VABK 10-Q Quarterly Report Sept. 30, 2019

VABK 10-Q Quarter ended Sept. 30, 2019

Exhibits

Exhibits

VIRGINIA NATIONAL BANKSHARES CORP

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10-Q 1 vabk-10q_20190930.htm 10-Q vabk-10q_20190930.htm

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC 20549

FORM 10-Q

(Mark One)

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

For the quarterly period ended September 30, 2019

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

For the transition period from ___________ to ___________

Commission File Number: 000-55117

VIRGINIA NATIONAL BANKSHARES CORPORATION

(Exact Name of Registrant as Specified in its Charter)

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

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

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

Title of each class

Trading

Symbol(s)

Name of each exchange on which registered

Common Stock

VABK

OTCQX

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ☒ No ☐

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

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

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

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

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

As of November 6, 2019, the registrant had 2,692,005 shares of common stock, $2.50 par value per share, outstanding.

VIRGINIA NATIONAL BANKSHARES CORPORATION

FORM 10-Q

TABLE OF CONTENTS

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

Item 2 Management’s Discussion and Analysis of Financial Condition and Results of Operations		Page 31
Application of Critical Accounting Policies and Estimates		Page 31
Financial Condition		Page 32
Results of Operations		Page 38

Item 3 Quantitative and Qualitative Disclosures About Market Risk		Page 46

Item 4 Controls and Procedures		Page 46

Part II. Other Information
Item 1 Legal Proceedings		Page 46
Item 1A Risk Factors		Page 46
Item 2 Unregistered Sales of Equity Securities and Use of Proceeds		Page 46
Item 3 Defaults Upon Senior Securities		Page 46
Item 4 Mine Safety Disclosures		Page 46
Item 5 Other Information		Page 46
Item 6 Exhibits		Page 47

Signatures		Page 48

PART I. FINANCI AL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

VIRGINIA NATIONAL BANKSHARES CORPORATION

CONSOLIDATED BALANCE SHEETS

(Dollars in thousands, except per share data)

	September 30, 2019			December 31, 2018*
ASSETS	(Unaudited)
Cash and due from banks	$	13,870		$	11,741
Federal funds sold		13,985			7,133
Securities:
Available for sale, at fair value		77,930			61,392
Restricted securities, at cost		1,684			1,683
Total securities		79,614			63,075
Loans		522,104			537,190
Allowance for loan losses		(3,983	)		(4,891	)
Loans, net		518,121			532,299
Premises and equipment, net		6,354			7,042
Bank owned life insurance		16,301			16,790
Goodwill		372			372
Other intangible assets, net		424			477
Accrued interest receivable and other assets		11,749			5,871
Total assets	$	660,790		$	644,800
LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities:
Demand deposits:
Noninterest-bearing	$	155,134		$	185,819
Interest-bearing		110,152			106,884
Money market and savings deposit accounts		190,568			171,299
Certificates of deposit and other time deposits		123,592			108,531
Total deposits		579,446			572,533
Accrued interest payable and other liabilities		5,790			1,525
Total liabilities		585,236			574,058

Commitments and contingent liabilities
Shareholders' equity:
Preferred stock, $2.50 par value, 2,000,000 shares authorized, no shares outstanding		-			-
Common stock, $2.50 par value, 10,000,000 shares authorized; 2,692,005 (including 4,000 nonvested shares), and 2,543,452 issued and outstanding at September 30, 2019 and December 31, 2018, respectively		6,720			6,359
Capital surplus		32,160			27,013
Retained earnings		36,611			38,647
Accumulated other comprehensive income (loss)		63			(1,277	)
Total shareholders' equity		75,554			70,742
Total liabilities and shareholders' equity	$	660,790		$	644,800

*	Derived from audited Consolidated Financial Statements

See Notes to Consolidated Financial Statements

VIRGINIA NATIONAL BANKSHARES CORPORATION

CONSOLIDATED STATEMENTS OF INCOME

(Dollars in thousands, except per share data)

(Unaudited)

	For the three months ended					For the nine months ended
	September 30, 2019			September 30, 2018		September 30, 2019		September 30, 2018
Interest and dividend income:
Loans, including fees	$	6,021		$	6,200	$	18,223	$	17,849
Federal funds sold		174			46		267		120
Investment securities:
Taxable		291			265		789		814
Tax exempt		64			86		221	257
Dividends		29			42		86		103
Total interest and dividend income		6,579			6,639		19,586		19,143

Interest expense:
Demand and savings deposits		531			277		1,375		773
Certificates and other time deposits		574			413		1,619		815
Repurchase agreements and other borrowings		—			158		89		376
Total interest expense		1,105			848		3,083		1,964
Net interest income		5,474			5,791		16,503		17,179
Provision for (recovery of) loan losses		(120	)		285		500		890
Net interest income after provision for (recovery of) loan losses		5,594			5,506		16,003		16,289

Noninterest income:
Trust income		377			409		1,126		1,250
Advisory and brokerage income		159			144		451		426
Royalty income		5			17		13		569
Deposit account fees		192			210		565		693
Debit/credit card and ATM fees		191			176		537		567
Earnings/increase in value of bank owned life insurance		111			113		687		333
Fees on mortgage sales		43			73		129		155
Gains on sales of securities		7			-		71		-
Losses on sales of other assets		-			-		-		(33	)
Loan swap fee income		116			-		151		-
Other		126			128		356		331
Total noninterest income		1,327			1,270		4,086		4,291

Noninterest expense:
Salaries and employee benefits		2,268			2,049		6,800		6,022
Net occupancy		450			458		1,373		1,387
Equipment		85			128		316		374
Data processing		341			281		987		828
Settlement of claims		160			-		460		-
Other		1,257			1,173		3,721		3,522
Total noninterest expense		4,561			4,089		13,657		12,133

Income before income taxes		2,360			2,687		6,432		8,447
Provision for income taxes		463			527		1,174		1,659
Net income	$	1,897		$	2,160	$	5,258	$	6,788
Net income per common share, basic *	$	0.71		$	0.81	$	1.96	$	2.55
Net income per common share, diluted *	$	0.71		$	0.80	$	1.96	$	2.52
Weighted average common shares outstanding, basic *		2,689,092			2,669,199		2,685,134		2,665,647
Weighted average common shares outstanding, diluted *		2,690,142			2,689,720		2,688,813		2,687,101

*	Share data has been retroactively adjusted to reflect the 5% stock dividend effective July 5, 2019.

See Notes to Consolidated Financial Statements

VIRGINIA NATIONAL BANKSHARES CORPORATION

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(Dollars in thousands)

(Unaudited)

	For the three months ended						For the nine months ended
	September 30, 2019			September 30, 2018			September 30, 2019			September 30, 2018
Net income	$	1,897		$	2,160		$	5,258		$	6,788

Other comprehensive income (loss)

Unrealized gain (loss) on securities, net of tax of $29 and $372 for the three and nine months ended September 30, 2019; and net of tax of ($59) and ($285) for the three and nine months ended September 30, 2018		106			(222	)		1,396			(1,070	)

Reclassification adjustment for realized gains on sales of securities, net of tax of ($1) and ($15) for the three and nine months ended September 30, 2019; and net of tax of $0 and $0 for the three and nine months ended September 30, 2018		(6	)		-			(56	)		-

Total other comprehensive income (loss)		100			(222	)		1,340			(1,070	)

Total comprehensive income	$	1,997		$	1,938		$	6,598		$	5,718

See Notes to Consolidated Financial Statements

VIRGINIA NATIONAL BANKSHARES CORPORATION

CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY

FOR THE THREE MONTHS ENDED MARCH 31, JUNE 30 AND SEPTEMBER 30, 2019 AND 2018

(Dollars in thousands, except per share data)

(Unaudited)

									Accumulated
									Other
	Common		Capital			Retained			Comprehensive
	Stock		Surplus			Earnings			Income (Loss)			Total
Balance, December 31, 2017	$	6,027	$	22,038		$	37,923		$	(883	)	$	65,105
Stock options exercised		16		128			-			-			144
Stock option expense		-		1			-			-			1
Stock dividend distributable *		301		4,673			(4,974	)		-			-
Cash dividends declared ($0.19 per share)		-		-			(482	)		-			(482	)
Net income		-		-			2,796			-			2,796
Other comprehensive loss		-		-			-			(743	)		(743	)
Balance, March 31, 2018	$	6,344	$	26,840		$	35,263		$	(1,626	)	$	66,821
Stock options exercised		9		65			-			-			74
Stock option expense		-		16			-			-			16
Cash dividends declared ($0.30 per share)		-		-			(763	)		-			(763	)
Net income		-		-			1,832			-			1,832
Other comprehensive loss		-		-			-			(105	)		(105	)
Balance, June 30, 2018	$	6,353	$	26,921		$	36,332		$	(1,731	)	$	67,875
Stock options exercised		6		44			-			-			50
Stock option expense		-		24			-			-			24
Cash dividends declared ($0.30 per share)		-		-			(763	)		-			(763	)
Net income		-		-			2,160			-			2,160
Other comprehensive loss		-		-			-			(222	)		(222	)
Balance, September 30, 2018	$	6,359	$	26,989		$	37,729		$	(1,953	)	$	69,124

Balance, December 31, 2018	$	6,359	$	27,013		$	38,647		$	(1,277	)	$	70,742
Stock options exercised		14		88			-			-			102
Stock option expense		-		24			-			-			24
Stock grants		27		397			-			-			424
Cash dividends declared ($0.30 per share)		-		-			(767	)		-			(767	)
Net income		-		-			1,246			-			1,246
Other comprehensive income		-		-			-			754			754
Balance, March 31, 2019	$	6,400	$	27,522		$	39,126		$	(523	)	$	72,525
Stock option expense		-		23			-			-			23
Stock dividend distributable **		320		4,593			(4,913	)		-			-
Cash dividends declared ($0.30 per share)		-		-			(806	)		-			(806	)
Net income		-		-			2,115			-			2,115
Other comprehensive income		-		-			-			486			486
Balance, June 30, 2019	$	6,720	$	32,138		$	35,522		$	(37	)	$	74,343
Stock option expense		-		24			-			-			24
Stock grants		-		3			-			-			3
Cash in lieu of fractional shares		-		(5	)		-			-			(5	)
Cash dividends declared ($0.30 per share)		-		-			(808	)		-			(808	)
Net income		-		-			1,897			-			1,897
Other comprehensive income		-		-			-			100			100
Balance, September 30, 2019	$	6,720	$	32,160		$	36,611		$	63		$	75,554

* 5% stock dividend distributed effective April 13, 2018.

** 5% stock dividend distributed effective July 5, 2019.

See Notes to Consolidated Financial Statements

VIRGINIA NATIONAL BANKSHARES CORPORATION

CONSOLIDATED STATEMENTS OF CASH FLOWS

(dollars in thousands)

(Unaudited)

	For the nine months ended
	September 30, 2019			September 30, 2018
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income	$	5,258		$	6,788
Adjustments to reconcile net income to net cash provided by operating activities:
Provision for loan losses		500			890
Net amortization and accretion of securities		200			209
Net gains on sale of securities		(71	)		-
Net losses on sales of assets		-			33
Earnings on bank owned life insurance		(687	)		(333	)
Amortization of intangible assets		67			83
Depreciation and other amortization		812			849
Stock option expense		74			41
Stock grants, unrestricted		424			-
Net change in:
Accrued interest receivable and other assets		(1,921	)		297
Accrued interest payable and other liabilities		(58	)		38
Net cash provided by operating activities		4,598			8,895

CASH FLOWS FROM INVESTING ACTIVITIES:
Net (increase) decrease in restricted investments		(1	)		176
Purchases of available for sale securities		(40,608	)		-
Proceeds from maturities, calls and principal payments of available for sale securities		4,573			3,837
Proceeds from sales of available for sale securities		21,065			-
Net decrease (increase) in organic loans		9,654			(604	)
Net decrease in purchased loans		4,024			1,806
Cash payment for wealth management book of business		(50	)		(100	)
Proceeds from settlement of bank owned life insurance		1,176			-
Purchase of bank premises and equipment		(124	)		(731	)
Net cash (used in) provided by investing activities		(291	)		4,384

CASH FLOWS FROM FINANCING ACTIVITIES:
Net decrease in demand deposits, NOW accounts, and money market accounts		(8,148	)		(22,417	)
Net increase in certificates of deposit and other time deposits		15,061			17,957
Net decrease in repurchase agreements		-			(11,899	)
Net decrease in other short term borrowings		-			(5,000	)
Proceeds from stock options exercised		102			268
Cash payment for stock dividend fractional shares		(5	)		-
Cash dividends paid		(2,336	)		(1,703	)
Net cash provided by (used in) financing activities		4,674			(22,794	)
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS	$	8,981		$	(9,515	)

CASH AND CASH EQUIVALENTS:
Beginning of period	$	18,874		$	18,277
End of period	$	27,855		$	8,762

SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION
Cash payments for:
Interest	$	2,963		$	1,800
Taxes	$	1,650		$	1,990

SUPPLEMENTAL SCHEDULE OF NONCASH INVESTING AND FINANCING ACTIVITIES
Unrealized gain (loss) on available for sale securities	$	1,697		$	(1,355	)
Initial right-of-use assets obtained in exchange for new operating lease liabilities	$	4,279		$	-

See Notes to Consolidated Financial Statements

VIRGINIA NATIONAL BANKSHARES CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

September 30, 2019

Note 1. Significant Accounting Policies

Basis of Presentation

The consolidated financial statements include the accounts of Virginia National Bankshares Corporation (the “Company”), and its subsidiaries Virginia National Bank (the “Bank”) and Masonry Capital Management, LLC (“Masonry Capital”), a registered investment adviser. Effective July 1, 2018, VNBTrust, National Association (“VNBTrust”), formerly a subsidiary of the Bank, was merged into Virginia National Bank, and the Bank continued to offer investment management, wealth advisory and trust and estate administration services under the name of VNB Wealth Management, also referred to herein as “VNB Wealth.” All references herein to VNB Wealth Management or VNB Wealth refer to VNBTrust for periods prior to July 1, 2018. In 2019, the services offered by VNB Wealth are provided by Masonry Capital or by the Bank under VNB Trust & Estate Services or VNB Investment Services. All significant intercompany balances and transactions have been eliminated in consolidation.

