Virginia National Bankshares Corp

RESULTS OF OPERATIONS

Industry events and economic environment

Management of the Company continually monitors the impact of various global and national events on the Company's results of operations and financial condition, including inflation, changes in interest rates, and the political environment in light of the recent U.S. presidential election and other elections. The timing and impact of inflation, fluctuations in and volatility of interest rates, and the competitive landscape of deposits on our business and results of operations will depend on future developments, which are uncertain and unpredictable.

In response to the modest progress on inflation, on September 18, 2024 and November 7, 2024, the FOMC announced that it was lowering the Federal Funds target rate by 50 bps and 25 bps, respectively. The Federal Funds target current range is 4.50% to 4.75%. While inflation has eased in 2024, it remains elevated over the FOMC's target of 2.0%. The FOMC noted that it has gained greater confidence that inflation is moving sustainably toward 2.0%. Further the FOMC has also noted that it will carefully assess incoming data, the evolving outlook, and the balance of risks in considering

additional adjustments to the target range for the Federal Funds rate and that its assessments will take into account a

wide range of information, including readings on labor market conditions, inflation pressures and inflation

expectations, and financial and international developments. The FOMC noted that it would be prepared to adjust the

stance of monetary policy as appropriate if risks emerge that could impede the attainment of the FOMC’s goals. The

FOMC also confirmed the continued reduction to the Federal Reserve’s holdings of U.S. Treasury securities and

agency debt and agency MBS.

Non-GAAP presentations

The accounting and reporting policies of the Company conform to GAAP and prevailing practices in the banking industry. However, certain non-GAAP measures are used by management to supplement the evaluation of the Company’s performance. These include tangible book value per share, tangible equity and the following fully-taxable equivalent measures: net interest income-FTE, efficiency ratio-FTE and net interest margin-FTE. Interest on tax-exempt loans and securities is presented on a taxable-equivalent basis (which converts the income on loans and investments for which no income taxes are paid to the equivalent yield as if income taxes were paid) using the federal corporate income tax rate of 21 percent that was applicable for all periods presented.

​Management believes that the use of these non-GAAP measures provides meaningful information about operating performance by enhancing comparability with other financial periods, other financial institutions, and between different sources of interest income. The non-GAAP measures used by management enhance comparability by excluding the effects of (1) items that do not reflect ongoing operating performance, (2) balances of intangible assets, including goodwill, that vary significantly between institutions, and (3) tax benefits that are not consistent across different opportunities for investment. These non-GAAP financial measures should not be considered an alternative to GAAP-basis financial statements, and other banks and bank holding companies may define or calculate these or similar measures differently. Net income is discussed in Management’s Discussion and Analysis on a GAAP basis unless noted as “non-GAAP.”

A reconcilement of the non-GAAP financial measures used by the Company to evaluate and measure the Company's performance to the most directly comparable GAAP financial measures is presented below (dollars in thousands, except for the per share data):

Net income

Net income for the three months ended September 30, 2024 was $4.6 million, a $53 thousand decrease compared to $4.7 million reported for the three months ended September 30, 2023. Net income per diluted share was $0.85 for the three months ended September 30, 2024 compared to $0.86 per diluted share for the same period in the prior year.

Net income for the nine months ended September 30, 2024 was $12.4 million, compared to $16.1 million for the nine months ended September 30, 2023. Net income per diluted share was $2.30 for the nine months ended September 30, 2024, compared to $2.99 for the nine months ended September 30, 2023.

The decline in net income for each of the periods noted above is primarily the result of increased cost of funds, as discussed in more detail below.

Net interest income

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).

