
)
Amortization of security premiums, net
Amortization of unearned compensation, net of forfeiture
Issuance of vested restricted stock
Bank-owned life insurance income
(360
)
(366
)
(361
)
Originations of mortgage loans held for sale
(4,898
)
(5,379
)
(2,042
)
Proceeds from mortgage loans held for sale
4,856
5,201
2,079
Gain on mortgage loans held for sale
(86
)
(69
)
(37
)
Changes in assets and liabilities:
(Increase) decrease in other assets
(4,731
)
(1,065
)
Increase (decrease) in other liabilities
(822
)
4,641
Net cash provided by operating activities
7,909
8,558
7,330
Cash Flows from Investing Activities
Proceeds from maturities, calls and principal payments of securities available for sale
16,166
8,196
11,707
Proceeds from sales of securities available for sale
18,762
13,871
-
Purchase of securities available for sale
(35,801
)
(27,626
)
(12,372
)
Purchase of premises and equipment
(334
)
(558
)
(839
)
(Purchase) redemption of restricted investments, net
(694
)
Loan originations, net
(66,612
)
(1,009
)
(47,036
)
Net cash used in investing activities
(67,638
)
(6,902
)
(49,234
)
Cash Flows from Financing Activities
Increase (decrease) in noninterest-bearing checking, interest-bearing checking, savings and money market accounts
144,697
(5,396
)
55,318
Increase (decrease) in time deposits
(733
)
(8,087
)
10,297
Increase (decrease) in Federal Home Loan Bank advances
(4,089
)
(7,085
)
15,920
Cash dividends paid on common stock
(1,897
)
(1,836
)
(1,813
)
Repurchase of common stock
(24
)
(21
)
(8
)
Net cash provided by (used in) financing activities
137,954
(22,425
)
79,714
Increase (decrease) in cash and cash equivalents
78,225
(20,769
)
37,810
Cash and Cash Equivalents
Beginning
46,341
67,110
29,300
Ending
$
124,566
$
46,341
$
67,110
Supplemental Disclosures of Cash Flow Information
Cash payments for:
Interest
$
2,651
$
4,603
$
3,061
Income taxes
$
1,255
$
$
Supplemental Disclosures of Noncash Investing Activities
Unrealized gain (loss) on securities available for sale, net of tax
$
1,349
$
2,142
$
(823
)
Unrealized gain (loss) on interest rate swaps, net of tax
$
(271
)
$
(250
)
$
Changes in Supplemental Executive Retirement Plans, net of tax
$
(124
)
$
$
See accompanying Notes to Consolidated Financial Statements.
FAUQUIER BANKSHARES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
Years Ended December 31, 2020, 2019 and 2018
Note 1.
Nature of Banking Activities and Significant Accounting Policies
Fauquier Bankshares, Inc. (the “Company”) is a bank holding company incorporated under the laws of the Commonwealth of Virginia. The Company owns all of the stock of The Fauquier Bank (the “Bank”), which is an independent commercial bank chartered under the laws of the Commonwealth of Virginia. In addition, the Company owns Fauquier Statutory Trust II (“Trust II”), which is an unconsolidated subsidiary. The subordinated debt owed to Trust II is reported as a liability of the Company. The Bank provides a full range of financial services, including internet banking, mobile banking, commercial, retail, insurance, wealth management, and financial planning services through eleven banking offices throughout Fauquier and Prince William counties in Virginia.
The accounting and reporting policies of the Company conform to U.S. generally accepted accounting principles (“GAAP”) and to the reporting guidelines prescribed by regulatory authorities. The following is a description of the more significant of those policies and practices.
Business Combination
On October 1, 2020, the Company and Virginia National Bankshares Corporation (“Virginia National”) announced a definitive agreement to combine in a strategic merger (the “Merger Agreement”) pursuant to which the Company will merge with and into Virginia National (the “Merger”). As a result of the Merger, the holders of shares of the Company's common stock will be converted into the right to receive 0.675 shares of Virginia National common stock for each share of the Company's common stock held immediately prior to the effective date of the Merger, plus cash in lieu of fractional shares. The transaction is expected to be completed in the second quarter of 2021, subject to approval of both companies' shareholders, regulatory approvals and other customary closing conditions.
Principles of Consolidation
The consolidated financial statements include the accounts of the Company, and its wholly-owned subsidiary, the Bank; and the Bank's wholly-owned subsidiaries, Fauquier Bank Services, Inc. and Specialty Properties Acquisitions - VA, LLC (formed for the sole purpose of holding foreclosed property). All significant intercompany balances and transactions have been eliminated.
Basis of Presentation
The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Material estimates that are particularly susceptible to significant change in the near term relate to the determination of the allowance for loan losses, the valuation of other real estate owned, the valuation of deferred taxes and fair value measurements. In the opinion of management, all adjustments, consisting only of normal recurring adjustments, which are necessary for a fair presentation of the results of operations in these financial statements, have been made.
Reclassifications
Certain reclassifications have been made to prior period balances to conform to the current year presentation. None of the reclassifications were material and none had an impact on net income.
Cash and Cash Equivalents
Cash and cash equivalents include cash on hand, amounts due from banks, interest-bearing deposits in other banks and federal funds sold. Generally, federal funds are purchased and sold for one day periods. The Company is required to maintain collateral against all loss positions in its interest rate swaps which are described in Note 16.
Securities
Investments in debt securities with readily determinable fair values are classified as either held to maturity, available for sale, or trading, based on management’s intent. Currently, all of the Company’s investment securities are classified as available for sale. Available for sale securities are carried at estimated fair value with the corresponding unrealized gains and losses excluded from earnings and reported in other comprehensive income. Gains or losses are recognized in earnings on the trade date using the amortized cost of the specific security sold. Purchase premiums and discounts are recognized in interest income using the specific identification method over the terms of the securities.
Impairment of securities occurs when the fair value of a security is less than its amortized cost. For debt securities, other-than-temporary impairment (“OTTI”) is recognized in its entirety in net income if either (i) the Company intends to sell the security or (ii) it is more-likely-than-not that the Company will be required to sell the security before recovery of its amortized cost basis. If, however, the Company does not intend to sell the security and it is not more-likely-than-not that the Company will be required to sell the security before recovery, the Company must determine what portion of the impairment is attributable to a credit loss, which occurs when the amortized cost basis of the security exceeds the present value of the cash flows expected to be collected from the security. If there is no credit loss, there is no other-than-temporary impairment. If there is a credit loss, other-than-temporary impairment exists, and the credit loss must be recognized in net income and the remaining portion of impairment must be recognized in other comprehensive income. The Company regularly reviews each investment security for other-than-temporary impairment based on criteria that include the extent to which cost exceeds market price, the duration of that market decline, the financial health of and specific prospects for the issuer, the Company’s best estimate of the present value of cash flows expected to be collected from debt securities, the Company’s intention with regard to holding the security to maturity and the likelihood that the Company would be required to sell the security before recovery.
Restricted Investments
The Bank is required to maintain investments in the capital stock of certain correspondent banks. No readily available market exists for these investments and they have no quoted market value. These investments are recorded at cost and they are reported on the Company’s consolidated balance sheets as restricted investments.
Mortgage Loans Held for Sale
Mortgage loans held for sale are carried at the lower of aggregate cost or fair value. The fair value of mortgage loans held for sale is determined using current secondary market prices for loans with similar characteristics.
Loans
The Company makes mortgage, commercial and consumer loans to customers. The Company’s recorded investment in loans that management has the intent and ability to hold for the foreseeable future or until maturity or pay-off generally is reported at the unpaid principal balances adjusted for charges-offs, unearned discounts, any deferred fees or costs on originated loans, and the allowance for loan losses. Interest on loans is credited to operations based on the principal amount outstanding. Loan fees and origination costs are deferred and the net amount is amortized as an adjustment of the related loan’s yield using the interest method. The Company amortizes these amounts over the contractual life of the related loans.
The past due status of a loan is based on the contractual due date of the most delinquent payment due. Loans are generally placed on nonaccrual status when the collection of principal or interest is 90 days or more past due, or earlier, if collection is uncertain based on an evaluation of the net realizable value of the collateral and the financial strength of the borrower. All interest accrued but not collected for loans that are placed on nonaccrual or charged-off is reversed against interest income. The interest on these loans is accounted for on the cost recovery method, until qualifying for return to accrual. Loans greater than 90 days past due may remain on accrual status if management determines it has adequate collateral to cover the principal and interest. For those loans that are carried on nonaccrual status, payments are first applied to the principal outstanding. A loan may be returned to accrual status if the borrower has demonstrated a sustained period of repayment performance in accordance with the contractual terms of the loan and there is reasonable assurance the borrower will continue to make payments as agreed. These policies are applied consistently across the loan portfolio.
Loans are 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. Impairment is measured on a loan-by-loan basis for these loans by either the present value of 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.
A loan is considered a trouble debt restructuring (“TDR”) when a concession has been granted to a borrower experiencing financial difficulty. TDRs are identified at the point when the borrower enters into a modification agreement. TDRs are considered impaired loans and are individually evaluated for impairment in the determination of the allowance for loan losses.
Allowance for Loan Losses
The allowance for loan losses is established through charges to earnings in the form of a provision for loan losses. Loan losses are charged against the allowance when management believes the collectability of loan principal is unlikely. Subsequent recoveries, if any, are credited to the allowance.
The allowance represents an amount that, in management’s judgment, will be adequate to absorb probable losses inherent in the loan portfolio. Management’s judgment in determining the level of the allowance is based on evaluations of the collectability of loans while taking into consideration such factors as historical experience, the nature and volume of the loan portfolio, adverse situations that may affect the borrower’s ability to repay, estimated value of any underlying collateral and prevailing economic conditions. This evaluation is inherently subjective as it requires estimates that are susceptible to significant revision as more information becomes available.
All loans are risk rated on a 1-9 grading system:
•
Level 1 through 5 are loans with minimal to marginally acceptable risk (Pass)
•
Level 6 are loans with potential weaknesses identified (Special mention)
•
Level 7 are loans with well-defined weaknesses that may result in possible losses (Substandard)
•
Level 8 are loans that are unlikely to be repaid in full and will probably result in losses (Doubtful)
•
Level 9 are loans that will not be repaid in full and losses will occur (Loss)
The allowance consists of specific and general components. The specific component relates to loans that are classified as impaired, and is established when the discounted cash flows, collateral value, or the observable market price of the impaired loan is lower than the carrying value of that loan. The general component covers nonimpaired loans and is based on historical loss experience adjusted for qualitative factors and is also maintained to cover uncertainties that could affect management’s estimate of probable losses. This includes an unallocated portion of the allowance which reflects the margin of imprecision inherent in the underlying assumptions used in the methodologies for estimating general losses in the portfolio.
The Company has identified the following loan segments and risk characteristics in evaluating the allowance for loan losses:
•
Commercial and industrial - Commercial and industrial loans are made to small businesses and carry risks associated with management, industry and economic fluctuations that can impact cash flow, which is the primary source of repayment. Collateral for these loans is primarily business assets. This collateral can fluctuate in value based on market conditions and timing of sale.
•
Commercial real estate - Loans secured by commercial real estate carry risks associated with a cyclical industry that has economic and collateral value fluctuations. Commercial real estate lending is primarily limited to the Company's specific geographic market area of Fauquier and Prince William counties.
•
Construction and land - Real estate construction loans carry risks that the project will not be finished according to schedule, the project will not be finished according to budget and the value of the collateral may, at any point in time, be less than the principal amount of the loan.
•
Consumer - Consumer loans carry risks associated with the continued credit-worthiness of the borrower and the value of the collateral (e.g., rapidly depreciating assets such as automobiles), or lack thereof.
•
Student - Student loans carry risks associated with the continued credit-worthiness of the borrower. Student loans are more likely to be immediately adversely affected by job loss, divorce, illness or personal bankruptcy.
•
Residential real estate - Residential real estate loans carry risks associated with the continued credit-worthiness of the borrower and changes in the value of the collateral.
•
Home equity lines of credit - Home equity lines of credit carry risks associated with the continued credit-worthiness of the borrower and changes in the value of the collateral.
Risk characteristics are evaluated for each portfolio segment by reviewing external factors such as: unemployment, new building permits, bankruptcies, foreclosures, economic conditions, competition and the regulatory environment. Internal risk characteristics evaluated include: lender turnover, lender experience, lending policy changes, loan portfolio characteristics, collateral, risk rating adjustments, loan concentrations, and loan review analysis.
Premises and Equipment
Land is carried at cost. Premises and equipment are stated at cost less accumulated depreciation and amortization. Premises and equipment are depreciated over their estimated useful lives ranging from 3 to 39 years; leasehold improvements are amortized over the lives of the respective leases or the estimated useful life of the leasehold improvement, whichever is less. Software is amortized over its estimated useful life ranging from 3 to 5 years. Depreciation and amortization are recorded on the straight-line method. Costs of maintenance and repairs are charged to expense as incurred.
Leases
The Company recognizes a lease liability and a right-of-use asset in connection with leases in which it is a lessee, except for leases with a term of twelve months or less. A lease liability represents the Company obligation to make future payments under lease contracts, and a right-of-use asset represents the Company right to control the use of the underlying property during the lease term. Lease liabilities and right-of-use assets are recognized upon commencement of a lease and measured as the present value of lease payments over the lease term, discounted at the incremental borrowing rate of the lessee. The Company has elected not to separate lease and nonlease components within the same contract and instead to account for the entire contract as a lease.
Other Real Estate Owned (“OREO”)
Assets acquired through, or in lieu of, loan foreclosure are held for sale and are initially recorded at fair value less costs to sell at the date of foreclosure. Subsequent to foreclosure, management periodically performs valuations of the foreclosed assets based on updated appraisals, general market conditions, recent sales of like properties, length of time the properties have been held, and the Company's ability and intention with regard to continued ownership of the properties. The Company may incur additional write-downs of foreclosed assets to fair value less costs to sell if valuations indicate a further deterioration in market conditions. Revenue and expenses from operations and changes in the property valuations are included in net expenses from foreclosed assets and improvements are capitalized.
Transfers of Financial Assets
Transfers of financial assets are accounted for as sales, when control over the asset has been surrendered. Control over transferred assets is deemed to be surrendered when (i) the assets have been isolated from the Company, and are presumptively beyond the reach of the transferor and its creditors, even in bankruptcy or other receivership, (ii) the transferee obtains the right (free of conditions that constrain it from taking advantage of that right) to pledge or exchange the transferred assets, and (iii) the Company does not maintain effective control over the transferred assets through an agreement to repurchase them before their maturity or the ability to unilaterally cause the holder to return specific assets.
Income Taxes
Deferred income tax assets and liabilities are determined using the 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.
When tax returns are filed, it is likely that some positions taken would be sustained upon examination by the applicable taxing authority, while others are subject to uncertainty about the merits of the position taken or the amount of the position that would be ultimately sustained. The benefit of a tax position is recognized in the financial statements in the period during which, based on all available evidence, the Company believes it is more-likely-than-not that the position will be sustained upon examination, including the resolution of appeals or litigation processes, if any. Tax positions taken are not offset or aggregated with other positions. Tax positions that meet the more-likely-than-not recognition threshold are measured as the largest amount of tax benefit that is more than fifty percent (50%) likely of being realized upon settlement with the applicable taxing authority. The portion of the benefits associated with tax positions taken that exceeds the amount measured, as described above, is reflected as a liability for unrecognized tax benefits in the balance sheet along with any associated interest and penalties that would be payable to the applicable taxing authority upon examination. Interest and penalties associated with unrecognized tax benefits are classified as additional income taxes in the statement of operations. The Company has no uncertain tax positions.
Share-based Compensation
Compensation cost relating to share-based payment transactions is measured based on the grant date fair value of the equity or liability instruments issued. Compensation cost for all stock awards is calculated and recognized over the employees’ service period, generally defined as the vesting period. For awards with graded-vesting, compensation cost is recognized on a straight-line basis over the requisite service period for the entire award. Additional information about the Company’s share-based compensation plans is presented in Note 12.
Earnings Per Share
Basic earnings per share represent income available to common shareholders divided by the weighted-average number of common shares outstanding during the period. Diluted earnings per share reflect additional common shares that would have been outstanding if dilutive potential common shares had been issued, as well as any adjustment to income that would result from the assumed issuance. Potential common shares that may be issued by the Company relate solely to restricted stock and are determined using the treasury method. Earnings per share calculations are presented in Note 11.
Comprehensive Income
Accounting principles generally require that recognized revenue, expenses, gains and losses be included in net income. Although certain changes in assets and liabilities, such as unrealized gains and losses on available for sale securities, changes in defined benefit plan assets and liabilities, and unrealized gains and losses on cash flow hedging instruments are reported as a separate component of the equity section of the balance sheet, such items, along with net income, are components of comprehensive income. These components are presented in the consolidated statements of comprehensive income.
Derivative Financial Instruments
The Company recognizes derivative financial instruments in the consolidated balance sheets at fair value. The fair value of a derivative is determined by quoted market prices and mathematical models using current and historical data. If certain hedging criteria are met, including testing for hedge effectiveness, special hedge accounting may be applied. The Company assesses each hedge, both at inception and on an ongoing basis, to determine whether the derivative used in a hedging transaction is effective in offsetting changes in the fair value or cash flows of the hedged item and whether the derivative is expected to remain effective during subsequent periods. The Company discontinues hedge accounting when (i) it determines that a derivative is no longer effective in offsetting changes in fair value or cash flows of a hedged item; (ii) the derivative expires or is sold, terminated or exercised; (iii) probability exists that the forecasted transaction will no longer occur or; (iv) management determines that designating the derivative as a hedging instrument is no longer appropriate. When hedge accounting is discontinued and a derivative remains outstanding, the Company recognizes the derivative in the balance sheet at its fair value and changes in the fair value are recognized in net income.
At inception, the Company designates a derivative as (i) a fair value hedge of recognized assets or liabilities or of unrecognized firm commitments (fair value hedge) or (ii) a hedge of forecasted transactions or variable cash flows to be received or paid in conjunction with recognized assets or liabilities (cash flow hedge). For a derivative treated as a fair value hedge, a change in fair value is recorded as an adjustment to the hedged item and recognized in net income. For a derivative treated as a cash flow hedge, the effective portion of a change in fair value is recorded as an adjustment to the hedged item and recognized as a component of accumulated other comprehensive income (loss) within shareholders’ equity. For a derivative treated as a cash flow hedge, the ineffective portion of a change in fair value is recorded as an adjustment to the hedged item and recognized in net income. For more information on derivative financial instruments see Note 16.
Wealth Management Services Division
Securities and other property held by the Wealth Management Services division in a fiduciary or agency capacity are not assets of the Company and are not included in the accompanying consolidated financial statements.
Marketing
The Company follows the policy of charging the costs of marketing, including advertising, to expense as incurred.
Fair Value Measurements
Fair values of financial instruments are estimated using relevant information and assumptions, as more fully disclosed in Note 18. Fair value estimates involve uncertainties and matters of significant judgment. Changes in assumptions or in market conditions could significantly affect those estimates.
Revenue Recognition
The majority of the Company's revenues are associated with financial instruments, including loans and securities. The Company’s noninterest income includes trust, estate and brokerage fee income, service charges on deposits accounts and net interchange fee income. Substantially all of the Company's revenue is generated from contracts with customers. Noninterest income streams are discussed below.
•
Trust, estate and brokerage fee income - Income is primarily comprised of fees earned from the management and administration of trusts, estates and other customer assets and by providing investment brokerage services. Fees that are transaction-based (e.g., execution of trades) are recognized on a monthly basis. Other fees, or commissions, are earned over time as the contracted monthly or quarterly services are provided and are generally assessed based on either account activity or the market value of assets under management.
•
Service charges on deposit accounts - The Company earns fees from its deposit customers for overdraft and account maintenance services. Overdraft fees are recognized when the overdraft occurs. Account maintenance fees, which relate primarily to monthly maintenance, are earned over the course of a month, representing the period over which the Company satisfies the performance obligation. The Company also earns fees from its customers for transaction-based services. Such services include safe deposit box, ATM, stop payment and wire transfer fees. In each case, these service charges and fees are recognized in income at the time or within the same period that the Company’s performance obligation is satisfied.