The unaudited consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) for interim financial information. Accordingly, the unaudited consolidated financial statements do not include all of the information and footnotes required by GAAP for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring items) considered necessary for a fair presentation have been included.

The preparation of financial statements in conformity with GAAP and the reporting guidelines prescribed by regulatory authorities requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Material estimates that are particularly susceptible to significant change in the near term relate to the determination of the allowance for loan losses (including impaired loans), other-than-temporary impairment of securities, intangible assets, and fair value measurements. Operating results for the three and nine months ended September 30, 2019 are not necessarily indicative of the results that may be expected for the year ending December 31, 2019.

The statements should be read in conjunction with the Notes to Consolidated Financial Statements included in the Company’s Form 10-K for the year ended December 31, 2018. If needed, certain previously reported amounts have been reclassified to conform to current period presentation. No such reclassifications were significant.

Recent Accounting Pronouncements

Financial Instruments – Credit Losses In June 2016, the FASB issued ASU No. 2016-13, “Financial Instruments – Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments.” The amendments in this ASU, among other things, require the measurement of all expected credit losses for financial assets held at the reporting date based on historical experience, current conditions, and reasonable and supportable forecasts. Financial institutions and other organizations will now use forward-looking information to better inform their credit loss estimates. Many of the loss estimation techniques applied today will still be permitted, although the inputs to those techniques will change to reflect the full amount of expected credit losses. In addition, the ASU amends the accounting for credit losses on available-for-sale debt securities and purchased financial assets with credit deterioration. At its October 16, 2019 meeting, FASB’s board affirmed its decision to delay the effective date of the ASU for smaller reporting companies, like the Company, until fiscal years beginning after December 15, 2022, and interim periods within those years. The Company is currently assessing the impact that ASU 2016-13 will have on its consolidated financial statements. Early in 2017, the Company formed a cross-functional steering committee, including some members of senior management, to provide governance and guidance over the project plan. The steering committee meets regularly to address the compliance requirements, data requirements and sources, and analysis efforts that are required to adopt these new requirements. In addition to attending seminars and webinars on this topic with regulators and other experts, the committee is working closely with the Company’s vendor to gather additional loan data which is anticipated to be needed for this calculation and is attending training sessions on the software to be utilized to calculate the expected credit losses. The extent of the change is indeterminable at this time as it will be dependent upon portfolio composition and credit quality at the adoption date, as well as economic conditions and forecasts at that time. Upon adoption, the impact to the allowance for credit losses (currently allowance for loan losses) will have an offsetting one-time cumulative-effect adjustment to retained earnings.

Goodwill Impairment Testing In January 2017, the FASB issued ASU No. 2017-04, “Intangibles – Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment.” The amendments in this A SU simplify how an entity is required to test goodwill for impairment by eliminating Step 2 from the goodwill impairment test. Step 2 measures a goodwill impairment loss by comparing the implied fair value of a reporting unit’s goodwill with the carrying a mount of that goodwill. Instead, under the amendments in this ASU, an entity should perform its annual, or interim, goodwill impairment test by comparing the fair value of a reporting unit with its carrying amount. An entity still has the option to perform the qualitative assessment for a reporting unit to determine if the quantitative impairment test is necessary. Public business entities that are SEC filers should adopt the amendments in this ASU for annual or interim goodwill impairment tests in fiscal y ears beginning after December 15, 2019. Early adoption is permitted for interim or annual goodwill impairment tests performed on testing dates after January 1, 2017. The Company does not expect the adoption of ASU 2017-04 to have a material impact on its c onsolidated financial statements.

Disclosure Framework - Changes to the Disclosure Requirements for Fair Value Measurement In August 2018, the FASB issued ASU 2018-13, “Fair Value Measurement (Topic 820): Disclosure Framework - Changes to the Disclosure Requirements for Fair Value Measurement.” The amendments modify the disclosure requirements in Topic 820 to add disclosures regarding changes in unrealized gains and losses, the range and weighted average of significant unobservable inputs used to develop Level 3 fair value measurements and the narrative description of measurement uncertainty. Certain disclosure requirements in Topic 820 are also removed or modified. The amendments are effective for fiscal years beginning after December 15, 2019, and interim periods within those fiscal years. Certain of the amendments are to be applied prospectively while others are to be applied retrospectively. Early adoption is permitted. The Company does not expect the adoption of ASU 2018-13 to have a material impact on its consolidated financial statements.

Financial Instruments – Credit Losses – Derivatives and Hedging In April 2019, the FASB issued ASU 2019-04, “Codification Improvements to Topic 326, Financial Instruments—Credit Losses, Topic 815, Derivatives and Hedging, and Topic 825, Financial Instruments.” This ASU clarifies and improves areas of guidance related to the recently issued standards on credit losses, hedging, and recognition and measurement including improvements resulting from various Transition Resource Group meetings. The amendments are effective for fiscal years beginning after December 15, 2019, and interim periods within those fiscal years. Early adoption is permitted. The Company is currently assessing the impact that ASU 2019-04 will have on its consolidated financial statements.

Financial Instruments – Credit Losses – Targeted Transition Relief In May 2019, the FASB issued ASU 2019-05, “Financial Instruments—Credit Losses (Topic 326): Targeted Transition Relief.” The amendments in this ASU provide entities that have certain instruments within the scope of Subtopic 326-20 with an option to irrevocably elect the fair value option in Subtopic 825-10, applied on an instrument-by-instrument basis for eligible instruments, upon the adoption of Topic 326. The fair value option election does not apply to held-to-maturity debt securities. An entity that elects the fair value option should subsequently measure those instruments at fair value with changes in fair value flowing through earnings. The amendments are effective for fiscal years beginning after December 15, 2019, and interim periods within those fiscal years. The amendments should be applied on a modified-retrospective basis by means of a cumulative-effect adjustment to the opening balance of retained earnings balance in the balance sheet. Early adoption is permitted. The Company is currently assessing the impact that ASU 2019-05 will have on its consolidated financial statements.

Note 2. Securities

The amortized cost and fair values of securities available for sale as of September 30, 2019 and December 31, 2018 were as follows (dollars in thousands):

September 30, 2019	Amortized		Gross Unrealized		Gross Unrealized			Fair
	Cost		Gains		(Losses)			Value
U.S. Government agencies	$	12,000	$	-	$	(25	)	$	11,975
Mortgage-backed securities/CMOs		50,987		45		(261	)		50,771
Municipal bonds		14,863		336		(15	)		15,184
Total Securities Available for Sale	$	77,850	$	381	$	(301	)	$	77,930

December 31, 2018	Amortized		Gross Unrealized		Gross Unrealized			Fair
	Cost		Gains		(Losses)			Value
U.S. Government agencies	$	19,500	$	-	$	(526	)	$	18,974
Mortgage-backed securities/CMOs		25,901		1		(839	)		25,063
Municipal bonds		17,608		12		(265	)		17,355
Total Securities Available for Sale	$	63,009	$	13	$	(1,630	)	$	61,392

As of September 30, 2019, there were $49.1 million, or 34 issues of individual securities, held in an unrealized loss position. These securities have an unrealized loss of $301 thousand and consisted of 27 mortgage-backed/CMOs, 4 municipal bonds, and 3 agency bonds.

The following table summarizes all securities with unrealized losses, segregated by length of time in a continuous unrealized loss position, at September 30, 2019, and December 31, 2018 (dollars in thousands) :

September 30, 2019
	Less than 12 Months					12 Months or more					Total
			Unrealized					Unrealized					Unrealized
	Fair Value		Losses			Fair Value		Losses			Fair Value		Losses
U.S. Government agencies	$	7,488	$	(12	)	$	1,987	$	(13	)	$	9,475	$	(25	)
Mortgage-backed/CMOs		26,816		(154	)		11,414		(107	)		38,230		(261	)
Municipal bonds		848		(15	)		502		-			1,350		(15	)
	$	35,152	$	(181	)	$	13,903	$	(120	)	$	49,055	$	(301	)

December 31, 2018
	Less than 12 Months					12 Months or more					Total
			Unrealized					Unrealized					Unrealized
	Fair Value		Losses			Fair Value		Losses			Fair Value		Losses
U.S. Government agencies	$	-	$	-		$	18,974	$	(526	)	$	18,974	$	(526	)
Mortgage-backed/CMOs		-		-			24,657		(839	)		24,657		(839	)
Municipal bonds		4,983		(34	)		10,722		(231	)		15,705		(265	)
	$	4,983	$	(34	)	$	54,353	$	(1,596	)	$	59,336	$	(1,630	)

The Company’s securities portfolio is primarily made up of fixed rate bonds, the prices of which move inversely with interest rates. Any unrealized losses are considered by management to be driven by increases in market interest rates over the yields available at the time the underlying securities were purchased. The fair value is expected to recover as the bonds approach their maturity date or repricing date or if market yields for such investments decline. At the end of any accounting period, the portfolio may have both unrealized gains and losses. Management does not believe any of the securities in an unrealized loss position are impaired due to credit quality. Accordingly, as of September 30, 2019, management believes the impairments detailed in the table above are temporary, and no impairment loss has been realized in the Company’s consolidated income statement.

An “other-than-temporary impairment” (“OTTI”) is considered to exist if either of the following conditions are met: it is more likely than not that the Company will be required to sell the security before recovery of its amortized cost basis, or the Company does not expect to recover the security’s entire amortized cost basis (even if the Company does not intend to sell). In the event that a security would suffer impairment for a reason that was “other than temporary,” the Company would be expected to write down the security’s value to its new fair value, and the amount of the write down would be included in earnings as a realized loss. As of September 30, 2019, management has concluded that none of its investment securities have an OTTI based upon the information available. Additionally, management has the ability to hold any security with an unrealized loss until maturity or until such time as the value of the security has recovered from its unrealized loss position.

Securities having carrying values of $5.0 million at September 30, 2019 were pledged as collateral to secure public deposits. At December 31, 2018, securities having carrying values of $18.0 million were similarly pledged.

For the nine months ended September 30, 2019, proceeds from the sales of securities amounted to $21.1 million, and realized gain on these securities was $71 thousand. For the nine months ended September 30, 2018, there were no sales of securities.

Restricted securities are securities with limited marketability and consist of stock in the Federal Reserve Bank of Richmond (“FRB”), the Federal Home Loan Bank of Atlanta (“FHLB”), and CBB Financial Corporation (“CBBFC”), the holding company for Community Bankers Bank. These restricted securities, totaling $1.7 million as of both September 30, 2019 and December 31, 2018 are carried at cost.

Note 3. Loans

The composition of the loan portfolio by loan classification at September 30, 2019 and December 31, 2018 appears below (dollars in thousands).

	September 30,			December 31,
	2019			2018
Commercial
Commercial and industrial - organic	$	38,308		$	41,526
Commercial and industrial - government guaranteed		36,799			31,367
Commercial and industrial - syndicated		6,406			12,134
Total commercial and industrial		81,513			85,027
Real estate construction and land
Residential construction		1,476			1,552
Commercial construction		6,290			5,078
Land and land development		8,905			10,894
Total construction and land		16,671			17,524
Real estate mortgages
1-4 family residential, first lien, investment		42,625			40,311
1-4 family residential, first lien, owner occupied		17,916			16,775
1-4 family residential, junior lien		2,643			3,169
1-4 family residential - purchased		18,339			18,647
Home equity lines of credit, first lien		8,954			8,325
Home equity lines of credit, junior lien		10,055			10,912
Farm		8,895			10,397
Multifamily		26,968			27,328
Commercial owner occupied		94,169			93,800
Commercial non-owner occupied		116,522			123,214
Total real estate mortgage		347,086			352,878
Consumer
Consumer revolving credit		24,987			21,540
Consumer all other credit		4,329			5,530
Student loans purchased		47,518			54,691
Total consumer		76,834			81,761
Total loans		522,104			537,190
Less: Allowance for loan losses		(3,983	)		(4,891	)
Net loans	$	518,121		$	532,299

The balances in the table above include unamortized premiums and net deferred loan costs and fees. As of September 30, 2019, and December 31, 2018, unamortized premiums on loans purchased were $2.7 million and $2.5 million, respectively. Net deferred loan costs (fees) totaled $96 thousand and $129 thousand as of September 30, 2019 and December 31, 2018, respectively.

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

Following is a breakdown by class of the loans classified as impaired loans as of September 30, 2019 and December 31, 2018. These loans are reported at their recorded investment, which is the carrying amount of the loan as reflected on the Company’s balance sheet, net of charge-offs and other amounts applied to reduce the net book balance. Average recorded investment in impaired loans is computed using an average of month-end balances for these loans for either the nine months ended September 30, 2019 or the twelve months ended December 31, 2018. Interest income recognized is for the nine months ended September 30, 2019 or the twelve months ended December 31, 2018. (Dollars below reported in thousands.)

