Attached files

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EX-32 - Village Bank & Trust Financial Corp.ex32.htm
EX-21 - Village Bank & Trust Financial Corp.ex21.htm
EX-31.1 - Village Bank & Trust Financial Corp.ex31-1.htm
EX-99.1 - Village Bank & Trust Financial Corp.ex99-1.htm
EX-10.9 - Village Bank & Trust Financial Corp.ex10-9.htm
EX-31.2 - Village Bank & Trust Financial Corp.ex31-2.htm
EX-99.2 - Village Bank & Trust Financial Corp.ex99-2.htm
EX-10.10 - Village Bank & Trust Financial Corp.ex10-10.htm

Washington, D.C. 20549


For the fiscal year ended December 31, 2010

Commission file number 0-50765

(Exact name of registrant as specified in its charter)

(State or other jurisdiction of
(I.R.S. Employer
incorporation or organization)
Identification No.)
15521 Midlothian Turnpike, Suite 200, Midlothian, Virginia             23113
                       (Address of principal executive offices)                    (Zip Code)
Issuer’s telephone number 804-897-3900

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

Title of each class
Name of each exchange on which registered
Common Stock, $4.00 par value
The Nasdaq Stock Market
Securities registered under Section 12(g) of the Exchange Act:

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.  Yes o Noþ
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Act. [  ]
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yesþ  Noo 
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every
Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes o No o 
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form10-K or any amendment to this Form 10-K.[  ]
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definition of “large accelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
Large Accelerated Filer o
Accelerated Filer o
Non-Accelerated Filer o(Do not check if smaller reporting company)
Smaller Reporting Company þ
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
Yes o No þ
The aggregate market value of common stock held by non-affiliates of the registrant as of the last business day of the Registrant’s most recent completed second fiscal quarter was approximately $12,291,000.
The number of shares of common stock outstanding as of March 8, 2011 was 4,238,416.
Portions of the definitive Proxy Statement to be used in conjunction with the 2011 Annual Meeting of Shareholders are incorporated by reference into Part III of this Form 10-K.



Village Bank and Trust Financial Corp.
Form 10-K

Risk Factors
Unresolved Staff Comments
Legal Proceedings
Removed and Reserved
Market for Registrant’s Common Equity, Related Stockholder
Matters and Issuer Purchases of Equity Securities
Selected Financial Data
Management’s Discussion and Analysis of Financial Condition
And Results of Operations
Financial Statements and Supplementary Data
Changes In and Disagreements with Accountants
on Accounting and Financial Disclosure
Controls and Procedures
Other Information
Directors, Executive Officers, and Corporate Governance
Executive Compensation
Security Ownership of Certain Beneficial Owners and
Management and Related Stockholder Matters
Certain Relationships and Related Transactions,
and Director Independence
Principal Accounting Fees and Services
Exhibits, Financial Statement Schedules



The disclosures set forth in this item are qualified by ITEM 1A. RISK FACTORS on pages 17 to 24 and the section captioned “Caution About Forward-Looking Statements” on page 29 and other cautionary statements set forth elsewhere in this report.


Village Bank and Trust Financial Corp. (the “Company”) was incorporated in January 2003 and was organized under the laws of the Commonwealth of Virginia as a bank holding company whose activities consist of investment in its wholly-owned subsidiary, Village Bank (the “Bank”).  The Bank opened to the public on December 13, 1999 as a traditional community bank offering deposit and loan services to individuals and businesses in the Richmond, Virginia metropolitan area.  During 2003, the Company acquired or formed three wholly owned subsidiaries of the Bank, Village Bank Mortgage Corporation (“Village Bank Mortgage”), a full service mortgage banking company, Village Insurance Agency, Inc. (“Village Insurance”), a full service property and casualty insurance agency, and Village Financial Services Corporation (“Village Financial Services”), a financial services company.  Currently, Village Insurance and Village Financial Services have no ongoing operations.  In addition we provide investment services through a separate division of the Bank, Village Investment Services.

The Company is the holding company of and successor to the Bank.  Effective April 30, 2004, the Company acquired all of the outstanding stock of the Bank in a statutory share exchange transaction.  In the transaction, the shares of the Bank’s common stock were exchanged for shares of the Company’s common stock, par value $4.00 per share (“Common Stock”), on a one-for-one basis.  As a result, the Bank became a wholly-owned subsidiary of the Company, the Company became the holding company for the Bank and the shareholders of the Bank became shareholders of the Company.  All references to the Company in this annual report for dates or periods prior to April 30, 2004 are references to the Bank.

We offer a wide range of banking and related financial services, including checking, savings, certificates of deposit and other depository services, and commercial, real estate and consumer loans.  In addition we provide investment services through a separate division of the Bank, Village Investment Services.  We are a community-oriented and locally managed financial institution focusing on providing a high level of responsive and personalized services to our customers, delivered in the context of a strong direct relationship with our customers.  We conduct our operations from our main office/corporate headquarters location in Chesterfield County, and we have fifteen branch offices.

On October 14, 2008, Village Bank and Trust Financial Corp. and Village Bank completed its merger with River City Bank pursuant to an Agreement and Plan of Reorganization and Merger (the “Merger Agreement”) dated as of March 9, 2008 by and among the Company, the Bank and River City Bank.  The merger had previously been approved by both companies’ shareholders at their respective annual meetings on September 30, 2008 as well as the banking regulators.  The Merger Agreement sets forth the terms and conditions of the Company’s merger with River City Bank through the merger of River City Bank with and into Village Bank.  Under the terms of the Merger Agreement, Village Bank acquired all of the outstanding shares of River City Bank.  The shareholders of River City Bank received, for each share of River City Bank common stock that they owned immediately prior to the effective time of the merger, either $11 per share in cash or one share of common stock of the Company.  Pursuant to the terms of the Merger Agreement, shareholders of River City Bank elected to receive cash, shares of common stock of the Company, or a combination of both, subject to allocation and proration procedures which ensured that 20% of the total merger consideration was in cash and 80% was in common stock of the Company.  In addition, at the effective time of the merger, each outstanding option to purchase shares of River City Bank common stock under any stock plans vested pursuant to its terms and was converted into an option to acquire the number of

shares of the Company’s common stock equal to the number of shares of River City Bank common stock underlying the option.  The Company issued approximately 1,440,000 shares in the Merger.