•
Interchange fee income, net - The Company earns interchange fees from debit and credit cardholder transactions conducted through various payment networks. Interchange fees from cardholder transactions represent a percentage of the underlying transaction value and are recognized daily, concurrently with the transaction processing services.
Recent Accounting Pronouncements and Other Regulatory Statements
In June 2016, the Financial Accounting Standards Board (the “FASB”) issued Accounting Standards Update (“ASU”) No. 2016-13, “Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments.” The amendments, among other things, require the measurement of all expected credit losses for financial assets held at the reporting date based on historical experience, current conditions, and reasonable and supportable forecasts. Financial institutions and other organizations will now use forward-looking information to better inform their credit loss estimates. Many of the loss estimation techniques applied today will still be permitted, although the inputs to those techniques will change to reflect the full amount of expected credit losses. In addition, the ASU amends the accounting for credit losses on available for sale debt securities and purchased financial assets with credit deterioration. The FASB has issued multiple updates to ASU No. 2016-13 as codified in Topic 326, including ASU Nos. 2019-04, 2019-05, 2019-10, 2019-11, 2020-02, and 2020-03. These ASUs have provided for various minor technical corrections and improvements to the codification as well as other transition matters. Smaller reporting companies who file with the Securities and Exchange Commission (“SEC”) and all other entities who do not file with the SEC are required to apply the guidance for fiscal years, and interim periods within those years, beginning after December 15, 2022. Changes under ASU No. 2016-13 and subsequent updates represent a fundamental shift from existing GAAP and may result in a material increase to the Company's accounting for credit losses on financial instruments. To prepare for implementation of the new standard the Company established a working group to evaluate the impact these changes will have on the Company’s financial statements and related disclosures. The Company also contracted with a third-party for credit modeling in accordance with ASU No. 2016-13. The Company has focused on model validations, the development of processes and related controls, and the evaluation of parallel runs. The Company has not yet determined an estimate of the effect of these changes.
Effective November 25, 2019, the SEC adopted Staff Accounting Bulletin (“SAB”) 119. SAB 119 updated portions of the SEC’s interpretative guidance to align with FASB Accounting Standards Codification (“ASC”) 326, “Financial Instruments - Credit Losses.” The SAB covers topics including (i) measuring current expected credit losses; (ii) development, governance, and documentation of a systematic methodology; (iii) documenting the results of a systematic methodology; and (iv) validating a systematic methodology.
In August 2018, the FASB issued ASU No. 2018-13, “Fair Value Measurement (Topic 820): “Changes to the Disclosure Requirements for Fair Value Measurement.” ASU No. 2018-13 modified the disclosure requirements on fair value measurements by requiring that Level 3 fair value disclosures include the range and weighted average of significant unobservable inputs used to develop those fair value measurements. For certain unobservable inputs, an entity may disclose other quantitative information in lieu of the weighted average if the entity determines that other quantitative information would be a more reasonable and rational method to reflect the distribution of unobservable inputs used to develop Level 3 fair value measurements. Certain disclosure requirements in Topic 820 were also removed or modified. ASU No. 2018-13 was effective for the Company on January 1, 2020. The Company’s adoption of ASU No. 2018-13 has not had a material impact on its consolidated financial statements.
In August 2018, the FASB issued ASU No. 2018-14, “Compensation - Retirement Benefits - Defined Benefit Plans - General (Subtopic 715-20): Disclosure Framework - Changes to the Disclosure Requirements for Defined Benefit Plans.” These amendments modify the disclosure requirements for employers that sponsor defined benefit pension or other postretirement plans. Certain disclosure requirements were deleted while the following disclosure requirements were added: the weighted-average interest crediting rates for cash balance plans and other plans with promised interest crediting rates and an explanation of the reasons for significant gains and losses related to changes in the benefit obligation for the period. The amendments also clarify the disclosure requirements in paragraph 715-20-50-3, which state that the following information for defined benefit pension plans should be disclosed: The projected benefit obligation (“PBO”) and fair value of plan assets for plans with PBOs in excess of plan assets and the accumulated benefit obligation (“ABO”) and fair value of plan assets for plans with ABOs in excess of plan assets. The amendments are effective for fiscal years ending after December 15, 2020. Early adoption is permitted. The Company does not expect the adoption of ASU No. 2018-14 to have a material impact on its consolidated financial statements.
In December 2019, the FASB issued ASU No. 2019-12, “Income Taxes (Topic 740) - Simplifying the Accounting for Income Taxes.” This ASU is expected to reduce the cost and complexity related to the accounting for income taxes by removing specific exceptions to general principles in Topic 740 (eliminating the need for an organization to analyze whether certain exceptions apply in a given period) and improving financial statement preparers’ application of certain income tax-related guidance. This ASU is part of the FASB’s
simplification initiative to make narrow-scope simplifications and improvements to accounting standards through a series of short-term projects. For public business entities, the amendments are effective for fiscal years beginning after December 15, 2020, and interim periods within those fiscal years. Early adoption is permitted. The Company is currently assessing the impact that ASU No. 2019-12 will have on its consolidated financial statements.
In January 2020, the FASB issued ASU No. 2020-01, “Investments - Equity Securities (Topic 321), Investments - Equity Method and Joint Ventures (Topic 323), and Derivatives and Hedging (Topic 815) - Clarifying the Interactions between Topic 321, Topic 323, and Topic 815.” This ASU is based on a consensus of the Emerging Issues Task Force and is expected to increase comparability in accounting for these transactions. ASU No. 2016-01 made targeted improvements to accounting for financial instruments, including providing an entity the ability to measure certain equity securities without a readily determinable fair value at cost, less any impairment, plus or minus changes resulting from observable price changes in orderly transactions for the identical or a similar investment of the same issuer. Among other topics, the amendments clarified that an entity should consider observable transactions that require it to either apply or discontinue the equity method of accounting. For public business entities, the amendments in this ASU are effective for fiscal years beginning after December 15, 2020, and interim periods within those fiscal years. Early adoption is permitted. The Company does not expect the adoption of ASU No. 2020-01 to have a material impact on its consolidated financial statements.
In March 2020, the FASB issued ASU No. 2020-04 “Reference Rate Reform (Topic 848): Facilitation of the Effects of Reference Rate Reform on Financial Reporting.” These amendments provide temporary optional guidance to ease the potential burden in accounting for reference rate reform. This ASU also provides optional expedients and exceptions for applying GAAP to contract modifications and hedging relationships, subject to meeting certain criteria, that reference London Inter-Bank Offered Rate (“LIBOR”) or another reference rate expected to be discontinued. It is intended to help stakeholders during the global market-wide reference rate transition period. The guidance is effective for all entities as of March 12, 2020 through December 31, 2022. Subsequently, in January 2021, the FASB issued ASU No. 2021-01 “Reference Rate Reform (Topic 848): Scope.” This ASU clarifies that certain optional expedients and exceptions in Topic 848 for contract modifications and hedge accounting apply to derivatives that are affected by the discounting transition. The ASU also amends the expedients and exceptions in Topic 848 to capture the incremental consequences of the scope clarification and to tailor the existing guidance to derivative instruments affected by the discounting transition. An entity may elect to apply ASU No. 2021-01 on contract modifications that change the interest rate used for margining, discounting, or contract price alignment retrospectively as of any date from the beginning of the interim period that includes March 12, 2020, or prospectively to new modifications from any date within the interim period that includes or is subsequent to January 7, 2021, up to the date that financial statements are available to be issued. An entity may elect to apply ASU No. 2021-01 to eligible hedging relationships existing as of the beginning of the interim period that includes March 12, 2020, and to new eligible hedging relationships entered into after the beginning of the interim period that includes March 12, 2020. The Company is assessing ASU 2020-04 and its impact on the Company’s transition away from LIBOR for its loan and other financial instruments.
On March 12, 2020, the SEC finalized amendments to its definitions of “accelerated filer” and “large accelerated filer.” The amendments increase the threshold criteria for meeting these filer classifications and are effective on April 27, 2020. Any changes in filer status are to be applied beginning with the filer’s first annual report filed with the SEC subsequent to the effective date. For the Company, this will be its annual report on Form 10-K with respect to the year ending December 31, 2020. Pursuant to Section 404(b) of the Sarbanes-Oxley Act, the classifications of “accelerated filer” and “large accelerated filer” require a public company to obtain an external auditor attestation concerning the effectiveness of a company’s internal control over financial reporting (“ICFR”) and include the opinion on ICFR in its annual report on Form 10-K. The Company has complied with such requirements during the years it was considered an accelerated filer. The SEC’s March 2020 definition amendments exclude from the accelerated filer and large accelerated filer definitions an issuer that (i) is eligible to be a smaller reporting company and (ii) had annual revenues of less than $100 million in the most recent fiscal year. Such entity can now be considered a “non-accelerated filer.” With respect to the 2020 fiscal year, the Company continues to be a smaller reporting company and is no longer be considered an accelerated filer.
In March 2020 (revised in April 2020), various regulatory agencies, including the Board of Governors of the Federal Reserve System and the Federal Deposit Insurance Corporation (collectively, “the agencies”), issued an interagency statement on loan modifications and reporting for financial institutions working with customers affected by COVID-19. The interagency statement was effective immediately and impacted accounting for loan modifications. Under ASC 310-40, “Receivables - Troubled Debt Restructurings by Creditors,” a restructuring of debt constitutes a TDR if the creditor, for economic or legal reasons related to the debtor’s financial difficulties, grants a concession to the debtor that it would not otherwise consider. The agencies confirmed with the staff of the FASB that short-term modifications made on a good faith basis in response to COVID-19 to borrowers who were current prior to any relief, are not to be
considered TDRs. This includes short-term modifications such as payment deferrals, fee waivers, extensions of repayment terms, or other delays in payment that are insignificant. Borrowers considered current are those that are less than 30 days past due on their contractual payments at the time a modification program is implemented. In August 2020, a joint statement on additional loan modifications was issued. Among other things, the Interagency Statement addresses accounting and regulatory reporting considerations for loan modifications, including those accounted for under Section 4013 of the Coronavirus Aid, Relief, and Economic Security (“CARES”) Act. The CARES Act was signed into law on March 27, 2020 to help support individuals and businesses through loans, grants, tax changes and other types of relief. The most significant impacts of the Act related to accounting for loan modifications and establishment of the Paycheck Protection Program (“PPP”). On December 21, 2020, the Consolidated Appropriates Act of 2021 (“CAA”) was passed. The CAA extends or modifies many of the relief programs first created by the CARES Act, including the PPP and treatment of certain loan modifications related to the COVID-19 pandemic. See Note 3 of the consolidated financial statements for additional disclosure of TDRs as of December 31, 2020.
In August 2020, the FASB issued ASU No. 2020-06 “Debt - Debt with Conversion and Other Options (Subtopic 470-20) and Derivatives and Hedging - Contracts in Entity’s Own Equity (Subtopic 815-40): Accounting for Convertible Instruments and Contracts in an Entity’s Own Equity.” The ASU simplifies accounting for convertible instruments by removing major separation models required under current U.S. GAAP. Consequently, more convertible debt instruments will be reported as a single liability instrument and more convertible preferred stock as a single equity instrument with no separate accounting for embedded conversion features. The ASU removes certain settlement conditions that are required for equity contracts to qualify for the derivative scope exception. The ASU also simplifies the diluted earnings per share calculation in certain areas. In addition, the amendment updates the disclosure requirements for convertible instruments to increase the information transparency. For public business entities, excluding smaller reporting companies, the amendments in the ASU are effective for fiscal years beginning after December 15, 2021, and interim periods within those fiscal years. For all other entities, the standard will be effective for fiscal years beginning after December 15, 2023, including interim periods within those fiscal years. Early adoption is permitted. The Company does not expect the adoption of ASU 2020-06 to have a material impact on its consolidated financial statements.
In October 2020, the FASB issued ASU No. 2020-08, “Codification Improvements to Subtopic 310-20, Receivables - Nonrefundable fees and Other Costs.” This ASU clarifies that an entity should reevaluate whether a callable debt security is within the scope of ASC paragraph 310-20-35-33 for each reporting period. For public business entities, the ASU is effective for fiscal years beginning after December 15, 2020, and interim periods within those fiscal years. Early adoption is not permitted. ASU No. 2020-08 states that all entities should apply the amendments in this ASU on a prospective basis as of the beginning of the period of adoption for existing or newly purchased callable debt securities. The Company does not expect the adoption of ASU 2020-06 to have a material impact on its consolidated financial statements.
Note 2.
Securities
The amortized cost and fair value of securities available for sale, are summarized as follows:
December 31, 2020
(In thousands)
Amortized
Cost
Gross
Unrealized
Gains
Gross
Unrealized
(Losses)
Fair
Value
Obligations of U.S. Government corporations and agencies
$
57,486
$
1,759
$
(35
)
$
59,210
Obligations of states and political subdivisions
22,016
1,623
(1
)
23,638
$
79,502
$
3,382
$
(36
)
$
82,848
December 31, 2019
(In thousands)
Amortized
Cost
Gross
Unrealized
Gains
Gross
Unrealized
(Losses)
Fair
Value
Obligations of U.S. Government corporations and agencies
$
63,090
$
$
(86
)
$
63,941
Obligations of states and political subdivisions
15,054
(14
)
15,842
$
78,144
$
1,739
$
(100
)
$
79,783
The amortized cost and fair value of securities available for sale, by contractual maturity, are shown below. Expected maturities may differ from contractual maturities because issuers may have the right to call or prepay obligations without penalties.
December 31, 2020
(In thousands)
Amortized
Cost
Fair
Value
Due in one year or less
$
2,054
$
2,072
Due after one year through five years
7,934
8,419
Due after five years through ten years
8,972
9,467
Due after ten years
60,542
62,890
$
79,502
$
82,848
Proceeds from maturities, calls and principal repayments of securities available for sale during 2020, 2019 and 2018 were $16.2 million, $8.2 million and $11.7 million, respectively. Proceeds from the sales of securities available for sale during 2020 and 2019 were $18.8 million and $13.9 million, respectively. There were no sales of securities available for sale during 2018. Net gains on sales and/or calls of securities available for sale were $992,000, $79,000, and $838,000 during 2020, 2019 and 2018, respectively. Securities available for sale totaling $35.8 million, $27.6 million and $12.4 million were purchased in 2020, 2019 and 2018, respectively.
The following table presents securities with gross unrealized losses and fair value, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position, at December 31, 2020 and 2019, respectively.
(In thousands)
Less than 12 Months
12 Months or More
Total
December 31, 2020
Fair
Value
Unrealized
(Losses)
Fair
Value
Unrealized
(Losses)
Fair
Value
Unrealized
(Losses)
Obligations of U.S. Government corporations and agencies
$
7,958
$
(35
)
$
-
$
-
$
7,958
$
(35
)
Obligations of states and political subdivisions
(1
)
-
-
(1
)
Total temporarily impaired securities
$
8,466
$
(36
)
$
-
$
-
$
8,466
$
(36
)
(In thousands)
Less than 12 Months
12 Months or More
Total
December 31, 2019
Fair
Value
Unrealized
(Losses)
Fair Value
Unrealized
(Losses)
Fair
Value
Unrealized
(Losses)
Obligations of U.S. Government corporations and agencies
$
11,460
$
(42
)
$
5,651
$
(44
)
$
17,111
$
(86
)
Obligations of states and political subdivisions
2,049
(14
)
-
-
2,049
(14
)
Total temporarily impaired securities
$
13,509
$
(56
)
$
5,651
$
(44
)
$
19,160
$
(100
)
At December 31, 2020, there were 5 securities totaling $8.5 million of aggregate fair value considered temporarily impaired. The primary cause of the temporary impairments in the Company’s investments in debt securities was fluctuations in interest rates. The Company concluded that no other-than-temporary impairment existed in its securities portfolio at December 31, 2020, and no other-than-temporary impairment loss has been recognized in net income, based primarily on the fact that changes in fair value were caused primarily by fluctuations in interest rates, there were no securities with unrealized losses that were significant relative to their carrying amounts, no securities have been in an unrealized loss position continuously for more than 12 months, securities with unrealized losses had generally high credit quality, the Company intends to hold these investments in debt securities to maturity and it is more-likely-than-not that the Company will not be required to sell these investments before a recovery of its investment, and issuers have continued to make timely payments of principal and interest. Additionally, the Company’s mortgage-backed securities are entirely issued by either U.S. government agencies or U.S. government-sponsored enterprises. Collectively, these entities provide a guarantee, which is either explicitly or implicitly supported by the full faith and credit of the U.S. government, that investors in such mortgage-backed securities will receive timely principal and interest payments.
The carrying value of securities pledged to secure deposits and for other purposes amounted to $13.1 million and $16.6 million at December 31, 2020 and 2019, respectively.
Note 3.Loans and Allowance for Loan Losses
The Company’s allowance for loan losses has three basic components: the specific allowance, the general allowance, and the unallocated component. The specific allowance is used to individually allocate an allowance for larger balance, non-homogeneous loans identified as impaired. The general allowance is used for estimating the loss on pools of smaller balance, homogeneous loans, including 1-4 family mortgage loans and other consumer loans. Also, the general allowance is used for the remaining pool of larger balance, non-homogeneous loans which were not identified as impaired. 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.
On March 27, 2020, the CARES Act was enacted to, among other provisions, provide emergency assistance for individuals, families and businesses affected by COVID-19. A provision in the CARES Act included the creation of the PPP through the Small Business Administration (“SBA”). Loans provided by the Bank through the PPP may be forgiven based on the borrowers’ compliance with the terms of the program. The SBA provides a 100% guaranty to the lender of principal and interest, unless the lender violates an obligation under the agreement. As loan losses are expected to be immaterial, if any at all, due to the SBA guaranty, there is no provision allocated for PPP loans within the allowance for loan loss calculation. As of December 31, 2020, the Bank’s Commercial and Industrial loan segment included the origination of 549 PPP loans, totaling $53.1 million, and under the terms of the PPP, subsequently issued forgiveness for 223 PPP loans, with an aggregate principal balance of $22.6 million.
The following table presents the activity in the allowance for loan losses by portfolio segment for each of the years ended December 31, 2020, 2019 and 2018.