September 30, 2019	Recorded Investment		Unpaid Principal Balance		Associated Allowance		Average Recorded Investment		Interest Income Recognized
Impaired loans without a valuation allowance:
Land and land development	$	15	$	59	$	-	$	26	$	-
1-4 family residential mortgages, first lien, owner occupied		-		-		-		26		-
1-4 family residential mortgages, junior lien		120		120		-		123		5
Commercial non-owner occupied real estate		887		887		-		906		36
Total impaired loans without a valuation allowance		1,022		1,066		-		1,081		41

Impaired loans with a valuation allowance
Student loans purchased		1,603		1,603		9		1,599		73
Total impaired loans with a valuation allowance		1,603		1,603		9		1,599		73
Total impaired loans	$	2,625	$	2,669	$	9	$	2,680	$	114

December 31, 2018	Recorded Investment		Unpaid Principal Balance		Associated Allowance		Average Recorded Investment		Interest Income Recognized
Impaired loans without a valuation allowance:
Land and land development	$	32	$	90	$	-	$	37	$	-
1-4 family residential mortgages, first lien, owner occupied		82		127		-		90		-
1-4 family residential mortgages, junior lien		127		127		-		248		15
Commercial non-owner occupied real estate		923		923		-		947		51
Total impaired loans without a valuation allowance		1,164		1,267		-		1,322		66

Impaired loans with a valuation allowance
Student loans purchased		1,602		1,602		90		1,387		86
Total impaired loans with a valuation allowance		1,602		1,602		90		1,387		86
Total impaired loans	$	2,766	$	2,869	$	90	$	2,709	$	152

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

	September 30, 2019		December 31, 2018
Land and land development	$	15	$	32
1-4 family residential mortgages, first lien, owner occupied		-		82
Student loans purchased		322		445
Commercial and industrial - organic		-		56
Total non-accrual loans	$	337	$	615

Additionally, Troubled Debt Restructurings (“TDRs”) are considered impaired loans. TDRs occur when the Company agrees to modify the original terms of a loan by granting a concession that it would not otherwise consider due to the deterioration in the financial condition of the borrower. These concessions are done in an attempt to improve the paying capacity of the borrower, and in some cases to avoid foreclosure, and are made with the intent to restore the loan to a

performing status once sufficient payme nt history can be demonstrated. These concessions could include reductions in the interest rate, payment extensions, forgiveness of principal, forbearance or other actions.

Based on regulatory guidance on Student Lending, the Company has classified 76 of its student loans purchased as TDRs for a total of $1.3 million as of September 30, 2019. These borrowers that should have been in repayment have requested and been granted payment extensions or reductions exceeding the maximum lifetime allowable payment forbearance of twelve months (36 months lifetime allowance for military service), as permitted under the regulatory guidance, and are therefore considered restructurings. Student loan borrowers are allowed in-school deferments, plus an automatic six-month grace period post in-school status, before repayment is scheduled to begin, and these deferments do not count toward the maximum allowable forbearance. Initially, all student loans were fully insured by a surety bond, and the Company did not expect to experience a loss on these loans. Based on the loss of insurance after July 27, 2018 due to the insolvency of the insurer, management has evaluated these loans individually for impairment and included any potential loss in the allowance for loan losses; interest continues to accrue on these TDRs during any deferment and forbearance periods.

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

Troubled debt restructurings (TDRs)	September 30, 2019				December 31, 2018
	No. of		Recorded		No. of		Recorded
	Loans		Investment		Loans		Investment
Performing TDRs
1-4 family residential mortgages, junior lien		1	$	120		1	$	127
Commercial non-owner occupied real estate		1		887		1		923
Student loans purchased		76		1,281		65		1,157
Total performing TDRs		78		2,288		67		2,207

Nonperforming TDRs
Student loans purchased		-	$	-		1	$	4
Land and land development		1		15		1		19
Total nonperforming TDRs		1		15		2		23
Total TDRs		79		2,303		69		2,230

A summary of loans shown above that were modified under the terms of a TDR during the three and nine months ended September 30, 2019 and 2018 is shown below by class (dollars in thousands). The Post-Modification Recorded Balance reflects the period end balances, inclusive of any interest capitalized to principal, partial principal paydowns, and principal charge-offs since the modification date. Loans modified as TDRs that were fully paid down, charged-off, or foreclosed upon by period end are not reported.

	For three months ended						For three months ended
	September 30, 2019						September 30, 2018
	Number of Loans		Pre- Modification Recorded Balance		Post- Modification Recorded Balance		Number of Loans		Pre- Modification Recorded Balance		Post- Modification Recorded Balance
Student loans purchased		10	$	78	$	78		1	$	15	$	15
Total loans modified during the period		10		78		78		1		15		15

	For the nine months ended						For the nine months ended
	September 30, 2019						September 30, 2018
	Number of Loans		Pre- Modification Recorded Balance		Post- Modification Recorded Balance		Number of Loans		Pre- Modification Recorded Balance		Post- Modification Recorded Balance
Student loans purchased		12	$	133	$	133		8	$	135	$	135
Total loans modified during the period		12		133		133		8		135		135

During the nine months ended September 30, 2019 , t here were t hree loans modified as TDRs that subsequently defaulted which had been modified as TDRs during the twelve months prior to default . These student loans had a balance of $ 23 thousand prior to being charged off. T here was one loan modified as a TDR that subsequently defaulted during th e year ending December 31, 2018 which had been modified as a TDR during the twelve months prior to default. This stu dent loan had a balance of $33 thousand prior to being charged off.

There were no loans secured by 1-4 family residential property that were in the process of foreclosure at either September 30, 2019 or December 31, 2018.

Note 4. Allowance for Loan Losses

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

For purposes of determining the allowance for loan losses, the Company has segmented certain loans in the portfolio by product type. Within these segments, the Company has sub-segmented its portfolio by classes within the segments, based on the associated risks within these classes.


Loan Classes by Segments

Commercial loan segment:
	Commercial and industrial - organic
	Commercial and industrial - government guaranteed
	Commercial and industrial - syndicated

Real estate construction and land loan segment:
	Residential construction
	Commercial construction
	Land and land development

Real estate mortgage loan segment:
	1-4 family residential, first lien, investment
	1-4 family residential, first lien, owner occupied
	1-4 family residential, junior lien
	Home equity lines of credit, first lien
	Home equity lines of credit, junior lien
	Farm
	Multifamily
	Commercial owner occupied
	Commercial non-owner occupied

Consumer loan segment:
	Consumer revolving credit
	Consumer all other credit
	Student loans purchased

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

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

•

Student loans purchased - On June 27, 2018, the Company was notified that ReliaMax Surety Company (“ReliaMax Surety”), the South Dakota insurance company which issued surety bonds for the student loan pools, was placed into liquidation due to insolvency. As such, the historical charge-off rate on this portfolio is determined

by using the Company’s ow n losses/charge-offs sin ce July 1, 2018 together with prior insurance claim history. For reporting periods prior to June 30, 2018, the Company did not charge off student loans as the insurance covered the past due loans, but the Company did apply qualitative factors to calculate a reserve on these loans, net of the deposit reserve accounts held by the Company for this group of loans.

•

Commercial and industrial government guaranteed loans – These loans require no reserve as these are 100% guaranteed by either the Small Business Administration (“SBA”) or the United States Department of Agriculture (“USDA”).

•

Commercial and industrial syndicated loans - Prior to the quarter ended September 30, 2016, there was not an established loss history in the commercial and industrial syndicated loans. The S&P credit and recovery ratings on the credit facilities were utilized to calculate a three-year weighted average historical default rate. During the third quarter of 2016, there was a small loss in the commercial and industrial syndicated loans; therefore, the Company utilized a combination of the migration analysis loss method and the S&P credit and recovery ratings.

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

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

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

Risk Ratings and Historical Loss Factor Assigned

Excellent

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

Good

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

Pass

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

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

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

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

Watch

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

Special Mention

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

Substandard

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

Doubtful

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

The following represents the loan portfolio designated by the internal risk ratings assigned to each credit as of September 30, 2019 and December 31, 2018 (dollars in thousands). There were no loans rated “Doubtful” as of either period.

September 30, 2019	Excellent		Good		Pass		Watch		Special Mention		Sub- standard		TOTAL
Commercial
Commercial and industrial - organic	$	2,244	$	18,810	$	16,564	$	158	$	30	$	502	$	38,308
Commercial and industrial - government guaranteed		36,799		-		-		-		-		-		36,799
Commercial and industrial - syndicated		-		-		6,406		-		-		-		6,406
Real estate construction
Residential construction		-		-		1,476		-		-		-		1,476
Commercial construction		-		-		6,290		-		-		-		6,290
Land and land development		-		-		8,399		477		-		29		8,905
Real estate mortgages
1-4 family residential, first lien investment		-		-		38,460		3,789		113		263		42,625
1-4 family residential, first lien, owner occupied		-		-		16,804		1,051		8		53		17,916
1-4 family residential, junior lien		-		-		2,129		35		19		460		2,643
1-4 family residential, first lien - purchased		-		-		18,339		-		-		-		18,339
Home equity lines of credit, first lien		-		-		8,292		662		-		-		8,954
Home equity lines of credit, junior lien		-		-		9,707		266		-		82		10,055
Farm		-		-		7,264		323		-		1,308		8,895
Multifamily		-		-		26,968		-		-		-		26,968
Commercial owner occupied		-		-		82,177		6,620		1,697		3,675		94,169
Commercial non-owner occupied		-		-		112,836		2,642		-		1,044		116,522
Consumer
Consumer revolving credit		91		24,442		442		11		-		1		24,987
Consumer all other credit		234		3,637		458		-		-		-		4,329
Student loans purchased		-		-		44,689		2,261		401		167		47,518
Total Loans	$	39,368	$	46,889	$	407,700	$	18,295	$	2,268	$	7,584	$	522,104

December 31, 2018	Excellent		Good		Pass		Watch		Special Mention		Sub- standard		TOTAL
Commercial
Commercial and industrial - organic	$	3,692	$	23,381	$	13,993	$	264	$	28	$	168	$	41,526
Commercial and industrial - government guaranteed		31,367		-		-		-		-		-		31,367
Commercial and industrial - syndicated		-		-		9,588		-		-		2,546		12,134
Real estate construction
Residential construction		-		-		1,552		-		-		-		1,552
Commercial construction		-		-		5,078		-		-		-		5,078
Land and land development		-		-		9,888		501		-		505		10,894
Real estate mortgages
1-4 family residential, first lien, investment		-		-		36,314		3,607		117		273		40,311
1-4 family residential, first lien, owner occupied		-		-		15,540		1,087		11		137		16,775
1-4 family residential, junior lien		-		-		2,573		58		22		516		3,169
1-4 family residential, first lien - purchased		-		-		18,647		-		-		-		18,647
Home equity lines of credit, first lien		-		-		7,911		414		-		-		8,325
Home equity lines of credit, junior lien		-		-		10,704		97		-		111		10,912
Farm		-		-		8,719		339		-		1,339		10,397
Multifamily		-		-		27,328		-		-		-		27,328
Commercial owner occupied		-		-		86,868		6,932		-		-		93,800
Commercial non-owner occupied		-		-		120,720		1,519		-		975		123,214
Consumer
Consumer revolving credit		44		20,852		644		-		-		-		21,540
Consumer all other credit		263		4,699		535		4		-		29		5,530
Student loans purchased		-		-		51,494		2,401		431		365		54,691
Total Loans	$	35,366	$	48,932	$	428,096	$	17,223	$	609	$	6,964	$	537,190

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

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

Changes in the value of underlying collateral;

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

Changes in volume of delinquent loans;

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

Changes in lending policies and procedures, including underwriting standards;

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

Changes in the level of policy exceptions.

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

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

Impaired loans are individually evaluated and, if deemed appropriate, a specific allocation is made for these loans. In reviewing the loans classified as impaired loans totaling $ 2. 6 million at September 30, 2019 , s pe cific valuation allowance was recogniz ed after consideration was given for each borrowing as to the fair value of the collat eral on the loan or the present value of expected future cash flows from the borrower . The $ 9 thousand in the allowance total shown below as individually evaluated for i mpairment was attributed to the impaired student loans that required an allowance as of September 30, 2019 due to the loss of the insurance on this portfolio as discusse d previously.

A summary of the transactions in the Allowance for Loan Losses by loan portfolio segment for the nine months ended September 30, 2019 and the year ended December 31, 2018 appears below (dollars in thousands):

Allowance for Loan Losses Rollforward by Portfolio Segment
As of and for the period ended September 30, 2019
	Commercial Loans			Real Estate Construction and Land			Real Estate Mortgages			Consumer Loans			Total
Allowance for Loan Losses:
Balance as of January 1, 2019	$	811		$	119		$	2,611		$	1,350		$	4,891
Charge-offs		(482	)		-			-			(1,088	)		(1,570	)
Recoveries		43			-			15			104			162
Provision for (recovery of) loan losses		(148	)		(13	)		(38	)		699			500
Ending Balance	$	224		$	106		$	2,588		$	1,065		$	3,983

Ending Balance:
Individually evaluated for impairment	$	-		$	-		$	-		$	9		$	9
Collectively evaluated for impairment		224			106			2,588			1,056			3,974
Loans:
Individually evaluated for impairment	$	-		$	15		$	1,007		$	1,603		$	2,625
Collectively evaluated for impairment		81,513			16,656			346,079			75,231			519,479
Ending Balance	$	81,513		$	16,671		$	347,086		$	76,834		$	522,104

As of and for the period ended December 31, 2018
	Commercial Loans			Real Estate Construction and Land			Real Estate Mortgages			Consumer Loans			Total
Allowance for Loan Losses:
Balance as of January 1, 2018	$	885		$	206		$	2,730		$	222		$	4,043
Charge-offs		(75	)		-			-			(1,022	)		(1,097	)
Recoveries		54			-			2			16			72
Provision for (recovery of) loan losses		(53	)		(87	)		(121	)		2,134			1,873
Ending Balance	$	811		$	119		$	2,611		$	1,350		$	4,891

Ending Balance:
Individually evaluated for impairment	$	-		$	-		$	-		$	90		$	90
Collectively evaluated for impairment		811			119			2,611			1,260			4,801
Loans:
Individually evaluated for impairment	$	-		$	32		$	1,132		$	1,602		$	2,766
Collectively evaluated for impairment		85,027			17,492			351,746			80,159			534,424
Ending Balance	$	85,027		$	17,524		$	352,878		$	81,761		$	537,190

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

The following tables show the aging of past due loans as of September 30, 2019 and December 31, 2018. (Dollars below reported in thousands.)

