VILLAGE BANK & TRUST FINANCIAL CORP. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (form 10-Q)

Caution about forward-looking statements


In addition to historical information, this report may contain forward-looking
statements. For this purpose, any statement that is not a statement of
historical fact may be deemed to be a forward-looking statement. These
forward-looking statements may include statements regarding profitability,
liquidity, allowance for loan losses, interest rate sensitivity, market risk,
growth strategy and financial and other goals. Forward-looking statements often
use words such as "believes," "expects," "plans," "may," "will," "should,"
"projects," "contemplates," "anticipates," "forecasts," "intends" or other words
of similar meaning. You can also identify them by the fact that they do not
relate strictly to historical or current facts. Forward-looking statements are
subject to numerous assumptions, risks and uncertainties, and actual results
could differ materially from historical results or those anticipated by such
statements.

There are many factors that could have a material adverse effect on the
operations and future prospects of the Company including, but not limited to:

? changes in assumptions underlying the establishment of allowances for loan

losses, and other estimates;

the risks of changes in interest rates on levels, composition and costs of

? deposits, loan demand, and the values and liquidity of loan collateral,

securities, and interest sensitive assets and liabilities;

? the effects of future economic, business and market conditions;

legislative and regulatory changes, including the Dodd-Frank Wall Street Reform

and Consumer Protection Act and other changes in banking, securities, and tax

? laws and regulations and their application by our regulators, and changes in

scope and cost of Federal Deposit Insurance Corporation insurance and other

coverages;

? our inability to maintain our regulatory capital position;

the Company’s computer systems and infrastructure may be vulnerable to attacks

? by hackers or breached due to employee error, malfeasance, or other disruptions

despite security measures implemented by the Company;

changes in market conditions, specifically declines in the residential and

? commercial real estate market, volatility and disruption of the capital and

credit markets, soundness of other financial institutions we do business with;

? risks inherent in making loans such as repayment risks and fluctuating

collateral values;

? changes in operations of the mortgage company as a result of the activity in

the residential real estate market;

exposure to repurchase loans sold to investors for which borrowers failed to

provide full and accurate information on or related to their loan application

? or for which appraisals have not been acceptable or when the loan was not

underwritten in accordance with the loan program specified by the loan

investor;

? governmental monetary and fiscal policies;

geopolitical conditions, including acts or threats of terrorism and/or military

? conflicts, or actions taken by the U.S. or other governments in response to

acts or threats of terrorism and/or military conflicts, negatively impacting

business and economic conditions in the U.S. and abroad;

? changes in accounting policies, rules and practices;

? reliance on our management team, including our ability to attract and retain

key personnel;

competition with other banks and financial institutions, and companies outside

? of the banking industry, including those companies that have substantially

greater access to capital and other resources;

? demand, development and acceptance of new products and services;

? problems with technology utilized by us;

natural disasters, war, terrorist activities, pandemics, or the outbreak of

? COVID-19 or similar outbreaks, and their effects on economic and business

environments in which the Company operates;

adverse effects due to COVID-19 on the Company and its customers,

? counterparties, employees, and third-party service providers, and the adverse

impacts to our business, financial position, results of operations, and

prospects;

? changing trends in customer profiles and behavior; and

? other factors described from time to time in our reports filed with the SEC.


                                       38

  Table of Contents

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

General


The Company's primary source of earnings is net interest income, and its
principal market risk exposure is interest rate risk. The Company is not able to
predict market interest rate fluctuations and its asset/liability management
strategy may not prevent interest rate changes from having a material adverse
effect on the Company's results of operations and financial condition.

Although we endeavor to minimize the credit risk inherent in the Company's loan
portfolio, we must necessarily make various assumptions and judgments about the
collectability of the loan portfolio based on our experience and evaluation of
economic conditions. If such assumptions or judgments prove to be incorrect, the
current allowance for loan losses may not be sufficient to cover loan losses and
additions to the allowance may be necessary, which would have a negative impact
on net income.

Results of operations

The following presents management's discussion and analysis of the financial
condition of the Company at September 30, 2022 and December 31, 2021 and the
results of operations for the Company for the three and nine months ended
September 30, 2022 and 2021. This discussion should be read in conjunction with
the Company's consolidated financial statements and the notes thereto appearing
elsewhere in this Quarterly Report.

Summary


For the three months ended September 30, 2022, the Company had net income of
$2,153,000, or $1.46 per fully diluted share, compared to net income of
$2,899,000, or $1.97 per fully diluted share, for the same period in 2021. For
the nine months ended September 30, 2022, the Company had net income of
$6,143,000, or $4.16 per fully diluted share, compared to net income of
$10,090,000, or $6.88 per fully diluted share, for the same period in 2021.

Net interest income


Net interest income, which represents the difference between interest earned on
interest-earning assets and interest incurred on interest-bearing liabilities,
is the Company's primary source of earnings. Net interest income can be affected
by changes in market interest rates as well as the level and composition of
assets, liabilities and shareholders' equity. Net interest spread is the
difference between the average rate earned on interest-earning assets and the
average rate paid on interest-bearing liabilities. The net yield on
interest-earning assets ("net interest margin" or "NIM") is calculated by
dividing tax equivalent net interest income by average interest-earning assets.