Business Strategy

Our current business strategies include the following:

To be a full service financial services provider enabling us to establish and maintain relationships with our customers.

To attract customers by providing the breadth of products offered by larger banks while maintaining the quick response and personal service of a community bank.  We will continue to look for opportunities to expand our products and services.  We have established a diverse product line, including commercial, mortgage and consumer loans as well as a full array of deposit products and services.

To reduce the level of our nonperforming assets.  Nonperforming assets, consisting of nonaccrual loans and real estate acquired through foreclosure, reached record highs in 2010 and continue to have a negative affect on profitability.  We have committed significant resources to reduce the level of nonperforming assets.

To expand our capacity to generate noninterest income through the sale of mortgage loans.  Our mortgage company has experienced a significant increase in loan production as a result of the addition of a loan production office in Northern Virginia.

To continue to emphasize commercial banking products and services.  Small-business commercial customers are a source of prime-based loans, fee income from cash management services, and low cost deposits, which we need to fund our growth.  We have been able to build a commercial business base because our staff of commercial bankers seeks opportunities to network within the local business community.  Significant additional growth in this banking area will depend on expanding our lending staff.

Our officers, employees and the directors live and work in our market area.  We believe that the existing and future banking market in our community represents an opportunity for locally owned and locally managed community banks.  In view of the continuing trend in the financial services industry toward consolidation into larger, sometimes impersonal, statewide, regional and national institutions, the market exists for the personal and customized financial services that an independent, locally owned bank with local decision making can offer.  With the flexibility of our smaller size and through an emphasis on relationship banking, including personal attention and service, we can be more responsive to the individual needs of our customers than our larger competitors.  As a community oriented and locally managed institution, we make most of our loans in our community and can tailor our services to meet the banking and financial needs of our customers who live and do business in our market.

We provide customers with high quality, responsive and technologically advanced banking services.  These services include loans that are priced on a deposit-based relationship, easy access to our decision makers, and quick and innovative action necessary to meet a customer’s banking needs.

Location and Market Area

Our overall strategy is to become the premier financial institution serving the Richmond metropolitan area.  We recognized early on that to be successful with this strategy, we needed to grow aggressively, expanding our branch network to reach the most people possible.  Initially, we focused our operations in Chesterfield County, Virginia, which, despite its potential for business development and population growth, has been underserved by community banks.  Chesterfield’s resources are very favorable for businesses seeking a profitable and stable environment.  The county offers superb commercial and industrial sites, an educated work force, well-designed and developed infrastructure and a competitive tax structure.  Chesterfield has been awarded the U.S. Senate Gold Medallion for

Productivity and Quality.  The county has the highest bond rating from three rating agencies - Standard and Poors, Moody’s and Fitch.

Once we established a strong banking presence in Chesterfield County market with eight branches, we continued the implementation of our strategy by expanding our franchise into other counties in the Richmond Metropolitan area.  In addition to Chesterfield County, we have now opened three branches in both Hanover and Henrico Counties and one in Powhatan County, all three along with Chesterfield have seen strong population growth in recent years.  Our mortgage company has experienced a significant increase in loan production as a result of the addition of a loan production office in Northern Virginia.

At December 31, 2010, we had fifteen full service banking offices, which were staffed by 62 full-time employees.  Our senior staff averages more than 25 years of professional or banking experience.  Our principal office, which houses our executive officers and loan department, was opened in August 2008 and is located at 15521 Midlothian Turnpike, Midlothian, Virginia 23113.  Our main telephone number is (804) 897-3900.

Historically the Richmond Metropolitan area has been a favorable market for us to provide banking services.  However, with the depressed economy that started in late 2008 and was prevalent throughout 2009 and 2010, this market area was negatively impacted by the decline in the housing market, especially in Chesterfield County where residential housing has been an economic driver in the past.  Because a substantial part of our loan portfolio is collateralized by residential real estate primarily in Chesterfield County, this decline in the housing market has had a negative impact on our asset quality.  The result has been a substantial increase in nonperforming assets, and in turn, a negative impact on profitability.  See further discussion of nonperforming assets under Asset Quality in Management’s Discussion and Analysis of Financial Condition and Results of Operations following.

Banking Services

We receive deposits, make consumer and commercial loans, and provide other services customarily offered by a commercial banking institution, such as business and personal checking and savings accounts, drive-up windows, and 24-hour automated teller machines.  We have not applied for permission to establish a trust department and offer trust services.  We are not a member of the Federal Reserve System.  Our deposits are insured under the Federal Deposit Insurance Act to the limits provided thereunder.

We offer a full range of short-to-medium term commercial and personal loans.  Commercial loans include both secured and unsecured loans for working capital (including inventory and receivables), business expansion (including acquisition of real estate and improvements) and purchase of equipment and machinery.  Consumer loans include secured and unsecured loans for financing automobiles, home improvements, education and personal investments.  We also originate fixed and variable rate mortgage loans and real estate construction and acquisition loans.  Residential loans originated by our mortgage company are usually sold in the secondary mortgage market.

Our lending activities are subject to a variety of lending limits imposed by federal and state law.  While differing limits apply in certain circumstances based on the type of loan or the nature of the borrower (including the borrower’s relationship to the bank), in general, for loans that are not secured by readily marketable or other permissible collateral, we are subject to a loans-to-one borrower limit of an amount equal to 15% of our capital and surplus.  We may voluntarily choose to impose a policy limit on loans to a single borrower that is less than the legal lending limit.  We are a member of the Community Bankers’ Bank and may participate out portions of loans when loan amounts exceed our legal lending limits or internal lending policies.