Past Due Aging as of September 30, 2019	30-59 Days Past Due		60-89 Days Past Due		90 Days or More Past Due		Total Past Due		Current		Total Loans		90 Days Past Due and Still Accruing
Commercial loans
Commercial and industrial - organic	$	-	$	-	$	-	$	-	$	38,308	$	38,308	$	-
Commercial and industrial - government guaranteed		-		548		-		548		36,251		36,799		-
Commercial and industrial - syndicated		-		-		-		-		6,406		6,406		-
Real estate construction and land
Residential construction		-		-		-		-		1,476		1,476		-
Commercial construction		-		-		-		-		6,290		6,290		-
Land and land development		266		14		-		280		8,625		8,905		-
Real estate mortgages
1-4 family residential, first lien, investment		-		-		-		-		42,625		42,625		-
1-4 family residential, first lien, owner occupied		-		-		-		-		17,916		17,916		-
1-4 family residential, junior lien		-		-		-		-		2,643		2,643		-
1-4 family residential - purchased		-		503		-		503		17,836		18,339		-
Home equity lines of credit, first lien		-		-		-		-		8,954		8,954		-
Home equity lines of credit, junior lien		-		-		-		-		10,055		10,055		-
Farm		-		-		-		-		8,895		8,895		-
Multifamily		-		-		-		-		26,968		26,968		-
Commercial owner occupied		-		-		-		-		94,169		94,169		-
Commercial non-owner occupied		-		-		-		-		116,522		116,522		-
Consumer loans
Consumer revolving credit		-		-		-		-		24,987		24,987		-
Consumer all other credit		1		22		-		23		4,306		4,329		-
Student loans purchased		657		411		521		1,589		45,929		47,518		199
Total Loans	$	924	$	1,498	$	521	$	2,943	$	519,161	$	522,104	$	199

Past Due Aging as of December 31, 2018	30-59 Days Past Due		60-89 Days Past Due		90 Days or More Past Due		Total Past Due		Current		Total Loans		90 Days Past Due and Still Accruing
Commercial loans
Commercial and industrial - organic	$	50	$	172	$	-	$	222	$	41,304	$	41,526	$	-
Commercial and industrial - government guaranteed		-		-		548		548		30,819		31,367		548
Commercial and industrial - syndicated		-		-		-		-		12,134		12,134		-
Real estate construction and land
Residential construction		-		-		-		-		1,552		1,552		-
Commercial construction		-		-		-		-		5,078		5,078		-
Land and land development		1		-		15		16		10,878		10,894		15
Real estate mortgages
1-4 family residential, first lien, investment		-		-		-		-		40,311		40,311		-
1-4 family residential, first lien, owner occupied		-		-		-		-		16,775		16,775		-
1-4 family residential, junior lien		-		-		-		-		3,169		3,169		-
1-4 family residential - purchased		954		-		-		954		17,693		18,647		-
Home equity lines of credit, first lien		-		-		-		-		8,325		8,325		-
Home equity lines of credit, junior lien		-		-		-		-		10,912		10,912		-
Farm		-		-		-		-		10,397		10,397		-
Multifamily		-		-		-		-		27,328		27,328		-
Commercial owner occupied		-		-		-		-		93,800		93,800		-
Commercial non-owner occupied		75		-		-		75		123,139		123,214		-
Consumer loans
Consumer revolving credit		-		-		-		-		21,540		21,540		-
Consumer all other credit		4		599		-		603		4,927		5,530		-
Student loans purchased		850		463		754		2,067		52,624		54,691		332
Total Loans	$	1,934	$	1,234	$	1,317	$	4,485	$	532,705	$	537,190	$	895

Note 5. Net Income Per Share

On June 13, 2019, the Board of Directors approved a stock dividend of five percent (5%) on the outstanding shares of common stock of the Company (or .05 share for each share outstanding) which was issued on July 5, 2019 to all shareholders of record as of the close of business on June 26, 2019, referred to as the “5% Stock Dividend”. Shareholders received cash in lieu of any fractional shares that they otherwise would have been entitled to receive in connection with the stock dividend. The price paid for fractional shares was based on the volume-weighted average price of a share of common stock for the most recent three (3) days prior to the record date during which a trade of the Company’s stock occurred.

For the following table, share and per share data have been adjusted to reflect the 5% Stock Dividend. The table shows the weighted average number of shares used in computing net income per common share and the effect on the weighted average number of shares of diluted potential common stock for the three and nine months ended September 30, 2019 and 2018. Potential dilutive common stock equivalents have no effect on net income available to common shareholders. (Dollars below reported in thousands except per share data.)

Three Months Ended	September 30, 2019						September 30, 2018
	Net Income		Weighted Average Shares		Per Share Amount		Net Income		Weighted Average Shares		Per Share Amount
Basic net income per share	$	1,897		2,689,092	$	0.71	$	2,160		2,669,199	$	0.81
Effect of dilutive stock options		-		1,050		-		-		20,521		(0.01	)
Diluted net income per share	$	1,897	$	2,690,142	$	0.71	$	2,160	$	2,689,720	$	0.80

Nine Months Ended	September 30, 2019						September 30, 2018
	Net Income		Weighted Average Shares		Per Share Amount		Net Income		Weighted Average Shares		Per Share Amount
Basic net income per share	$	5,258		2,685,134	$	1.96	$	6,788		2,665,647	$	2.55
Effect of dilutive stock options		-		3,679		-		-		21,454		(0.03	)
Diluted net income per share	$	5,258	$	2,688,813	$	1.96	$	6,788	$	2,687,101	$	2.52

For the nine months ended September 30, 2019, there were 66,301 option shares, as adjusted, considered anti-dilutive and excluded from this calculation. For the nine months ended September 30, 2018, there were 65,888 options shares, as adjusted, considered anti-dilutive and excluded from this calculation.

Note 6. Stock Incentive Plans

At the Annual Shareholders Meeting on May 21, 2014, shareholders approved the Virginia National Bankshares Corporation 2014 Stock Incentive Plan (“2014 Plan”). The 2014 Plan makes available up to 275,625 shares of the Company’s common stock, as adjusted by the 5% Stock Dividend and prior stock dividends, to be issued to plan participants. The 2014 Plan provides for granting of both incentive and nonqualified stock options, as well as restricted stock and other stock based awards. No new grants will be issued under the 2005 Plan as this plan has expired.

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

A summary of the shares issued and available under each of the Plans is shown below as of September 30, 2019. Share data and exercise price range per share have been adjusted to reflect the 5% Stock Dividend. Although the 2005 Plan has expired and no new grants will be issued under this plan, there were options issued before the plan expired that are still outstanding as shown below.

	2005 Plan			2014 Plan
Aggregate shares issuable		253,575			275,625
Options or shares issued, net of forfeited and expired options		(59,870	)		(84,047	)
Cancelled due to Plan expiration		(193,705	)		-
Remaining available for grant		-			191,578

Grants issued and outstanding:
Total vested and unvested shares		1,379			67,404
Fully vested shares		1,379			13,171
Exercise price range	$13.69 to			$27.39 to
	$	13.69		$	42.62

The Company accounts for all of its stock incentive plans under recognition and measurement accounting principles which require that the compensation cost relating to stock-based payment transactions be recognized in the financial statements. Stock-based compensation arrangements include stock options and restricted stock. All stock-based payments to employees are required to be valued at a fair value on the date of grant and expensed based on that fair value over the applicable vesting period. For the nine months ended September 30, 2019 and 2018, the Company recognized $71 thousand and $41 thousand, respectively, in compensation expense for stock options. As of September 30, 2019, there was $336 thousand in unrecognized compensation expense remaining to be recognized in future reporting periods through 2024.

Stock Options

Changes in the stock options outstanding related to all of the Plans are summarized below. Share and per share data have been adjusted to reflect the 5% Stock Dividend. (Dollars in thousands except per share data):

	September 30, 2019
	Number of Options			Weighted Average Exercise Price			Aggregate Intrinsic Value
Outstanding at January 1, 2019		86,594		$	36.21
Issued		420			36.19
Exercised		(5,976	)		(17.04	)	$	120
Expired		(12,255	)		(16.56	)
Outstanding at September 30, 2019		68,783		$	41.38		$	43

Options exercisable at September 30, 2019		14,550		$	39.52		$	32

The fair value of any stock option grant is estimated at the grant date using the Black-Scholes pricing model. Stock option grants for 420 and 65,888 shares, as adjusted for the 5% Stock Dividend, were issued during the nine months ended September 30, 2019 and 2018, respectively. The fair value of each option granted in 2019 was estimated based on the assumptions noted in the following table:

	For the nine months ended
	September 30, 2019
Expected volatility ¹		16.88	%
Expected dividends ²		3.24	%
Expected term (in years) ³		6.50
Risk-free rate ⁴		1.83	%

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

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

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

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

Summary information pertaining to options outstanding at September 30, 2019 is shown below. Share and per share data have been adjusted to reflect the 5% Stock Dividend.

	Options Outstanding					Options Exercisable
Exercise Price	Number of Options Outstanding		Weighted- Average Remaining Contractual Life	Weighted- Average Exercise Price		Number of Options Exercisable		Weighted- Average Exercise Price
$10.65 to $20.00		1,379	3.5 Years	$	13.69		1,379	$	13.69
$20.01 to $30.00		1,103	7.6 Years		27.39		—		—
$30.01 to $40.00		8,820	8.7 Years		39.36		1,680		39.52
$40.01 to $42.62		57,481	8.7 Years		42.62		11,491		42.62
Total		68,783	8.6 Years	$	41.38		14,550	$	39.52

Stock Grants

On February 20, 2019, a total of 11,535 shares of stock, as adjusted for the 5% Stock Dividend, were granted to non-employee directors and certain members of executive management for services to be provided during the year ending December 31, 2019. Based on the market price on February 20, 2019 of $36.72, as adjusted for the 5% Stock Dividend, the total expense for these shares will be $424 thousand which is being expensed over the twelve months of 2019 as those services are provided. For the nine months ended September 30, 2019, $318 thousand of this total has been realized in stock grant expense. In addition, in September 2019, 4,000 restricted shares were granted to certain members of executive management, vesting over a four-year period. $3 thousand of expense related to such restricted shares was recognized during the third quarter of 2019. There were no stock grants issued during the year ended December 31, 2018.

Note 7. Fair Value Measurements

Determination of Fair Value

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

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

Fair Value Hierarchy

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

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

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

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

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

Securities available for sale

Securities available for sale are recorded at fair value on a recurring basis. Fair value measurement is based upon quoted market prices, when available (Level 1). If quoted market prices are not available, fair values are measured utilizing independent valuation techniques of identical or similar securities for which significant assumptions are

derived primarily from or corroborated by observable market data. Third party vendors compile prices from various sources and may determine the fair value of identical or similar securities by using pricing models that consider observable market data (Level 2).

The following tables present the balances measured at fair value on a recurring basis as of September 30, 2019 and December 31, 2018 (dollars in thousands):

			Fair Value Measurements at September 30, 2019 Using:
			Quoted Prices in Active Markets for Identical Assets		Significant Other Observable Inputs		Significant Unobservable Inputs
Description	Balance		(Level 1)		(Level 2)		(Level 3)
Assets:
U.S. Government agencies	$	11,975	$	-	$	11,975	$	-
Mortgage-backed securities/CMOs		50,771		-		50,771		-
Municipal bonds		15,184		-		15,184		-
Total securities available for sale	$	77,930	$	-	$	77,930	$	-

			Fair Value Measurements at December 31, 2018 Using:
			Quoted Prices in Active Markets for Identical Assets		Significant Other Observable Inputs		Significant Unobservable Inputs
Description	Balance		(Level 1)		(Level 2)		(Level 3)
Assets:
U.S. Government agencies	$	18,974	$	-	$	18,974	$	-
Mortgage-backed securities/CMOs		25,063		-		25,063		-
Municipal bonds		17,355		-		17,355		-
Total securities available for sale	$	61,392	$	-	$	61,392	$	-

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

Other Real Estate Owned

Other real estate owned (“OREO”) is measured at fair value less cost to sell, based on an appraisal conducted by an independent, licensed appraiser outside of the Company. If the collateral value is significantly adjusted due to differences in the comparable properties, or is discounted by the Company because of marketability, then the fair value is considered Level 3. OREO is measured at fair value on a nonrecurring basis. Any initial fair value adjustment is charged against the Allowance for Loan Losses. Subsequent fair value adjustments are recorded in the period incurred and included in other noninterest expense on the Consolidated Statements of Income. As of September 30, 2019 and December 31, 2018, the Company had no OREO property.

Impaired Loans

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

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

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

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

Impaired loans allocated to the Allowance for Loan Losses are measured at fair value on a nonrecurring basis. Any fair value adjustments are recorded in the period incurred as provision for loan losses on the Consolidated Statements of Income. The Company had impaired loans of $2.6 million as of September 30, 2019 and $2.8 million as of December 31, 2018. All impaired loans were measured based on expected future cash flows discounted at the loan’s effective interest rate.