December 31, 2020
(In thousands)
Commercial
and Industrial
Commercial Real Estate
Construction and Land
Consumer
Student
Residential
Real Estate
Home Equity
Lines of Credit
Unallocated
Total
Allowance for Loan Losses
Beginning balance, December 31, 2019
$
$
1,788
$
$
$
$
1,596
$
$
$
5,227
Charge-offs
(148
)
-
-
(34
)
(15
)
-
-
-
(197
)
Recoveries
-
-
-
-
-
Provision (recovery)
(24
)
(17
)
-
1,773
Ending balance, December 31, 2020
$
$
2,334
$
1,080
$
$
$
1,839
$
$
$
6,870
Ending balances individually evaluated for impairment
$
$
$
-
$
-
$
-
$
-
$
-
$
-
$
Ending balances collectively evaluated for impairment
$
$
2,282
$
1,080
$
$
$
1,839
$
$
$
6,798
Loans
Individually evaluated for impairment
$
$
8,345
$
-
$
-
$
-
$
$
-
$
9,608
Collectively evaluated for impairment
67,881
192,345
73,966
6,355
6,971
230,131
29,492
607,141
Ending balance, December 31, 2020
$
68,390
$
200,690
$
73,966
$
6,355
$
6,971
$
230,885
$
29,492
$
616,749
December 31, 2019
(In thousands)
Commercial and Industrial
Commercial Real Estate
Construction and Land
Consumer
Student
Residential
Real Estate
Home Equity
Lines of Credit
Unallocated
Total
Allowance for Loan Losses
Beginning balance, December 31, 2018
$
$
1,738
$
$
$
$
1,311
$
$
$
5,176
Charge-offs
(328
)
-
-
(50
)
(13
)
-
-
-
(391
)
Recoveries
-
-
-
-
-
Provision
(30
)
(120
)
-
Ending balance, December 31, 2019
$
$
1,788
$
$
$
$
1,596
$
$
$
5,227
Ending balances individually evaluated for impairment
$
-
$
$
-
$
-
$
-
$
-
$
-
$
-
$
Ending balances collectively evaluated for impairment
$
$
1,559
$
$
$
$
1,596
$
$
$
4,998
Loans
Individually evaluated for impairment
$
$
2,847
$
$
-
$
-
$
$
-
$
3,646
Collectively evaluated for impairment
27,217
179,051
64,998
5,958
8,151
224,937
36,268
546,580
Ending balance, December 31, 2019
$
27,404
$
181,898
$
65,231
$
5,958
$
8,151
$
225,316
$
36,268
$
550,226
December 31, 2018
(In thousands)
Commercial and Industrial
Commercial Real Estate
Construction and Land
Consumer
Student
Residential
Real Estate
Home Equity
Lines of Credit
Unallocated
Total
Allowance for Loan Losses
Beginning balance, December 31, 2017
$
$
1,609
$
$
$
$
1,174
$
$
$
5,094
Charge-offs
(106
)
(47
)
(312
)
(14
)
(24
)
(200
)
(80
)
-
(783
)
Recoveries
-
-
-
Provision (recovery)
-
Ending balance, December 31, 2018
$
$
1,738
$
$
$
$
1,311
$
$
$
5,176
Ending balances individually evaluated for impairment
$
$
$
-
$
-
$
-
$
-
$
$
-
$
Ending balances collectively evaluated for impairment
$
$
1,579
$
$
$
$
1,311
$
$
$
4,773
Loans
Individually evaluated for impairment
$
$
3,191
$
2,679
$
-
$
-
$
$
$
7,666
Collectively evaluated for impairment
26,199
184,606
68,730
5,562
9,158
205,238
42,205
541,698
Ending balance, December 31, 2018
$
26,721
$
187,797
$
71,409
$
5,562
$
9,158
$
205,945
$
42,772
$
549,364
Loans by credit quality indicators as of December 31, 2020 and 2019 are summarized as follows:
December 31, 2020
(In thousands)
Commercial and Industrial
Commercial Real Estate
Construction and Land
Consumer
Student
Residential
Real Estate
Home Equity
Lines of Credit
Total
Grade:
Pass
$
67,499
$
189,656
$
71,630
$
6,352
$
6,971
$
223,681
$
27,650
$
593,439
Special mention
9,273
2,273
-
-
12,216
Substandard
1,761
-
-
6,885
1,842
11,094
Doubtful
-
-
-
-
-
-
-
-
Loss
-
-
-
-
-
-
-
-
Total
$
68,390
$
200,690
$
73,966
$
6,355
$
6,971
$
230,885
$
29,492
$
616,749
December 31, 2019
(In thousands)
Commercial and Industrial
Commercial Real Estate
Construction and Land
Consumer
Student
Residential
Real Estate
Home Equity Lines of Credit
Total
Grade:
Pass
$
26,555
$
175,063
$
62,231
$
5,955
$
8,151
$
218,686
$
34,218
$
530,859
Special mention
3,487
2,594
-
6,969
Substandard
3,348
-
-
6,294
1,923
12,398
Doubtful
-
-
-
-
-
-
-
-
Loss
-
-
-
-
-
-
-
-
Total
$
27,404
$
181,898
$
65,231
$
5,958
$
8,151
$
225,316
$
36,268
$
550,226
The past due status of loans as of December 31, 2020 and 2019 are summarized as follows:
December 31, 2020
(In thousands)
30-59 Days
Past Due
60-89 Days
Past Due
90+ Days
Past Due
Total Past Due
Current
Total Loans
90+ Days
Past Due
and Accruing
Nonaccruals
Commercial and industrial
$
$
-
$
$
$
67,842
$
68,390
$
$
Commercial real estate
-
-
200,333
200,690
-
Construction and land
-
-
-
-
73,966
73,966
-
-
Consumer
-
-
6,346
6,355
-
-
Student
1,440
5,531
6,971
-
Residential real estate
-
1,147
229,738
230,885
-
Home equity lines of credit
-
29,057
29,492
-
-
Total
$
1,356
$
$
1,829
$
3,936
$
612,813
$
616,749
$
$
1,245
December 31, 2019
(In thousands)
30-59 Days
Past Due
60-89 Days
Past Due
90+ Days
Past Due
Total Past Due
Current
Total Loans
90+ Days
Past Due
and Accruing
Nonaccruals
Commercial and industrial
$
$
-
$
$
$
27,040
$
27,404
$
$
-
Commercial real estate
-
-
180,909
181,898
-
Construction and land
5,472
-
-
5,472
59,759
65,231
-
-
Consumer
-
5,946
5,958
-
-
Student
1,204
1,769
6,382
8,151
1,205
-
Residential real estate
1,245
224,071
225,316
-
Home equity lines of credit
-
-
35,879
36,268
-
-
Total
$
7,286
$
$
2,624
$
10,240
$
539,986
$
550,226
$
1,636
$
The following table presents information related to impaired loans by portfolio segment as of December 31, 2020 and 2019.
December 31, 2020
(In thousands)
Recorded
Investment
Unpaid
Principal
Balance
Related
Allowance
Average
Recorded
Investment
Interest
Income
Recognized
With no specific allowance recorded:
Commercial real estate
$
7,562
$
7,562
$
-
$
7,944
$
Residential real estate
-
With an allowance recorded:
Commercial and industrial
$
$
$
$
$
Commercial real estate
Total:
Commercial and industrial
$
$
$
$
$
Commercial real estate
8,345
8,345
8,741
Residential real estate
-
Total
$
9,608
$
9,608
$
$
10,011
$
December 31, 2019
(In thousands)
Recorded
Investment
Unpaid
Principal
Balance
Related
Allowance
Average
Recorded
Investment
Interest
Income
Recognized
With no specific allowance recorded:
Commercial and industrial
$
$
$
-
$
$
Commercial real estate
1,048
1,048
-
1,213
Construction and land
-
Residential real estate
-
With an allowance recorded:
Commercial real estate
$
1,799
$
1,813
$
$
1,806
$
Total:
Commercial and industrial
$
$
$
-
$
$
Commercial real estate
2,847
2,861
3,019
Construction and land
-
Residential real estate
-
Total
$
3,646
$
3,660
$
$
4,184
$
Trouble Debt Restructurings
For each of the years ended December 31, 2020 and 2019, there were five loans in the loan portfolio, totaling $8.4 million and $2.5 million, respectively, that were identified as TDRs, all of which were current and performing in accordance with their modified terms. The following table summarizes a modification that was classified as a TDR during 2020. There were no loan modifications that were classified as TDRs during 2019. There were no payment defaults for TDRs occurring within twelve months of modification during the years ended December 31, 2020 and 2019.
Class of Loan
Number of Contracts
Pre-Modification Outstanding Recorded Investment
Post-Modification Outstanding Recorded Investment
Commercial and industrial
$
6,221
$
6,221
The CARES Act, along with interagency guidance, provided financial institutions the option to temporarily suspend certain accounting requirements related to TDRs with respect to loan modifications, including the deferral of scheduled payments. As of December 31, 2020, under the current regulatory guidance, 5 loans, totaling $518,000 in principal loan balances, were granted a 90-day deferment of scheduled payments and one loan, with a principal balance of $2.6 million was modified. These 6 loans were not considered TDRs under the current guidance.
At December 31, 2020 and 2019, the Company had no foreclosed residential real estate properties in its possession and none in the process of foreclosure.
Note 4. Related Party Transactions
Loans outstanding to directors and executive officers and certain of their affiliates totaled $2.3 million and $2.2 million at December 31, 2020 and 2019, respectively. Loan advances totaled $652,000 and repayments totaled $596,000 in the year ended December 31, 2020. Total deposits for directors and executive officers and their affiliates were $6.1 million and $5.2 million at December 31, 2020 and 2019, respectively. In the opinion of management, these transactions were made in the ordinary course of business on substantially the same terms and conditions, including interest rates, collateral and repayment terms, as those prevailing at the same time for comparable transactions with unrelated persons and do not involve more than normal risk or present other unfavorable features.
Note 5.
Premises and Equipment, Net
The following table presents the cost and accumulated depreciation of premises and equipment at December 31, 2020 and 2019.
(In thousands)
Land
$
4,246
$
4,254
Buildings and improvements
22,807
22,709
Furniture and equipment
6,178
6,410
Leasehold improvements
33,326
33,411
Accumulated depreciation
(16,797
)
(15,919
)
$
16,529
$
17,492
Depreciation expense totaled $1.1 million for the year ended December 31, 2020 and $1.3 for each of the years ended December 31, 2019 and 2018.
Note 6.
Deposits
The aggregate amounts of time deposits in denominations of $250,000 or more at December 31, 2020 and 2019 were $13.0 million and $13.4 million, respectively.
Overdraft deposits totaling $76,000 and $192,000 were reclassified to loans at December 31, 2020 and 2019, respectively.
The following table presents scheduled maturities of time deposits at December 31, 2020.
(In thousands)
$
62,932
7,399
3,017
$
73,392
Note 7.
Employee Benefit Plans
Supplemental Executive Retirement Plan (“SERP”)
The Company has a defined benefit SERP for certain executives, in which the contribution is solely funded by the Company. For the years ended December 31, 2020, 2019 and 2018, SERP expenses were $233,000, $270,000 and $256,000, respectively.
The following table summarizes the projected benefit obligations, plan assets, funded status and rate assumptions associated with the SERP based upon actuarial valuations, for the years ended December 31, 2020, 2019 and 2018.
(In thousands)
Changes in Benefit Obligations
Benefit obligation, beginning
$
2,675
$
2,574
$
2,485
Service cost
Interest cost
Actuarial gain
(20
)
(18
)
Benefits paid
(212
)
(148
)
(148
)
Benefit obligation, ending
$
2,853
$
2,675
$
2,574
Funded status at December 31,
$
(2,853
)
$
(2,675
)
$
(2,574
)
Changes in Plan Assets
Fair value of plan assets, beginning
$
-
$
-
$
-
Employer contributions
Benefits paid
(212
)
(148
)
(148
)
Fair value of plan assets, ending
$
-
$
-
$
-
Amounts recognized in the Balance Sheets
Other assets, deferred income tax benefit
$
$
$
Other liabilities
2,853
2,675
2,574
Accumulated other comprehensive income
Amounts recognized in accumulated other comprehensive income (loss)
Net gain
$
$
$
Prior service cost
Deferred tax expense
(8
)
(41
)
(37
)
Amount recognized
$
$
$
Components of net periodic benefit cost
Service cost
$
$
$
Interest cost
Amortization of prior service cost
Net periodic benefit cost
$
$
$
Other changes in plan assets and benefit obligations recognized in other comprehensive income
Net gain
$
(158
)
$
$
Amortization of prior service cost
Total recognized
(157
)
Less: Income tax effect
(33
)
Net amount recognized in other comprehensive income
$
(124
)
$
$
The total recognized net periodic benefit costs and other comprehensive income before income tax follows:
(In thousands)
$
$
$
Weighted-average assumptions:
Discount rate used for net periodic benefit cost
3.00
%
4.00
%
3.50
%
Discount rate used for benefit obligation
2.25
%
3.00
%
4.00
%
Rate of compensation increase for net periodic benefit cost and benefit obligation
3.25
%
3.25
%
3.25
%
Estimated future benefit payments follows:
(In thousands)
For the years ending December 31,
Amount
$
The Company has also established supplemental retirement plans for certain additional executives. The expense for these plans was $52,000, $27,100 and $35,600 during 2020, 2019 and 2018, respectively.
401(k) Plan
The Company has a defined contribution retirement plan under Internal Revenue Code of 1986 (“Code”) Section 401(k) covering all employees who are at least 18 years of age and worked more than 20 hours per week. Under the plan, a participant may contribute an amount up to 100% of their covered compensation for the year, not to exceed the dollar limit set by law (Code Section 402(g)). The Company will make an annual matching contribution, equal to 100% on the first 6% of compensation deferred for a maximum match of 6% of compensation. The Company makes an additional safe harbor contribution equal to 3% of compensation to all eligible participants. The Company’s 401(k) expenses for the years ended December 31, 2020, 2019 and 2018 were $788,000, $747,000 and $688,000, respectively.
Deferred Compensation Plans
The Company maintains a Director Deferred Compensation Plan. This plan provides that any nonemployee director of the Company may elect to defer receipt of all or any portion of his or her compensation as a director. A participating director may elect to have amounts held in a deferred cash account, which is credited on a quarterly basis with interest equal to the highest rate offered by the Bank at the end of the preceding quarter. Alternatively, a participant may elect to have a deferred stock account in which deferred amounts are treated as if invested in the Company’s common stock at the fair market value on the date of deferral. The value of a stock account will change based upon the fair market value of an equivalent number of shares of common stock. In addition, the deferred amounts deemed invested in common stock will be credited with dividends on an equivalent number of shares. Amounts considered invested in the Company’s common stock are paid, at the election of the director, either in cash or in whole shares of the common stock and cash in lieu of fractional shares. Directors may elect to receive amounts contributed to their respective accounts in one or up to five installments. There were no directors participating in the Director Deferred Compensation Plan in 2020, 2019 and 2018.
The Company has a nonqualified deferred compensation program for a former key employee’s retirement, in which the contribution expense is solely funded by the Company. The retirement benefit to be provided is variable based upon the performance of underlying life insurance policy assets. Deferred compensation expense amounted to $28,000, $77,000 and $44,000 for the years ended December 31, 2020, 2019 and 2018, respectively. Concurrent with the establishment of the deferred compensation program, the Company purchased life insurance policies on this employee with the Company named as owner and beneficiary. These life insurance policies are intended to be utilized as a source of funding the deferred compensation program. At December 31, 2020 and 2019, the Company recorded on the consolidated balance sheets, $1.4 million in cash surrender value for these policies and $155,000 and $153,000 in accrued liabilities as of December 31, 2020 and 2019, respectively. The Company has recorded on the consolidated statements of operations, noninterest income of $29,000, for the year ended December 31, 2020 and $28,000 for each of the years ended December 31, 2019 and 2018.
Note 8.Dividend Reinvestment and Stock Purchase Plan
In 2004, the Company implemented a dividend reinvestment and stock purchase plan (the “DRSPP”) that allows participating shareholders to purchase additional shares of the Company’s common stock through automatic reinvestment of dividends or optional cash investments at 100% of the market price of the common stock, which is either the actual purchase price of the shares if obtained on the open market, or the average of the closing bid and asked quotations for a share of common stock on the day before the purchase date for shares, if acquired directly from the Company, as newly issued shares under the DRSPP. There were no new shares issued during 2020 and 2019. The Company had 236,529 shares available for issuance under the DRSPP at December 31, 2020.
Note 9.Commitments and Contingent Liabilities
The Bank has two data processing contractual obligations that began in June 2014 and will end in December 2021. The expense for these obligations totaled $1.3 million for the year ended December 31, 2020 and $1.2 million for each of the years ended December 31, 2019 and 2018. In addition, the core data processing contract provides for interchange processing where the expense is based on interchange volume and is more than offset by interchange income on the same transactions. The net interchange income was $1.2 million for the year ended December 31, 2020 and $1.3 million for each of the years ended December 31, 2019 and 2018.
In accordance with Regulation D of the Federal Reserve Act, the Bank is typically required to maintain cash reserve balances on hand or with the Federal Reserve Bank. In March 2020, the Federal Reserve Bank eliminated the reserve requirement. For the final weekly reporting period for the year ended December 31, 2020 and 2019, the Bank had no required reserve balances.
In the normal course of business, the Company makes various commitments and incurs certain contingent liabilities, which are not reflected in the accompanying financial statements. These commitments and contingent liabilities include various guarantees, commitments to extend credit and standby letters of credit. The Company does not anticipate any material losses as a result of these commitments. See Note 15 with respect to financial instruments with off-balance sheet risk.
Note 10.
Income Taxes
The Company files income tax returns in the U.S. federal jurisdiction and the Commonwealth of Virginia.
The following table summarizes the components of the net deferred tax assets included in other assets at December 31, 2020 and 2019.
(In thousands)
Deferred tax assets:
Allowance for loan losses
$
1,443
$
1,098
Interest on nonaccrual loans
Accrued vacation
SERP obligation
OREO
Accumulated depreciation
Restricted stock
Other
2,944
2,371
Deferred tax liabilities:
Securities available for sale
Other
Net deferred tax assets
$
2,221
$
2,016
The Company has not recorded a valuation allowance for deferred tax assets as management feels it is more-likely-than-not that they will be ultimately realized.
Components of income tax expense is summarized below:
Year Ended December 31,
(In thousands)
Current tax expense
$
1,554
$
$
Deferred taxes
(487
)
$
1,067
$
1,004
$
Income tax expense for the years ended December 31, 2020, 2019 and 2018 differed from the federal statutory rate applied to income before income taxes for the following reasons:
(In thousands)
Computed “expected” tax expense
$
1,458
$
1,643
$
1,445
Changes in income taxes resulting from:
Tax-exempt interest income
(160
)
(146
)
(149
)
Tax credits
(479
)
(552
)
(504
)
Other
(46
)
$
1,067
$
1,004
$
Note 11.Earnings Per Share
The following table presents the weighted average number of shares used in computing earnings per share and the effect on weighted average number of shares of dilutive potential common stock.
Shares
Per Share Amount
Shares
Per Share Amount
Shares
Per Share Amount
Basic earnings per share
3,793,366
$
1.55
3,783,322
$
1.80
3,772,421
$
1.63
Effect of dilutive stock awards
5,450
7,396
6,945
Diluted earnings per share
3,798,816
$
1.55
3,790,718
$
1.80
3,779,366
$
1.62
Unvested restricted shares have voting rights and receive nonforfeitable dividends during the vesting period; therefore, they are included in calculating basic earnings per share. The portion of unvested performance-based restricted stock units that are expected to vest, but have not yet been awarded, are included in the calculation of diluted earnings per share.
Note 12.
Share-based Compensation
Stock Incentive Plan
On May 21, 2019, the shareholders of the Company approved the Fauquier Bankshares, Inc. Amended and Restated Stock Incentive Plan (the “Plan”). Under the Plan, awards of options, restricted stock, and other stock-based awards may be granted to employees, directors or consultants of the Company or any affiliate. The effective date of the Plan was May 21, 2019 and the termination date is May 21, 2029. The Company’s Board of Directors may terminate, suspend or modify the Plan within certain restrictions. The Plan authorizes for issuance 350,000 shares of the Company’s common stock.
Restricted Shares
Restricted shares are accounted for using the fair market value of the Company’s common stock on the date in which these shares were awarded. Restricted shares are issued to certain executive officers and are subject to a vesting period, whereby, the restrictions on the shares lapse on the third anniversary of the date the shares were awarded. Compensation expense for these shares is recognized over the three-year period. The restricted shares issued to nonemployee directors are not subject to a vesting period and compensation expense is recognized at the date the shares are granted. Compensation expense for restricted shares amounted to $344,000, $243,000 and $223,000, net of forfeiture, for the years ended December 31, 2020, 2019 and 2018, respectively. As of December 31, 2020, there was $78,000 of total unrecognized compensation cost related to restricted shares. This amount is expected to be recognized through 2023, however the acceleration of this expense is expected as a result of the completion of the Merger.
The table below summarizes the Company’s unvested restricted shares.
December 31, 2020
December 31, 2019
Shares
Weighted Average Grant Date Fair Value
Per Share
Shares
Weighted Average Grant Date Fair Value
Per Share
Unvested shares, beginning
20,352
$
20.20
22,569
$
18.08
Granted
12,182
20.95
12,058
21.69
Vested
(21,906
)
20.27
(12,105
)
21.20
Forfeited or surrendered
(2,007
)
19.21
(2,170
)
20.46
Unvested shares, ending
8,621
$
21.31
20,352
$
20.20
Performance-based Restricted Stock Units
The Company grants performance-based restricted stock units to certain executive officers. Performance-based restricted stock units are accounted for using the fair market value of the Company’s common stock on the date awarded, and adjusted as the market value of the stock changes. Performance-based restricted stock units issued to executive officers are subject to a vesting period, whereby the restrictions on the rights lapse on the third anniversary of the date the units were awarded. Until vesting, the shares underlying the units are not issued and are not included in shares outstanding. Vesting is contingent upon the Company reaching predetermined performance goals as compared with a predetermined peer group of banks. Compensation expense for performance-based restricted stock units totaled $74,000, $97,000 and $80,000 for the years ended December 31, 2020, 2019 and 2018, respectively. As of December 31, 2020, there was $37,000 unrecognized compensation expense related to these performance-based restricted stock units. This expense is expected to be recognized through 2023, however the acceleration of this expense is expected in connection with the completion of the Merger.