Lending Activities

Our primary focus is on making loans to small businesses and consumers in our local market area.  In addition, we also provide a select range of real estate finance services.  Our primary lending

activities are principally directed to our market area.

Loan Portfolio.  The net loan portfolio was $446,555,000 at December 31, 2010, which compares to $457,047,000 at December 31, 2009.  The Company continued to see a decline in loan levels in 2010, with a decline of 2.3% compared to a decline of 1.6% in 2009.  In 2008, loans grew significantly by 44%.  The decline in loans in 2010 and 2009 was a direct result of the prolonged economic downturn while the majority of the loan growth in 2008 came as a result of our merger with River City Bank.  Our loan customers are generally located in the Richmond metropolitan area.  We do not have any subprime loans in our loan portfolio.

Commercial Real Estate Lending.  We finance commercial real estate for our clients and commercial real estate loans represent the largest segment of our loan portfolio.  This segment of our loan portfolio has been the largest segment since 2004 due to the significant real estate opportunities in our market area.  We generally will finance owner-occupied commercial real estate at an 80% loan-to-value ratio or less.  In many cases our loan-to-value ratio is less than 80%, which provides us with a higher level of collateral security.  Our underwriting policies and procedures focus on the borrower’s ability to repay the loan as well as assessment of the underlying real estate.  Risks inherent in managing a commercial real estate loan portfolio relate to sudden or gradual drops in property values as well as changes in the economic climate.  We attempt to mitigate those risks by carefully underwriting loans of this type as well as following appropriate loan-to-value standards.  Commercial real estate loans (generally owner occupied) at December 31, 2010 were $261,517,000, or 57.7% of the total loan portfolio.

Residential Mortgage Lending.  We make permanent residential mortgage loans for inclusion in the loan portfolio.  We seek to retain in our portfolio variable rate loans secured by one-to-four-family residences.  However, the majority of permanent residential loans are made by the Bank’s subsidiary, Village Bank Mortgage, which sells them to investors in the secondary mortgage market on a pre-sold basis.  Given the low fixed rate residential loan market in recent years, this allows us to offer this service to our customers without retaining a significant low rate residential loan portfolio which would be detrimental to earnings as interest rates increase.  We originate both conforming and non-conforming single-family loans.

Before we make a loan we evaluate both the borrower’s ability to make principal and interest payments and the value of the property that will secure the loan.  We make first mortgage loans in amounts up to 90% of the appraised value of the underlying real estate.  We retain some second mortgage loans secured by property in our market area, as long as the loan-to-value ratio combined with the first mortgage does not exceed 90%.  For conventional loans in excess of 80% loan-to-value, private mortgage insurance is required.

Our current one-to-four-family residential adjustable rate mortgage loans have interest rates that adjust annually after a fixed period of 1, 3 and 5 years, generally in accordance with the rates on comparable U.S. Treasury bills plus a margin.  Our adjustable rate mortgage loans generally limit interest rate increases to 2% each rate adjustment period and have an established ceiling rate at the time the loans are made of up to 6% over the original interest rate.  There are risks resulting from increased costs to a borrower as a result of the periodic repricing mechanisms of these loans.  Despite the benefits of adjustable rate mortgage loans to our asset/liability management, they pose additional risks, primarily because as interest rates rise; the underlying payments by the borrowers rise, increasing the potential for default.  At the same time, the marketability of the underlying property may be adversely affected by higher interest rates.  At December 31, 2010, $103,386,000, or 22.8% of our loan portfolio, consisted of residential mortgage loans.

Real Estate Construction Lending.  This segment of our loan portfolio is predominately residential in nature and comprised of loans with short duration, meaning maturities of twelve months or less.  Residential houses under construction and the underlying land for which the loan was obtained secure the construction loans.  Construction lending entails significant risks compared with residential mortgage lending.  These risks involve larger loan balances concentrated with single borrowers with funds advanced upon the security of the land and home under construction, which is estimated prior to the completion of the home.  Thus it is more difficult to evaluate accurately the

total loan funds required to complete a project and related loan-to-value ratios.  To mitigate these risks we generally limit loan amounts to 80% of appraised values on pre-sold homes and 75% on speculative homes, and obtain first lien positions on the property taken as security.  Additionally, we offer real estate construction financing to individuals who have demonstrated the ability to obtain a permanent loan.  At December 31, 2010, construction loans totaled $45,220,000, or 10.0% of the total loan portfolio.

Commercial Business Lending.  Our commercial business lending consists of lines of credit, revolving credit facilities, term loans, equipment loans, stand-by letters of credit and unsecured loans.  Commercial loans are written for any business purpose including the financing of plant and equipment, carrying accounts receivable, general working capital, contract administration and acquisition activities.  Our client base is diverse, and we do not have a concentration of loans in any specific industry segment.  Commercial business loans are generally secured by accounts receivable, equipment, inventory and other collateral such as marketable securities, cash value of life insurance, and time deposits.  Commercial business loans have a higher degree of risk than residential mortgage loans, but have higher yields.  To manage these risks, we generally obtain appropriate collateral and personal guarantees from the borrower’s principal owners and monitor the financial condition of business borrowers.  The availability of funds for the repayment of commercial business loans may substantially depend on the success of the business itself.  Further, the collateral for commercial business loans may depreciate over time and cannot be appraised with as much precision as residential real estate.  All commercial loans we make have recourse under the terms of a promissory note.  At December 31, 2010, commercial loans totaled $31,706,000, or 7.0% of the total loan portfolio.