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

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

The carrying values and estimated fair values of the Company's financial instruments as of September 30, 2019 and December 31, 2018 are as follows (dollars in thousands):

			Fair Value Measurements at September 30, 2019 Using:
			Quoted Prices in Active Markets for Identical Assets		Significant Other Observable Inputs		Significant Unobservable Inputs
	Carrying value		Level 1		Level 2		Level 3		Fair Value
Assets
Cash and cash equivalent	$	27,855	$	27,855	$	-	$	-	$	27,855
Available for sale securities		77,930		-		77,930		-		77,930
Loans, net		518,121		-		-		504,370		504,370
Bank owned life insurance		16,301		-		16,301		-		16,301
Accrued interest receivable		2,258		-		338		1,920		2,258

Liabilities
Demand deposits and
interest-bearing transaction, money market, and savings accounts	$	455,854	$	-	$	455,854	$	-	$	455,854
Certificates of deposit		123,592		-		124,278		-		124,278
Accrued interest payable		363		-		363		-		363

			Fair Value Measurements at December 31, 2018 Using:
			Quoted Prices in Active Markets for Identical Assets		Significant Other Observable Inputs		Significant Unobservable Inputs
	Carrying value		Level 1		Level 2		Level 3		Fair Value
Assets
Cash and cash equivalent	$	18,874	$	18,874	$	-	$	-	$	18,874
Available for sale securities		61,392		-		61,392		-		61,392
Loans, net		532,299		-		-		514,917		514,917
Bank owned life insurance		16,790		-		16,790		-		16,790
Accrued interest receivable		2,100		-		342		1,758		2,100

Liabilities
Demand deposits and
interest-bearing transaction and money market accounts	$	464,002	$	-	$	464,002	$	-	$	464,002
Certificates of deposit		108,531		-		108,323		-		108,323
Accrued interest payable		243		-		243		-		243

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

Note 8. Other Comprehensive Income

A component of the Company’s other comprehensive income, in addition to net income from operations, is the recognition of the unrealized gains and losses on available for sale securities, net of income taxes. Reclassifications of realized gains and losses on available for sale securities are reported in the income statement as “Gains (losses) on sales and calls of securities” with the corresponding income tax effect reflected as a component of income tax expense. Amounts reclassified out of accumulated other comprehensive income are presented below for the three and nine months ended September 30, 2019 and 2018 (dollars in thousands)

	Three Months Ended					Nine Months Ended
	September 30, 2019			September 30, 2018		September 30, 2019			September 30, 2018
Available for sale securities
Realized gains on sales of securities	$	7		$	-	$	71		$	-
Tax effect		(1	)		-		(15	)		-
Realized gains, net of tax	$	6		$	-	$	56		$	-

Note 9 . Segment Reporting

Beginning in 2019, the Company has four reportable segments. Each reportable segment is a strategic business unit that offers different products and services. They are managed separately, because each segment appeals to different markets and, accordingly, require different technology and marketing strategies. The accounting policies of the segments are the same as those described in the summary of significant accounting policies provided earlier in this report.

The four reportable segments are:

•

Bank - The commercial banking segment involves making loans and generating deposits from individuals, businesses and charitable organizations. Loan fee income, service charges from deposit accounts, and other non-interest-related fees, such as fees for debit cards and ATM usage and fees for treasury management services, generate additional income for the Bank segment.

•

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

•

VNB Trust & Estate Services – VNB Trust & Estate Services offers corporate trustee services, trust and estate administration, IRA administration and custody services. Revenue for this segment is generated from administration, service and custody fees, as well as management fees which are derived from Assets Under Management and incentive income which is based on the investment returns generated on performance-based Assets Under Management. Investment management services currently are offered through in-house and third-party managers. In addition, royalty income, in the form of fixed and incentive fees, from the sale of Swift Run Capital Management, LLC in 2013 is reported as income of VNB Trust & Estate Services. More information on royalty income and the related sale can be found under Summary of Significant Accounting Policies in Note 1 of the notes to consolidated financial statements, which is found in Item 8. Financial Statements and Supplementary Data, in the Company’s Form 10-K Report for December 31, 2018.

•

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

A management fee for administrative and technology support services provided by the Bank is allocated to the other three lines of business previously combined under VNB Wealth. For both the nine months ended September 30, 2019 and 2018, management fees totaling $75 thousand were charged by the Bank and eliminated in consolidated totals.

Segment information for the three and nine months ended September 30, 2019 and 2018 is shown in the following tables (dollars in thousands) .

Three months ended September 30, 2019	Bank			VNB Investment Services		VNB Trust & Estate Services		Masonry Capital			Consolidated
Net interest income	$	5,474		$	-	$	-	$	-		$	5,474
Provision for (recovery of) loan losses		(120	)		-		-		-			(120	)
Noninterest income		786			159		314		68			1,327
Noninterest expense		3,905			155		308		193			4,561
Income before income taxes		2,475			4		6		(125	)		2,360
Provision for income taxes		487			1		1		(26	)		463
Net income	$	1,988		$	3	$	5	$	(99	)	$	1,897
Total assets	$	660,513		NR*		NR*		$	277		$	660,790

Nine months ended September 30, 2019	Bank			VNB Investment Services		VNB Trust & Estate Services		Masonry Capital			Consolidated
Net interest income	$	16,503		$	-	$	-	$	-		$	16,503
Provision for loan losses		500			-		-		-			500
Noninterest income		2,496			451		1,008		131			4,086
Noninterest expense		11,777			438		918		524			13,657
Income before income taxes		6,722			13		90		(393	)		6,432
Provision for income taxes		1,234			3		19		(82	)		1,174
Net income	$	5,488		$	10	$	71	$	(311	)	$	5,258

Not reportable. Asset information is not reported for these segments, as the assets previously allocated to VNB Wealth are reported at the Bank level subsequent to the merger of VNBTrust into the Bank effective July 1, 2018; also, assets specifically allocated to these VNB Wealth lines of business are insignificant and are no longer provided to the chief operating decision maker.

Prior to January 1, 2019, Virginia National Bankshares Corporation had two reportable segments, the Bank and VNB Wealth.

Three months ended September 30, 2018	Bank		VNB Wealth		Consolidated
Net interest income	$	5,791		-	$	5,791
Provision for loan losses		285		-		285
Noninterest income		700		570		1,270
Noninterest expense		3,542		547		4,089
Income before income taxes		2,664		23		2,687
Provision for income taxes		522		5		527
Net income	$	2,142	$	18	$	2,160

Nine months ended September 30, 2018	Bank		VNB Wealth		Consolidated
Net interest income	$	17,106	$	73	$	17,179
Provision for loan losses		890		-		890
Noninterest income		2,046		2,245		4,291
Noninterest expense		10,547		1,586		12,133
Income before income taxes		7,715		732		8,447
Provision for income taxes		1,505		154		1,659
Net income	$	6,210	$	578	$	6,788

Note 10. Leases

On January 1, 2019, the Company adopted ASU No. 2016-02 “Leases (Topic 842)” and all subsequent ASUs that modified Topic 842. The Company elected the prospective application approach provided by ASU 2018-11 and did not adjust prior periods for ASC 842. The Company also elected certain practical expedients within the standard and consistent with such elections did not reassess whether any expired or existing contracts are or contain leases, did not reassess the lease classification for any expired or existing leases, and did not reassess any initial direct costs for existing leases. Lease payments for short-term leases are recognized as lease expense on a straight-line basis over the lease term. Payments for leases with terms longer than twelve months are included in the determination of the lease liability.

The implementation of the new standard resulted in recognition of a right-of-use asset and lease liability of $4.3 million at the date of adoption, which is related to the Company’s lease of premises used in operations. The right-of-use asset and lease liability are included in other assets and other liabilities, respectively, in the Consolidated Balance Sheets.

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

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

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

	September 30, 2019
Lease liability	$	3,776
Right-of-use asset	$	3,754
Weighted average remaining lease term	5.28 years
Weighted average discount rate		2.84	%

	Three Months Ended September 30,				Nine Months Ended September 30,
Lease Expense	2019		2018		2019		2018
Operating lease expense	$	203	NR*		$	611	NR*
Short-term lease expense		34	NR*			107	NR*
Total lease expense	$	237	$	225	$	718	$	676
Cash paid for amounts included in lease liabilities	$	196	NR*		$	589	NR*

Not reportable

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

Undiscounted Cash Flow	September 30, 2019
Three months ending December 31, 2019	$	198
Twelve months ending December 31, 2020		799
Twelve months ending December 31, 2021		807
Twelve months ending December 31, 2022		767
Twelve months ending December 31, 2023		680
Twelve months ending December 31, 2024		469
Thereafter		354
Total undiscounted cash flows	$	4,074
Less: Discount		(298	)
Lease liability	$	3,776

Note 11. Commitments and Contingent Liabilities

During the third quarter of 2019, the Company settled two claims, both relating to the same matter, seeking to recover approximately $2.7 million. While management did not believe that the claims against the Company had merit and was prepared to vigorously defend such claims, the Company agreed to settle for $460 thousand. The Company accrued a contingent liability of $300 thousand related to these claims in the second quarter of 2019 and additional expense of $160 thousand in the third quarter of 2019. The settlement amount has been recognized as a loss and appears as Settlement of claims within noninterest expense in the Consolidated Statements of Income for the nine months ended September 30, 2019. There are no material pending claims against the Company at this time.

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

The following discussion should be read in conjunction with Virginia National Bankshares Corporation’s consolidated financial statements, and notes thereto, for the year ended December 31, 2018, included in the Company’s 2018 Form 10-K. Per share data for September 30, 2019 and all preceding periods disclosed have been adjusted to reflect the 5% stock dividend effective July 5, 2019 (the “5% Stock Dividend”). Operating results for the three and nine months ended September 30, 2019 are not necessarily indicative of the results for the year ending December 31, 2019 or any future period.

FORWARD-LOOKING STATEMENTS AND FACTORS THAT COULD AFFECT FUTURE RESULTS

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

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

APPLICATION OF CRITICAL ACCOUNTING POLICIES AND ESTIMATES

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

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

For additional information regarding critical accounting policies, refer to the Application of Critic al Accounting Policies and Critical Accounting Estimates section unde r Item 7 in the Company’s 201 8 Form 10-K. There have been no significant changes in the Company’s application of critical accounting policies since December 31, 2018 .

FINANCIAL CONDITION

Total assets

The total assets of the Company as of September 30, 2019 were $660.8 million. This is a $16.0 million increase from the $644.8 million total assets reported at December 31, 2018 and a $34.0 million increase from the $626.8 million reported at September 30, 2018. A $16.5 million increase in securities since December 31, 2018 was the major reason for the increase in assets since year-end. In addition, fed funds sold increased $6.9 million, while right of use assets, included in accrued interest receivable and other assets, increased $3.8 million. These increases during the first nine months of 2019 were offset by a decrease in gross loans of $15.1 million.

Federal funds sold

The Company had overnight federal funds sold of $14.0 million as of September 30, 2019, compared to $7.1 million as of December 31, 2018 and $1.1 million as of September 30, 2018. Any excess funds are sold on a daily basis in the federal funds market. The Company intends to maintain sufficient liquidity at all times to meet its funding commitments.

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

Securities

The Company’s investment securities portfolio as of September 30, 2019 totaled $79.6 million, an increase of $16.5 million compared with the $63.1 million reported at December 31, 2018 and an increase of $15.4 million from the $64.2 million reported at September 30, 2018. Management proactively manages the mix of earning assets and cost of funds to maximize the earning capacity of the Company. At September 30, 2019 and September 30, 2018, the investment securities holdings represented 12.0% and 10.2% of the Company’s total assets, respectively.

The Company’s investment securities portfolio included restricted securities totaling $1.7 million as of September 30, 2019 and December 31, 2018, compared to $2.1 million as of September 30, 2018. These securities represent stock in the Federal Reserve Bank of Richmond (“FRB-R”), the Federal Home Loan Bank of Atlanta (“FHLB-A”), and CBB Financial Corporation (“CBBFC”), the holding company for Community Bankers Bank. The level of FRB-R and FHLB-A stock that the Company is required to hold is determined in accordance with membership guidelines provided by the Federal Reserve Bank Board of Governors and the Federal Home Loan Bank of Atlanta, respectively. The decrease compared to September 30, 2018 was due to the decrease in the Company’s short-term borrowing initiated with the FHLB-A from the third quarter of 2018 to the third quarter of 2019. Stock ownership in the bank holding company for Community Bankers’ Bank provides the Bank with several benefits that are not available to non-shareholder correspondent banks. None of these restricted securities are traded on the open market and can only be redeemed by the respective issuer.

At September 30, 2019, the unrestricted securities portfolio totaled $77.9 million. The following table summarizes the Company's available for sale securities by type as of September 30, 2019, December 31, 2018, and September 30, 2018 (dollars in thousands):

	September 30, 2019					December 31, 2018					September 30, 2018
			Percent					Percent					Percent
	Balance		of Total			Balance		of Total			Balance		of Total
U.S. Government agencies	$	11,975		15.4	%	$	18,974		30.9	%	$	18,718		30.1	%
Mortgage-backed securities/CMOs		50,771		65.1	%		25,063		40.8	%		25,877		41.7	%
Municipal bonds		15,184		19.5	%		17,355		28.3	%		17,505		28.2	%
Total available for sale securities	$	77,930		100.0	%	$	61,392		100.0	%	$	62,100		100.0	%

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

Loan portfolio

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

As of September 30, 2019, total loans were $522.1 million, compared to $537.2 million as of December 31, 2018 and $527.3 million at September 30, 2018. Loans as a percentage of total assets at September 30, 2019 were 79.0%, compared to 84.1% as of September 30, 2018. Loans as a percentage of deposits at September 30, 2019 were 90.1%, compared to 97.9% as of September 30, 2018.