Quarterly overview -Net interest income (FTE) for the three months ended September 30, 2024 was $12.1 million, a $924 thousand increase compared to net interest income (FTE) of $11.2 million for the three months ended September 30, 2023. The net interest margin (FTE) of 3.24% for the three months ended September 30, 2024 was 20 bps higher than the 3.04% realized during the three months ended September 30, 2023. The main driver of this increase was increased volume of loans; the increase in average loan balances, from $986.5 million for the three months ended September 30, 2023 to $1.2 billion for the three months ended September 30, 2024, positively impacted interest income by $2.8 million, while the increase in rates associated with such loans positively impacted interest income by $812 thousand. These increases were partially offset by the decrease in the average balances of securities, decreasing from $454.0 million in the three months ended September 30, 2023 to $287.9 in the three months ended September 30, 2024, negatively impacting interest income (FTE) by $1.2 million period over period. Interest expense increased $1.3 million, negatively impacting net interest income (FTE) and net interest margin (FTE), compared to the same period in the prior year. Overall, the cost of interest-bearing deposits increased 45 bps period over period, from 226 bps to 271 bps. A $81.9 million increase in average balances of time deposit products contributed to the higher interest expense during the third quarter of 2024.

Year-to-date overview -Net interest income (FTE) for the nine months ended September 30, 2024 was $34.4 million, a $4.1 million decrease compared to net interest income (FTE) for the nine months ended September 30, 2023. The net interest margin (FTE) of 3.07% for the nine months ended September 30, 2024 was 45 bps lower than the 3.52% realized during the nine months ended September 30, 2023. Interest expense increased $8.8 million, negatively impacting net interest income (FTE) and net interest margin (FTE), compared to the same period in the prior year. Overall, the cost of interest-bearing deposits increased 103 bps period over period, from 170 bps to 273 bps. A $146.0 million increase in average balances of time deposit products contributed to the higher interest expense during the first nine months of 2024. The increase in average loan balances, from $953.4 million for the nine months ended September 30, 2023 to $1.1 billion for the nine months ended September 30, 2024, positively impacted interest income by $8.2 million. This increase was partially offset by the decrease in the average balances of securities, decreasing from $485.3 million in the nine months ended September 30, 2023 to $328.5 in the nine months ended September 30, 2024, negatively impacting interest income (FTE) by $3.4 million period over period.

For the quarterly and year-to-date periods of 2024, the shift in the composition of earnings assets was intentional to shift the mix to higher yielding assets.

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.

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, 2024 and 2023. These tables also include rate/volume analyses for these same periods (dollars in thousands).

Consolidated Average Balance Sheet and Analysis of Net Interest Income

(1)

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

(2)

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

(3)

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

(4)

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

Consolidated Average Balance Sheet and Analysis of Net Interest Income

(1)

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

(2)

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

(3)

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

(4)

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

Provision for credit losses

A recovery of provision for credit losses of $114 thousand was recognized during the three months ended September 30, 2024 compared to a recovery of $73 thousand recognized during the three months ended September 30, 2023. The third quarter 2024 recovery of provision for credit losses was comprised of $3 thousand of recovery of provision for loan losses and $111 thousand of recovery of provision for losses on unfunded commitments.

A recovery of provision for credit losses of $474 thousand was recognized during the nine months ended September 30, 2024 compared to a recovery of $60 thousand recognized during the nine months ended September 30, 2023. The first nine months of 2024 recovery of provision for credit losses was comprised of $511 thousand of recovery of provision for loan losses and $37 thousand of provision for losses on unfunded commitments.

An update to the peer data used in the Company's CECL model was performed during the three months ended June 30, 2024. This included a new group of peer banks, an adjustment to the k-factors used in the DCF models, and the election to mirror CRE non-owner occupied data for the multifamily pool based on the more appropriate and reasonable data fit. In addition, during the second quarter of 2024, a reallocation of qualitative factor weightings for each pool was performed based on assessment of applicability and significance in terms of anticipated effect of each factor on loss rates for each pool. An update to the prepayment and curtailment rates used in the Company's CECL model was performed during the three months ended September 30, 2024.

A significant portion of the increase in loan balances in the first nine months of 2024 was attributable to the purchase of government-guaranteed loans which do not require an ACL as they are 100% guaranteed, with balances increasing by $111.1 million from December 31, 2023 to September 30, 2024.