Consumer Installment Lending.  We offer various types of secured and unsecured consumer loans.  We make consumer loans primarily for personal, family or household purposes as a convenience to our customer base since these loans are not the primary focus of our lending activities.  Our general guideline is that a consumer’s total debt service should not exceed 40% of the consumer’s gross income.  Our underwriting standards for consumer loans include making a determination of the applicant’s payment history on other debts and an assessment of his or her ability to meet existing obligations and payments on the proposed loan.  The stability of an applicant’s monthly income may be determined by verification of gross monthly income from primary employment and additionally from any verifiable secondary income.  Consumer loans totaled $11,414,000 at December 31, 2010, which was 2.5% of the total loan portfolio.

Loan Commitments and Contingent Liabilities.  In the normal course of business, the Company makes various commitments and incurs certain contingent liabilities which are disclosed in the footnotes of our annual financial statements, including commitments to extend credit.  At December 31, 2010, undisbursed credit lines, standby letters of credit and commitments to extend credit totaled $59,240,000.

Credit Policies and Administration.  We have a comprehensive lending policy, which includes stringent underwriting standards for all types of loans.  Our lending staff follows pricing guidelines established periodically by our management team.  In an effort to manage risk, all credit decisions in excess of the officers’ lending authority must be approved prior to funding by a management loan committee and/or a board of directors-level loan committee.  Any loans above $5,000,000 require full board of directors’ approval.  Management believes that it employs experienced lending officers, secures appropriate collateral and carefully monitors the financial conditions of our borrowers and the concentration of such loans in the portfolio.

In addition to the normal repayment risks, all loans in our portfolio are subject to the state of the economy and the related effects on the borrower and/or the real estate market.  Generally, longer-term loans have periodic interest rate adjustments and/or call provisions.  Our senior management monitors the loan portfolio closely to ensure that past due loans are minimized and that potential problem loans are swiftly dealt with.  In addition to the internal business processes employed in the credit administration area, the Company utilizes an outside consulting firm to review the loan portfolio.  A detailed annual review is performed, with an interim update occurring at least once a year.  Results of the report are used to validate our internal loan ratings and to provide independent

commentary on specific loans and loan administration activities.

Lending Limit.  As of December 31, 2010, our legal lending limit for loans to one borrower was approximately $8,490,000.  However, we generally will not extend credit to any one individual or entity in excess of $5,000,000, and, as noted above, any amount over that must be approved by the full Board of Directors.

Investments and Funding

We balance our liquidity needs based on loan and deposit growth via the investment portfolio, purchased federal funds, and Federal Home Loan Bank advances.  It is our goal to provide adequate liquidity to support our loan growth.  Should we have excess liquidity, investments are used to generate positive earnings.  In the event deposit growth does not fully support our loan growth, a combination of investment sales, federal funds and Federal Home Loan Bank advances will be used to augment our funding position.  However, we believe that due to a continued depressed economy as well as capital limitations, we will not see any significant growth in our loan portfolio in 2011.  Accordingly, any growth in our deposits will be used to increase our investment portfolio or reduce higher cost borrowings.

Our investment portfolio is actively monitored and is classified as “available for sale.”  Under such a classification, investment instruments may be sold as deemed appropriate by management.  On a monthly basis, the investment portfolio is marked to market via equity as required by generally accepted accounting principles.  Additionally, we use the investment portfolio to balance our asset and liability position.  We will invest in fixed rate or floating rate instruments as necessary to reduce our interest rate risk exposure.

For securities classified as available-for-sale securities, we evaluate whether a decline in fair value below the amortized cost basis is other than temporary.  If the decline in fair value is judged to be other than temporary, the cost basis of the individual security is written down to fair value as a new cost basis and the amount of the write-down is included in earnings.  There were no securities at December 31, 2010 where a decline in market value was considered other than temporary.

Asset and Liability Management

Our Asset Liability Management Committee (ALCO), composed of senior managers of the Bank, manages the Bank’s assets and liabilities and strives to provide a stable, optimized net interest income and margin, adequate liquidity and ultimately a suitable after-tax return on assets and return on equity. ALCO conducts these management functions within the framework of written policies that the Bank’s board of directors has adopted.  ALCO works to maintain an acceptable position between rate sensitive assets and rate sensitive liabilities.  The board of directors oversees the ALCO function on an ongoing basis.


We encounter strong competition from other local commercial banks, savings and loan associations, credit unions, mortgage banking firms, consumer finance companies, securities brokerage firms, insurance companies, money market mutual funds and other financial institutions.  A number of these competitors are well-established.  Competition for loans is keen, and pricing is important.  Most of our competitors have substantially greater resources and higher lending limits than ours and offer certain services, such as extensive and established branch networks and trust services, which we do not provide at the present time.  Deposit competition also is strong, and we may have to pay higher interest rates to attract deposits.  Nationwide banking institutions and their branches have increased competition in our markets, and federal legislation adopted in 1999 allows non-banking companies, such as insurance and investment firms, to establish or acquire banks.

The greater Richmond metropolitan market has experienced several significant mergers or acquisitions involving all four regional banks formerly headquartered in central Virginia over the past fifteen years.  Additionally, other larger banks from outside Virginia have acquired local banks.  We

believe that the Company can capitalize on the recent merger activity and attract customers from those who are dissatisfied with the recently acquired banks.

At June 30, 2010, the latest date such information is available from the FDIC, the Bank’s deposit market share in Chesterfield County was 7.94% and 0.88% in the Richmond MSA.


We are subject to extension regulation by certain federal and state agencies and receive periodic examinations by those regulatory authorities.  As a consequence, our business is affected by state and federal legislation and regulations.

General. The discussion below is only a summary of the principal laws and regulations that comprise the regulatory framework applicable to us.  The descriptions of these laws and regulations, as well as descriptions of laws and regulations contained elsewhere herein, do not purport to be complete and are qualified in their entirety by reference to applicable laws and regulations.  In recent years, regulatory compliance by financial institutions such as ours has placed a significant burden on us both in costs and employee time commitment.