The table below summarizes the Company’s unvested performance-based stock units.
December 31, 2020
December 31, 2019
Shares
Weighted Average Fair Value
Per Share
Performance Based Stock Rights
Weighted Average Fair Value
Per Share
Unvested shares, beginning
30,012
$
18.90
22,103
$
17.90
Granted
7,889
20.95
7,909
21.69
Vested
(4,662
)
21.02
-
-
Forfeited
(15,534
)
18.00
-
-
Unvested shares, ending
17,705
$
20.05
30,012
$
18.90
Note 13.
Federal Home Loan Bank Advances and Other Borrowings
The Company’s borrowings from the Federal Home Loan Bank of Atlanta (“FHLB”) were $12.6 million and $16.7 million at December 31, 2020 and 2019, respectively. At December 31, 2020, the fixed interest rates on FHLB advances were 2.06%, and the weighted average interest rate at December 31, 2020 and 2019 was 2.06% and 2.21%, respectively.
At December 31, 2020, the Bank’s available line of credit with the FHLB was approximately $109.1 million. FHLB advances and the available line of credit were secured by certain first and second lien loans on 1-4 family single unit dwellings and eligible commercial real estate loans of the Bank. The amount of available credit is limited to 100% of the market value of qualifying collateral for 1-4 family single unit residential loans, 68% to 84% for home equity loans and 70% for commercial real estate loans. Any borrowing in excess of the qualifying collateral requires pledging of additional assets.
The following table presents the contractual maturities of FHLB advances at December 31, 2020:
(In thousands)
$
2,606
10,000
$
12,606
At December 31, 2020, the Bank has $96.0 million in federal funds lines of credit with several different commercial banks and $22.6 million available from the Federal Reserve Bank of Richmond. As of December 31, 2020, the Bank also had a letter of credit in the amount of $35.0 million with the FHLB issued as collateral for public fund depository accounts. At December 31, 2020, none of the available federal funds lines of credit or letter of credit were in use.
Note 14.
Dividend Limitations on Affiliate Bank
Transfers of funds from the Bank to the Company in the form of loans, advances and cash dividends are restricted by federal and state regulatory authorities. As of December 31, 2020, the aggregate amount of unrestricted funds, which could be transferred from the Bank to the Company, without prior regulatory approval, totaled $13.7 million.
Note 15.
Financial Instruments with Off-Balance Sheet Risk
The Company is party to credit related financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments to extend credit and standby letters of credit. Such commitments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the consolidated balance sheets.
The Company’s exposure to credit loss is represented by the contractual amount of these commitments. The Company follows the same credit policies in making commitments as it does for on-balance-sheet instruments.
At December 31, 2020 and 2019, the following financial instruments were outstanding whose contract amounts represent credit risk:
(In thousands)
Commitments to extend credit
$
112,712
$
91,564
Standby letters of credit
5,466
4,892
$
118,178
$
96,456
Commitments to extend credit are agreements to lend to a customer provided that there are no violations of the terms of the contract prior to funding. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee by the customer. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The Company evaluates each customer’s credit worthiness on a case-by-case basis.
Unfunded commitments under commercial lines of credit, revolving credit lines and overdraft protection agreements are commitments for possible future extensions of credit to existing customers. These lines of credit usually do not contain a specified maturity date and may not be drawn upon to the total extent to which the Company is committed.
Standby letters of credit are conditional commitments issued by the Company to guarantee the performance of a customer to a third-party. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers.
Note 16.
Derivative Instruments and Hedging Activities
The Company uses interest rate swaps to reduce interest rate risk and to manage net interest income. Interest differentials paid or received under the swap agreements are reflected as adjustments to interest income. These interest rate swap agreements include both cash flow and fair value hedge derivative instruments that qualify for hedge accounting. The notional amounts of the interest rate swaps are not exchanged and do not represent exposure to credit loss. In the event of default by a counter party, the risk in these transactions is the cost of replacing the agreements at current market rates.
The Company entered into an interest rate swap agreement on July 1, 2010 to manage the interest rate exposure on its Junior Subordinated Debt due 2036. By entering into this agreement, the Company converted a floating rate liability into a fixed rate liability through the maturity date of September 15, 2020. Under the terms of the agreement, the Company receives interest quarterly at the rate equivalent to three-month LIBOR plus 1.70% repricing every three months on the same date as the Company’s Junior Subordinated Debt and pays interest monthly at the fixed rate of 3.21%. In addition, on June 24, 2016, the Company entered into a forward interest rate swap agreement to convert the floating rate liability on the same Junior Subordinated Debt to fixed from 2020 to 2031. Interest expense on these interest rate swaps was $87,000, $31,000 and $43,000 for the years ended December 31, 2020, 2019 and 2018, respectively. There was no cash flow hedge ineffectiveness identified during 2020, 2019 and 2018. These swaps are designated as cash flow hedges and changes in the fair value are recorded as an adjustment through other comprehensive income.
The Company entered into two swap agreements to manage the interest rate risk related to two commercial loans on February 11, 2015 and April 7, 2015. The agreements allow the Company to convert fixed rate assets to floating rate assets through 2022 and 2025. The Company receives interest monthly at the rate equivalent to one-month LIBOR plus a spread repricing on the same date as the loans and pays interest at fixed rates. Interest expense recognized on the interest rate swaps was $54,000 for the year ended December 31, 2020 and interest income of $26,000 and $5,000 for the years ended December 31, 2019 and 2018. These swaps are designated as fair value hedges and changes in fair value are recorded in current earnings. On July 28, 2020, one of these swap agreements with a notional/contract amount of $1.2 million terminated, resulting in a termination fee of $89,200.
Cash collateral held at other banks for these swaps was $1.1 million and $730,000 at December 31, 2020 and 2019, respectively. Collateral is dependent on the market valuation of the underlying hedges.
The follow table summarizes the Company’s derivative instruments as of December 31, 2020 and 2019:
(In thousands)
December 31, 2020
Derivatives designated as hedging instruments
Notional/Contract Amount
Fair Value
Fair Value
Balance Sheet Location
Expiration Date
Interest rate forward swap - cash flow
$
4,000
$
(442
)
Other Liabilities
6/15/2031
Interest rate swap - fair value
4,150
(76
)
Other Liabilities
2/12/2022
(In thousands)
December 31, 2019
Derivatives designated as hedging instruments
Notional/Contract Amount
Fair Value
Fair Value
Balance Sheet Location
Expiration Date
Interest rate swap - cash flow
$
4,000
$
(41
)
Other Liabilities
9/15/2020
Interest rate forward swap - cash flow
4,000
(59
)
Other Liabilities
6/15/2031
Interest rate swap - fair value
1,167
(17
)
Other Liabilities
4/9/2025
Interest rate swap - fair value
4,230
(23
)
Other Liabilities
2/12/2022
Note 17. Accumulated Other Comprehensive Income (Loss)
The following table presents information on changes in accumulated other comprehensive income (loss), net of tax, for the periods indicated.
(In thousands)
Gains (Losses) on Cash Flow Hedges
Unrealized Gains (Losses) on Available for Sale Securities
Supplemental Executive Retirement Plans
Total
Balance, December 31, 2017
$
$
(37
)
$
$
Reclassification of the income tax effect of the Tax Cuts and Jobs Act from accumulated other comprehensive income (loss)
-
-
Other comprehensive income before reclassifications
(823
)
(673
)
Balance, December 31, 2018
$
$
(850
)
$
$
(538
)
Other comprehensive income (loss) before reclassifications
(250
)
2,142
1,909
Balance, December 31, 2019
$
(78
)
$
1,292
$
$
1,371
Other comprehensive income (loss) before reclassifications
(271
)
1,349
(124
)
Balance, December 31, 2020
$
(349
)
$
2,641
$
$
2,325
Note 18. Fair Value Measurements
GAAP requires the Company to record fair value adjustments to certain assets and liabilities. The fair value of certain assets and liabilities is an exit price, representing the amount that would be received to sell an asset or paid to transfer a liability in the principal or most advantageous market in an orderly transaction between market participants as of the measurement date.
GAAP requires that valuation techniques maximize the use of observable inputs and minimize the use of unobservable inputs. GAAP also establishes a fair value hierarchy which prioritizes the valuation inputs into three broad levels. Based on the underlying inputs, each fair value measurement in its entirety is reported in one of the three levels. These levels are:
Level 1:Inputs are defined as quoted prices (unadjusted) in active markets for identical assets or liabilities.
Level 2:
Inputs are defined as inputs other than quoted prices included in Level 1 that are observable for the asset or liability, either directly or indirectly.
Level 3:Inputs are defined as unobservable inputs for the asset or liability.
The following describes the valuation techniques used by the Company to measure certain financial assets and liabilities recorded at fair value on a recurring basis in the consolidated financial statements:
Securities available for sale: Fair value measurement is based upon quoted market prices, when available (Level 1). If quoted market prices are not available, fair values are measured utilizing independent valuation techniques of identical or similar securities for which significant assumptions are derived primarily from or corroborated by observable market data (Level 2). If the inputs used to provide the evaluation for certain securities are unobservable and/or there is little, if any, market activity, then the security would fall to the lowest level of the hierarchy (Level 3). The Company’s investment portfolio is primarily valued using fair value measurements that are considered to be Level 2. The Company has contracted with an independent pricing service that uses Interactive Data Corporation (“IDC”) as the primary source for valuation. IDC utilizes evaluated pricing models that vary by asset class and include available trade, bid, and other market information. Generally, the methodology includes broker quotes, proprietary models, vast descriptive terms and conditions databases, as well as extensive quality control programs.
Interest rate swaps: The Company recognizes interest rate swaps at fair value. The Company has contracted with a third-party to provide valuations for interest rate swaps using standard valuation techniques. The Company’s interest rate swaps are classified as Level 2.
The following table presents the balances of financial assets and liabilities measured at fair value on a recurring basis:
Fair Value Measurements
(In thousands)
Balance
Level 1
Level 2
Level 3
Assets at December 31, 2020:
Available for sale securities:
Obligations of U.S. Government corporations and agencies
$
59,210
$
-
$
59,210
$
-
Obligations of states and political subdivisions
23,638
-
23,638
-
Total available for sale securities
82,848
-
82,848
-
Mutual funds
-
-
Total assets at fair value
$
83,267
$
$
82,848
$
-
Liabilities at December 31, 2020:
Interest rate swaps
$
$
-
$
$
-
Total liabilities at fair value
$
$
-
$
$
-
Assets at December 31, 2019:
Available for sale securities:
Obligations of U.S. Government corporations and agencies
$
63,941
$
-
$
63,941
$
-
Obligations of states and political subdivisions
15,842
-
15,842
-
Total available for sale securities
79,783
-
79,783
-
Mutual funds
-
-
Total assets at fair value
$
80,186
$
$
79,783
$
-
Liabilities at December 31, 2019:
Interest rate swaps
$
$
-
$
$
-
Total liabilities at fair value
$
$
-
$
$
-
The Company may be required, from time to time, to measure and recognize certain assets at fair value on a nonrecurring basis in accordance with GAAP. The following describes the valuation techniques and inputs used by the Company in determining the fair value of certain assets recorded at fair value on a nonrecurring basis in the consolidated financial statements.
Mortgage Loans Held for Sale: Mortgage loans held for sale are carried at lower of cost or market value. These loans currently consist of 1-4 family residential loans originated for sale in the secondary market. Fair value is based on the price secondary markets are currently offering for similar loans using observable market data which is not materially different than cost due to the short duration between origination and sale (Level 2). No nonrecurring fair value adjustments were recorded on mortgage loans held for sale during 2020 and 2019. Net gains and losses on the sale of loans are recorded as a component of noninterest income on the consolidated statements of operations.
Impaired Loans: A loan is designated as impaired when, in the judgment of management based on current information and events, it is probable that all amounts due according to the contractual terms of the loan agreement will not be collected. The measurement of loss associated with impaired loans can be based on either the observable market price of the loans or the fair value of the collateral securing the loans, or the present value of the cash flows. Collateral may be in the form of real estate or business assets including equipment, inventory, and accounts receivable. The vast majority of the Company’s collateral is real estate. The value of real estate collateral is determined utilizing an income or market valuation approach based on an appraisal of one year or less, conducted by an independent, licensed appraiser using observable market data (Level 2). However, if the collateral is in the process of construction or if an appraisal of the real estate property is more than one-year-old and not solely based on observable market comparables or management determines the fair value of the collateral is further impaired below the appraised value, then the fair value is considered Level 3. The value of business equipment is based upon an outside appraisal of one year or less, if deemed significant, or the net book value on the applicable business’ financial statements if not considered significant using observable market data. Likewise, values for inventory and accounts receivable collateral are based on financial statement balances or aging reports (Level 3). Any fair value adjustments are recorded in the period incurred as provision for loan losses on the consolidated statements of operations.
Other Real Estate Owned: OREO is measured at fair value less estimated selling costs. Fair value is based upon independent market prices, appraised values of the collateral, or management’s estimation of the value of the collateral. The Company considers OREO as Level 3.
The following table summarizes the Company’s financial assets that were measured at fair value on a nonrecurring basis during the period:
December 31, 2020
(In thousands)
Balance
Level 1
Level 2
Level 3
Assets:
Mortgage loans held for sale
$
$
-
$
$
-
Impaired loans, net
1,220
-
-
1,220
Other real estate owned, net
1,356
-
-
1,356
December 31, 2019
(In thousands)
Balance
Level 1
Level 2
Level 3
Assets:
Mortgage loans held for sale
$
$
-
$
$
-
Impaired loans, net
1,570
-
-
1,570
Other real estate owned, net
1,356
-
-
1,356
The following table displays quantitative information about Level 3 fair value measurements at December 31, 2020 and 2019:
December 31, 2020
(Dollars in thousands)
Fair Value
Valuation Technique
Unobservable Input
Weighted Average Discount
Impaired loans, net
$
1,220
Appraised values
Age of appraisals, current market conditions, and experience within local market
%
Other real estate owned, net
1,356
Appraised values
Age of appraisal, current market conditions and selling costs
%
Total
$
2,576
December 31, 2019
(Dollars in thousands)
Fair Value
Valuation Technique
Unobservable Input
Weighted Average Discount
Impaired loans, net
$
1,570
Appraised values
Age of appraisal, current market conditions, and experience within local market
%
Other real estate owned, net
1,356
Appraised values
Age of appraisal, current market conditions and selling costs
%
Total
$
2,926
Accounting Standards Codification (“ASC”) 825, “Financial Instruments”, requires disclosure about fair value of financial instruments, including those financial assets and financial liabilities that are not required to be measured and reported at fair value on a recurring or nonrecurring basis. ASC 825 excludes certain financial instruments and all nonfinancial instruments from its disclosure requirements. Accordingly, the aggregate fair value amounts presented may not necessarily represent the underlying fair value of the Company. Additionally, the Company uses the exit price notion, rather than the entry price notion, in calculating the fair values of financial instruments not measured at fair value on a recurring basis.
The following tables present the Company’s estimated fair values and related carrying amounts:
December 31, 2020
(In thousands)
Carrying Amount
Level 1
Level 2
Level 3
Fair Value
Assets
Cash and short-term investments
$
124,566
$
124,566
$
-
$
-
$
124,566
Securities available for sale
82,848
-
82,848
-
82,848
Restricted investments
1,835
-
1,835
-
1,835
Mortgage loans held for sale
-
-
Loans, net
609,879
-
-
607,181
607,181
Accrued interest receivable
2,305
-
2,305
-
2,305
Mutual Funds
-
-
Bank-owned life insurance
14,321
-
14,321
-
14,321
Total financial assets
$
836,548
$
124,985
$
101,684
$
607,181
$
833,850
Liabilities
Deposits
$
766,119
$
-
$
766,449
$
-
$
766,449
FHLB advances
12,606
-
16,724
-
16,724
Junior subordinated debt
4,124
-
3,990
-
3,990
Accrued interest payable
-
-
Interest rate swaps
-
-
Total financial liabilities
$
783,474
$
-
$
787,788
$
-
$
787,788
December 31, 2019
(In thousands)
Carrying Amount
Level 1
Level 2
Level 3
Fair Value
Assets
Cash and short-term investments
$
46,341
$
46,341
$
-
$
-
$
46,341
Securities available for sale
79,783
-
79,783
-
79,783
Restricted investments
2,016
-
2,016
-
2,016
Mortgage loans held for sale
-
-
Loans, net
544,999
-
-
541,367
541,367
Accrued interest receivable
1,984
-
1,984
-
1,984
Mutual funds
-
-
Bank-owned life insurance
13,961
-
13,961
-
13,961
Total financial assets
$
689,734
$
46,744
$
97,991
$
541,367
$
686,102
Liabilities
Deposits
$
622,155
$
-
$
622,295
$
-
$
622,295
FHLB advances
16,695
-
16,724
-
16,724
Junior subordinated debt
4,124
-
4,446
-
4,446
Accrued interest payable
-
-
Interest rate swaps
-
-
Total financial liabilities
$
643,331
$
-
$
643,822
$
-
$
643,822
The Company assumes interest rate risk (the risk that general interest rate levels will change) during its normal operations. As a result, the fair values of the Company’s financial instruments will change when interest rate levels change and that change may be either favorable or unfavorable to the Company. Management attempts to match maturities of assets and liabilities to the extent believed necessary to minimize interest rate risk. However, borrowers with fixed rate obligations are less likely to prepay in a rising rate environment. Conversely, depositors who are receiving fixed rates are more likely to withdraw funds before maturity in a rising rate environment and less likely to do so in a falling rate environment. Management monitors rates and maturities of assets and liabilities and attempts to minimize interest rate risk by adjusting terms of new loans and deposits and by investing in securities with terms that mitigate the Company’s overall interest rate risk.
Note 19.
Other Operating Expenses
The following table summarizes the principal components of other operating expenses in the consolidated statements of operations:
(In thousands)
Postage and courier
$
$
$
Paper and supplies
Taxes, other than income taxes
Charge-offs, other than loan charge-offs
Telephone
Directors' compensation
Managed service agreements
Other
1,347
1,419
1,338
$
3,565
$
3,427
$
3,414
Note 20.Concentration Risk
The Company maintains its cash accounts in several correspondent banks. The balances with these correspondent banks may exceed federally insured limits at times, which management considers a normal business risk.
Note 21.
Capital Requirements
The Bank is subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect on the Company’s financial condition and results of operations. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Bank must meet specific capital guidelines that involve quantitative measures of its assets, liabilities, and certain off-balance-sheet items as calculated under regulatory accounting practices. The capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors.
The Board of Governors of the Federal Reserve System (the “Federal Reserve”) and the Federal Deposit Insurance Corporation have adopted rules to implement the Basel III capital framework and certain provisions of the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Basel III Capital Rules”). The Basel III Capital Rules require the Bank to comply with the minimum capital ratios set forth in the table below, plus a “capital conservation buffer.” The capital conservation buffer requirement was phased in beginning on January 1, 2016, at 0.625% of risk-weighted assets, and increased by the same amount each year until it was fully implemented at 2.5% on January 1, 2019. The capital conservation buffer is designed to absorb losses during periods of economic stress. The capital conservation buffer is applicable to all ratios except the leverage ratio, which is noted below as Tier 1 capital to average assets.
The Bank must also comply with the capital requirements set forth in the “prompt corrective action” regulations pursuant to Section 38 of the Federal Deposit Insurance Act. At December 31, 2020, the most recent notification from the Federal Reserve Bank of Richmond categorized the Bank as well capitalized under the prompt corrective action regulations. To be considered “well capitalized” under these regulations, the Bank must have the capital ratios set forth in the table below.