The following table summarizes the Company's loan portfolio by type of loan as of September 30, 2019, December 31, 2018, and September 30, 2018 (dollars in thousands):

	September 30, 2019					December 31, 2018					September 30, 2018
	Balance		Percent of Total			Balance		Percent of Total			Balance		Percent of Total
Commercial and industrial	$	81,513		15.6	%	$	85,027		15.8	%	$	89,579		17.0	%
Real estate - commercial		246,554		47.2	%		254,739		47.4	%		250,368		47.5	%
Real estate - residential mortgage		100,532		19.3	%		98,139		18.3	%		81,845		15.5	%
Real estate - construction		16,671		3.2	%		17,524		3.3	%		18,781		3.5	%
Consumer loans		76,834		14.7	%		81,761		15.2	%		86,754		16.5	%
Total loans	$	522,104		100.0	%	$	537,190		100.0	%	$	527,327		100.0	%

Loan balances declined $15.1 million, or 2.8%, since December 31, 2018 and declined $5.2 million, or 1.0%, from September 30, 2018. Since year-end, the loan fluctuation consisted of $24.8 million in new funding from organic loan growth and $7.1 million in purchases of government guaranteed loans, offset by the following: 1) $27.6 million in regular payoffs and normal amortization; 2) $10.6 million in payoffs from businesses sold or properties sold by borrowers; 3) $5.4 million reduction in syndicated loans due to a refinance of one and a sale of a second loan; 4) $1.8 million in a participation purchased being recalled by the primary lender; and 5) $1.6 million in charge-offs. The purchase of loans is considered a secondary strategy, which allows the Company to supplement organic loan growth. Purchased loans with balances outstanding of $109.0 million as of September 30, 2019 were comprised of:

•

Student loans totaling $47.5 million. The Company purchased two student loan packages in 2015 and a third in the fourth quarter of 2016. A fourth tranche was closed in December 2017 for an additional $15.0 million. Along with the purchase of these four packages of student loans, the Company purchased surety bonds to fully insure this portion of the Company’s consumer portfolio. However, during June 2018, ReliaMax Surety, the insurance company which issued the surety bonds, was placed into liquidation due to insolvency. Loss claims were filed for loans in default as of July 27, 2018, when the surety bonds were terminated, and the Company anticipates payment on approved claims. Student loans continue to be profitable for the Company.

•

Loans guaranteed by a U.S. government agency (“government guaranteed”) totaling $36.8 million, inclusive of premium. During the fourth quarter of 2016, the Company began augmenting the commercial and industrial portfolio with government guaranteed loans which represent the portion of loans that are 100% guaranteed by either the United States Department of Agriculture (“USDA”) or the Small Business Administration (“SBA”); the originating institution holds the unguaranteed portion of each loan and services it. These government guaranteed portion of loans are typically purchased at a premium. In the event of early prepayment, the Company may need to write off any unamortized premium.

•

Mortgage loans totaling $ 18. 3 million. In the fourth quarter of 2018, the Company purchased a package of 1-to-4 family residential mortgages. Each of the 42 ad justable rate loans purchased were individually underwritten by the Company prior to the closing of the purchase. The collateral on these loans is located primarily on the East Coast of the United States.

•

Syndicated loans totaling $6.4 million. Syndicated loans represent shared national credits in leveraged lending transactions and are included in the commercial and industrial portfolio. The Company has developed policies to limit overall credit exposure to the syndicated market, as well as limits by industry and amount per borrower. Management proactively manages shared national credits and has opportunistically increased or decreased exposure over time. In the third quarter of 2019, we elected to sell our interest in a credit which significantly lowered our allowance for loan losses and allowed for a recovery of loan loss provision.

Management will continue to evaluate loan purchase transactions to strengthen earnings, diversity the loan portfolio and supplement organic loan growth.

Loan quality

Non-accrual loans totaled $337 thousand at September 30, 2019, compared to the $615 thousand and $566 thousand reported at December 31, 2018 and September 30, 2018, respectively. The Company had loans in its portfolio totaling $199 thousand, $895 thousand and $520 thousand, as of September 30, 2019, December 31, 2018 and September 30, 2018, respectively, that were ninety or more days past due, with all such loans still accruing interest as the Company deems them to be collectible.

At September 30, 2019, the Company had loans classified as impaired loans in the amount of $2.6 million, compared to $2.8 million at December 31, 2018 and September 30, 2018. Based on regulatory guidance on Student Lending, the Company has classified 76 of its purchased student loans as TDRs for a total of $1.3 million as of September 30, 2019. These borrowers that should have been in repayment have requested and been granted payment extensions or reductions exceeding the maximum lifetime allowable payment forbearance of twelve months (36 months lifetime allowance for military service), as permitted under the regulatory guidance, and are therefore considered restructurings. Student loan borrowers are allowed in-school deferments, plus an automatic six-month grace period post in-school status, before repayment is scheduled to begin, and these deferments do not count toward the maximum allowable forbearance. Management has evaluated these loans individually for impairment and included any potential loss in the allowance for loan loss; interest continues to accrue on these TDRs during any deferment and forbearance periods.

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

Allowance for loan losses

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

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

Changes in the value of underlying collateral;

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

Changes in volume of delinquent loans;

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

Changes in lending policies and procedures, including underwriting standards;

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

Changes in the level of policy exceptions.

A s discussed earlier, the Company utilizes a loss migration model. Migration analysis uses loan level attributes to track the movement of loans through various risk classific ations in order to estimate the percentage of losses likely in the portfolio.

The relationship of the allowance for loan losses to total loans appears below (dollars in thousands):

	September 30, 2019			December 31, 2018			September 30, 2018
Loans held for investment at period-end	$	522,104		$	537,190		$	527,327
Allowance for loan losses	$	3,983		$	4,891		$	4,678
Allowance as a percent of period-end loans		0.76	%		0.91	%		0.89	%

The Allowance for Loan Losses as a percentage of assets declined from 0.91% at December 31, 2018 to 0.76% at September 30, 2019 due to: 1) the recapture of a portion of the loan loss provision previously allocated to a shared national credit that was sold during the third quarter of 2019; 2) the lower level of delinquencies within the student loan portfolio; and 3) the decreased balances in the organic loan portfolio.

Provisions for loan losses totaling $500 thousand and $890 thousand were recorded in the nine months ended September 30, 2019 and 2018, respectively. The following is a summary of the changes in the allowance for loan losses for the nine months ended September 30, 2019 and 2018 (dollars in thousands):

	2019			2018
Allowance for loan losses, January 1	$	4,891		$	4,043
Charge-offs		(1,570	)		(316	)
Recoveries		162			61
Provision for loan losses		500			890
Allowance for loan losses, September 30	$	3,983		$	4,678

For additional insight into management’s approach and methodology in estimating the allowance for loan losses, please refer to the earlier discussion of “Allowance for Loan Losses” in Note 4 of the Notes to Consolidated Financial Statements. In addition, Note 4 includes details regarding the rollforward of the allowance by loan portfolio segments. The rollforward tables indicate the activity for loans that are charged-off, amounts received from borrowers as recoveries of previously charged-off loan balances, and the allocation by loan portfolio segment of the provision made during the period. The events that can positively impact the amount of allowance in a given loan segment include any one or all of the following: the recovery of a previously charged-off loan balance; the decline in the amount of classified or delinquent loans in a loan segment from the previous period, which most commonly occurs when these loans are repaid or are foreclosed; or when there are improvements in the ratios used to estimate the probability of loan losses. Improvements to the ratios could include lower historical loss rates, improvements to any of the qualitative factors mentioned above, or reduced loss expectations for individually-classified loans.

Management reviews the Allowance for Loan Losses on a quarterly basis to ensure it is adequate based upon the calculated potential losses inherent in the portfolio. Management believes the allowance for loan losses was adequately provided for as of September 30, 2019.

Premises and equipment

The Company’s premises and equipment, net of depreciation, as of September 30, 2019 totaled $6.4 million compared to $7.0 million as of December 31, 2018 and $7.2 million as of September 30, 2018. Premises and equipment are stated at cost less accumulated depreciation. Depreciation is computed by the straight-line method based on the estimated useful lives of assets. Expenditures for repairs and maintenance are charged to expense as incurred. The costs of major renewals and betterments are capitalized and depreciated over their estimated useful lives. Upon disposition, assets and related accumulated depreciation are removed from the books, and any resulting gain or loss is charged to income.

As of September 30, 2019, the Company and its subsidiaries occupied five full-service banking facilities in the cities of Charlottesville and Winchester, as well as the county of Albemarle in Virginia. The Company also operates a drive-through location at 301 East Water Street, Charlottesville, Virginia. The Bank closed its Orange, Virginia office effective

April 13, 2018; expanded messenger service continue s to be available to the customers within and surrounding Orange, Virginia.

The multi-story office building at 404 People Place, Charlottesville, Virginia, located in Albemarle County, also serves as the Company’s corporate headquarters and operations center, as well as the principal offices of VNB Investment Services and Masonry Capital. VNB Trust & Estate Services is located at 112 Third Street, SE, Charlottesville, Virginia.

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

Leases

$3.8 million of the increase in each of Other Assets and Other Liabilities resulted from the Company’s implementation of ASU 2016-02 “Leases” (Topic 842). This implementation required the Company to recognize right-of-use assets, which are assets that represent the Company’s right to use, or control the use of, a specified asset for the lease term, offset by the lease liability, which is the Company’s obligation to make lease payments arising from a lease, measured on a discounted basis.

Deposits

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

Total deposits as of September 30, 2019 were $579.4 million, an increase of $6.9 million compared to the balances of $572.5 million at December 31, 2018, and an increase of $40.9 million compared to the $538.5 million total as of September 30, 2018.

Deposit accounts
(dollars in thousands)	September 30, 2019					December 31, 2018					September 30, 2018
	Balance		% of Total Deposits			Balance		% of Total Deposits			Balance		% of Total Deposits
No cost and low cost deposits:
Noninterest demand deposits	$	155,134		26.8	%	$	185,819		32.4	%	$	170,623		31.7	%
Interest checking accounts		110,152		19.0	%		106,884		18.7	%		87,418		16.2	%
Money market and savings deposit accounts		190,568		32.9	%		171,299		29.9	%		153,271		28.5	%

Total noninterest and low cost deposit accounts		455,854		78.7	%		464,002		81.0	%		411,312		76.4	%

Time deposit accounts:
Certificates of deposit		96,040		16.5	%		81,265		14.2	%		84,164		15.6	%
CDARS deposits		27,552		4.8	%		27,266		4.8	%		43,026		8.0	%
Total certificates of deposit and other time deposits		123,592		21.3	%		108,531		19.0	%		127,190		23.6	%

Total deposit account balances	$	579,446		100.0	%	$	572,533		100.0	%	$	538,502		100.0	%

Noninterest-bearing demand deposits on September 30, 2019 were $155.1 million, representing 26.8% of total deposits. Interest-bearing transaction, money market, and savings accounts totaled $300.7 million, and represented 51.9% of total deposits at September 30, 2019. Collectively, noninterest-bearing and interest-bearing transaction and money market accounts represented 78.7% of total deposit accounts at September 30, 2019. These account types are an excellent source of low-cost funding for the Company.

The Company implemented insured cash sweep (“ICS ^® ”) deposit products during the third quarter of 2018. ICS ^® deposit balances of $18.8 million and $28.8 million are included in the interest checking accounts and the money market and

savings deposit accounts balances, r espectively, in the table above, as of September 30, 2019. As of December 31, 2018, ICS ^® deposit balances of $15.8 million and $21.0 million are included in the interest checking accounts and the money market and savings deposit account balances, respecti vely.

The remaining 21.3% of total deposits consisted of certificates of deposit and other time deposit accounts totaling $123.6 million at September 30, 2019. Included in this deposit total are Certificate of Deposit Account Registry Service CDs, known as CDARS ^TM , whereby depositors can obtain FDIC deposit insurance on account balances of up to $50 million. CDARS ^TM deposits totaled $27.6 million as of September 30, 2019, all of which were reciprocal balances for the Bank’s customers.

Borrowings

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

Repurchase agreements, also referred to as securities sold under agreement to repurchase, were available to non-individual accountholders on an overnight term through the Company’s investment sweep product. Under the agreements to repurchase, invested funds were fully collateralized by security instruments that were pledged on behalf of customers utilizing this product. The repurchase agreement product was discontinued by the Company effective December 31, 2018, in connection with the roll-out of ICS ^® to customers, and therefore, there were no balances in repurchase agreements as of September 30, 2019 or December 31, 2018. Total balances in repurchase agreements as of September 30, 2018 were $7.2 million.

The Company has a collateral dependent line of credit with the FHLB of Atlanta. As of September 30, 2019 and December 31, 2018, the Company had no outstanding balances from FHLB advances. As of September 30, 2018, the Company had outstanding FHLB advances of $10.0 million.

Additional borrowing arrangements maintained by the Bank include formal federal funds lines with four major regional correspondent banks. The Company had no outstanding balances on these lines as of September 30, 2019, December 31, 2018 or September 30, 2018.

Shareholders' equity and regulatory capital ratios

The following table displays the changes in shareholders' equity for the Company from December 31, 2018 to September 30, 2019 (dollars in thousands):

Equity, December 31, 2018	$	70,742
Net income		5,258
Other comprehensive income		1,340
Cash dividends declared		(2,381	)
Cash in lieu of fractional shares		(5	)
Stock granted		427
Stock options exercised		102
Equity increase due to expensing of stock options		71
Equity, September 30, 2019	$	75,554

The Basel III regulatory capital rules effective January 1, 2015 required the Company and its subsidiaries to comply with the following new minimum capital ratios: (i) a new common equity Tier 1 capital ratio of 4.50% of risk-weighted assets; (ii) a Tier 1 capital ratio of 6% of risk-weighted assets (increased from the prior requirement of 4.00%); (iii) a total capital ratio of 8.00% of risk-weighted assets (unchanged from the prior requirement); and (iv) a leverage ratio of 4.00% of total assets (unchanged from the prior requirement). These were the initial capital requirements.

Beginning January 1, 2016 a capital conservation buffer requirement began to be phased in over a four-year period, beginning at 0.625% of risk-weighted assets and increasing annually to 2.50% at January 1, 2019. Therefore, for the calendar year 2019, this 2.5% buffer effectively results in the minimum (i) common equity Tier 1 capital ratio of 7.00% of

risk-weighted assets; (ii) Tier 1 capital ratio of 8.50 % of risk-weighted assets; and (iii) total capital ratio of 10.50 % of risk-weighted assets . The minimum leverage ratio remains at 4 .00 %. For additional information regarding the new capital requirements, refer to the Supervision and Regulation section, under Item 1. Business, found in the Company’s Form 10-K Report for December 31, 2018 .