Generally, the net interest margin will exceed the net interest spread because a
portion of interest earning assets are funded by various noninterest-bearing
sources, principally noninterest-bearing deposits and shareholders' equity.
                                                        For the Three Months Ended September 30,
                                                         2022                2021            Change

                                                                 (dollars in thousands)
Average interest-earning assets                     $      700,755      $      681,164      $  19,591
Interest income                                     $        6,955      $        6,921      $      34
Yield on interest-earning assets                              3.94 %              4.03 %       (0.09) %
Average interest-bearing liabilities                $      406,837      $      396,194      $  10,643
Interest expense                                    $          420      $          492      $    (72)
Cost of interest-bearing liabilities                          0.41 %       
      0.49 %       (0.08) %
Net interest income                                 $        6,535      $        6,429      $     106
Net interest margin                                           3.70 %              3.74 %       (0.04) %


                                       39

  Table of Contents

The following are variances of note for the three months ended September 30,
2022
compared to the three months ended September 30, 2021:

?NIM compressed by four basis points to 3.70% for the three months ended
September 30, 2022 compared to 3.74% for the three months ended September 30,
2021
. The compression was driven by the following:

The Commercial Banking Segment recorded SBA fee income, net of deferred costs,

of $23,000 for the three months ended September 30, 2022, compared to

$1,210,000 for the three months ended September 30, 2021, through interest

income as a result of normal amortization and the receipt of funds from PPP

o loans forgiven by the SBA. In addition, the Commercial Banking Segment recorded

interest income associated with PPP loans of $3,000 for the three months ended

September 30, 2022, compared to $192,000 for the three months ended September

30, 2021. Total income associated with PPP loans was $26,000 for the three

months ended September 30, 2022 compared to $1,402,000 for the three months

ended September 30, 2021.

The yield on average earning assets compressed by nine basis points, 3.94% for

the three months ended September 30, 2022 vs. 4.03% for the three months ended

o September 30, 2021. The increase in our yield on earning assets, adjusting for

PPP income, is a result of improvement in our earning asset mix as well as the

impact of the rise in interest rates during 2022.

The cost of interest bearing liabilities dropped by eight basis points to 0.41%

for the three months ended September 30, 2022 compared to 0.49% for the three

months ended September 30, 2021, because of the shift in our deposit mix from

o higher cost time deposits to lower cost relationship deposits. Average time

deposits decreased $23,066,000, or 28.75%, from the three months ended

September 30, 2021, and low cost relationship deposits and non-interest bearing

   deposits together increased $59,220,000, or 10.69%, from the three months ended
   September 30, 2021.


                                           For the Nine Months Ended September 30,
                                             2022               2021           Change

                                                    (dollars in thousands)
Average interest-earning assets         $      705,935     $      669,583     $  36,352
Interest income                         $       19,954     $       20,923     $   (969)
Yield on interest-earning assets                  3.78 %             4.18 %      (0.40) %
Average interest-bearing liabilities    $      408,150     $      400,963     $   7,187
Interest expense                        $        1,238     $        1,728     $   (490)
Cost of interest-bearing liabilities              0.41 %             0.58 %
     (0.17) %
Net interest income                     $       18,716     $       19,195     $   (479)
Net interest margin                               3.54 %             3.83 %      (0.29) %

The following are variances of note for the nine months ended September 30, 2022
compared to the nine months ended September 30, 2021:

NIM compressed by 29 basis points to 3.54% for the nine months ended September

? 30, 2022 compared to 3.83% for the nine months ended September 30, 2021. The

expansion was driven by the following:

The Commercial Banking Segment recorded SBA fee income, net of deferred costs,

of $973,000 for the nine months ended September 30, 2022 compared to $4,034,000

for the nine months ended September 30, 2021, through interest income as a

result of normal amortization and the receipt of funds from PPP loans forgiven

o by the SBA. In addition, the Commercial Banking Segment recorded interest

income associated with PPP loans of $81,000 for the nine months ended September

30, 2022 compared to $930,000 for the nine months ended September 30, 2021.

Total income associated with PPP loans was $1,054,000 for the nine months ended

September 30, 2022 compared to $4,964,000 for the nine months ended September

30, 2021.

The yield on average earning assets compressed by 40 basis points, 3.78% for

o the nine months ended September 30, 2022 vs. 4.18% for the nine months ended

   September 30, 2021. The decrease in our yield on earning assets for the


                                       40

  Table of Contents

nine months ended September 30, 2022, adjusting for PPP income, was a result of

the shift in our earning asset mix which was driven by an increase in our liquid

assets (i.e. interest bearing due from other institutions and investment

securities) due to the reduction in the PPP loan balances because of loan

forgiveness, which was partially offset by growth in the core loan portfolio and

growth in our deposit base. The rise in interest rates during the nine months

ended September 30, 2022 partially offset the impact of the increased liquid

assets.

The cost of interest bearing liabilities dropped by 17 basis points to 0.41%

for the nine months ended September 30, 2022 compared to 0.58% for the nine

months ended September 30, 2021, because of the shift in our deposit mix from

o higher cost time deposits to lower cost relationship deposits. Average time

deposits decreased $28,322,000, or 30.68%, from September 30, 2021, and average

low cost relationship deposits and non-interest bearing deposits together

   increased $80,956,000, or 15.36%, from September 30, 2021.


                                       41

  Table of Contents
The following tables illustrate average balances of total interest-earning
assets and total interest-bearing liabilities for the periods indicated, showing
the average distribution of assets, liabilities, shareholders' equity and
related income, expense and corresponding weighted-average yields and rates
(dollars in thousands). The average balances used in these tables and other
statistical data were calculated using daily average balances. We had no tax
exempt interest-earning assets for the periods presented.