Actual
Minimum Capital Requirement
Well Capitalized Under
Prompt Corrective Action Provisions
(Dollars In thousands)
Amount
Ratio
Amount
Ratio
Amount
Ratio
As of December 31, 2020
Total capital (to risk-weighted assets)
$
79,784
13.9
%
$
46,024
8.0
%
$
57,530
10.0
%
Common equity Tier 1 capital (to risk-weighted assets)
$
72,914
12.7
%
$
25,889
4.5
%
$
37,395
6.5
%
Tier 1 capital (to risk-weighted assets)
$
72,914
12.7
%
$
34,518
6.0
%
$
46,024
8.0
%
Tier 1 capital (to average assets)
$
72,914
8.5
%
$
34,163
4.0
%
$
42,704
5.0
%
As of December 31, 2019
Total capital (to risk-weighted assets)
$
74,090
13.5
%
$
43,776
8.0
%
$
54,720
10.0
%
Common equity Tier 1 capital (to risk-weighted assets)
$
68,863
12.6
%
$
24,624
4.5
%
$
35,568
6.5
%
Tier 1 capital (to risk-weighted assets)
$
68,863
12.6
%
$
32,832
6.0
%
$
43,776
8.0
%
Tier 1 capital (to average assets)
$
68,863
9.4
%
$
29,298
4.0
%
$
36,622
5.0
%
Note 22. Junior Subordinated Debt
On September 21, 2006, the Company’s wholly-owned Connecticut statutory business trust, Fauquier Statutory Trust II, privately issued $4.0 million face amount of the trust’s Floating Rate Capital Securities in a pooled capital securities offering. Simultaneously, the trust used the proceeds of that sale to purchase $4.0 million principal amount of the Company’s Floating Rate Junior Subordinated Deferrable Interest Debentures due 2036. The interest rate on the capital security resets every three months at 1.70% above the then current three-month LIBOR. Interest is paid quarterly. Total capital securities at December 31, 2020 and 2019 were $4.1 million. The Trust II issuance of capital securities and the respective subordinated debentures are callable at any time. The subordinated debentures are an unsecured obligation of the Company and are junior in right of payment to all present and future senior indebtedness of the Company. The capital securities are guaranteed by the Company on a subordinated basis.
Note 23.Parent Company Only Financial Statements
Balance Sheets
(In thousands)
December 31,
Assets
Cash
$
$
Interest-bearing deposits in other banks
Investment in subsidiaries
75,588
70,313
Other assets
Total assets
$
77,134
$
71,412
Liabilities and Shareholders' Equity
Junior subordinated debt
$
4,124
$
4,124
Other liabilities
Total liabilities
4,673
4,290
Shareholders' Equity
Common stock and additional paid-in capital
16,369
15,964
Retained earnings
53,767
49,787
Accumulated other comprehensive income
2,325
1,371
Total shareholders' equity
72,461
67,122
Total liabilities and shareholders' equity
$
77,134
$
71,412
Statements of Operations
Years Ended December 31, 2020, 2019 and 2018
(In thousands)
Income
Interest income
$
$
$
Dividends from subsidiaries
2,423
2,654
1,813
Total interest and dividend income
2,425
2,663
1,817
Expenses
Interest expense
Legal and professional fees
Directors' fees
Miscellaneous
Total expense
Income before income tax benefits and equity in undistributed net income of subsidiaries
1,519
1,777
Income tax benefit
(307
)
(298
)
(289
)
Income before equity in undistributed net income of subsidiaries
1,826
2,075
1,252
Equity in undistributed net income of subsidiaries
4,051
4,745
4,883
Net income
$
5,877
$
6,820
$
6,135
Statements of Cash Flows
Years Ended December 31, 2020, 2019 and 2018
(In thousands)
Cash Flows from Operating Activities
Net income
$
5,877
$
6,820
$
6,135
Adjustments to reconcile net income to net cash provided by operating activities:
Undistributed earnings of subsidiaries
(4,051
)
(4,745
)
(4,883
)
Issuance of vested restricted stock
Amortization of unearned compensation, net of forfeiture
(Increase) decrease in other assets
-
(33
)
Increase in other liabilities
Net cash provided by operating activities
2,296
2,323
1,460
Cash Flows from Financing Activities
Repurchase of common stock
(24
)
(21
)
(8
)
Cash dividends paid on common stock
(1,897
)
(1,836
)
(1,813
)
Net cash used in financing activities
(1,921
)
(1,857
)
(1,821
)
Increase (decrease) in cash and cash equivalents
(361
)
Cash and Cash Equivalents
Beginning
Ending
$
1,303
$
$
Note 24.
Investment in Affordable Housing Projects
The Company has investments in certain affordable housing projects located in the Commonwealth of Virginia through several limited liability partnerships of the Bank. These partnerships exist to develop and preserve affordable housing for low income families through residential rental property projects. The Company exerts no control over the operating or financial policies of the partnerships. Return on these investments is through receipt of tax credits and other tax benefits which are subject to recapture by taxing authorities based on compliance features at the project level. The investments are due to expire by 2035. The Company accounts for the affordable housing investments using the equity method and has recorded $3.8 million and $4.2 million in other assets at December 31, 2020 and 2019, respectively. The Company has also recorded $397,000 and $749,000 in other liabilities at December 31, 2020 and 2019, respectively, related to unfunded capital commitments through 2023. The related federal tax credits for the years ended December 31, 2020, 2019 and 2018 were $479,000, $552,000 and $504,000, respectively, and were included in income tax expense in the consolidated statements of
operations. There were $409,000, $236,000 and $266,000 in flow-through losses recognized during the year ended December 31, 2020, 2019 and 2018, respectively, that were included in noninterest income.
Note 25.Leases
The following tables present information about the Company’s leases:
(Dollars in thousands)
December 31, 2020
Lease liability
$
4,570
Right-of-use asset
$
4,495
Weighted average remaining lease term
7.82 years
Weighted average discount rate
3.55
%
(In thousands)
Lease Expense
Operating lease expense
$
$
$
Short-term lease expense
Total lease expense
$
$
$
Cash paid for amounts included in lease liabilities
$
NR*
*Not reportable
Maturities of the Company’s lease liabilities are set forth in the table below.
(In thousands)
December 31, 2020
$
Thereafter
2,067
Total undiscounted cash flows
5,277
Less: Discount
(707
)
Total
$
4,570

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ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None.

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ITEM 9A. CONTROLS AND PROCEDURES
ITEM 9A. CONTROLS AND PROCEDURES
Disclosure Controls and Procedures
The Company maintains disclosure controls and procedures that are designed to provide assurance that the information required to be disclosed in the reports filed or submitted under the Exchange Act is recorded, processed, summarized and reported within the time periods required by the SEC. An evaluation of the effectiveness of the design and operations of the Company’s disclosure controls and procedures (as defined in Rule 13a-15(e) and Rule 15d-15(e) under the Exchange Act) at the end of the period covered by this report was carried out under the supervision and with the participation of the management of Fauquier Bankshares, Inc., including the Company’s Chief Executive Officer and the Chief Financial Officer. Based on such an evaluation, the Chief Executive Officer and the Chief Financial Officer concluded the Company’s disclosure controls and procedures were effective as of the end of such period.
The Company regularly assesses the adequacy of its internal control over financial reporting and enhances its controls in response to internal control assessments and internal and external audit and regulatory recommendations. There have not been any significant changes in the Company’s internal control over financial reporting or in other factors that have materially affected or are reasonably likely to materially affect, such controls during the quarter ended December 31, 2020.
There have been no material changes to the quantitative and qualitative disclosures made in the Company’s Annual Report on Form 10-K for the year ended December 31, 2020.
Management’s Report on Internal Control Over Financial Reporting
The management of Fauquier Bankshares, Inc. (“Management”) is responsible for establishing and maintaining adequate internal control over financial reporting (as defined in Rule 13a-15(f) of the Exchange Act). Management’s internal control over financial reporting is a process designed under the supervision of the Company’s Chief Executive Officer and Chief Financial Officer to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles in the United States of America.
As of December 31, 2020, Management has assessed the effectiveness of the internal control over financial reporting based on the criteria for effective internal control over financial reporting established in “Internal Control-Integrated Framework” issued by the Committee of Sponsoring Organizations of the Treadway Commission in Internal Control - Integrated Framework (2013). Based on the assessment, Management determined that it maintained effective internal control over the financial reporting as of December 31, 2020, based on the 2013 framework criteria.
No changes were made in Management’s internal control over financial reporting during the year ended December 31, 2020 that have materially affected, or that are reasonably likely to materially affect, Management’s internal control over financial reporting.

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ITEM 9B. OTHER INFORMATION
ITEM 9B. OTHER INFORMATION
None.
PART III

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ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
Directors
The following biographical information discloses each director’s age and business experience, including the specific skills or attributes that qualify each director for service on the Board, and the year that each individual was first elected to the Board.
John B. Adams, Jr. (age 75) has been a director of Fauquier since 2003 and a director of The Fauquier Bank since 2002. He was elected chairman of Fauquier and The Fauquier Bank in 2010. Mr. Adams was president and chief executive officer of A. Smith Bowman Distillery from 1989 to 2003. Mr. Adams serves as president and chief executive officer of Bowman Companies, Inc., primarily a family real estate holding company, and was a director of Universal Corporation, a publicly traded company headquartered in Richmond, Virginia, from 2003 to 2018. Mr. Adams served as chairman of The National Theatre in Washington, D.C. for 25 years and has served on the foundation boards of several higher education institutions. As a result of his various leadership roles, Mr. Adams brings to the Fauquier Board valuable insight and business acumen, along with significant business expertise.
Marc J. Bogan (age 54) has been a director of Fauquier and The Fauquier Bank since February 2016. He has served as president of Fauquier and The Fauquier Bank since February 2016 and became chief executive officer of Fauquier and The Fauquier Bank effective March 2016. Mr. Bogan has over 30 years of experience in the financial services industry. He served as president and chief operating officer of New Dominion Bank in Charlotte, North Carolina, from June 2011 until February 2016, when he joined Fauquier. Mr. Bogan was executive vice president, chief operating officer and chief retail officer for Ameris Bank, a four-state community bank based in Georgia, from 2008 to 2011, and was coastal regional executive - Eastern South Carolina for Ameris Bank from 2006 to 2008. Prior to joining Ameris Bank in 2006, Mr. Bogan held several senior management positions with Bank of America and South Carolina Bank and Trust. Mr. Bogan brings to the Fauquier Board significant management experience in diverse areas such as retail and commercial banking, private wealth management, information technology, operations, treasury services and mortgage banking.
Kevin T. Carter (age 55) has been a director of Fauquier and The Fauquier Bank since November 2016. Mr. Carter has served as the managing director of Landsdown Resort since December 2020. He has over 38 years of experience in the hospitality industry, holding positions such as director, corporate director, resident manager, general manager, independent consultant and president of Guests, Inc. from October 2016 to December 2020. Mr. Carter served on the management teams of some of the country’s most notable properties including the Guests, Inc., the U.S. Grant Hotel, Intercontinental Hotel San Diego, Rancho Valencia Resort, Kiawah Island Resort, Bald Head Island Resort and The Founders Inn. He is currently a member of the Town Council of Warrenton, Virginia. Mr. Carter has been a member of the board of directors of the Fauquier County Chamber of Commerce, the Fauquier Hospital and Health System and the PATH Foundation. In addition, he has served as the president of the Warrenton Rotary Club and Senior Warden and School Board Treasurer for the St. James Episcopal Church in Warrenton, Virginia. Through his personal community involvement in the Town of Warrenton and Fauquier County, Virginia, and his professional experience, Mr. Carter provides the Fauquier Board with significant knowledge of Fauquier’s market base and financial management skills.
Donna D. Flory (age 60) has been a director of Fauquier and The Fauquier Bank since 2015. Ms. Flory is currently the director of human resources for QMT Windchimes, a manufacturing company based in Manassas Park, Virginia. In addition, as an independent contractor, Ms. Flory provides financial support to the Industrial Development Authority of Prince William County, Virginia. Ms. Flory served as the Vice President of the Flory Small Business Development Center, Inc. (the “Flory Center”), located in Manassas, Virginia, from 1992 to 2019 and was responsible for financial operations, human resources, payroll, employee benefits and general operations. The Flory Center was a nonprofit organization that assisted small businesses and start-up entrepreneurs in accessing capital, developing business and marketing plans, and was a resource partner with the SBA. Ms. Flory also has significant experience in hospitality management, holding various management positions with Tysons Westpark Hotel and Ramada Inn from 1982 to 1989. Ms. Flory serves her community through leadership roles in the American Red Cross, Rotary International, March of Dimes and Bugles Across America. She is a Past President of Habitat for Humanity of Prince William County, and the cities of Manassas and Manassas Park, Virginia. Through her business and community involvement, Ms. Flory brings to the Fauquier Board a diverse range of professional skills and relationships.
Randolph D. Frostick (age 64) has been a director of Fauquier and The Fauquier Bank since 2009. He is an attorney with Vanderpool, Frostick and Nishanian, P.C., a law firm located in Manassas, Virginia, which focuses primarily on civil litigation, business, employment, real estate transactions, financing, land use and development. Mr. Frostick joined the firm in 1987. In addition to practicing law, Mr.
Frostick is actively involved in real estate development and commercial leasing in Manassas, Virginia. Mr. Frostick brings to the Fauquier Board insightful knowledge of Fauquier’s market base, and valuable business expertise.
Jay B. Keyser (age 64) has been a director of Fauquier and The Fauquier Bank since 2009. Since January 2015, he has served as the chief executive of the William A. Hazel Family Office. He is also the manager of various real estate ventures and trustee of multiple trusts relating to the Hazel family. He currently serves on the board and was the chief executive officer of William A. Hazel, Inc., a site construction company headquartered in Chantilly, Virginia, from June 2008 to December 2014. Mr. Keyser had served for 25 years in various capacities, including chief financial officer, of this construction entity. He has served as board trustee for Highland School, located in Warrenton, Virginia. He received his Certified Public Accountant certification in 1982 and is a member of the American Institute of Certified Public Accountants and the Virginia Society of CPAs. Mr. Keyser brings vast business and financial management knowledge and experience to the Fauquier Board.
Randolph T. Minter (age 61) has been a director of Fauquier and The Fauquier Bank since 1996. Mr. Minter has been president and owner of Moser Funeral Home, Inc. since 1986, having worked prior to that time in various positions at the funeral home since 1980. He also has owned and operated Bright View Cemetery, Inc. in Fauquier County, Virginia since 1990. Through his involvement and leadership positions with a variety of business and community organizations, Mr. Minter brings to the Fauquier Board a vast knowledge of Fauquier’s community market base, and its business related issues.
Brian S. Montgomery (age 68) has been a director of Fauquier and The Fauquier Bank since 1990. Mr. Montgomery was the owner and president of Warrenton Foreign Car, Inc. located in Warrenton, Virginia, from 1972 to 2020 and is the owner and manager of various commercial real estate properties located in Warrenton, Virginia. Mr. Montgomery brings extensive knowledge of the financial services industry to the Fauquier Board, with a specialty in insurance through his tenure on the board of Loudoun Mutual Insurance Company, where he has been a director since 1999.
P. Kurtis Rodgers (age 53) has been a director of Fauquier and The Fauquier Bank since 2007. Mr. Rodgers is president and chief executive officer of S.W. Rodgers Co., Inc., a heavy highway site contractor headquartered in Gainesville, Virginia that operates throughout Virginia. Prior to his appointment as president in 1998, Mr. Rodgers served in multiple capacities within S.W. Rodgers Co., Inc. since its establishment in 1980. He is the past president of the Heavy Construction Contractors Association (a Virginia association) and has served on advisory panels for the James Madison University College of Business and the George Mason University Prince William Campus. Mr. Rodgers brings valuable business management expertise and knowledge to the Fauquier Board.
Sterling T. Strange, III (age 60) has been a director of Fauquier and The Fauquier Bank since 2007. Mr. Strange is president and chief executive officer of The Solution Design Group, Inc., an information technology software firm to the public sector and higher education industries, located in Warrenton, Virginia and Orlando, Florida. Prior to founding The Solution Design Group, Inc. in 2004, Mr. Strange was president and founder of Decision Support Technologies, Inc., a transportation software company that provided solutions and services to over 100 airports and seaports worldwide. Mr. Strange has served in senior management positions in both private and public companies for over 30 years. He provides valuable entrepreneurial experience and financial management expertise to the Fauquier Board.
Executive Officers
The following provides information on the executive officers of the Company who are not directors:
Christine E. Headly (age 65) has served as executive vice president and chief financial officer of Fauquier and The Fauquier Bank since September 2016. Ms. Headly was senior vice president and controller of The Fauquier Bank from May 2013 to September 2016, and previously served as a vice president and controller from 2007 to May 2013. Ms. Headly joined The Fauquier Bank in 1999.
Chip S. Register (age 64) has served as Executive Vice President and Chief Operating Officer of Fauquier and The Fauquier Bank since January 2020. Mr. Register was Senior Vice President, Chief Administrative Officer and Chief Information Officer of The Fauquier Bank from June 2016 to January 2020, and previously served as Chief Information Officer of The Fauquier Bank beginning in 2008.
Committees of the Board
Audit Committee. The Board has an Audit Committee, composed entirely of directors who satisfy the independence and financial literacy requirements for audit committee members under the Nasdaq listing standards and applicable Securities and Exchange Commission (“SEC”) regulations. In addition, at least one member of the Audit Committee has past employment experience in finance or accounting or comparable experience which results in the individual’s financial sophistication. The Audit Committee is responsible for the appointment, compensation and oversight of the work performed by the Company’s independent registered public accounting firm. The Audit Committee held five official meetings and several informal discussions in 2020. The current members of the Audit Committee are Messrs. Adams, Keyser, Rodgers and Strange and Ms. Flory. The Board of Directors has determined that Messrs. Keyser and Strange qualify as the audit committee financial experts as defined by SEC regulations and has designated them as the Company’s Audit Committee Financial Experts. The Audit Committee operates pursuant to a written charter, which is posted on the Bank’s website: www.tfb.bank under “About Us - Investor Relations - Corporate Profile - Corporate Governance.” The committee reviews and reassesses the charter annually and recommends any changes to the Board for approval.
Governance Committee. The responsibilities of the Governance Committee include the evaluation of the Board’s structure, personnel and processes; and the maintaining of a current and viable set of corporate governance principles applicable to the Company. The committee is composed of a majority of directors who satisfy the independence requirements under the Nasdaq listing standards. The members of the Governance Committee are Messrs. Adams, Bogan, Carter, Frostick and Strange. The committee held three official meetings in 2020 and several informal discussions. The Governance Committee operates pursuant to a written charter, which is posted on the Bank’s website: www.tfb.bank under “About Us - Investor Relations - Corporate Profile - Corporate Governance.” The committee reviews and reassesses the charter annually and recommends any changes to the Board for approval.
Compensation and Benefits Committee. The Board has a Compensation and Benefits Committee, whose function is to aid the full Board of Directors of the Company in meeting its overall responsibilities with regard to the oversight and determination of executive compensation. The committee, composed entirely of directors who satisfy the independence requirements for compensation committee members under the Nasdaq listing standards, held six official meetings and several informal discussions in 2020. The current members of the Company’s Compensation and Benefits Committee are Messrs. Adams, Carter, Minter, Montgomery and Rodgers. The Compensation and Benefits Committees operate pursuant to written charters, which are posted on the Bank’s website: www.tfb.bank under “About Us - Investor Relations - Corporate Profile - Corporate Governance.” The committees review and reassess the charters annually and recommend any changes to the Board for approval.
Enterprise Risk Management Committee. The responsibilities of the Enterprise Risk Management Committee are to assist the Board in its oversight of the Company’s management of financial, operational, information technology (to include cyber risk), credit, market, capital, liquidity, reputation, strategic, legal, compliance and other risks; and to oversee the Company’s enterprise risk management framework. The committee is composed entirely of directors who satisfy the independence requirements under the Nasdaq listing standards and applicable SEC regulations. The Enterprise Risk Management Committee held eight official meetings and several informal discussions in 2020. Current members of the committee are Messrs. Adams, Carter, Frostick, Keyser and Strange and Ms. Flory. The Enterprise Risk Management Committee operates pursuant to a written charter, which is posted on the Bank’s website: www.tfb.bank under “About Us - Investor Relations - Corporate Profile - Corporate Governance.” The committee reviews and reassesses the charter annually and recommends any changes to the Board for approval.
Nominating Committee. The responsibilities of the Nominating Committee include the identification and evaluation of potential director candidates and making recommendations to the full Board regarding nominations of individuals for election to the Board of Directors. The committee is composed entirely of directors who satisfy the independence requirements for nominating committee members under the Nasdaq listing standards. The members of the Nominating Committee are Messrs. Adams and Minter and Ms. Flory. The committee held two official meeting in 2020 and several informal discussions. The committee operates pursuant to a written charter, which is posted on the Bank’s website: www.tfb.bank under “About Us - Investor Relations - Corporate Profile - Corporate Governance.” The committee reviews and reassesses the charter annually and recommends any changes to the Board for approval.