Using the new capital requirements, the Company’s capital ratios remain well above the levels designated by bank regulators as "well capitalized" at September 30, 2019. Under the current risk-based capital guidelines of federal regulatory authorities, the Company’s common equity Tier 1 capital ratio and Tier 1 capital ratio are both at 14.76% of its risk-weighted assets and are in excess of the well-capitalized minimum capital requirements of 6.50% and 8.00%, respectively. Additionally, the Company has a total capital ratio of 15.55% of its risk-weighted assets and leverage ratio of 11.42% of total assets, which are both in excess of the well-capitalized minimum 10.00% and 5.00% levels, respectively, designated by bank regulators under “well capitalized” capital guidelines.

On September 17, 2019 the Federal Deposit Insurance Corporation finalized a rule that introduces an optional simplified measure of capital adequacy for qualifying community banking organizations, referred to as, the community bank leverage ratio (CBLR) framework, as required by the Economic Growth, Regulatory Relief and Consumer Protection Act. The CBLR framework is designed to reduce burden by removing the requirements for calculating and reporting risk-based capital ratios for qualifying community banking organizations that opt into the framework.

In order to qualify for the CBLR framework, a community banking organization must have a tier 1 leverage ratio of greater than 9 percent, less than $10 billion in total consolidated assets, and limited amounts of off-balance-sheet exposures and trading assets and liabilities. A qualifying community banking organization that opts into the CBLR framework and meets all requirements under the framework will be considered to have met the well-capitalized ratio requirements under the Prompt Corrective Action regulations and will not be required to report or calculate risk-based capital.

The CBLR framework will be available for banks to use in their March 31, 2020 Call Report. The Company has decided not to opt into the CBLR framework.

RESULTS OF OPERATIONS

Non-GAAP presentations

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

•

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

•

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

•

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

Net interest income is discussed in Management’s Discussion and Analysis on a GAAP basis , unless noted as “FTE” ; and the reconcilement below sh ows the fully taxable-equivalent adjustment to net interest income to aid the reader in understanding the computations of net interest margin and the efficiency ratio on a non-GAAP basis (dollars in thousands):

Reconcilement of Non-GAAP Measures:	For the three months ended						For the nine months ended
	September 30, 2019			September 30, 2018			September 30, 2019			September 30, 2018
Net interest income	$	5,474		$	5,791		$	16,503		$	17,179
Fully taxable-equivalent adjustment		17			23			58			69
Net interest income (FTE)	$	5,491		$	5,814		$	16,561		$	17,248

Efficiency ratio		67.1	%		57.9	%		66.3	%		56.5	%
Impact of FTE adjustment		-0.2	%		-0.2	%		-0.2	%		-0.2	%
Efficiency ratio (FTE)		66.9	%		57.7	%		66.1	%		56.3	%

Net interest margin		3.52	%		3.78	%		3.64	%		3.79	%
Fully tax-equivalent adjustment		0.02	%		0.02	%		0.02	%		0.02	%
Net interest margin (FTE)		3.54	%		3.80	%		3.66	%		3.81	%

Net income

Net income for the three months ended September 30, 2019 was $1.9 million, a 12.2% decrease compared to the $2.2 million reported for the three months ended September 30, 2018. Net income per diluted share was $0.71 for the quarter ended September 30, 2019 compared to $0.80 per diluted share for the same quarter in the prior year, each adjusted to reflect the 5% Stock Dividend. The decrease in net income for the third quarter of 2019, when compared to the same period of 2018, was driven by a $317 decrease in net interest income, a $219 thousand increase in salaries and employee benefits and a $160 thousand loss accrual, included in other noninterest expense, related to the settlement of pending and threatened legal proceedings, offset by $405 thousand positive fluctuation in the provision for (recovery of) loan losses. The loss accrual had the impact of reducing net income by $126 thousand and earnings per share, diluted and adjusted for the 5% Stock Dividend, by $0.05, in the third quarter of 2019. For more information regarding this accrual, please refer to the earlier discussion of Commitments and Contingent Liabilities in Note 11 of the Notes to Consolidated Financial Statements.

Net income for the first nine months of 2019 was $5.3 million, a 22.5% decrease compared to the $6.8 million reported for the nine months ended September 30, 2018. Net income per diluted share was $1.96 for the nine months ended September 30, 2019 compared to $2.52 per diluted share for the same quarter in the prior year, as adjusted to reflect the 5% Stock Dividend. The decrease in net income for the first nine months of 2019, when compared to the same period of 2018, was driven by a $778 thousand increase in salaries and employee benefits, a $676 thousand decrease in net interest income, a $556 thousand decrease in royalty income, and a $460 thousand loss accrual included in other noninterest expense, as noted above, offset by a $390 positive fluctuation in the provision for (recovery of) loan losses and $354 thousand increase in earnings from the proceeds of bank owned life insurance. The loss accrual had the impact of reducing net income by $363 thousand and earnings per share, diluted and adjusted for the 5% Stock Dividend, by $0.14, for the first nine months of 2019.

Net interest income

Net interest income (FTE) for the three months ended September 30, 2019 was $5.5 million, a 5.5% decrease compared to net interest income of $5.8 million for the three months ended September 30, 2018. Net interest income was negatively impacted by the decrease in average gross loan balances of $16.2 million, which reduced interest income by $189 thousand, as well as the effect of higher rates paid on deposit accounts, increasing interest expense by $354 thousand. The lower volume of the Company’s borrowing, reduced from an average of $38.7 million in the third quarter of 2018 to zero in the third quarter of 2019 positively impacted net interest income by $159 thousand on a period over period comparison.

Net interest income (FTE) for the first nine months of 2019 was $ 1 6.6 million, a 4.0 % decrease compared to net interest income of $ 17.2 million for the first nin e months of 2018. Net interest income was negatively impacted by the effect of higher rates paid on deposit balances, increasing interest expense by $ 1.3 million , offset by t he effect of higher rates earned on loans, which positively impacted net interest income by $ 537 thousand. The lower volume of the Company’s borrowing positively impacted net interest income by $2 88 thousand for the third quarter of 2019 as compared to the thir d quarter of 2018.

Net interest margin (FTE) is the ratio of net interest income (FTE) to average earning assets for the period. The level of interest rates, together with the volume and mix of earning assets and interest-bearing liabilities, impact net interest income (FTE) and net interest margin (FTE). The net interest margin (FTE) of 3.54% for the three months ended September 30, 2019 was twenty-six basis points lower than the 3.80% for the three months ended September 30, 2018. The net interest margin (FTE) of 3.66% for the nine months ended September 30, 2019 was fifteen basis points lower than the 3.81% for the nine months ended September 30, 2018. Refer to the Reconcilement of Non-GAAP Measures table within the Non-GAAP presentations section for a reconcilement of GAAP to non-GAAP net interest margin.

Total interest income (FTE) for the three months ended September 30, 2019 was $67 thousand lower than the same period in the prior year. The decrease in average gross loans balances was the major contributor to the decreased interest income. This shift resulted in an earning asset yield, as computed on a tax-equivalent basis, of 4.25% on average earning asset balances of $616.3 million for the three months ended September 30, 2019. The earning asset yield, as computed on a tax-equivalent basis, was 4.35% on average earning asset balances of $607.7 million for the three months ended September 30, 2018.

Total interest income (FTE) for the nine months ended September 30, 2019 was $432 thousand higher than the same period in the prior year. The increased yield on loans was the major contributor to the increased interest income. This shift resulted in an earning asset yield, as computed on a tax-equivalent basis, of 4.34% on average earning asset balances of $605.4 million for the nine months ended September 30, 2019. The earning asset yield, as computed on a tax-equivalent basis, was 4.24% on average earning asset balances of $605.8 million for the nine months ended September 30, 2018.

Interest expense increased $257 thousand for the three months ended September 30, 2019 compared to the same period in the prior year. Interest expense increased $1.1 million for the nine months ended September 30, 2019 compared to the same period in the prior year. The primary reason for the increase in interest expense is the increased rates paid on deposits to be competitive in the market. The rate paid on interest-bearing deposits averaged 106 basis points in the three months ended September 30, 2019, compared to 75 basis points for the three months ended September 30, 2018. The rate paid on interest-bearing deposits averaged 101 basis points for the nine months ended September 30, 2019, compared to 59 basis points for the nine months ended September 30, 2018. Average balances of interest-bearing deposits also increased, from $363.2 million in the three months ended September 30, 2018 to $414.5 million in the three months ended September 30, 2019 and from $362.9 million for the nine months ended September 30, 2018 to $397.3 million for the nine months ended September 30, 2019. Average balances of borrowed funds decreased from $38.7 million in the three months ended September 30, 2018 to zero in the three months ended September 30, 2019, and decreased from $38.2 million for the nine months ended September 30, 2018 to $4.6 million for the nine months ended September 30, 2019, causing a decrease in interest expense on borrowed funds over both periods. A table showing the mix of no cost and low cost deposit accounts is shown under “Financial Condition - Deposits” earlier in this report.

The following tables detail the average balance sheet, including an analysis of net interest income (FTE) for earning assets and interest bearing liabilities, for the three and nine months ended September 30, 2019 and 2018. These tables also include a rate/volume analysis for these same periods (dollars in thousands).

Consolidated Ave rage Balance Sheet and Analysis o f Net Interest Income

	For the three months ended
	September 30, 2019								September 30, 2018								Change in Interest Income/ Expense
	Average			Interest		Average			Average			Interest		Average			Change Due to : ⁴						Total
	Balance			Income		Yield/Cost			Balance			Income		Yield/Cost			Volume			Rate			Increase/
(dollars in thousands)				Expense								Expense											(Decrease)
ASSETS
Interest Earning Assets:
Securities
Taxable Securities	$	58,210		$	320		2.20	%	$	52,765		$	308		2.33	%	$	31		$	(19	)	$	12
Tax Exempt Securities ¹		9,505			81		3.41	%		13,195			108		3.27	%		(31	)		4			(27	)
Total Securities ¹		67,715			401		2.37	%		65,960			416		2.52	%		—			(15	)		(15	)
Total Loans		516,637			6,021		4.62	%		532,876			6,201		4.62	%		(189	)		9			(180	)
Fed Funds Sold		31,956			174		2.16	%		8,904			46		2.05	%		125			3			128
Total Earning Assets		616,308			6,596		4.25	%		607,740			6,663		4.35	%		(64	)		(3	)		(67	)
Less: Allowance for Loan Losses		(4,827	)							(4,702	)
Total Non-Earning Assets		43,604								37,983
Total Assets	$	655,085							$	641,021

LIABILITIES AND SHAREHOLDERS' EQUITY
Interest Bearing Liabilities:
Interest Bearing Deposits:
Interest Checking	$	107,179		$	57		0.21	%	$	85,754		$	14		0.06	%	$	4		$	39		$	43
Money Market and Savings Deposits		185,019			474		1.02	%		154,231			263		0.68	%		60			151			211
Time Deposits		122,274			574		1.86	%		123,213			413		1.33	%		(3	)		164			161
Total Interest-Bearing Deposits		414,472			1,105		1.06	%		363,198			690		0.75	%		61			354			415
Repurchase agreements and other borrowed funds		—			—		0.00	%		38,698			158		1.62	%		(79	)		(79	)		(158	)
Total Interest-Bearing Liabilities		414,472			1,105		1.06	%		401,896			848		0.84	%		(18	)		275			257
Non-Interest-Bearing Liabilities:
Demand deposits		160,491								169,720
Other liabilities		4,574								243
Total Liabilities		579,537								571,859
Shareholders' Equity		75,548								69,162
Total Liabilities & Shareholders' Equity	$	655,085							$	641,021
Net Interest Income (FTE)				$	5,491							$	5,815				$	(46	)	$	(278	)	$	(324	)
Interest Rate Spread ²							3.19	%							3.51	%
Interest Expense as a Percentage of Average Earning Assets							0.71	%							0.55	%
Net Interest Margin (FTE) ³							3.54	%							3.80	%

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

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

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

(4)

The impact on the net interest income (FTE) resulting from changes in average balances and average rates is shown for the period indicated. The change in interest due to both volume and rate has been allocated to volume and rate changes in proportion to the relationship of the absolute dollar amounts of the change in each.

Consolidated Ave rage Balance Sheet and Analysis o f Net Interest Income

	For the nine months ended
	September 30, 2019								September 30, 2018								Change in Interest Income/ Expense
	Average			Interest		Average			Average			Interest		Average			Change Due to : ⁴						Total
	Balance			Income		Yield/Cost			Balance			Income		Yield/Cost			Volume			Rate			Increase/
(dollars in thousands)				Expense								Expense											(Decrease)
ASSETS
Interest Earning Assets:
Securities
Taxable Securities	$	52,798		$	874		2.21	%	$	53,890		$	917		2.27	%	$	(18	)	$	(25	)	$	(43	)
Tax Exempt Securities ⁽¹⁾		11,705			280		3.19	%		13,253			325		3.27	%		(37	)		(8	)		(45	)
Total Securities ⁽¹⁾		64,503			1,154		2.39	%		67,143			1,242		2.47	%		(55	)		(33	)		(88	)
Total Loans		524,723			18,223		4.64	%		529,556			17,850		4.51	%		(164	)		537			373
Fed Funds Sold		16,124			267		2.21	%		9,142			120		1.75	%		110			37			147
Total Earning Assets		605,350			19,644		4.34	%		605,841			19,212		4.24	%		(109	)		541			432
Less: Allowance for Loan Losses		(4,892	)							(4,247	)
Total Non-Earning Assets		42,602								37,912
Total Assets	$	643,060							$	639,506

LIABILITIES AND SHAREHOLDERS' EQUITY
Interest Bearing Liabilities:
Interest Bearing Deposits:
Interest Checking	$	103,708		$	153		0.20	%	$	90,781		$	37		0.05	%	$	6		$	110		$	116
Money Market and Savings Deposits		171,971			1,222		0.95	%		155,548			736		0.63	%		84			402			486
Time Deposits		121,646			1,620		1.78	%		116,573			815		0.93	%		37			768			805
Total Interest-Bearing Deposits		397,325			2,995		1.01	%		362,902			1,588		0.59	%		127			1,280			1,407
Repurchase agreements and other borrowed funds		4,580			88		2.57	%		38,249			376		1.31	%		(483	)		195			(288	)
Total Interest-Bearing Liabilities		401,905			3,083		1.03	%		401,151			1,964		0.65	%		(356	)		1,475			1,119
Non-Interest-Bearing Liabilities:
Demand deposits		164,093								170,135
Other liabilities		3,443								413
Total Liabilities		569,441								571,699
Shareholders' Equity		73,619								67,807
Total Liabilities & Shareholders' Equity	$	643,060							$	639,506
Net Interest Income (FTE)				$	16,561							$	17,248				$	247		$	(934	)	$	(687	)
Interest Rate Spread ⁽²⁾							3.31	%							3.59	%
Interest Expense as a Percentage of Average Earning Assets							0.68	%							0.43	%
Net Interest Margin (FTE) ³							3.66	%							3.81	%

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

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

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

(4)

Provision for l oan l osses

A recovery of loan losses of $120 thousand was recognized in the third quarter of 2019 due primarily to the recapture of a portion of the loan loss provision previously allocated to a shared national credit that was sold during the quarter, the lower level of delinquencies within the student loan portfolio, along with the decreased balances in the organic loan portfolio. A provision of $285 thousand was recognized in the third quarter of 2018. A provision for loan losses of $500 thousand was recorded in the first nine months of 2019, compared to $890 thousand recorded for the first nine months of 2018. The allowance for loan losses as a percentage of total loans at September 30, 2019 was 0.76%, compared to 0.91% as of December 31, 2018 and 0.89% as of September 30, 2018. Further discussion of management’s assessment of the allowance for loan losses is provided earlier in the report and in Note 4 – Allowance for Loan Losses, found in the Notes to the Consolidated Financial Statements. In management’s opinion, the allowance was adequately provided for at September 30, 2019.