                                              Three Months Ended September 30, 2022            Three Months Ended September 30, 2021
                                                                 Interest                                         Interest
                                              Average            Income/         Yield         Average            Income/         Yield
                                              Balance            Expense          Rate         Balance            Expense          Rate
Loans
Commercial                                $        86,757      $      1,055

4.82 % $ 128,417 $ 1,921 5.93 %
Real estate – residential

                          91,071             1,091        4.75 %           85,660               977        4.53 %
Real estate - commercial                          290,769             3,282        4.48 %          247,158             2,881        4.62 %
Real estate - construction                         38,728               412
       4.22 %           47,358               463        3.88 %
Student loans                                      23,062               252        4.34 %           28,285               269        3.77 %
Consumer                                            4,004                48        4.76 %            3,067                40        5.17 %
Loans net of deferred fees                $       534,391      $      6,140

4.56 % $ 539,945 $ 6,551 4.81 %
Loans held for sale

                                 5,239                70        5.30 %           13,668               104        3.02 %
Investment securities                             130,288               559        1.70 %           56,931               244        1.70 %
Federal funds and other                            30,837               186        2.39 %           70,620                22        0.12 %
Total interest earning assets                     700,755             6,955        3.94 %          681,164             6,921        4.03 %
Allowance for loan losses                         (3,329)                                          (3,444)
Cash and due from banks                            17,828                                           12,592
Premises and equipment, net                        11,681                  
                        12,027
Other assets                                       22,383                                           22,765
Total assets                              $       749,318                                  $       725,104

Interest bearing deposits
Interest checking                                  87,371                27        0.12 %           80,049                26        0.13 %
Money market                                      196,469               110        0.22 %          180,261               103        0.23 %
Savings                                            51,391                20        0.15 %           41,245                16        0.15 %
Certificates                                       57,163                83        0.58 %           80,229               204        1.01 %
Total deposits                                    392,394               240        0.24 %          381,784               349        0.36 %
Borrowings
Long-term debt - trust
preferred securities                                8,764                80        3.62 %            8,764                42        1.90 %
Subordinated debt, net                              5,679               100        6.99 %            5,646               101        7.10 %
Other borrowings                                        -                 -           - %                -                 -           - %
Total interest bearing liabilities                406,837               420        0.41 %          396,194               492        0.49 %
Noninterest bearing deposits                      277,758                                          261,714
Other liabilities                                   3,260                                            6,035
Total liabilities                                 687,855                                          663,943
Equity capital                                     61,463                                           61,161
Total liabilities and capital             $       749,318                                  $       725,104


Net interest income before provision
for loan losses                                                $      6,535                                     $      6,429
Interest spread - average yield on
interest earning assets, less average
rate on interest bearing liabilities                                               3.53 %                                           3.54 %
Net interest margin (net interest
income expressed as a percentage of
average earning assets)                                                            3.70 %                                           3.74 %


                                       42

  Table of Contents

                                            Nine Months Ended September 30, 2022            Nine Months Ended September 30, 2021
                                                             Interest                                        Interest
                                           Average           Income/         Yield         Average           Income/        Yield
                                           Balance           Expense          Rate         Balance           Expense         Rate
Loans
Commercial                              $       85,429     $      3,682         5.76 %  $      169,218     $      6,401       5.06 %
Real estate - residential                       91,475            2,932         4.29 %          86,733            2,991       4.61 %
Real estate - commercial                       278,196            9,379         4.51 %         239,041            8,286       4.63 %
Real estate - construction                      41,057            1,048         3.41 %          37,202            1,195       4.29 %
Student loans                                   24,293              729         4.01 %          28,902              805       3.72 %
Consumer                                         3,609              139         5.15 %           3,165              129       5.45 %
Loans net of deferred fees              $      524,059     $     17,909         4.57 %  $      564,261     $     19,807       4.69 %
Loans held for sale                              5,854              192         4.39 %          16,162              341       2.82 %
Investment securities                          125,447            1,535         1.64 %          48,219              743       2.06 %
Federal funds and other                         50,575              318         0.84 %          40,941               32       0.10 %
Total interest earning assets                  705,935           19,954         3.78 %         669,583           20,923       4.18 %
Allowance for loan losses                      (3,490)                                         (3,803)
Cash and due from banks                         17,858                                          12,826
Premises and equipment, net                     11,716                                          11,980
Other assets                                    20,000                                          23,008
Total assets                            $      752,019                                  $      713,594

Interest bearing deposits
Interest checking                               86,679               80         0.12 %          75,823               76       0.13 %
Money market                                   194,635              321         0.22 %         171,093              359       0.28 %
Savings                                         50,701               59         0.16 %          39,827               47       0.16 %
Certificates                                    61,700              295         0.64 %          92,328              793       1.15 %
Total deposits                                 393,715              755         0.26 %         379,071            1,275       0.45 %
Borrowings
Long-term debt - trust
preferred securities                             8,764              181         2.76 %           8,764              130       1.98 %
Subordinated debt, net                           5,671              302         7.12 %           5,639              302       7.16 %
Other borrowings                                     -                -            - %           7,489               21       0.37 %
Total interest bearing liabilities             408,150            1,238    
    0.41 %         400,963            1,728       0.58 %
Noninterest bearing deposits                   276,662                                         247,523
Other liabilities                                5,203                                           7,252
Total liabilities                              690,015                                         655,738
Equity capital                                  62,004                                          57,856
Total liabilities and capital           $      752,019                                  $      713,594


Net interest income before provision
for loan losses                                            $     18,716                                    $     19,195
Interest spread - average yield on
interest earning assets, less
average rate on interest bearing
liabilities                                                                     3.37 %                                        3.60 %
Net interest margin (net interest
income expressed as a percentage of
average earning assets)                                                         3.54 %                                        3.83 %


Provision for (recovery of) loan losses

The amount of the allowance for loan losses is determined by an evaluation of
the level of loans outstanding, the level of non-performing loans, historical
loan loss experience, delinquency trends, underlying collateral values, the
amount of actual losses charged to the reserve in a given period and assessment
of present and anticipated economic conditions.