The Nominating Committee considers diversity in board composition and qualifications for consideration as a director nominee may vary according to the particular areas of expertise being sought as a complement to the existing Board composition. The committee generally reviews a potential candidate’s background, experience and abilities, the contributions the individual could be expected to make to the collective functioning of the Board and the needs of the Board at the time. The Board has adopted Corporate Governance Guidelines for the Company, which outline certain specific criteria that the Board seeks to attract, which include (i) a commitment to the Company’s purpose; (ii) informed, mature and practical judgment developed as a result of management or policy-making experience; (iii) business
acumen, with an appreciation of the major issues facing a company of comparable size and sophistication; (iv) financial literacy in reading and understanding key performance reports; (v) integrity and an absence of conflicts of interest; (vi) visionary thinking and strategic planning expertise; (vii) ability to influence others; (viii) strong organizational and self-management skills; (ix) being independent according to Nasdaq listing standards and SEC rules; (x) having sufficient time to prepare and meet Board commitments; (xi) works or resides in the Bank’s market area, thereby bringing current and relevant demographic knowledge to the Board; and (xii) meeting age limit requirements.
The Nominating Committee will consider candidates for directors proposed by shareholders. The committee will accept written submissions that include the name, address and telephone number of the proposed nominee, along with a brief statement of the candidate’s qualifications to serve as a director. All such shareholder recommendations should be submitted to the attention of the Chairman, Nominating Committee, Fauquier Bankshares, Inc., 10 Courthouse Square, Warrenton, Virginia 20186. Any candidates submitted by a shareholder are reviewed and considered in the same manner as all other candidates.
Delinquent Section 16(a) Reports
Section 16(a) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”) requires that directors and executive officers, and persons who beneficially own more than 10% of the Company’s equity securities, file reports of ownership and reports of changes in ownership of the Company’s outstanding equity securities. Based on a review of these reports filed by the Company’s officers and directors, the Company believes that its officers and directors complied with all filing requirements under Section 16(a) of the Exchange Act during 2020.
Code of Ethics
The Company has adopted a Code of Business Conduct and Ethics that applies to its directors, executive officers and employees.

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ITEM 11. EXECUTIVE COMPENSATION
ITEM 11. EXECUTIVE COMPENSATION
Executive Compensation
Compensation Philosophy. The Company strives to be an organization where the atmosphere is satisfying, challenging and rewarding to our knowledgeable and skillful employees, which is critical to the Company’s ability to provide quality products and services to its customers, as well as a reasonable return to its shareholders. The compensation system is an integral part of this strategy and contributes significantly to the achievement of goals and objectives for the ongoing development of the Company and its human resources.
The Company’s compensation system is designed to: (i) attract employees whose qualifications clearly meet or exceed the minimum education, experience and skills specified for each job; (ii) attract employees who are willing to be held accountable for results; (iii) retain employees who achieve the high level of results expected; (iv) motivate employees to seek additional accountability, make and communicate well-informed business decisions, and achieve greater than expected results; and (v) differentiate employees between those who perform and those who do not want to be accountable or fail to achieve results.
Overview of Compensation Program. The Company’s Compensation and Benefits Committee (the “Committee”) approves the Company’s compensation philosophy, strategy and policy. The Committee develops Company goals and objectives relevant to the compensation of the Chief Executive Officer, Chief Financial Officer and Chief Operating Officer (“named executive officers” or “NEOs”), including annual and long-term performance objectives for joint approval by the independent members of the Boards of the Company and the Bank.
With the assistance of the independent members of the Company and Bank Boards, the Committee evaluates the performance of the NEOs and sets their annual compensation, including annual salary, cash and equity incentive awards, and other direct or indirect benefits. The Committee and the Company and Bank Boards annually approve compensation structures, job values, compensation budgets and distribution guidelines. In addition to the Chief Executive Officer, the Human Resources Director periodically attends Committee meetings and makes presentations to the Committee on compensation and benefits matters. The Committee meets in executive session, without the Chief Executive Officer, when discussing his compensation.
Finally, the Committee is responsible for reviewing the competitiveness of the Company’s executive compensation programs to ensure (i) the attraction and retention of senior management; (ii) the motivation of senior management to achieve the Company’s business objectives; and (iii) the alignment of key leadership with the long-term interests of the Company’s shareholders.
Establishing Executive Compensation. The Company compensates our NEOs, and other members of senior management, through a mix of base salary, cash and equity incentive compensation, and perquisites and benefits designed to be competitive with our peer financial institutions, consisting of publicly traded banks, similar in asset size, and predominantly located in the greater Washington, D.C./Virginia markets. Cash and equity incentive awards to senior management are made pursuant to our Management Incentive Plan and Stock Incentive Plan (together, the “Incentive Plans”), which are designed to reward company-wide performance through tying awards to selected performance goals. Our goal is to provide our NEOs with a level of assured cash compensation in the form of base salary as well as cash and equity opportunities in the form of incentive compensation that will help recruit, retain and reward competent and effective executive talent, and at the same time align senior management’s interests with the long-term interests of our shareholders.
The compensation planning process consists primarily of annually establishing an overall executive compensation package, and allocating that compensation among base salary and cash and equity incentives under the Incentive Plans. In order to recruit and retain top executive talent whom we expect to provide performance that will create and sustain long-term value for our shareholders, we intentionally pay overall compensation that we believe is competitive with our peer group. Our base salaries are comparable with the base salaries paid by most of our peer group for comparable positions.
Decisions regarding the base salaries for the NEOs are generally made at the Committee’s first meeting following the availability of the Company’s financial results for the prior year. In addition to referring to proposed pay ranges, the Committee uses the prior year’s financial results to evaluate each NEO’s performance against individual performance plans for the prior year. Generally, at this meeting, the Committee also determines the extent to which the cash and equity incentive awards under the Incentive Plans for the prior year were earned by measuring actual outcomes against pre-determined performance goals. Performance goals are made as early as practicable in the year in order to maximize the time period for the incentives associated with the awards to be achieved. The Committee’s schedule is determined several months in advance, and the proximity of granting equity awards to announcements of earnings or other market events is coincidental. The Committee seeks the Chief Executive Officer’s input regarding the performance evaluation and compensation recommendations for the Company’s other NEO, although the Committee makes the final decision.
Base Salaries. Based on the evaluation of each NEO’s performance against individual performance plans and the review of the Company’s overall performance in 2019, the Committee recommended, and the independent members of the Board approved, the 2020 base salaries as follows:
•
$332,500 for the Chief Executive Officer
•
$200,000 for the Chief Financial Officer
•
$215,000 for the Chief Operating Officer
Management Incentive Plan. Our practice is to award incentive compensation based on satisfactory completion of pre-determined performance objectives. Cash incentive awards to senior management are made pursuant to our Management Incentive Plan, which is designed to reward the achievement of company-wide performance through the tying of awards to selected performance measures. The Committee approves the performance goals and award payouts and has the discretion to increase or decrease cash awards earned under the Management Incentive Plan.
The Committee reviewed the Company’s strategic objectives for 2020 and chose award factors relative to meeting certain primary objectives. The NEOs’ performance goal objectives were based on the following measures of the Company’s 2020 performance: net income, efficiency ratio, noninterest and fee income, loan growth, deposit growth, nonperforming assets, and CAMELS rating. Performance criteria, which the Company considers confidential strategic information, is not publicly disclosed for competitive reasons. Performance goals were scaled in order for a recipient to receive part of an award in the event a portion of the targeted goals were achieved.
The annual target award opportunity for each named executive officer is a percentage of the midpoint of his or her established position salary range as determined by the Committee. The 2020 annual target award opportunity for the Chief Executive Officer was 40% of such midpoint and for the Chief Financial Officer and Chief Operating Officer was 30% of such midpoint. Based on the results of the pre-determined goals, each officer earned approximately 130% of the target award opportunity.
The participants of the MIP are eligible for payment once net income reaches 90% of budgeted net income. Actual net income for 2020 was $5.9 million which includes $1.5 million in merger related expenses. These merger expenses were removed and net income of $7.4 million was used to calculate the MIP results and payments.
Stock Incentive Plan. The Company believes that ownership of the Company’s common stock will motivate officers for the successful conduct of its business, and will better align their interests with the interests of the Company’s shareholders. The Stock Incentive Plan was adopted by the Board of Directors of the Company on February 21, 2019 and approved by the shareholders on May 21, 2019 at the Company’s 2019 Annual Meeting.
Under the Stock Incentive Plan, incentive and non-statutory stock options, restricted stock, restricted stock units and other stock-based awards may be granted to employees and directors. The plan makes available up to 350,000 shares for issuance to participants under the plan. No more than 200,000 shares may be issued in connection with any type of award other than stock appreciation rights or incentive stock options.
The Stock Incentive Plan is administered by the Committee, which determines the employees to be granted options, restricted stock awards, restricted stock units or other stock-based awards, whether such options will be incentive or non-statutory options, the number of shares subject to each option or award, whether such options may be exercised by delivering other shares of common stock, and when such options or awards vest.
We have granted equity awards under the Stock Incentive Plan, and historically those awards have been made in the forms of restricted stock and restricted stock units. The Committee believes that restricted stock and restricted stock units are generally more effective than stock options when aligning the interests of the executives with those of the Company’s shareholders. The overall target award opportunity is defined as a percentage of base salary, divided equally between awards of restricted stock that have a time-based vesting component and restricted stock units that have a performance-based vesting component. The restricted stock awards vest according to a three-year cliff, becoming fully vested after three full years of continued employment. The restricted stock unit awards are earned at the end of a three-year performance period depending on the average of the Company’s past three years’ actual return on average equity performance relative to the defined SNL National Peer Group’s average over the three-year period. Each performance-based restricted stock unit award agreement allows the award to be issued in stock at 50% of the value of the award and in cash at 50% of the value of the award, to allow for applicable taxes withheld by the participants.
The 2020 annual target award opportunity was 35% of base salary for the Chief Executive Officer and 25% of base salary for the Chief Financial Officer and the Chief Operating Officer. The grants of time-based restricted stock and performance-based restricted stock units were made on February 20, 2020 under the Stock Incentive Plan.
In December 2020, the Company’s Board of Directors approved the acceleration of service-based vesting of certain restricted stock awards, and the acceleration of vesting and payment of certain restricted stock units, in each case with respect to awards that would otherwise have become fully vested upon completion of the Merger. The vesting and payment of the impacted restricted stock units was based on target performance for the applicable performance period. These actions resulted in the (i) vesting on an accelerated basis of 8,017 and 3,205 shares of restricted stock of the Chief Executive Officer and the Chief Operating Officer, respectively, (ii) vesting and payment on an accelerated basis of 5,419 and 2,250 restricted stock units of the Chief Executive Officer and the Chief Operating Officer, respectively, with such restricted stock units settled 50% in cash and 50% in shares of the Company’s common stock,
401(k) Savings Plan. To encourage saving for retirement and as a retention tool, the Bank maintains a defined contribution 401(k) savings plan (the “401(k) Savings Plan”), covering employees on the first day of hire who are at least 18 years of age and work at least 20 hours per week. Under the plan, participants may contribute an amount up to the Internal Revenue Service maximum amount of their covered compensation for the year. Eligible participants receive a 3% employer contribution that is 100% vested. In addition, eligible participants receive a 100% match on the first 6% of compensation deferred.
Supplemental Executive Retirement Plan. In 2005, the Company adopted a Supplemental Executive Retirement Plan for executives (the “Executive SERP”), which is a supplemental benefit plan designed to ensure that participants will have, upon retirement from the Company or its subsidiaries, retirement benefits targeted at 70% (prorated if the participant has fewer than 10 years of benefit service) of base salary and incentive pay when added together with benefits provided through Social Security, the Company’s non-contributory defined benefit plan (terminated in 2009), and employer contributions to the 401(k) Savings Plan. A participant’s employee contributions to the 401(k) Savings Plan are not taken into account in determining the 70% target and thus will increase the total retirement benefits available to the participant.
The Company adopted this plan to provide consistent retirement benefits as a percent of final compensation for individuals whose retirement compensation under any qualified retirement plan sponsored by the Company or the Bank is limited by maximums imposed on these plans by law. Employees eligible to participate in the Executive SERP during 2019 included Mr. Bogan and any individuals designated by the Board of Directors as plan participants. Subject to certain specified forfeiture events (termination of employment for cause, pre-change in control competition, or unauthorized disclosure of confidential information), an eligible employee will have a vested and non-forfeitable right in supplemental retirement benefits under the Executive SERP upon the first of the following events to occur while being an active participant in the Executive SERP: (i) the participant meets the age and service requirements for early retirement under the Executive SERP (60 years of age with 10 years of vesting service); (ii) the participant reaches normal retirement date (65 years of age); (iii) the participant retires on a disability retirement date (first day of the month following the date participant retires as a result of a disability); or (iv) a change in control of the Company or the Bank.
Supplemental retirement benefits are payable under the Executive SERP for 180 months (15 years), with the amount payable reduced actuarially in the event payment begins before the participant reaches the normal retirement date. If the participant dies before receiving monthly payments for 180 months, the remaining monthly benefits will be paid to the participant’s beneficiary until the Executive SERP has made a total of 180 monthly payments. In addition, the Executive SERP provides a pre-retirement death benefit payable for 15 years to the participant’s beneficiary, with the amount payable reduced actuarially in the event payment begins before the participant reaches the normal retirement date.
On September 21, 2016, the Company entered into a participation agreement with Mr. Bogan relating to the Executive SERP. Mr. Bogan has not met the vesting requirements for the plan. Based on contribution rates and plan provisions and assumptions in effect on January 1, 2020, with retirement at age 65, the estimated monthly retirement benefit for Mr. Bogan under the Executive SERP is $4,427.
On January 19, 2017, the Company entered into a separate Supplemental Executive Retirement Plan agreement with Ms. Headly. Supplemental retirement benefits are payable under this plan for 15 years with the amount payable accruing after each year of service. At the end of 2020, Ms. Headly had a 100% vested annual benefit of $10,000. Each year after 2017 the annual vested benefit increases 25% or $2,500 until attainment of age 65, at which time she will be fully vested with an annual benefit of $10,000.
On September 14, 2015, the Company entered into a separate Supplemental Executive Retirement Plan agreement with Mr. Register. Mr. Register will have a vested and non-forfeitable right in supplemental retirement benefits under the Executive Supplemental Retirement Plan upon the first of the following events to occur while being an active participant in the Plan: (i) the participant reaches normal retirement date (65 years of age); (ii) the participant becomes disabled and terminates employment or upon death (after having completed 10 years of continuous service); or (iv) a change in control of the Company or the Bank. Upon vesting Mr. Register will benefits payable under this plan for 15 years in the amount of $10,000 annually.
Pursuant to the Merger Agreement, Virginia National and the Company have agreed to fully vest the Company’s supplemental executive retirement plans and agreements that are subject to Section 409A of the Internal Revenue Code (the “Code”) and terminate and liquidate those plans and agreements by making a lump sum payment to each plan participant in accordance with Section 409A of the Code. The Company’s Chief Financial Officer, who will be fully vested in benefits under her plan prior to the effective time of the Merger, will receive a lump sum payment of benefits under her plan equal to $150,000, without reduction for present value. The Company’s Chief Operating Officer will receive a lump sum payment of benefits under his plan equal to $150,000, without reduction for present value. The Company’s Chief Executive Officer will receive a lump sum payment of benefits under his plan equal to $1,850,000; provided, however, that this amount may be adjusted in the event that the discount rate used for financial accounting with respect to the supplemental executive retirement plans changes to a rate that is five or more whole percentage points from the rate in effect as of the date of the Merger Agreement.
Employment Agreement with Chief Executive Officer. On June 6, 2016, the Company entered into an employment agreement with Mr. Bogan effective February 18, 2016 with an initial term until December 31, 2019. The Company’s Board of Directors determined that an employment agreement with Mr. Bogan was appropriate because it clarifies the terms of his employment and ensures that the Company and the Bank are protected by non-competition, non-solicitation and confidentiality provisions in the event Mr. Bogan ceases employment. In addition, the Company’s Board of Directors believes an employment agreement is necessary to attract and retain a qualified chief executive officer. Beginning December 31, 2017 and on each December 31st thereafter, the term of the employment agreement is automatically extended for an additional year so as to terminate three years from each renewal date, unless the Company notifies Mr. Bogan in writing prior to the renewal date. During December 2020, the Company’s Board of Directors and Mr. Bogan amended the employment agreement to clarify certain matters related to a termination following a change in control.
Under the agreement, Mr. Bogan serves as the chief executive officer of the Company and the Bank at an annual base salary of not less than $310,000 per year. The base salary may be increased or decreased in the sole discretion of the compensation and benefits committee or the Company’s Board of Directors, but not below the minimum amount of $310,000. The agreement also provides that Mr. Bogan is eligible to participate in the Company’s short and long-term incentive plans, with targeted performance levels for the Company to be established by the compensation and benefits committee or the Company’s Board of Directors. Any incentive-based compensation or award to which Mr. Bogan is entitled is subject to clawback by the Company as required by applicable federal law. The agreement further provides that Mr. Bogan is eligible to participate in any employee benefit plans that are provided for executive management, including group medical, disability and life insurance, paid time off and retirement.
The agreement provides that Mr. Bogan will be entitled to receive certain severance payments in the event of a termination of employment under certain circumstances. If the Company terminates Mr. Bogan’s employment without “cause” or Mr. Bogan terminates his employment with “good reason” (as such terms are defined in the agreement), in a non-change in control context, he will receive (i) any earned but unpaid incentive bonus with respect to any completed calendar year immediately preceding the date of termination, (ii) the product of the annual cash bonus paid or payable, including by reason or deferral, for the most recently completed year and a fraction, the numerator of which is the number of days in the current year through the date of termination and the denominator of which is 365, and (iii) base salary in effect on the date of termination for a period of 24 months from the date of termination. In addition, if he elects coverage under COBRA, Mr. Bogan will be entitled to a reimbursement of the difference between the monthly COBRA premium amount paid by Mr. Bogan for him and his eligible dependents and the monthly premium paid by the Company for similarly situated active employees, provided that such benefits will not extend beyond the 18-month period permitted by COBRA.
If Mr. Bogan’s employment ends due to death prior to a “change in control” of the Company (as such term is defined in the agreement), the Company will continue to pay his base salary for three months following the month of his death to his designated beneficiary. If Mr. Bogan’s employment ends due to his termination by the Company for cause, or if he resigns his position without good reason or, prior to a change in control of the Company, he is terminated as a result of his incapacity, he would not be entitled to any additional compensation, bonus or benefits under the agreement.
If Mr. Bogan’s employment is terminated by him for good reason or by the Company on account of its failure to renew the agreement or without cause (other than on account of his death or incapacity), in each case within 24 months following a change in control of the Company, he is entitled to receive the following payments and benefits, provided he signs a release in favor of the Company: (i) the sum of (a) any accrued but unpaid base salary, unreimbursed expenses and such employee benefits (including equity compensation) to which he is entitled, (b) the amount, if any, of any earned but unpaid incentive or bonus compensation with respect to any completed calendar year immediately preceding the date of termination, (c) the product of the annual cash bonus paid or payable for the most recently completed year and a fraction, the numerator of which is the number of days in the current year through the date of termination and the denominator of which is 365, and (d) any benefits or awards (including cash and stock components) which pursuant to the terms of any plans, policies or programs have been earned or become payable, but which have not been paid; (ii) a lump sum payment amount equal to 2.99 times the total of (a) his base salary in effect at the date of termination plus (b) the highest annual cash bonus paid or payable for the two most recently completed years; and (iii) reimbursement of the difference between the monthly COBRA premium amount paid by Mr. Bogan for him and his eligible dependents and the monthly premium paid by the Company for similarly situated active employees, provided that such benefits will not extend beyond the 18-month period permitted by COBRA.
Under the agreement, Mr. Bogan is subject to two-year noncompetition restriction and a two-year nonsolicitation restriction following the termination of his employment for any reason.
Mr. Bogan has entered into an employment agreement with Virginia National that will be effective at the closing of the Merger that will supersede and replace his existing employment agreement with the Company. See the following description of that employment agreement.