Bank Holding Company.  The Company is a bank holding company under the federal Bank Holding Company Act of 1956, as amended, and is subject to supervision and regulation by the Board of Governors of the Federal Reserve System (the “Federal Reserve”) and Virginia Bureau of Financial Institutions (the “BFI”).  As a bank holding company, the Company is required to furnish to the Federal Reserve annual and quarterly reports of its operations and such additional information as the Federal Reserve may require.  The Federal Reserve, Federal Deposit Insurance Corporation (the “FDIC”) and BFI also may conduct examinations of the Company and/or its subsidiary bank.

Bank Regulation.  As a Virginia-chartered bank that is not a member of the Federal Reserve System, the Bank is subject to regulation, supervision and examination by the BFI and the FDIC.  Federal and state law also specify the activities in which we may engage, the investments we may make and the aggregate amount of loans that may be granted to one borrower.  Various consumer and compliance laws and regulations also affect our operations.  Earnings are affected by general economic conditions, management policies and the legislative and governmental actions of various regulatory authorities, including those referred to above.  The following description summarizes some of the laws to which we are subject.  The BFI and the FDIC conduct regular examinations, reviewing such matters as the overall safety and soundness of the institution, the adequacy of loan loss reserves, quality of loans and investments, management practices, compliance with laws, and other aspects of our operations.  In addition to these regular examinations, we must furnish the FDIC and BFI with periodic reports containing a full and accurate statement of our affairs. Supervision, regulation and examination of banks by these agencies are intended primarily for the protection of depositors rather than shareholders.

Memorandum of Understanding.  In December 2010, the Bank entered into a Memorandum of Understanding with the FDIC and the BFI.  Pursuant to the Memorandum of Understanding, the Bank agreed to provide certain reports and to:

eliminate from its books, by charge-offs or collections, all assets or portions of assets classified “Loss” and 50 percent of those assets classified “Doubtful” in the regulatory examination reports that have not been previously collected or charged-off;
submit to the FDIC and the BFI specific plans and proposals to effect the reduction and improvement of any loans or lines of credit which are adversely classified in the regulatory examination reports or any internal or external loan review, and which aggregate $500,000 or more;
not extend, directly or indirectly, any additional credit to or for the benefit of any borrower who is obligated in any manner to the Bank on any extension of credit or portion thereof that has been charged off by the Bank or classified Loss or Doubtful in any report of examination, so long as such credit remains uncollected;
enhance the formal loan review program to provide accurate and timely identification of problem loans;

formulate a management plan that shall contain a review of each existing officer’s performance, abilities and assignments to positions within the Bank, the need, if any, for personnel outside the Bank, and an organizational chart and written job descriptions for personnel in the supervisory, administrative, and accounting functions;
review and update the written profit and strategic plan;
adopt a written plan for monitoring and reducing the Commercial Real Estate (CRE) concentration;
maintain the Allowance for Loan and Lease Losses at a level that is appropriate to cover estimated losses on individually evaluated loans determined to be impaired, as well as estimated credit losses inherent in the remainder of the loan portfolio;
limit asset growth to no more than five (5) percent per annum;
incorporate within the Bank’s Contingency Funding Plan certain recommendations contained in the regulatory examination reports;
maintain a Tier 1 Leverage Capital Ratio of not less than eight (8) percent and a Total Risk-Based Capital Ratio of not less than 11.5 percent;
take steps necessary, consistent with sound banking practices, to correct all violations of law and regulations cited in the regulatory examination reports;
not pay any cash dividends without the prior written consent of the FDIC and BFI; and
furnish written quarterly progress reports to the FDIC and BFI detailing steps taken to comply with the various provisions of the Memorandum of Understanding.

In February 2011, the Company also entered into a Memorandum of Understanding with the Federal Reserve Bank of Richmond (the “Reserve Bank”) and the BFI.  Pursuant to this Memorandum of Understanding, the Company must submit to the Reserve Bank and the BFI acceptable policies and procedures to ensure that the Company does not violate Sections 23A and 23B of the Federal Reserve Act and Regulation W of the Federal Reserve, which governs transactions between the Company and the Bank.  In addition, the Company will not, without prior written approval of the Reserve Bank and the BFI:

declare or pay any dividends on its common stock or preferred stock;
take dividends or any other form of payment representing a reduction in capital from the Bank;
make any payments on trust preferred securities;
incur, increase, repay, refinance or guarantee any debt; or
purchase or redeem any shares of its stock.

The Company also must notify the Reserve Bank and the BFI prior to using its cash assets other than (i) investment in obligations or equity of the Bank, (ii) investment in short-term, liquid assets or (iii) its normal and customary expenses, including regularly scheduled interest payments on existing debt.

Both Memorandums require the Company to furnish written quarterly progress reports to the Supervisory Authorities detailing steps taken to comply with their various provisions.  Management believes that it is currently or is in the process of being in full compliance with all of the items in the Memorandums and has met all reporting requirements.

The Dodd-Frank Wall Street Reform and Consumer Protection Act.  In July 2010, the Dodd-Frank Act Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”) was signed into law, incorporating numerous financial institution regulatory reforms.  Many of these reforms will be implemented over the course of 2011 and beyond through regulations to be adopted by various federal banking and securities regulatory agencies.  The following discussion describes the material elements of the regulatory framework that currently apply.  The Dodd-Frank Act implements far-reaching reforms of major elements of the financial landscape, particularly for larger financial institutions.  Many of its provisions do not directly impact community-based institutions like the Bank.  For instance, provisions that regulate derivative transactions and limit derivatives trading activity of federally-insured institutions, enhance supervision of “systemically significant” institutions, impose

new regulatory authority over hedge funds, limit proprietary trading by banks, and phase-out the eligibility of trust preferred securities for Tier 1 capital are among the provisions that do not directly impact the Bank either because of exemptions for institutions below a certain asset size or because of the nature of  the Bank’s operations.  Provisions that do impact the Bank include the following:

FDIC Assessments. The Dodd-Frank Act changes the assessment base for federal deposit insurance from the amount of insured deposits to average consolidated total assets less its average tangible equity.  In addition, it increases the minimum size of the Deposit Insurance Fund (“DIF”) and eliminates its ceiling, with the burden of the increase in the minimum size on institutions with more than $10 billion in assets.
Deposit Insurance.  The Dodd-Frank Act makes permanent the $250,000 limit for federal deposit insurance and provides unlimited federal deposit insurance until December 31, 2012 for non-interest-bearing demand transaction accounts at all insured depository institutions.
Interest on Demand Deposits.  The Dodd- Frank Act also provides that, effective one year after the date of enactment, depository institutions may pay interest on demand deposits, including business transaction and other accounts.
Consumer Financial Protection Bureau.  The Dodd-Frank Act centralizes responsibility for consumer financial protection by creating a new agency, the Consumer Financial Protection Bureau, responsible for implementing federal consumer protection laws, although banks below $10 billion in assets will continue to be examined and supervised for compliance with these laws by their federal bank regulator.
Mortgage Lending.  New requirements are imposed on mortgage lending, including new minimum underwriting standards, prohibitions on certain yield-spread compensation to mortgage originators, special consumer protections for mortgage loans that do not meet certain provision qualifications, prohibitions and limitations on certain mortgage terms and various new mandated disclosures to mortgage borrowers.
Holding Company Capital Levels.  Bank regulators are required to establish minimum capital levels for holding companies that are at least as stringent as those currently applicable to banks.  In addition, all trust preferred securities issued after May 19, 2010 will be counted as Tier 2 capital, but the Company’s currently outstanding trust preferred securities will continue to qualify as Tier 1 capital.
De Novo Interstate Branching.  National and state banks are permitted to establish de novo interstate branches outside of their home state, and bank holding companies and banks must be well-capitalized and well managed in order to acquire banks located outside their home state.
Transactions with Affiliates. The Dodd-Frank Act enhances the requirements for certain transactions with affiliates under Section 23A and 23B of the Federal Reserve Act, including an expansion of the definition of “covered transactions” and increasing the amount of time for which collateral requirements regarding covered transactions must be maintained.
Transactions with Insiders. Insider transaction limitations are expanded through the strengthening of loan restrictions to insiders and the expansion of the types of transactions subject to the various limits, including derivative transactions, repurchase agreements, reverse repurchase agreements and securities lending or borrowing transactions. Restrictions are also placed on certain asset sales to and from an insider to an institution, including requirements that such sales be on market terms and, in certain circumstances, approved by the institution’s board of directors.
Corporate Governance.  The Dodd-Frank Act includes corporate governance revisions that apply to all public companies, not just financial institutions, including with regard to executive compensation and proxy access to shareholders.

Many aspects of the Dodd-Frank Act are subject to rulemaking and will take effect over several years, and their impact on the Company or the financial industry is difficult to predict before such regulations are adopted.

Insurance of Accounts, Assessments and Regulation by the FDIC.  Our deposits are insured by the FDIC up to the limits set forth under applicable law, currently $250,000.  We are subject to the deposit insurance assessments of the DIF.  The amount of the assessment is a function of the institution’s risk
category, of which there are four, and its assessment base.  An institution’s risk category is determined according to its supervisory ratings and capital levels and is used to determine the institution’s assessment rate.  Beginning April 1, 2011, the assessment base is an institution’s average consolidated total assets less its average tangible equity.

The FDIC is authorized to prohibit any DIF-insured institution from engaging in any activity that the FDIC determines by regulation or order to pose a serious threat to the respective insurance fund.  Also, the FDIC may initiate enforcement actions against banks, after first giving the institution’s primary regulatory authority an opportunity to take such action.  The FDIC may terminate the deposit insurance of any depository institution if it determines, after a hearing, that the institution has engaged or is engaging in unsafe or unsound practices, is in an unsafe or unsound condition to continue operations, or has violated any applicable law, regulation, order or any condition imposed in writing by the FDIC.  It also may suspend deposit insurance temporarily during the hearing process for the permanent termination of insurance if the institution has no tangible capital.  If deposit insurance is terminated, the deposits at the institution at the time of termination, less subsequent withdrawals, shall continue to be insured for a period from six months to two years, as determined by the FDIC.  We are aware of no existing circumstances that could result in termination of our deposit insurance.

Payment of Dividends.  We are a legal entity separate and distinct from the Bank and our other subsidiaries.  Virtually all of our cash revenues will result from dividends paid to us by the Bank, which is subject to laws and regulations that limit the amount of dividends that it can pay. Under Virginia law, a bank may not declare a dividend in excess of its accumulated retained earnings without BFI approval.  As of December 31, 2010, the Bank did not have any accumulated retained earnings.  In addition, the Bank may not declare or pay any dividend if, after making the dividend, the bank would be "undercapitalized," as defined in FDIC regulations.

The FDIC and the state have the general authority to limit the dividends paid by insured banks if the payment is deemed an unsafe and unsound practice. Both the state and the FDIC have indicated that paying dividends that deplete a bank's capital base to an inadequate level would be an unsound and unsafe banking practice.

In addition, we are subject to certain regulatory requirements to maintain capital at or above regulatory minimums. These regulatory requirements regarding capital affect our dividend policies. Regulators have indicated that holding companies should generally pay dividends only if the organization's net income available to common shareholders over the past year has been sufficient to fully fund the dividends, and the prospective rate of earnings retention appears consistent with the organization's capital needs, asset quality and overall financial condition.  In addition, the Federal Reserve has issued guidelines that bank holding companies should inform and consult with the Federal Reserve in advance of declaring or paying a dividend that exceeds earnings for the period (e.g., quarter) for which the dividend is being paid or that could result in a material adverse change to the organization’s capital structure.