The level of the allowance reflects changes in the size of the portfolio or in
any of its components as well as management's continuing evaluation of industry
concentrations, specific credit risks, loan loss experience, current loan
portfolio quality, and present economic, political and regulatory conditions.
Portions of the allowance may be allocated for specific credits; however, the
entire allowance is available for any credit that, in management's judgment,
should be charged off. While management utilizes its best judgment and
information available, the ultimate adequacy of the allowance is dependent upon
a variety of factors beyond the Company's control, including the performance of
the Company's loan portfolio, the economy, changes in interest rates and the
view of the regulatory authorities toward loan classifications.

                                       43

Table of Contents

The Company recorded a provision for loan loss expense of $100,000 for the three
months ended September 30, 2022, compared to no provision for loan loss expense
for the three months ended September 30, 2021. The provision expense for three
months ended September 30, 2022 was due to growth in the overall loan portfolio
as well as the impact of the $153,000 net charge-offs during the quarter. The
lack of a provision for loan loss, during the three months ended September 30,
2021, was driven by improving macroeconomic conditions, the return of all loan
deferrals to contractual payment terms and credit quality remaining strong.
While current economic challenges due to higher inflation and the speed at which
interest rates are rising remain risks to credit quality, we believe our current
level of allowance for loan losses is sufficient.

The Company recorded a recovery of provision for loan loss expense of $300,000
and $500,000 for the nine months ended September 30, 2022 and September 30,
2021, respectively. The recovery of provision for loan loss expense, during the
nine months ended September 30, 2022 and September 30, 2021, resulted from
reductions in the qualitative factors driven by improving economic factors,
improved credit metrics, and reductions in loan deferrals. While current
economic challenges due to higher inflation and the speed at which interest
rates are rising remain risks to credit quality, we believe our current level of
allowance for loan losses is sufficient.

For more financial data and other information about the allowance for loan
losses refer to section, “Balance Sheet Analysis under this Item 2 –
“Management’s Discussion and Analysis of Financial Condition and Results of
Operations”, and Note 5 “Loans and allowance for loan losses” in the “Notes to
Consolidated Financial Statements” contained in Item 1 of this Form 10-Q.

Noninterest income


Noninterest income includes service charges and fees on deposit accounts, fee
income related to loan origination, mortgage banking income, net, and gains and
losses on securities available for sale. The most significant noninterest income
item has been mortgage banking income, net, representing 56% and 73% for the
three month periods ended September 30, 2022 and 2021, respectively, and 55% and
79% for the nine month periods ended September 30, 2022 and 2021, respectively.

                                   For the Three Months Ended
                                         September 30,                    Change
                                    2022               2021             $          %

                                                (dollars in thousands)
Service charges and fees        $         670      $         580    $      90      15.5 %
Mortgage banking income, net              973              2,171      (1,198)    (55.2) %
Other                                     107                108          (1)     (0.9) %
Total noninterest income        $       1,750      $       2,859    $ (1,109)    (38.8) %

The decrease in noninterest income of $1,109,000 for the three months ended
September 30, 2022, was the result of the following:

?The $90,000 increase in service charges and fees was driven by higher consumer
and business spending during the three months ended September 30, 2022.


?The $1,198,000 decrease in mortgage banking income, net is a result of
decreased loan originations and sales compared to the prior year due the sharp
rise in mortgage rates during the nine months ended September 30, 2022, the
historically low inventory of homes for sale, and compressed gain on sale
margins during the three months ended September 30, 2022. As a result of the
sharp drop in origination volume, the Mortgage Banking Segment has taken steps
to right size its expense structure to minimize the impact to earnings.

                                  For the Nine Months Ended
                                        September 30,                   Change
                                    2022              2021            $          %

                                               (dollars in thousands)
Service charges and fees        $      1,960      $      1,711    $     249      14.6 %
Mortgage banking income, net           2,942             7,827      (4,885)    (62.4) %
Gain on sale of SBA loans                 79                 -           79     100.0 %
Other                                    336               344          (8)     (2.3) %
Total noninterest income        $      5,317      $      9,882    $ (4,565)    (46.2) %


                                       44

  Table of Contents

The decrease in noninterest income of $4,565,000 for the nine months ended
September 30, 2022, was the result of the following:

?The $249,000 increase in service charges and fees was driven by higher consumer
and business spending during the nine months ended September 30, 2022.


?The $4,885,000 decrease in mortgage banking income, net is a result of
decreased loan originations and sales compared to the prior year due the sharp
rise in mortgage rates during the nine months ended September 30, 2022, the
historically low inventory of homes for sale, and compressed gain on sale
margins during the nine months ended September 30, 2022. As a result of the
sharp drop in origination volume, the Mortgage Banking Segment has taken steps
to right size its expense structure to minimize the impact to earnings.