New Virginia National Employment Agreement with Chief Executive Officer. Pursuant to the Merger Agreement, at the effective time of the merger of The Bank into Virginia National Bank, Mr. Bogan will be employed as president and chief executive officer of Virginia National Bank. Virginia National and Virginia National Bank have entered into an employment agreement with Mr. Bogan pursuant to which he will serve as president and chief executive officer of Virginia National Bank and that will be effective upon consummation of the merger until the two-year anniversary of the effectiveness of the merger. Upon its effectiveness, the new employment agreement with Mr. Bogan will supersede Mr. Bogan’s current employment agreement with the Company, and accordingly Mr. Bogan will have no rights or entitlements and will receive no payments or benefits under his current employment agreement with the Company at the effective time of the merger.
Mr. Bogan’s new employment agreement provides that Mr. Bogan will receive an annual base salary to be determined by Virginia National in accordance with its salary administration program, with the initial base salary equal to Mr. Bogan’s base salary as president and chief executive officer of the Company prior to the merger (currently, $350,000). Mr. Bogan’s base salary will be reviewed annually and will be subject to adjustment by the board of directors or compensation committee of Virginia National, provided that any downward adjustment may only be made in connection with a general reduction of base salary that affects all senior officers of Virginia National. Mr. Bogan’s new employment agreement provides opportunities for short- and long-term cash and equity incentive opportunities and certain other benefits, including an automobile allowance and reimbursement of business and relocation expenses.
Mr. Bogan’s new employment agreement further provides that, if Mr. Bogan is not promoted to chief executive officer of Virginia National on or before the first anniversary of the effectiveness of the merger but remains employed by Virginia National on that date, Mr. Bogan will receive a lump sum payment of $475,000 within thirty (30) days of such first anniversary.
Further, if Mr. Bogan is either (i) not promoted to chief executive officer of Virginia National on or before the second anniversary of the effective date of the merger but remains employed by Virginia National on that date, or (ii) Mr. Bogan is promoted to chief executive officer within two years following the effective date of the merger, then he will be offered an agreement, which will be effective no later than the earlier of the day following the second anniversary of the effectiveness of the merger or the date he is promoted to chief executive officer, as may be applicable, providing for benefits on a change in control of Virginia National in an amount no less favorable than those provided to the then-serving chief executive officer of Virginia National.
If, prior to being promoted to chief executive officer of Virginia National or otherwise entering into the change in control agreement described in the preceding paragraph, Mr. Bogan is terminated without “cause” or resigns for “good reason” (as those terms are defined in the employment agreement), Mr. Bogan’s new employment agreement provides certain benefits. In such cases, Mr. Bogan will receive the sum of (i) any accrued but unpaid base salary, unreimbursed expenses and such employee benefits (including equity compensation) to which he is entitled, (ii) the amount, if any, of any earned but unpaid incentive or bonus compensation with respect to any completed calendar year immediately preceding the date of termination, (iii) the product of the annual cash bonus paid or payable for the most recently completed year and a fraction, the numerator of which is the number of days in the current year through the date of termination and the denominator of which is 365, and (iv) any benefits or awards (including cash and stock components) which pursuant to the terms of any plans, policies or programs have been earned or become payable, but which have not been paid. Unless otherwise specified in the employment agreement, such benefits will be paid in a lump sum within 10 days following the effective date of the release (described below).
Further, he will receive an amount equal to 2.99 times the sum of (i) his base salary in effect at the date of termination, and (ii) his highest annual cash bonus paid or payable for the two most recently completed years. This severance benefit will be paid to Mr. Bogan in a lump sum cash payment within thirty (30) days after the effective date of the release (described below). In addition, if he elects coverage under the Consolidated Omnibus Reconciliation Act of 1985, as amended (“COBRA”), Mr. Bogan will be entitled to a reimbursement of the difference between the monthly COBRA premium amount paid by Mr. Bogan for him and his eligible dependents and the monthly premium paid by Virginia National for similarly situated active employees, provided that such benefits will not extend beyond the 18-month period permitted by COBRA.
Mr. Bogan’s entitlement to the foregoing severance payments is subject to his execution of a release and waiver of claims against Virginia National and its affiliates.
Mr. Bogan’s new employment agreement requires Mr. Bogan to execute Virginia National’s standard non-disclosure, non-solicitation and non-competition agreement except that the non-competition period may be up to 24 months following termination of employment depending upon the circumstances of his termination.
Under the new employment agreement with Mr. Bogan, if the payments and benefits under the employment agreement, together with other payments and benefits Mr. Bogan has received or may have the right to receive, on account of a change in control would subject Mr. Bogan to the excise tax imposed under Section 4999 of the Code, then the payments and benefits shall be reduced by Virginia National to the minimum extent necessary so that none of the payments or benefits are subject to the excise tax, provided that no such reduction shall be made if Mr. Bogan’s net after-tax benefit, assuming no reduction, exceeds by $25,000 or more the net after-tax benefit assuming such reduction is made.
Under the new employment agreement with Mr. Bogan, he will generally have “good reason” to terminate his employment if Virginia National assigns duties inconsistent with his position, authority, duties or responsibilities without his prior consent; takes action that results
in a substantial reduction in his status including a diminution in position, authority, duties or responsibilities (which will occur on the date of the merger as a result of the diminution of Mr. Bogan’s position because of the merger); moves his primary office outside of the city of Charlottesville, Virginia or Albemarle County, Virginia, unless either Virginia National or Virginia National Bank moves its principal executive offices to such other place; fails to comply with any material term of the agreement; or fails to nominate him for election to Virginia National’s board of directors. Under the new employment agreement, except for the diminution of Mr. Bogan’s position because of the merger, good reason to terminate employment would not exist unless Mr. Bogan has notified Virginia National of the condition giving rise to good reason, Virginia National has failed to remedy the condition, and Mr. Bogan terminates employment within ninety days of the initial occurrence of the condition giving rise to good reason. For good reason due to the diminution of Mr. Bogan’s position because of the merger, good reason will apply provided Mr. Bogan provides written notice to Virginia National at least 30 days prior to his termination date.
Under the new employment agreement with Mr. Bogan, termination for “cause” would generally include Mr. Bogan’s failure to perform material duties or responsibilities or failure to follow reasonable instructions or policies; conviction of, indictment for or entry of a guilty plea or plea of no contest with respect to a felony or misdemeanor involving moral turpitude, misappropriation or embezzlement of funds or property; fraud or dishonesty with respect to Virginia National; breach of fiduciary duties owed to Virginia National; breach of a material term of the agreement or material violation of applicable policies, codes and standards of behavior; or conduct reasonably likely to result in material injury to Virginia National. Under the new employment agreement, and except in cases involving irreparable injury, Virginia National would not have cause to terminate Mr. Bogan’s employment unless Virginia National has notified Mr. Bogan of the acts constituting “cause” and Mr. Bogan has failed to remedy them.
Employment Agreement with Chief Financial Officer. On August 1, 2020, we entered into an updated employment agreement with Ms. Headly effective on that date. The Board determined that an employment agreement with Ms. Headly was appropriate because it clarifies the terms of her employment and ensures the Company and the Bank are protected by non-compete, non-solicitation and confidentiality provisions in the event Ms. Headly ceases employment. In addition, the Board believes an employment agreement is necessary to attract and retain a qualified Chief Financial Officer in our industry.
Ms. Headly’s employment agreement provides for a fixed term through December 31, 2021, unless terminated earlier in accordance with the terms of the agreement. The employment agreement provides for a minimum base salary of $200,000 per year. Ms. Headly will have the opportunity to earn short- and long-term cash and equity incentive awards and certain other benefits, including reimbursement of business expenses.
Ms. Headly’s employment agreement provides for benefits in the event of a termination of her employment by the Company without “cause” or by her for “good reason” (as those terms are defined in the employment agreement). In such cases, Ms. Headly will be entitled to receive (i) the amount, if any, of any earned but unpaid incentive or bonus compensation with respect to any completed calendar year immediately preceding the date of termination; (ii) the product of the annual incentive bonus paid or payable for the year that includes the date of termination, based on attainment of applicable goals for the year, and a fraction, the numerator of which is the number of days in the current year through the date of termination and the denominator of which is 365; and (iii) her then-current base salary for the lesser of the remainder of the term of her agreement or a period of 12 months. Ms. Headly’s entitlement to the foregoing severance payments is subject to her execution of a release and waiver of claims against the Company and its affiliates and her compliance with the restrictive covenants provided in her employment agreement.
Ms. Headly’s employment agreement contains restrictive covenants relating to the protection of confidential information, non-disclosure, non-competition and non-solicitation. The non-competition and non-solicitation covenants generally continue for a period of 12 months following the earlier of the expiration of the employment agreement or termination of employment.
Change in Control with Chief Operating Officer. The Bank has entered into a change in control agreement with Mr. Register. Mr. Register’s change in control agreement provides for benefits if, within three years following a change in control, his employment by the Bank is terminated without “cause” or he resigns for “good reason” (as those terms are defined in the change in control agreement). In such cases, Mr. Register will receive (i) a cash amount equal to 2.99 times his highest annual compensation for the six month period prior to his termination; (ii) a cash amount equal to the actuarial equivalent of his retirement pension to which he would have been entitled to receive under the terms of such retirement plan or programs had he accumulated three additional years of continuous service after his termination at his base salary rate in effect on the date of his termination under such retirement plans or programs and reduced by the single sum actuarial equivalent of any amounts to which he is entitled; and (iii) continued participation in all of the employee benefit plans and programs that he was entitled to participate in prior to his termination for three years. If such participation is not possible, alternative coverage or cash equivalent will be provided or paid on a monthly basis. Upon a change in control, all outstanding stock options, if any,
will vest and become fully exercisable. In the event of litigation to challenge, enforce or interpret the agreement that does not end in the Bank’s favor, The Bank will indemnify Mr. Register for reasonable attorneys’ fees and pay post-judgement interest on any money judgement.
Under the change in control agreement with Mr. Register, if the payments and benefits under the employment agreement, together with other payments and benefits Mr. Register has received or may have the right to receive, on account of a change in control would subject Mr. Register to the excise tax imposed under Section 4999 of the Code, then the payments and benefits shall be reduced by the Bank to the minimum extent necessary so that none of the payments or benefits are subject to the excise tax.
The term of Mr. Register’s change in control agreement automatically renews and is extended for three years following a change in control.
Summary Compensation Table
The following table summarizes the total compensation of the Company’s Chief Executive Officer and Chief Financial Officer for the years ended December 31, 2020 and 2019 and the Company’s Chief Operating Officer for the year ended December 31, 2020.
Name and Principal Position
Year
Salary
Stock Awards
(1)
Non-Equity Incentive Plan Compensation
(2)
Nonqualified Deferred Compensation Earnings
(3)
All Other Compensation
(4)
Total
Marc J. Bogan
President & Chief Executive Officer
$
377,900
(5)
$
350,162
(6)
$
172,296
$
182,501
$
37,316
$
1,120,175
$
327,500
$
114,610
$
124,216
$
162,331
$
33,277
$
761,934
Christine E. Headly
Executive Vice President & Chief Financial Officer
$
200,000
$
49,987
$
84,506
$
39,573
$
21,572
$
395,638
$
190,276
$
47,588
$
59,206
$
27,748
$
21,689
$
346,507
Chip S. Register
Executive Vice President & Chief Operating Officer
$
236,501
(7)
$
148,667
(8)
$
84,506
$
12,471
$
26,669
$
508,814
(1)
The amounts in this column represent the grant date fair value of equity awards in the year granted, in accordance with FASB ASC Topic 718. For 2020, the awards included time-based restricted stock and performance-based restricted stock units. Performance-based awards in the above table assume the probable outcome of performance conditions is equal to the target potential value of the awards. The assumptions made in the valuation of the stock awards are set forth in Note 12 to the Company’s audited financial statements for the fiscal year ended December 31, 2020 included in the Company’s Annual Report on Form 10-K filed with the SEC on March 26, 2021.
(2)
The amounts in this column represent the amounts of cash incentive compensation earned for the years indicated.
(3)
The amounts in this column reflect the actuarial increase in the present value of the NEOs accumulated benefit under the Executive SERP, for Mr. Bogan and the Supplemental Executive Retirement Plan agreement, for Ms. Headly and Mr. Register, determined using factors consistent with those used in the Company’s audited financial statements.
(4)
The amounts in this column consist of, for 2020 for Mr. Bogan, personal use of a company car of $3,849, a 401(k) Savings Plan company match of $17,100, a 401(k) Savings Plan employer contribution of $8,550, and $7,817 in cumulative dividends received during 2020 on restricted stock; for Ms. Headly, a health and welfare benefit of $200, a 401(k) Savings Plan company match of $11,939, a 401(k) Savings Plan employer contribution of $7,779, and $1,654 in cumulative dividends received during 2019 on restricted stock; and for Mr. Register, a 401(k) Savings Plan company match of $15,653, a 401(k) Savings Plan employer contribution of $7,940, and $3,076 in cumulative dividends received during 2020 on restricted stock.
(5)
Includes $45,400 paid on an accelerated basis for accrued but unused paid time off in connection with the proposed Merger of the Company and Virginia National.
(6)
Amount also includes $233,787 additional expense in 2020 related to the accelerated vesting of restricted stock awards and accelerated vesting and settlement of performance based restricted stock units in connection with the proposed merger of the Company and Virginia National.
(7)
Includes $21,501 paid on an accelerated basis for accrued but unused paid time off in connection with the proposed Merger of the Company and Virginia National.
(8)
Amount also includes $94,917 additional expense in 2020 related to the accelerated vesting of restricted stock awards and accelerated vesting and settlement of performance based restricted stock units in connection with the proposed merger of the Company and Virginia National.
Outstanding Equity Awards at 2020 Fiscal Year-End
The following table includes certain information with respect to the value of all previously awarded unvested restricted stock awards held by the NEOs at December 31, 2020. Neither of the NEOs own any unexercised options.
Stock Awards
Name
Number of Shares or Units of Stock That Have Not Vested
Market Value of Shares or Units of Stock That Have Not Vested (1)
Equity Incentive Plan Awards: Number of Unearned Shares, Units or Other Rights That Have Not Vested
Equity Incentive Plan Awards: Market or Payout Value of Unearned Shares, Units or Other Rights That Have Not Vested (1)
Marc J. Bogan
-
$
-
-
$
-
-
$
-
-
$
-
-
$
-
2,598
(7)
$
45,153
Christine E. Headly
1,193
(2)
$
20,734
1,193
(3)
$
20,734
1,097
(4)
$
19,066
1,097
(5)
$
19,066
1,030
(6)
$
17,901
1,030
(7)
$
17,901
Chip S. Register
-
$
-
-
$
-
-
$
-
-
$
-
-
$
-
(7)
$
16,598
(1)
The amounts in this column represent the number of shares of restricted stock held multiplied by the closing price of the Company’s common stock of $17.38 per share on December 31, 2020.
(2)
These shares of restricted stock were awarded on February 20, 2020 under the Stock Incentive Plan and vest in full on the third anniversary of the grant date.
(3)
These restricted stock units were awarded on February 21, 2020 under the Stock Incentive Plan and will be earned on December 31, 2021 contingent on actual performance of predefined measures and subject to accelerated vesting upon the earlier occurrence of a change in control. Each restricted stock unit is equivalent to one share of Company common stock.
(4)
These shares of restricted stock were awarded on February 21, 2019 under the Stock Incentive Plan and vest in full on the third anniversary of the grant date.
(5)
These restricted stock units were awarded on February 21, 2019 under the Stock Incentive Plan and will be earned on December 31, 2021 contingent on actual performance of predefined measures and subject to accelerated vesting upon the earlier occurrence of a change in control. Each restricted stock unit is equivalent to one share of Company common stock.
(6)
These shares of restricted stock were awarded on February 15, 2018 under the Stock Incentive Plan and vest in full on the third anniversary of the grant date.
(7)
These restricted stock units were awarded on February 15, 2018 under the Stock Incentive Plan and will be earned on December 31, 2020 contingent on actual performance of predefined measures. Each restricted stock unit is equivalent to one share of Company common stock.
Potential Payments Upon Termination or Change in Control
Employment Agreements and Change in Control Agreement
For a description of the payments that may be made to the Company’s NEOs upon certain termination events or upon a change in control of the Company, see “-Employment Agreement with Chief Executive Officer,” “-Employment Agreement with Chief Financial Officer,” and “Change in Control Agreement with Chief Operating Officer” above.
Equity Awards. Our restricted stock grants normally vest on the third anniversary of the date of grant, if the conditions with respect to the grants are met. In addition to any equity vesting provisions contained in the employment agreements we have with our NEOs, under the terms of their restricted stock agreements, early vesting of their restricted stock occurs upon any of the following events (as defined in the Stock Incentive Plan): (i) the occurrence of a “change in control,” (ii) the executive’s death while an employee, (iii) the executive’s disability while an employee, (iv) the executive’s retirement, or (v) the termination of the executive’s employment by the Company or a subsidiary other than for “just cause” or “cause” under circumstances where the plan committee provides for special vesting rules or restrictions and waives the otherwise applicable automatic forfeiture on cessation of employment.
Executive SERP. The benefits payable to (i) Mr. Bogan under the Executive SERP (ii) Ms. Headly under her Supplemental Executive Retirement Plan Agreement, and (iii) Mr. Register under his Supplemental Executive Retirement Plan Agreement upon termination are described under “Supplemental Executive Retirement Plan.”
The following table shows the estimated payments for the NEOs upon the described termination events or upon a change in control of the Company, based on following assumptions and not taking into account the potential effects of the pending merger between the Company and Virginia National:
•
The table assumes each termination event or the change in control occurred on December 31, 2020, and assumes a stock price of $17.38 which was the Company’s closing stock price on December 31, 2020.
•
The amounts reflected in the following table are estimates, as the actual amounts to be paid to the NEO can only be determined at the time of termination or change in control.
•
In any case where a choice of payment is permitted, the table assumes all amounts were paid in a lump sum.
•
Except as noted in the table below, at termination, an NEO is entitled to receive all amounts accrued and vested under our 401(k) Savings Plan according to the same terms as other employees participating in those plans, whose benefits are not shown in the table below.
•
The NEO is entitled to receive amounts earned during the term of employment regardless of the manner in which the NEO’s employment is terminated. These amounts include base salary, unused vacation pay, and vested stock or option awards. These amounts are not shown in the table below.
•
Except as provided in their employment agreements, the NEO generally must be employed by the Company or the Bank on December 31, 2020 in order to receive any cash award under the Management Incentive Plan for 2020. In the event a termination occurs on an earlier date, the Committee has the discretion to award the employee an annual cash incentive under the plan. Discretionary annual cash compensation payments would not typically be awarded in the event of termination by the Company for cause or termination by the NEOs without good reason.