Noninterest income

The components of noninterest income for the three months ended September 30, 2019 and 2018 are shown below (dollars in thousands):

	For the three months ended				Variance
	September 30, 2019		September 30, 2018		$			%
Noninterest income:
Trust income	$	377	$	409	$	(32	)		-7.8	%
Advisory and brokerage income		159		144		15			10.4	%
Royalty income		5		17		(12	)		-70.6	%
Deposit account fees		192		210		(18	)		-8.6	%
Debit/credit card and ATM fees		191		176		15			8.5	%
Earnings/increase in value of bank owned life insurance		111		113		(2	)		-1.8	%
Fees on mortgage sales		43		73		(30	)		-41.1	%
Gains on sales of securities		7		-		7		N/A
Loan swap fee income		116		-		116		N/A
Other		126		128		(2	)		-1.6	%
Total noninterest income	$	1,327	$	1,270	$	57			4.5	%

Noninterest income for the quarter ended September 30, 2019 of $1.3 million was $57 thousand or 4.5% higher than the amount recorded for the quarter ended September 30, 2018. This increase was largely due to the collection of loan swap income during the current quarter of $116 thousand.

The components o f noninterest income for the nine months ended September 30, 2019 and 2018 are shown below (dollars in thousands) :

	For the nine months ended					Variance
	September 30, 2019		September 30, 2018			$			%
Non interest income:
Trust income	$	1,126	$	1,250		$	(124	)		-9.9	%
Advisory and brokerage income		451		426			25			5.9	%
Royalty income		13		569			(556	)		-97.7	%
Deposit account fees		565		693			(128	)		-18.5	%
Debit/credit card and ATM fees		537		567			(30	)		-5.3	%
Earnings/increase in value of bank owned life insurance		687		333			354			106.3	%
Fees on mortgage sales		129		155			(26	)		-16.8	%
Gains on sales of securities		71		-			71		N/A
Losses on sales of assets		-		(33	)		33		N/A
Loan swap fee income		151		-			151		N/A
Other		356		331			25			7.6	%
Total noninterest income	$	4,086	$	4,291		$	(205	)		-4.8	%

Noninterest income for the nine months ended September 30, 2019 of $4.1 million was $205 thousand or 4.8% lower than the amount recorded for the nine months ended September 30, 2018. This decrease was predominantly due to the lack of performance fee royalty income in the first quarter of 2019, compared to $518 thousand in the first quarter of 2018. Royalty income is collected periodically from SRCM Holdings, LLC, as described in Note 1 – Summary of Significant Accounting Policies, found in the Notes to the Consolidated Financial Statements within the Company’s Form 10-K for the year ended December 31, 2018. The decrease was offset by the increased earnings from bank owned life insurance of $354 thousand and increased loan swap fee income of $151 thousand.

Noninterest expense

The components of noninterest expense for the three months ended September 30, 2019 and 2018 are shown below (dollars in thousands):

	For the three months ended				Variance
	September 30, 2019		September 30, 2018		$			%
Noninterest expense:
Salaries and employee benefits	$	2,268	$	2,049	$	219			10.7	%
Net occupancy		450		458		(8	)		-1.7	%
Equipment		85		128		(43	)		-33.6	%
ATM, debit and credit card		51		48		3			6.3	%
Bank franchise tax		151		126		25			19.8	%
Computer software		144		108		36			33.3	%
Data processing		341		281		60			21.4	%
FDIC deposit insurance assessment		6		44		(38	)		-86.4	%
Loan expenses		67		72		(5	)		-6.9	%
Marketing, advertising and promotion		203		170		33			19.4	%
Professional fees		213		227		(14	)		-6.2	%
Settlement of claims		160		-		160		N/A
Other		422		378		44			11.6	%
Total noninterest expense	$	4,561	$	4,089	$	472			11.5	%

Noninterest expense for the third quarter of 2019 of $4.6 million was $472 thousand higher than the third quarter of 2018. Salaries and employee benefits increased $219 thousand due to increased staffing for our new Richmond market and cyber and network security professionals, as well as the quarterly expense of stock grants for executive management

issued in February 2019. The Company incurred an expense of $ 160 th ousand in the third quarter of 2019 , related to settlement of pending and threatened l itigation . For more information regarding this accrual, please refer to the earlier discussion of Commitments and Contingent Liabilities in Note 11 of the Notes to Cons olidated Financial Statements. FDIC deposit insurance assessment expense decreased as a result of the Deposit Insurance Fund restoration plan, which provide s automatic small bank credits to reduce small banks’ regular deposit insurance assessments up to the full amount of their assessments or the full amount of their credits, whichever is less. The reserve ratio reached the required limits effective June 30, 2019. Management continues to evaluate expenses for potential containments and reductions that w ould have a positive impact on net income on an ongoing basis.

The components of noninterest expense for the nine months ended September 30, 2019 and 2018 are shown below (dollars in thousands):

	For the nine months ended				Variance
	September 30, 2019		September 30, 2018		$			%
Noninterest expense:
Salaries and employee benefits	$	6,800	$	6,022	$	778			12.9	%
Net occupancy		1,373		1,387		(14	)		-1.0	%
Equipment		316		374		(58	)		-15.5	%
ATM, debit and credit card		142		163		(21	)		-12.9	%
Bank franchise tax		455		375		80			21.3	%
Computer software		391		307		84			27.4	%
Data processing		987		828		159			19.2	%
FDIC deposit insurance assessment		36		154		(118	)		-76.6	%
Loan expenses		208		228		(20	)		-8.8	%
Marketing, advertising and promotion		592		520		72			13.8	%
Professional fees		620		654		(34	)		-5.2	%
Settlement of claims		460		-		460		N/A
Other		1,277		1,121		156			13.9	%
Total noninterest expense	$	13,657	$	12,133	$	1,524			12.6	%

Noninterest expense for the first nine months of 2019 of $13.7 million was $1.5 million higher than the first nine months of 2018. Salaries and employee benefits increased $778 thousand due to increased staffing for our new Richmond market and cyber and network security professionals, as well as the expense of stock grants for executive management issued in February 2019. The Company incurred an expense of $460 thousand in the first nine months of 2019, related to settlement of pending and threatened litigation. FDIC deposit insurance assessment expense decreased $118 thousand from the nine months ended September 30, 2018 to the nine months ended September 30, 2019 for the reason as noted above.

The efficiency ratio (FTE) of 66.9% for the third quarter of 2019 was less favorable than the 57.7% for the same quarter of 2018, due to the increase in noninterest expense. Noninterest expense will continue to increase as the Company positions itself for growth and enters into new markets. Refer to the Reconcilement of Non-GAAP Measures table within the Non-GAAP presentations section for a reconcilement of GAAP to non-GAAP efficiency ratio.

Provision for Income Taxes

The Company benefited from the Tax Cuts and Jobs Act (“Tax Act”) enacted on December 22, 2017, which permanently lowered the corporate income tax rate to 21% effective January 1, 2018, amongst other significant changes to the U.S. tax law. For the three months ended September 30, 2019 and September 30, 2018, the Company provided $463 thousand and $527 thousand for Federal income taxes, respectively, resulting in an effective income tax rate of 19.6% for each period. For the nine months ended September 30, 2019 and September 30, 2018, the Company provided $1.2 million and $1.7 million for Federal income taxes, respectively, resulting in an effective income tax rate of 18.3% and 19.6%, respectively. The effective income tax rates differed from the U.S. statutory rate of 21% primarily due to the effect of tax-exempt income from life insurance policies and municipal bonds.

OTHER SIGNIFICANT EVENTS

None

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Not required

ITEM 4. CONTROLS AND PROCEDURES

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

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

Based on their evaluation as of the end of the period covered by this quarterly report on Form 10-Q, the Company’s Chief Executive Officer and Chief Financial Officer have concluded that the disclosure controls and procedures were effective at the reasonable assurance level. There was no change in the internal control over financial reporting that occurred during the quarter ended September 30, 2019 that has materially affected, or is reasonably likely to materially affect, the internal control over financial reporting.

PART II. OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS.

None

ITEM 1A. RISK FACTORS.

Not required

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

None

ITEM 3. DEFAULTS UPON SENIOR SECURITIES.

None

ITEM 4. MINE SAFETY DISCLOSURES.

Not applicable

ITEM 5. O THER INFORMATION.

(a)	Required 8-K disclosures.

None

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

None

ITEM 6. EXHIBITS.

Exhibit Number		Description of Exhibit
2.0		Reorganization Agreement and Plan of Share Exchange, dated as of March 6, 2013, between Virginia National Bank and Virginia National Bankshares Corporation (incorporated by reference to Virginia National Bankshares Corporation’s Current Report on Form 8-K, filed with the Securities and Exchange Commission on December 18, 2013).

3.1		Articles of Incorporation of Virginia National Bankshares Corporation, as amended and restated (incorporated by reference to Virginia National Bankshares Corporation’s Current Report on Form 8-K, filed with the Securities and Exchange Commission on December 18, 2013).

3.2		Bylaws of Virginia National Bankshares Corporation (incorporated by reference to Virginia National Bankshares Corporation’s Current Report on Form 8-K, filed with the Securities and Exchange Commission on December 18, 2013).

31.1		302 Certification of Principal Executive Officer

31.2		302 Certification of Principal Financial Officer

32.1		906 Certification

101.0		Interactive data files pursuant to Rule 405 of Regulation S-T: (i) the Consolidated Balance Sheets as of September 30, 2019 and December 31, 2018, (ii) the Consolidated Statements of Income for the three and nine months ended September 30, 2019 and September 30, 2018, (iii) the Consolidated Statements of Comprehensive Income for the three and nine months ended September 30, 2019 and September 30, 2018, (iv) the Consolidated Statements of Changes in Shareholders’ Equity for the quarterly periods within 2019 and 2018, (v) the Consolidated Statements of Cash Flows for the nine months ended September 30, 2019 and September 30, 2018 and (vi) the Notes to the Consolidated Financial Statements (furnished herewith).

SIGNAT URES

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

VIRGINIA NATIONAL BANKSHARES CORPORATION
(Registrant)

By:		/s/ Glenn W. Rust
		Glenn W. Rust
		President and Chief Executive Officer

Date:		November 8, 2019

By:		/s/ Tara Y. Harrison
		Tara Y. Harrison
		Executive Vice President and Chief Financial Officer

Date:		November 8, 2019

TABLE OF CONTENTS

Part I Item 1. Financial Statements Note 1. Significant Accounting Policies Note 2. Securities Note 3. Loans Note 4. Allowance For Loan Losses Note 5. Net Income Per Share Note 6. Stock Incentive Plans Note 7. Fair Value Measurements Note 8. Other Comprehensive Income Note 9. Segment Reporting Note 10. Leases Note 11. Commitments and Contingent Liabilities Item 2. Management's Discussion and Analysis Of Financial Condition and Results Of Operations Item 3. Quantitative and Qualitative Disclosures About Market Risk Item 4. Controls and Procedures Part II. Other Information Item 1. Legal Proceedings Item 1A. Risk Factors Item 2. Unregistered Sales Of Equity Securities and Use Of Proceeds Item 3. Defaults Upon Senior Securities Item 4. Mine Safety Disclosures Item 5. Other Information Item 6. Exhibits

2.0 Reorganization Agreement and Plan of Share Exchange, dated as of March 6, 2013, between Virginia National Bank and Virginia National Bankshares Corporation (incorporated by reference to Virginia National Bankshares Corporations Current Report on Form 8-K, filed with the Securities and Exchange Commission on December 18, 2013). 3.1 Articles of Incorporation of Virginia National Bankshares Corporation, as amended and restated (incorporated by reference to Virginia National Bankshares Corporations Current Report on Form 8-K, filed with the Securities and Exchange Commission on December 18, 2013). 3.2 Bylaws of Virginia National Bankshares Corporation (incorporated by reference to Virginia National Bankshares Corporations Current Report on Form 8-K, filed with the Securities and Exchange Commission on December 18, 2013). 31.1 302 Certification of Principal Executive Officer 31.2 302 Certification of Principal Financial Officer 32.1 906 Certification

Large accelerated filer

Accelerated filer

Non-accelerated filer

Smaller reporting company

Emerging growth company