?The Company began selling the guaranteed strip on SBA loans again during the
nine months ended September 30, 2022, and recognized a gain of $79,000 for the
period, compared to no sales for the same period in 2021.

Noninterest expense

                                                    For the Three Months Ended
                                                          September 30,                   Change
                                                     2022               2021            $         %

                                                                (dollars in thousands)
Salaries and benefits                            $       3,446      $       3,607    $ (161)     (4.5) %
Occupancy                                                  305                315       (10)     (3.2) %
Equipment                                                  260                267        (7)     (2.6) %
Supplies                                                    46                 49        (3)     (6.1) %
Professional and outside services                          655             
  730       (75)    (10.3) %
Advertising and marketing                                   67                 99       (32)    (32.3) %
FDIC insurance premium                                      64                 38         26      68.4 %
Other operating expense                                    681                532        149      28.0 %
Total noninterest expense                        $       5,524      $       5,637    $ (113)     (2.0) %

The decrease in noninterest expense of $113,000 for the three months ended
September 30, 2022, was the result of the following:


?The $161,000 decrease in salaries and benefits expense was driven primarily by
lower expenses related to the decreased mortgage production for the three months
ended September 30, 2022.
?Professional and outside services expenses decreased by $75,000 primarily due
to lower expenses associated with data processing.
?Advertising and marketing expense decreased by $32,000 as a result of decreased
marketing efforts during the three months ended September 30, 2022, compared to
the three months ended September 30, 2021.
?Other operating expense increased $149,000 as a result of an increase in check
and card fraud during the three months ended September 30, 2022.

                                       45

  Table of Contents

                                                    For the Nine Months Ended
                                                          September 30,                    Change
                                                     2022               2021            $          %

                                                                 (dollars in thousands)
Salaries and benefits                            $      10,394      $     
10,541    $ (147)      (1.4) %
Occupancy                                                  919                948       (29)      (3.1) %
Equipment                                                  818                788         30        3.8 %
Supplies                                                   120                138       (18)     (13.0) %
Professional and outside services                        2,118              2,085         33        1.6 %
Advertising and marketing                                  271                347       (76)     (21.9) %
Foreclosed assets, net                                       -                (8)          8    (100.0) %
FDIC insurance premium                                     187                142         45       31.7 %
Other operating expense                                  1,893              1,716        177       10.3 %
Total noninterest expense                        $      16,720      $     

16,697 $ 23 0.1 %

The increase in noninterest expense of $23,000 for the nine months ended
September 30, 2022, was the result of the following:


?The $147,000 decrease in salaries and benefits expense was driven primarily by
lower expenses related to the decreased mortgage production for the nine months
ended September 30, 2022.
?Advertising and marketing expense decreased by $76,000 as a result of decreased
marketing efforts during the nine months ended September 30, 2022, compared to
the nine months ended September 30, 2021.
?Other operating expense increased $177,000 primarily as a result of an increase
in check and card fraud during the nine months ended September 30, 2022.

Income taxes


The Company's effective tax rate, income tax as a percent of pre-tax income, may
vary significantly from the statutory rate due to permanent difference and
available tax credits. Income tax expense for the three and nine months ended
September 30, 2022 was $508,000 and $1,470,000, respectively, resulting in an
effective tax rate of 19.1% and 19.3%, respectively, compared to $752,000 and
$2,790,000, or 20.6% and 21.7%, respectively, for the same periods in 2021. The
decrease in the effective tax rate was primarily related to an increase in the
tax credit received related to state taxes attributed to the Company and the
Mortgage Banking Segment.  The Bank is not subject to Virginia income taxes, and
instead is subject to a franchise tax based on bank capital.

Balance Sheet Analysis

Investment securities

At September 30, 2022 and December 31, 2021, all of our investment securities
were classified as available for sale.

For more financial data and other information about investment securities refer
to Note 4 “Investment Securities Available for Sale” in the “Notes to
Consolidated Financial Statements” contained in Item 1 of this Form 10-Q.

Loans

The Company maintains rigorous underwriting standards coupled with regular
evaluation of the creditworthiness of and the designation of lending limits for
each borrower. The portfolio strategies include seeking industry, loan type and
loan size diversification in order to minimize credit concentration risk.
Management also focuses on originating loans in markets with which the Company
is familiar. Additionally, as a significant amount of the loan losses we have
experienced in the past is attributable to construction and land development
loans, our strategy has shifted from reducing this type of lending to closely
managing the quality and concentration in these loan types.

Approximately 78.2% of all loans are secured by mortgages on real property
located principally in the Commonwealth of Virginia. Approximately 4.1% of the
loan portfolio consists of rehabilitated student loans purchased by the Bank
from 2014 to 2017 (see discussion following). The Company's commercial and
industrial loan portfolio represents approximately 16.9% of all loans.  Loans in

                                       46

  Table of Contents
this category are typically made to individuals and small and medium-sized
businesses, and range between $250,000 and $2.5 million. Based on underwriting
standards, commercial and industrial loans may be secured in whole or in part by
collateral such as liquid assets, accounts receivable, equipment, inventory, and
real property.  The collateral securing any loan may depend on the type of loan
and may vary in value based on market conditions.  The remainder of our loan
portfolio is in consumer loans which represent less than 1% of the total.