Termination with no Change in Control
Termination with Change in Control
Benefits & Payments Upon Termination
Death
Disability (1)
Termination without Cause or Resignation for Good Reason
Termination for Cause or Resignation without Good Reason
Retirement
Change in Control with or without Termination (2)
Death
Disability
Termination without Cause or Resignation for Good Reason (3)
Termination for Cause or Resignation without Good Reason
Resignation for Other than Good Reason including Retirement
Marc J. Bogan
President & Chief Executive Officer
Compensation:
Base Salary
$
83,125
$
-
$
-
$
-
$
-
$
-
$
-
$
-
$
-
$
-
$
-
Long-Term Incentive:
Restricted Stock Vesting
99,031
99,031
99,031
-
99,031
99,031
-
-
-
-
-
Benefits & Perquisites:
Severance:
Base Salary Continuation
-
-
665,000
-
-
-
-
-
1,509,340
-
-
Bonus Continuation
172,296
172,296
172,296
-
172,296
-
172,296
172,296
172,296
-
172,296
Health & Welfare Coverage (4)
-
-
-
-
-
-
-
-
-
Long-Term Disability
-
-
-
-
-
-
-
-
-
Paid Time Off
-
-
-
-
-
-
-
-
-
-
-
SERP
-
-
-
-
-
-
811,946
811,946
811,946
-
811,946
Total Value
$
354,452
$
271,522
$
936,550
$
-
$
271,327
$
99,031
$
984,242
$
984,437
$
2,493,805
$
-
$
984,242
Termination with no Change in Control
Termination with Change in Control
Benefits & Payments Upon Termination
Death
Disability (1)
Termination without Cause or Resignation for Good Reason
Termination for Cause or Resignation without Good Reason
Retirement
Change in Control with or without Termination (2)
Death
Disability
Termination without Cause or Resignation for Good Reason (3)
Termination for Cause or Resignation without Good Reason
Resignation for Other than Good Reason including Retirement
Christine E. Headly
Executive Vice President & Chief Financial Officer
Compensation:
Base Salary
$
50,000
$
-
$
-
$
-
$
-
$
-
$
-
$
-
$
-
$
-
$
-
Long-Term Incentive:
Restricted Stock Vesting
135,269
135,269
135,269
-
135,269
135,269
-
-
-
-
-
Benefits & Perquisites:
Severance:
Base Salary Continuation
-
-
200,000
-
-
-
-
-
-
-
-
Bonus Continuation
84,506
84,506
84,506
-
84,506
-
-
Health & Welfare Coverage (4)
-
-
-
-
-
-
-
-
-
-
Long-Term Disability
-
-
-
-
-
-
-
-
-
-
Paid Time Off
32,308
32,308
32,308
32,308
32,308
-
-
-
SERP
-
-
-
-
-
-
-
-
-
-
-
Total Value
$
302,083
$
252,126
$
452,282
$
32,308
$
252,083
$
135,269
$
-
$
-
$
-
$
-
$
-
Termination with no Change in Control
Termination with Change in Control
Benefits & Payments Upon Termination
Death
Disability (1)
Termination without Cause or Resignation for Good Reason
Termination for Cause or Resignation without Good Reason
Retirement
Change in Control with or without Termination (2)
Death
Disability
Termination without Cause or Resignation for Good Reason (3)
Termination for Cause or Resignation without Good Reason
Resignation for Other than Good Reason including Retirement
Chip S. Register
Executive Vice President & Chief Operating Officer
Compensation:
Base Salary
$
-
$
-
$
-
$
-
$
-
$
-
$
-
$
-
$
-
$
-
$
-
Long-Term Incentive:
Restricted Stock Vesting
35,073
35,073
35,073
-
35,073
35,073
-
-
-
-
-
Benefits & Perquisites:
Severance:
Base Salary Continuation
-
-
-
-
-
-
-
-
895,523
-
-
Bonus Continuation
84,506
84,506
84,506
-
84,506
-
-
-
84,506
-
-
Health & Welfare Coverage (4)
-
-
-
-
-
-
-
-
-
-
-
Long-Term Disability
-
-
-
-
-
-
-
-
-
-
Paid Time Off
-
-
-
-
-
-
-
-
-
-
-
Retirement
-
-
-
-
-
-
-
-
58,050
-
-
SERP
-
-
-
-
-
-
-
-
7,615
-
-
Total Value
$
119,579
$
119,626
$
119,579
$
-
$
119,579
$
35,073
$
-
$
-
$
1,045,694
$
-
$
-
(1)
Assumes disability continues through retirement age of 65.
(2)
These benefits are received upon a change in control whether or not the NEO is terminated in connection with the change in control.
(3)
These amounts may be reduced in order to avoid excess parachute payments under Section 280G of the Internal Revenue Code, in accordance with the executive’s agreement.
(4)
Represents the difference between the NEO’s premium payments and the Company’s premium payments for continued health and welfare coverage.
Compensation of Directors
Retainer and Meeting Fees. Each non-employee director received an annual retainer of $5,000 for board service during 2020. Non-employee directors of The Fauquier Bank received an annual retainer of $5,000 for The Fauquier Bank board service during 2020. The chairman received a retainer from the Company of $29,500 during 2020, but did not receive a retainer from The Fauquier Bank. Annual retainers are pro-rated at one half for any director who does not serve after an annual meeting of shareholders. For 2020, all board meetings were joint meetings of Fauquier and The Fauquier Bank, and the fee paid to non-employee directors was $800 per meeting. Non-employee
directors of the Company and The Fauquier Bank received committee fees of $300 for each committee meeting attended. Committee chairmen for the audit, compensation and benefits, and enterprise risk management committees received $800 for each committee meeting they chaired. Committee chairmen for the governance and nominating committees received $400 for each committee meeting they chaired. The chairman of the Company receives a committee fee only if he chairs the committee.
Equity Compensation. During 2020, the Company granted restricted stock to non-employee directors under the Fauquier Bankshares, Inc. Amended and Restated Stock Incentive Plan, which was approved by shareholders at Fauquier’s 2019 annual meeting. The number of shares of restricted stock granted to each director was calculated by dividing $10,000 by the closing price of the Company’s common stock on the day prior to the day the compensation and benefits committee made the grant determination.
The compensation and benefits committee believes that granting restricted stock as part of director compensation better aligns the directors’ and shareholders’ long-term interest in a way that cannot be accomplished through cash compensation, and increases director ownership of the Company’s shares in an appropriate manner. On February 20, 2020, 477 shares of restricted stock were awarded to each non-employee director continuing in office after the 2020 annual meeting. The shares automatically vested on such date but are subject to transferability restrictions that lapse on the third anniversary of the grant date. On February 1, 2021, 539 shares of restricted stock were awarded to each non-employee director. The shares automatically vested on such date but are subject to transferability restrictions that lapse on the third anniversary of the grant date or, for any director that does not serve on the Board of Directors of Virginia National following the effectiveness of the Merger, that lapse upon the effectiveness of the Merger.
The following table provides compensation information for the year ended December 31, 2020 for each non-employee director. Mr. Bogan is an employee director and does not receive separate compensation for serving on the Board.
Name
Fees Earned or Paid in Cash (1)
Stock Awards (2)
Total
John B. Adams, Jr.
$
40,367
$
9,993
$
50,360
Kevin T. Carter
27,300
9,993
37,293
Donna D. Flory
28,800
9,993
38,793
Randolph D. Frostick
31,500
9,993
41,493
Jay B. Keyser
34,600
9,993
44,593
Randolph T. Minter
31,300
9,993
41,293
Brian S. Montgomery
32,100
9,993
42,093
P. Kurtis Rodgers
34,200
9,993
44,193
Sterling T. Strange, III
31,800
9,993
41,793
(1)
Because each director also serves on The Fauquier Bank’s board of directors, the amounts reported in this table reflect compensation for board services paid by the Company and The Fauquier Bank.
(2)
Reflects the grant date fair value of the restricted stock award granted to each non-employee director on February 20, 2020 under the Company’s stock incentive plan calculated in accordance with FASB ASC Topic 718.

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ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS
Beneficial Ownership of Directors, Executive Officers, and Principal Shareholders of the Company
The Company has a Stock Ownership Policy which requires all directors to acquire within five years of becoming a director and retain a minimum of 5,000 shares of the Company’s common stock. The policy requires that within five years of being named executive officers, the Chief Executive Officer must retain a minimum of 25,000 shares and other NEOs must retain a minimum of 15,000 shares of common stock.
For purposes of the following tables, beneficial ownership has been determined in accordance with the provisions of Rule 13d-3 of the Securities Exchange Act of 1934 under which, in general, a person is deemed to be the beneficial owner of a security if the person has or shares the power to vote or direct the voting of the security or the power to dispose of or direct the disposition of the security, or if the person has the right to acquire beneficial ownership of the security within 60 days. All shares of common stock indicated in the below tables are subject to the sole investment and voting power of the identified person except as otherwise set forth in the footnotes, except that shares of restricted stock over which an individual has sole voting power but does not have investment power until transferability restrictions have lapsed, are not specifically identified.
The following table sets forth, as of March 1, 2021, the number and percentage of shares of Company common stock held by each director and nominee for director of the Company, each of the NEOs and all directors and executive officers of the Company as a group.
Name of Beneficial Owner(s)
Amount and Nature of Beneficial Ownership
Percent of Class
John B. Adams, Jr.
26,078
*
Marc J. Bogan
22,026
*
Kevin T. Carter
6,276
(1)
*
Donna D. Flory
5,908
(2)
*
Randolph D. Frostick
9,115
*
Christine E. Headly
8,985
(3)
*
Jay B. Keyser
9,875
(4)
*
Randolph T. Minter
39,848
1.05%
Brian S. Montgomery
41,136
(5)
1.08%
Chip S. Register
9,838
*
P. Kurtis Rodgers
12,345
*
Sterling T. Strange, III
8,524
*
All directors and executive officers as a group (12 persons)
199,954
5.25%
*
Percentage ownership is less than one percent of the outstanding shares of common stock.
(1)
Includes 2,724 shares held jointly with spouse, over which Mr. Carter shares voting and investment power.
(2)
Includes 3,965 shares held jointly with spouse, over which Ms. Flory shares voting and investment power.
(3)
Includes (i) 657 shares held jointly with spouse, over which Ms. Headly shares voting and investment power; and (ii) 2,290 shares that are restricted stock holdings. The restricted shares are subject to a vesting schedule, forfeiture risk and other restrictions.
(4)
Includes 8,398 shares held in the Jay B. Keyser Revocable Trust, over which Mr. Keyser shares voting and investment power with spouse.
(5)
Includes 10,376 shares held jointly with spouse, over which Mr. Montgomery shares voting and investment power.
The following table sets forth, as of March 1, 2021, the number and percentage of shares of Company common stock beneficially held by persons known by the Company to be the owners of more than 5% of the Company’s common stock.
Name and Address of Beneficial Owner
Amount and Nature of Beneficial Ownership
Percent of Class
Royce & Associates, LLC
745 Fifth Avenue
New York, NY 10151
294,000 (1)
7.72%
Ategra Community Financial Institution Fund, L.P.
Jonathan Holtaway 8229 Boone Blvd., Suite 305
Vienna, VA 22182
351,331 (2)
9.23%
Daniel R. Long, III, CFA
588 Eagle Watch Lane
Osprey, FL 34229
257,549 (3)
6.76%
(1)
Based on a Schedule 13G/A filed with the SEC on January 21, 2021 by Royce & Associates, LLC (“Royce”). Pursuant to the Schedule 13G/A, as of December 31, 2020, Royce was the beneficial owner of 294,000 shares of the Company’s common stock and had sole voting power and sole investment power with respect to all 294,000 shares.
(2)
Based on a Schedule 13D filed with the SEC on January 29, 2021 by (i) Ategra Community Financial Institution Fund, L.P. (“ACFIF”), (ii) Ategra GP, LLC (“AGP”), (iii) Ategra Capital Management, LLC (“ACM”), (iv) Jonathan Holtaway, and (v) Jacques Rebibo. Pursuant to the Schedule 13D, as of January 29, 2021, ACFIF, AGP, ACM and Mr. Holtaway were each the beneficial owners of 349,331 shares of the Company’s common stock and had shared voting power and shared investment power with respect to all 349,331 shares. The Schedule 13D also states that, as of such date, Jacques Rebibo was the beneficial owner of 351,331 shares of the Company’s common stock, had sole voting and sole investment power with respect to 2,000 shares, and had shared voting power and shared investment power with respect to 349,331 shares.
(3)
Based on a Schedule 13D/A filed with the SEC on October 9, 2019 by Daniel R. Long, III, CFA. Pursuant to the Schedule 13D/A, as of October 8, 2019, Mr. Long was the beneficial owner of 257,549 shares of the Company’s common stock and had sole voting power and sole investment power with respect to 252,549 shares and only investment power with respect to certain other shares held by family members of Mr. Long.
Securities Authorized for Issuance under Equity Compensation Plans
The following table sets forth information as of December 31, 2020 with respect to compensation plans under which equity securities of the Company are authorized for issuance:
Plan Category
Number of securities to be issued upon exercise of outstanding options, warrants and rights (a)
Weighted-average exercise price of outstanding options, warrants and rights (b)
Number of securities remaining available for future issuance under equity compensation plans (excluding securities reflected in column (a))
Equity compensation plans approved by security holders
17,705
(1)
$
20.05
66,553
Total
17,705
$
20.05
66,553
(1)
Consists of shares underlying performance-based stock units that were granted under the Amended and Restated Stock Incentive Plan approved by shareholders May 21, 2019.
For additional information concerning the material features of the Company’s equity compensation plans refer to Note 12 of the Company’s Notes to Consolidated Financial Statements contained in Item 8 of this Form 10-K.

---

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE
Certain Relationships and Related Transactions
Pursuant to our Code of Business Conduct and Ethics, all directors (including our NEOs) are prohibited from being a consultant to (excluding an attorney), a director, officer, or employee of, or otherwise operate, another bank or financial institution that markets products or services in competition with the Bank. Our Chief Executive Officer implements our Code of Business Conduct and Ethics and is responsible for overseeing compliance with the Code of Business Conduct and Ethics.
The Bank has had, and may be expected to have in the future, banking transactions in the ordinary course of business with executive officers, directors, their immediate families and affiliated companies in which they are principal shareholders. Such loans were made in the ordinary course of business, on substantially the same terms, including interest rate and collateral, as those prevailing at the time for comparable transactions with other persons and did not involve more than the normal risk of collectibility or present other unfavorable features.
Independence of the Directors
A majority of the directors are “independent directors” as defined by the listing standards of the Nasdaq Stock Market LLC and the Board has determined that these independent directors have no relationships with the Company that would interfere with the exercise of their independent judgment in carrying out the responsibilities of a director. The independent directors are Messrs. Adams, Carter, Frostick, Keyser, Minter, Montgomery, Rodgers, Strange and Ms. Flory. In determining the independence of the directors, the Board considered that Vanderpool, Frostick and Nishanian, P.C., a law firm of which Mr. Frostick is a partner and shareholder, has been engaged by The Fauquier Bank for legal services. During 2020, the firm was paid $16,520 for its services. After considering this relationship, the Board concluded that Mr. Frostick is independent.

---

ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES
ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES
The Company’s independent registered public accounting firm, Brown Edwards, billed the following fees for services provided to the Company for the years ended December 31, 2020 and 2019.
Year Ended December 31,
Audit fees (1)
$
96,904
$
101,813
Audit-related fees (2)
27,700
26,000
Tax fees
-
-
All other fees
-
-
Total
$
124,604
$
127,813
(1)
Audit fees consist of audit and review services, consents and review of documents filed with the SEC. For 2019, audit fees also include an attestation report on internal controls under SEC rules.
(2)
Audit-related fees consist of employee benefit plan audits, Housing and Urban Development audits, and audits of the Federal Family Education Loan Program.
Pre-Approval Policies
Pursuant to the terms of the Company’s Audit Committee Charter, the Audit Committee is responsible for the appointment, compensation and oversight of the work performed by the Company’s independent registered public accounting firm. The Audit Committee, or a designated member of the Audit Committee, must pre-approve all audit (including audit-related) and non-audit services performed by the Company’s independent registered public accounting firm in order to assure that the provisions of such services does not impair the accountants’ independence. The Audit Committee has delegated interim pre-approval authority to Mr. Keyser, Chairman of the Audit Committee. Any interim pre-approval of permitted non-audit services is required to be reported to the Audit Committee at its next scheduled meeting. The Audit Committee does not delegate its responsibilities to pre-approve services performed by the independent registered public accounting firm to management.
PART IV

---

ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES
ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
(a)
(1) and (2). The response to this portion of Item 15 is submitted as a separate section of this report.
(a)
(3) Exhibits
The following exhibits are filed as part of this Form 10-K and this list includes the Exhibit Index.
Exhibit
Number
Exhibit Description
2.1
Agreement and Plan of Reorganization, dated as of October 1, 2020, between Virginia National Bankshares Corporation and Fauquier Bankshares, Inc., incorporated by reference to Exhibit 2.1 to Form 8-K filed on October 2, 2020.
3.1
Articles of Incorporation of Fauquier Bankshares, Inc., as amended, incorporated by reference to Exhibit 3.1 to Form 10-K filed March 15, 2010.
3.2
Bylaws of Fauquier Bankshares, Inc., as amended and restated, incorporated by reference to Exhibit 3.2 to Form 8-K filed April 20, 2020.
4.1
Description of Fauquier Bankshares, Inc.’s Securities, incorporate by reference to Exhibit 4.1 to Form 10-K filed March 6, 2020.
10.1
Fauquier Bankshares, Inc. Director Deferred Compensation Plan, as adopted effective May 1, 1995, incorporated by reference to Exhibit 4.C to Form S-8 filed October 15, 2002.
10.2*
Fauquier Bankshares, Inc. Amended and Restated Stock Incentive Plan (incorporated by reference to Appendix A of the Proxy Statement for the Annual Meeting of Shareholders held on May 21, 2019, filed on April 12, 2019).
10.3*
Fauquier Bankshares, Inc. Stock Incentive Plan, incorporated by reference to Exhibit 99.0 to Form S-8 filed August 21, 2009.
10.3.1*
Form of Incentive Stock Option Agreement relating to Fauquier Bankshares, Inc. Stock Incentive Plan, incorporated by reference to Exhibit 10.4.1 to Form 10-K filed March 15, 2010.
10.3.2*
Form of Nonstatutory Stock Option Agreement relating to Fauquier Bankshares, Inc. Stock Incentive Plan, incorporated by reference to Exhibit 10.4.2 to Form 10-K filed March 15, 2010.
10.3.3*
Form of Restricted Stock Award Agreement relating to Fauquier Bankshares, Inc. Stock Incentive Plan , incorporated by reference to Exhibit 10.4.3 to Form 10-K filed March 15, 2010.
10.4*
Employment Agreement, dated June 6, 2016, between Fauquier Bankshares, Inc., The Fauquier Bank, and Marc J. Bogan, incorporated by reference to Exhibit 10.21 to Form 8-K/A filed June 7, 2016.
10.5*
Employment Agreement, dated February 8, 2017, between Fauquier Bankshares, Inc., The Fauquier Bank, and Christine E. Headly, incorporated by reference to Exhibit 10.21 to Form 8-K/A filed February 13, 2017.
10.6*
Fauquier Bankshares, Inc. Supplemental Executive Retirement Plan, as amended and restated October 21, 2010, incorporated by reference to Exhibit 10.15 to Form 10-Q filed November 8, 2010.
10.6.1*
Form of Participation Agreement for Fauquier Bankshares, Inc. Supplemental Executive Retirement Plan, incorporated by reference to Exhibit 10.15.1 to Form 10-Q filed November 8, 2010.
10.7*
Employment Agreement, dated August 1, 2020, by and between Fauquier Bankshares, Inc., The Fauquier Bank and Christine E. Headly, incorporated by reference to Exhibit 10.1 to Form 8-K filed August 4, 2020.
Code of Business Conduct and Ethics, incorporated by reference to Exhibit 14 to Form 10-K filed March 11, 2019.
Subsidiaries of the Fauquier Bankshares, Inc., incorporated herein by reference to Part I of this Form 10-K.
23.1
Consent of Brown, Edwards & Company, L.L.P.
31.1
Certification of CEO pursuant to Rule 13a-14(a).
31.2
Certification of CFO pursuant to Rule 13a-14(a).
32.1
Certification of CEO pursuant to 18 U.S.C. Section 1350.
32.2
Certification of CFO pursuant to 18 U.S.C. Section 1350.
99.1
Form of Affiliate Agreement, dated as of September 30, 2020, by and among Virginia National Bankshares Corporation, Fauquier Bankshares, Inc., and certain shareholders of Fauquier Bankshares, Inc, incorporated by reference to Exhibit 99.1 to Form 8-K filed October 2, 2020.
99.2
Form of Affiliate Agreement, dated as of September 30, 2020, by and among Virginia National Bankshares Corporation, Fauquier Bankshares, Inc., and certain shareholders of Virginia National Bankshares Corporation, incorporated by reference to Exhibit 99.2 to Form 8-K filed October 2, 2020.
The following materials from the Company’s 10-K Report for the period ended December 31, 2020, formatted in inline XBRL: (i) the Consolidated Balance Sheets, (ii) the Consolidated Statements of Operations, (iii) the Consolidated Statements of Comprehensive Income (iv) the Consolidated Statements of Changes in Shareholders’ Equity, (v) the Consolidated Statements of Cash Flows and (vi) the Notes to the Consolidated Financial Statements.
The cover page from the Company’s Annual Report on Form 10-K for the year ended December 31, 2020, formatted in Inline eXtensible Business Reporting Language (included with Exhibit 101).
*Indicates management contract