The Company is currently subject to a Memorandum of Understanding with the Reserve Bank and the BFI pursuant to which the Company must obtain the prior written approval of the Reserve Bank and the BFI to declare or pay any dividends on its common stock or preferred stock, take dividends or any other form of payment representing a reduction in capital from the Bank or make any payments on its trust preferred securities.

Capital Adequacy.  Both the Company and the Bank are required to comply with the capital adequacy standards established by the Federal Reserve, in the case of the Company, and the FDIC, in the case of the Bank.  The Federal Reserve has established a risk-based and a leverage measure of capital adequacy for bank holding companies.  The Bank is also subject to risk-based and leverage capital requirements adopted by the FDIC, which are substantially similar to those adopted by the Federal Reserve for bank holding companies.  Under the risk-based capital requirements, we and our bank subsidiary are each generally required to maintain a minimum ratio of total capital to risk-weighted assets (including specific off-balance sheet activities, such as standby letters of credit) of 8%.  At least half of the total capital must be composed of “Tier 1 Capital,” which is defined as common equity, retained earnings, qualifying perpetual preferred stock and minority interests in
common equity accounts of consolidated subsidiaries, less certain intangibles.  The remainder may consist of “Tier 2 Capital”, which is defined as specific subordinated debt, some hybrid capital instruments and other qualifying preferred stock and a limited amount of the loan loss allowance and pretax net unrealized holding gains on certain equity securities.  In addition, each of the federal banking regulatory agencies has established minimum leverage capital requirements for banking organizations.  Under these requirements, banking organizations must maintain a minimum ratio of Tier 1 capital to adjusted average quarterly assets equal to 3% to 5%, subject to federal bank regulatory evaluation of an organization’s overall safety and soundness.  In summary, the capital measures used by the federal banking regulators are:

Total Risk-Based Capital ratio, which is the total of Tier 1 Risk-Based Capital (which includes common shareholders’ equity, trust preferred securities, minority interests and qualifying preferred stock, less goodwill and other adjustments)  and Tier 2 Capital (which includes preferred stock not qualifying as Tier 1 capital, mandatory convertible debt, limited amounts of subordinated debt, other qualifying term debt and the allowance for loan losses up to 1.25 percent of risk-weighted assets and other adjustments) as a percentage of total risk-weighted assets,
Tier 1 Risk-Based Capital ratio (Tier 1 capital divided by total risk-weighted assets), and
the Leverage ratio (Tier 1 capital divided by adjusted average total assets).

Under these regulations, a bank will be:

“well capitalized” if it has a Total Risk-Based Capital ratio of 10% or greater, a Tier 1 Risk-Based Capital ratio of 6% or greater, a Leverage ratio of 5% or greater, and is not subject to any written agreement, order, capital directive, or prompt corrective action directive by a federal bank regulatory agency to meet and maintain a specific capital level for any capital measure,
“adequately capitalized” if it has a Total Risk-Based Capital ratio of 8% or greater, a Tier 1 Risk-Based Capital ratio of 4% or greater, and a Leverage ratio of 4% or greater (or 3% in certain circumstances) and is not well capitalized,
“undercapitalized” if it has a Total Risk-Based Capital ratio of less than 8%, a Tier 1 Risk-Based Capital ratio of less than 4% (or 3% in certain circumstances), or a Leverage ratio of less than 4% (or 3% in certain circumstances),
“significantly undercapitalized” if it has a Total Risk-Based Capital ratio of less than 6%, a Tier 1 Risk-Based Capital ratio of less than 3%, or a Leverage ratio of less than 3%, or
“critically undercapitalized” if its tangible equity is equal to or less than 2% of tangible assets.

In addition, the FDIC may require banks to maintain capital at levels higher than those required by general regulatory requirements.

In late 2010, the Basel Committee on Banking Supervision issued Basel III, a new capital framework for banks and bank holding companies that will impose a stricter definition of capital, with more focus on common equity.  If Basel III is implemented in the United States and becomes applicable to us, the Company and the Bank would likely be subject to higher minimum capital ratios than those to which we are currently subject.

Failure to meet statutorily mandated capital guidelines or more restrictive ratios separately established for a financial institution (like those contained in the Bank’s Memorandum of Understanding with the FDIC and BFI) could subject a bank or bank holding company to a variety of enforcement remedies, including issuance of a capital directive, the termination of deposit insurance by the FDIC, a prohibition on accepting or renewing brokered deposits, limitations on the rates of interest that the institution may pay on its deposits and other restrictions on its business. As described above, significant additional restrictions can be imposed on FDIC-insured depository institutions that fail to meet applicable capital requirements.

Additionally, the Federal Deposit Insurance Corporation Improvement Act of 1991 establishes a system of prompt corrective action to resolve the problems of undercapitalized banks. Federal banking regulators are required to take various mandatory supervisory actions and are authorized to

take other discretionary actions with respect to banks in the three “undercapitalized” categories. The severity of the action depends upon the capital category in which the institution is placed. Generally, subject to a narrow exception, the banking regulator must appoint a receiver or conservator for an institution that is critically undercapitalized. The federal banking agencies have specified by regulation the relevant capital level for each category.

An institution that is categorized as undercapitalized, significantly undercapitalized, or critically undercapitalized is required to submit an acceptable capital restoration plan to its appropriate federal banking agency.  A bank holding company must guarantee that a subsidiary depository institution meets its capital restoration plan, subject to various limitations.  The controlling holding company’s obligation to fund a capital restoration plan is limited to the lesser of 5% of an undercapitalized subsidiary’s assets or the amount required to meet regulatory capital requirements.  An undercapitalized institution is also generally prohibited from increasing its average total assets, making acquisitions, establishing any branches or engaging in any new line of business, except under an accepted capital restoration plan or with FDIC approval.  The regulations also establish procedures for downgrading an institution and a lower capital category based on supervisory factors other than capital.  As of December 31, 2010, the Bank would be considered “well-capitalized” by the FDIC.