Loans classified by type as of September 30, 2022 and December 31, 2021 are as
follows (dollars in thousands):


                                           September 30, 2022    December 

31, 2021

                                          Amount        %         Amount    

%

Construction and land development
Residential                              $   8,437      1.56 %  $    6,805      1.29 %
Commercial                                  32,109      5.94 %      42,344      8.05 %
                                            40,546      7.50 %      49,149      9.34 %
Commercial real estate
Owner occupied                             122,067     22.59 %     113,108     21.48 %
Non-owner occupied                         155,981     28.85 %     129,786     24.65 %
Multifamily                                 11,309      2.09 %      11,666      2.22 %
Farmland                                       564      0.10 %         977      0.19 %
                                           289,921     53.63 %     255,537     48.54 %
Consumer real estate
Home equity lines                           19,891      3.68 %      17,977      3.41 %
Secured by 1-4 family residential,
First deed of trust                         65,704     12.15 %      62,277     11.83 %
Second deed of trust                         6,930      1.28 %      12,118      2.31 %
                                            92,525     17.11 %      92,372     17.55 %
Commercial and industrial loans
(except those secured by real estate)       91,603     16.94 %     100,421 
   19.07 %
Guaranteed student loans                    22,010      4.07 %      25,975      4.93 %
Consumer and other                           4,078      0.75 %       3,003      0.57 %

Total loans                                540,683    100.00 %     526,457    100.00 %
Deferred fees and costs, net                   592                   (433)
Less: allowance for loan losses            (3,370)                 (3,423)
                                         $ 537,905              $  522,601


PPP loans included in commercial and industrial loans in the above table were
$710,000 and $32,601,000 as of September 30, 2022 and December 31, 2021,
respectively.

For more financial data and other information about loans refer to Note 5 “Loans
and allowance for loan losses” in the “Notes to Consolidated Financial
Statements” contained in Item 1 of this Form 10-Q.

                                       47

  Table of Contents

Allowance for loan losses
We monitor and maintain an allowance for loan losses to absorb an estimate of
probable losses inherent in the loan portfolio. The following table presents the
loan loss experience for the dates indicated (dollars in thousands).

                                                              Provision for                                                              Ratio of Net
                                               Beginning      (Recovery of)                                       Ending     Average    Charge-offs to
                                                Balance        Loan Losses       Charge-offs      Recoveries     Balance      Loans      Average Loans
Nine Months Ended September 30, 2022
Construction and land development
Residential                                   $        57    $            12    $           -    $          -    $     69   $   6,676               - %
Commercial                                            229               (54)                -               -         175      34,381               - %
                                                      286               (42)                -               -         244      41,057               - %
Commercial real estate
Owner occupied                                        833                 42                -               -         875     122,052               - %
Non-owner occupied                                  1,083                224                -               -       1,307     141,138               - %
Multifamily                                            35                (2)                -               -          33      14,194               - %
Farmland                                                2                (1)                -               -           1         812               - %
                                                    1,953                263                -               -       2,216     278,196               -
Consumer real estate
Home equity lines                                      12               (58)                -              58          12      19,468            0.30 %
Secured by 1-4 family residential
First deed of trust                                   123                  2                -               4         129      61,001               - %
Second deed of trust                                   47              (312)             (27)             330          38      11,006            2.75 %
                                                      182              (368)             (27)             392         179      91,475            0.40 %
Commercial and industrial loans
(except those secured by real estate)                 486                189            (157)              64         582      85,429          (0.11) %
Student loans                                          65                 26             (24)               -          67      24,293          (0.10) %
Consumer and other                                     29                 
9              (1)               -          37       3,609          (0.03) %
Unallocated                                           422              (377)                -               -          45           -               - %

                                              $     3,423    $         (300)    $       (209)    $        456    $  3,370   $ 524,059            0.05 %

Year Ended December 31, 2021
Construction and land development
Residential                                   $       214    $         (157)    $           -    $          -    $     57   $   7,959               - %
Commercial                                            285               (56)                -               -         229      32,750               - %
                                                      499              (213)                -               -         286      40,709               - %
Commercial real estate
Owner occupied                                      1,047              (214)                -               -         833     127,150               - %
Non-owner occupied                                  1,421              (352)                -              14       1,083     103,535            0.01 %
Multifamily                                            47               (12)                -               -          35      11,111               - %
Farmland                                                2                  -                -               -           2         744               - %
                                                    2,517              (578)                -              14       1,953     242,540            0.01
Consumer real estate
Home equity lines                                      24               (23)                -              11          12      17,860            0.06 %
Secured by 1-4 family residential
First deed of trust                                   166               (54)                -              11         123      57,446            0.02 %
Second deed of trust                                   79                  1             (84)              51          47      11,821          (0.28) %
                                                      269               (76)             (84)              73         182      87,127          (0.01) %
Commercial and industrial loans
(except those secured by real estate)                 408                 47                -              31         486     152,760            0.02 %
Student loans                                          87                 13             (35)               -          65      28,502          (0.12) %
Consumer and other                                     36                 39             (46)               -          29       3,079          (1.49) %
Unallocated                                           154                268                -               -         422           -               - %

                                              $     3,970    $         (500)    $       (165)    $        118    $  3,423   $ 554,717          (0.01) %


                                       48

  Table of Contents

For more financial data and other information about loans refer to Note 5 “Loans
and allowance for loan losses” in the “Notes to Consolidated Financial
Statements” contained in Item 1 of this Form 10-Q.