The decrease in unfunded commitment reserve from the prior quarter, and therefore the recovery of provision related thereto, was almost entirely due to the decrease in the balances of unfunded construction loans, declining from $24.8 million as of June 30, 2024 to $17.3 million as of September 30, 2024.

Further discussion of management’s assessment of the ACL is provided earlier in the report and in Note 5 – Allowance for Credit Losses, found in the Notes to the Consolidated Financial Statements. In management’s opinion, the ACL was adequately provided for at September 30, 2024. The ACL calculation, provision for credit losses, asset quality and collateral values may be significantly impacted by deterioration in economic conditions. Should economic conditions worsen, we could experience further increases in our required ACL and record additional provision for credit loss exposure.

Noninterest income

The components of noninterest income for the three months ended September 30, 2024 and 2023 are shown below (dollars in thousands):

Noninterest income for the three months ended September 30, 2024 of $1.5 million was $1.2 million or 45.1% less than the amount recorded for the three months ended September 30, 2023, due primarily to the receipt of proceeds from bank-owned life insurance due to the death of a former employee in the third quarter of the prior year.

The components of noninterest income for the nine months ended September 30, 2024 and 2023 are shown below (dollars in thousands):

Noninterest income for the nine months ended September 30, 2024 of $5.3 million was $1.6 million or 23.6% less than the amount recorded for the nine months ended September 30, 2023, due primarily, as noted above, to the receipt of proceeds from bank-owned life insurance due to the death of a former employee in the third quarter of the prior year. In addition, wealth management and debit/credit card and ATM fees declined as a result of a reduction in number of accounts.

Noninterest expense

The components of noninterest expense for the three months ended September 30, 2024 and 2023 are shown below (dollars in thousands):

Noninterest expense for the quarter ended September 30, 2024 of $7.9 million was $397 thousand or 4.8% lower than the quarter ended September 30, 2023. This decrease is primarily due to reduced compensation and occupancy costs, as a result of right-sizing the branch network from the Merger, and reduced marketing, advertising and promotion expense.

The components of noninterest expense for the nine months ended September 30, 2024 and 2023 are shown below (dollars in thousands):

Noninterest expense for the nine months ended September 30, 2024 of $24.9 million was $881 thousand or 3.4% lower than the nine months ended September 30, 2023. This decrease is primarily due to reduced compensation, occupancy and data processing costs, as a result of right-sizing the branch network from the Merger, and reduced marketing, advertising and promotion expense.

The efficiency ratio (FTE) was 58.6% for the three months ended September 30, 2024 compared to 60.3% for the same quarter of 2023, due predominantly to the increase in net interest income (FTE), as described above. The efficiency ratio (FTE) of 62.6% for the nine months ended September 30, 2024 increased from the 56.7% realized in the nine months ended September 30, 2023 due predominantly to the decline in net interest income (FTE). Refer to the Reconcilement of Non-GAAP Measures table within the Non-GAAP presentations section for a reconcilement of GAAP to non-GAAP efficiency ratio.

Provision for Income Taxes

For the three months ended September 30, 2024 and 2023, the Company provided $1.0 million and $824 thousand for Federal income taxes, respectively, resulting in effective income tax rates of 18.5% and 15.0%, respectively. The effective income tax rate was lower in the prior period due to the effect of tax-exempt income from bank owned life insurance proceeds received due to the death of a former employee in the third quarter of the prior year. For the nine months ended September 30, 2024 and 2023, the Company provided $2.6 million and $3.4 million for Federal income taxes, respectively, resulting in effective income tax rates of 17.6% and 17.4%, respectively. For each period, the effective income tax rate differed from the U.S. statutory rate of 21% due to the recognition of low-income housing tax credits and the effect of tax-exempt income from municipal bonds and bank owned life insurance policies.

OTHER SIGNIFICANT EVENTS

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