Asset quality


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

                                                             September 30,       December 31,
                                                                  2022               2021
Nonaccrual loans                                             $           984    $         1,359
Foreclosed properties                                                      -                  -
Total nonperforming assets                                   $           984    $         1,359

Restructured loans (not included in nonaccrual loans
above)

                                                       $         

4,890 $ 5,734


Loans past due 90 days and still accruing (1)                $         

1,714 $ 1,961


Nonaccrual loans to total loans (2)                                     0.18 %             0.26 %

Nonperforming assets to loans (2)                                       0.18 %             0.26 %

Nonperforming assets to total assets                                    0.13 %             0.18 %

Allowance for loan losses to
Loans, net of deferred fees and costs                                   0.62 %             0.65 %
Loans, net of deferred fees and costs (excluding
guaranteed loans)                                                       0.65 %             0.69 %
Nonaccrual loans                                                      342.48 %           251.94 %

(1) All loans 90 days past due and still accruing are rehabilitated student
loans which have a 98% guarantee by the DOE.

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

Nonperforming assets, consisting solely of nonaccrual loans, totaled $984,000 at
September 30, 2022, compared to $1,359,000 at December 31, 2021.

The following table presents an analysis of the changes in nonperforming assets
for the nine months ended September 30, 2022 (in thousands):

                                 Nonaccrual
                                   Loans        OREO      Total
Balance December 31, 2021       $      1,359    $   -    $ 1,359
Additions                                168        -        168
Loans placed back on accrual           (177)        -      (177)
Repayments                             (339)        -      (339)
Charge-offs                             (27)        -       (27)
 Balance September 30, 2022     $        984    $   -    $   984

Nonperforming restructured loans are included in nonaccrual loans. Until a
nonperforming restructured loan has performed in accordance with its
restructured terms for a minimum of nine months, it will remain on nonaccrual
status.


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

                                       49

Table of Contents

only to the extent cash is received. Interest accruals are resumed on such loans
only when in the judgment of management, the loans are estimated to be fully
collectible as to both principal and interest.

There were no specific allowances associated with the total nonaccrual loans of
$984,000 and $1,359,000 at September 30, 2022 and December 31, 2021,
respectively, that were considered impaired.


Cumulative interest income that would have been recorded had nonaccrual loans
been performing would have been approximately $84,000 and $82,000 for the nine
months ended September 30, 2022 and 2021, respectively. Student loans totaling
$1,714,000 and $1,961,000 at September 30, 2022 and December 31, 2021,
respectively, were past due 90 days or more and interest was still being accrued
as principal and interest on such loans have a 98% guarantee by the DOE.  The 2%
not covered by the DOE guarantee is provided for in the allowance for loan
losses.

Deposits


Deposits as of September 30, 2022 and December 31, 2021 were as follows (dollars
in thousands):

                                       September 30, 2022       December 31, 2021
                                         Amount         %        Amount         %
Demand accounts                       $    279,269     41.8 %  $   268,804     40.5 %
Interest checking accounts                  86,894     13.0 %       89,599     13.5 %
Money market accounts                      193,642     29.0 %      187,942     28.3 %
Savings accounts                            57,498      8.6 %       54,106      8.1 %
Time deposits of $250,000 and over           4,643      0.7 %        6,977 
    1.1 %
Other time deposits                         45,873      6.9 %       56,620      8.5 %
Total                                 $    667,819    100.0 %  $   664,048    100.0 %

Total deposits increased by $3,771,000, or 0.57%, from December 31, 2021.
Variances of note are as follows:

?Noninterest bearing demand account balances increased $10,464,000 from December
31, 2021
and represented 41.8% of total deposits compared to 40.5% as of
December 31, 2021. The increase in noninterest bearing demand accounts is a
result of core relationship growth and continued success at converting
non-customer PPP loan applicants into customers.

?Low cost relationship deposits (i.e. interest checking, money market, and
savings) balances increased $6,388,000, or 1.93%, from December 31, 2021. The
increase in these accounts continues to be a result of adding core
relationships, continued growth in accounts from non-customer PPP loan
applicants and the migration of customer funds from time deposits.

?Time deposits decreased by $13,081,000, or 22.11%, from December 31, 2021. The
decrease in time deposits continues to be driven by the migration of customers
from time deposits to lower cost deposit products and the maturity of $993,000
of internet listing service deposits which were not replaced. This decrease
continues to allow us to lower our cost of interest bearing deposits.

                                       50

Table of Contents

The following table presents the average deposits balance and average rate paid
for the dates indicated (dollars in thousands).


                                                   Average Balance                       Average Cost Rate
                                          Nine Months Ended                       Nine Months Ended
                                            September 30,       December 31,        September 30,       December 31,
                                                2022                2021                2022                2021
Noninterest bearing deposits             $           276,662   $      254,481
Interest checking                                     86,679           77,665              0.12 %             0.14 %
Money market                                         194,635          175,313              0.22 %             0.26 %
Savings                                               50,701           41,135              0.16 %             0.16 %
Certificates
Less than $250,000                                    55,329           74,515              0.63 %             1.10 %
$250,000 or more                                       6,371           12,254              0.69 %             0.99 %
Total interest bearing deposits                      393,715          380,882              0.40 %             0.41 %
Total deposits                           $           670,377   $      635,363              0.26 %             0.25 %

The following table presents (in thousands) the scheduled maturities of time
deposits greater than $250,000 which is the maximum FDIC insurance limit.


                            September 30,   December 31,
                                2022            2021
Months to maturity:
Three or less              $         1,029  $       2,458
Over three through six                   -            938
Over six through twelve              2,013          2,785
Over twelve                          1,601            796
Total                      $         4,643  $       6,977


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

Borrowings


We utilize borrowings to supplement deposits to address funding or liability
duration needs. For more financial data and other information about borrowings
refer to Note 7 "Borrowings" in the "Notes to Consolidated Financial Statements"
contained in Item 1 of this Form 10-Q.

Capital resources


Shareholders' equity at September 30, 2022 was $58,372,000 compared to
$63,401,000 at December 31, 2021. The $5,029,000 decrease in shareholders'
equity during the nine months ended September 30, 2022 is primarily due to the
$10,824,000 increase in accumulated other comprehensive loss associated with the
unrealized holding losses arising in the available for sale investment
securities portfolio during the period, which were the result of the movement in
interest rates during the nine months ended September 30, 2022. The increase in
the holding losses was partially offset by the net income of $6,143,000 during
the nine months ended September 30, 2022.

                                       51

Table of Contents

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

                                                             September 30,       December 31,
                                                                  2022               2021
Tier 1 capital
Total bank equity capital                                   $         68,058    $        73,380
Net unrealized loss on available-for-sale securities                  11,547                717
Defined benefit postretirement plan                                       21                 27
Total Tier 1 capital                                                  79,626             74,124

Tier 2 capital
Allowance for loan losses                                              3,370              3,423
Tier 2 capital deduction                                                   -                  -
Total Tier 2 capital                                                   3,370              3,423

Total risk-based capital                                              82,996             77,547

Risk-weighted assets                                        $        573,012    $       531,225

Average assets                                              $        756,336    $       751,708

Capital ratios
Leverage ratio (Tier 1 capital to average assets)                      10.53 %             9.86 %
Common equity tier 1 capital ratio (CET 1)                             13.90 %            14.01 %
Tier 1 capital to risk-weighted assets                                 13.90 %            14.01 %
Total capital to risk-weighted assets                                  14.48 %            14.66 %
Equity to total assets                                                  9.16 %             9.83 %

For more financial data and other information about capital resources, refer to
Note 13 “Shareholders’ Equity and Regulatory Matters” in the “Notes to
Consolidated Financial Statements” contained in Item 1 of this Form 10-Q.

Liquidity


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

At September 30, 2022, our liquid assets, consisting of cash, cash equivalents
and investment securities available for sale, totaled $166,684,000, or 22.44% of
total assets. Investment securities traditionally provide a secondary source of
liquidity since they can be converted into cash in a timely manner.

Our holdings of liquid assets plus the ability to maintain and expand our
deposit base and borrowing capabilities serve as our principal sources of
liquidity. We plan to meet our future cash needs through the liquidation of
temporary investments, the generation of deposits, and from additional
borrowings. In addition, we will receive cash upon the maturity and sale of
loans and the maturity of investment securities. We maintain two federal funds
lines of credit with correspondent banks totaling $15 million for which there
were no borrowings against the lines at September 30, 2022 and December 31,
2021.

We are also a member of the Federal Home Loan Bank of Atlanta, from which
applications for borrowings can be made. The FHLB requires that securities,
qualifying mortgage loans, and stock of the FHLB owned by the Bank be pledged to
secure any advances from the FHLB. The unused borrowing capacity currently
available from the FHLB at September 30, 2022 was $33.4 million, based on the


                                       52

  Table of Contents

Bank's qualifying collateral available to secure any future borrowings. However,
we are able to pledge additional collateral to the FHLB in order to increase our
available borrowing capacity up to 25% of assets.

Liquidity provides us with the ability to meet normal deposit withdrawals, while
also providing for the credit needs of customers. We are committed to
maintaining liquidity at a level sufficient to protect depositors, provide for
reasonable growth, and fully comply with all regulatory requirements.

At September 30, 2022, we had commitments to originate $124,152,000 of loans.
Fixed commitments to incur capital expenditures were less than $100,000 at
September 30, 2022. Certificates of deposit scheduled to mature in the 12-month
period ending September 30, 2022 totaled $32,879,000. We believe that a
significant portion of such deposits will remain with us. We further believe
that deposit growth, loan repayments and other sources of funds will be adequate
to meet our foreseeable short-term and long-term liquidity needs.

Interest rate sensitivity

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

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

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

Impact of inflation and changing prices


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

LIBOR and Other Benchmark Rates


Following the announcement by the U.K.'s Financial Conduct Authority in July
2017 that it will no longer persuade or require banks to submit rates for LIBOR
after 2021, central banks and regulators around the world have commissioned
working groups to find suitable replacements for Interbank Offered Rates
("IBOR") and other benchmark rates and to implement financial benchmark reforms
more generally. These actions have resulted in uncertainty regarding the use of
alternative reference rates ("ARRs") and could cause disruptions in a variety of
markets, as well as adversely impact our business, operations and financial
results.

                                       53

  Table of Contents

To facilitate an orderly transition from IBORs and other benchmark rates to
ARRs, the Company has established a company-wide initiative led by senior
management. The objective of this initiative is to identify and assess the
Company’s exposure and develop an appropriate action plan to address prior to
transition.

© Edgar Online, source Glimpses

Source link

Leave a Reply

Your email address will not be published. Required fields are marked *