The Dodd-Frank Act contains a number of provisions dealing with capital adequacy of insured depository institutions and their holding companies, which may result in more stringent capital requirements for insured depository institutions and their holding companies.  Under the Collins Amendment to the Dodd-Frank Act, federal regulators were directed to establish minimum leverage and risk-based capital requirements for, among other entities, banks and bank holding companies on a consolidated basis.  These minimum requirements can’t be less than the generally applicable leverage and risk-based capital requirements established for insured depository institutions nor quantitatively lower than the leverage and risk-based capital requirements established for insured depository institutions that were in effect as of the date that the Dodd-Frank Act was enacted.  These requirements in effect create capital level floors for bank holding companies similar to those in place currently for insured depository institutions.  The Collins Amendment also excludes trust preferred securities issued after May 19, 2010 from being included in Tier 1 capital unless the issuing company is a bank holding company with less than $500 million in total assets.  Trust preferred securities issued prior to that date will continue to count as Tier 1 capital for bank holding companies with less than $15 billion in total assets, and such securities will be phased out of Tier 1 capital treatment for bank holding companies with over $15 billion in total assets over a three-year period beginning in 2013.  The Collins Amendment did not exclude preferred stock issued to the U.S. Treasury through the TARP Capital Purchase Program from Tier 1 capital treatment. Accordingly, the Company’s trust preferred securities and preferred stock issued to the U.S. Treasury through the TARP Capital Purchase Program will continue to qualify as Tier 1 capital as should any preferred stock issued to the U.S. Treasury under the Small Business Lending Fund, if any.

In the fourth quarter of 2010, the Bank entered into the Memorandum of Understanding with the FDIC and BFI that it would maintain a minimum Tier 1 capital to average assets ratio of 8% and a minimum total capital to risk-weighted assets ratio of 11.5%.  At December 31, 2010, the Bank’s Tier 1 risk-based capital ratio was 10.85%, its total risk-based capital ratio was 12.11% and its leverage ratio was 8.76%, compared to 10.06%, 11.33% and 8.24% at December 31, 2009, respectively.  More information concerning our regulatory ratios at December 31, 2010 is included in Note 16 to the “Notes to Consolidated Financial Statements” included elsewhere in this Annual Report on Form 10-K.

Restrictions on Transactions with Affiliates.  Both the Company and the Bank are subject to the provisions of Section 23A of the Federal Reserve Act.  Section 23A places limits on the amount of:

A bank’s loans or extensions of credit, including purchases of assets subject to an agreement to repurchase, to affiliates;
A bank’s investment in affiliates;
Assets a bank may purchase from affiliates, except for real and personal property exempted by the Federal Reserve;
The amount of loans or extensions of credit to third parties collateralized by the securities or debt obligations of affiliates;
Transactions involving the borrowing or lending of securities and any derivative transaction that results in credit exposure to an affiliate; and
A bank’s guarantee, acceptance or letter of credit issued on behalf of an affiliate.

The total amount of the above transactions is limited in amount, as to any one affiliate, to 10% of a bank’s capital and surplus and, as to all affiliates combined, to 20% of a bank’s capital and surplus. In addition to the limitation on the amount of these transactions, each of the above transactions must also meet specified collateral requirements.  The Bank must also comply with other provisions designed to avoid acquiring low-quality assets from its affiliates.

The Company and the Bank are also subject to the provisions of Section 23B of the Federal Reserve Act which, among other things, prohibits an institution from engaging in the above transactions with affiliates unless the transactions are on terms substantially the same, or at least as favorable to the institution or its subsidiaries, as those prevailing at the time for comparable transactions with nonaffiliated companies.

On September 30, 2010, the Company sold its headquarters building at the Watkins Centre to the Bank.  This transaction allowed us to repay the outstanding mortgage loan on the building resulting in a reduction of our interest expense and improvement in earnings on a consolidated basis.  The Reserve Bank has determined that the sale of the headquarters building from the Company to the Bank was not permitted under Section 23A of the Federal Reserve Act as the amount of the transaction exceeded 10% of the Bank’s capital stock and surplus.  As a result, the Reserve Bank has directed the Company to take corrective action.  The Company has provided a plan to the Reserve Bank for its approval which provides that the Company will seek to borrow funds to repurchase the building or effect a sale lease-back transaction with a third party.

The Bank is also subject to restrictions on extensions of credit to its executive officers, directors, principal shareholders and their related interests.  These extensions of credit (1) must be made on substantially the same terms, including interest rates and collateral, as those prevailing at the time for comparable transactions with third parties, and (2) must not involve more than the normal risk of repayment or present other unfavorable features.

The Dodd-Frank Act also provides that an insured depository institution may not purchase an asset from, or sell an asset to a bank insider (or their related interests) unless (1) the transaction is conducted on market terms between the parties, and (2) if the proposed transaction represents more than 10 percent of the capital stock and surplus of the insured institution, it has been approved in advance by a majority of the institution’s non-interested directors.

Support of Subsidiary Institutions. Under the Dodd-Frank Act, and previously under Federal Reserve policy, we are required to act as a source of financial strength for our bank subsidiary, Village Bank, and to commit resources to support the Bank.  This support can be required at times when it would not be in the best interest of our shareholders or creditors to provide it.  In the unlikely event of our bankruptcy, any commitment by us to a federal bank regulatory agency to maintain the capital of the Bank would be assumed by the bankruptcy trustee and entitled to a priority of payment.

Incentive Compensation Policies and Restrictions.  In July 2010, the federal banking agencies issued guidance which applies to all banking organizations supervised by the agencies (thereby including both the Company and the Bank). Pursuant to the guidance, to be consistent with safety and soundness principles, a banking organization’s incentive compensation arrangements should: (1) provide employees with incentives that appropriately balance risk and reward; (2) be compatible with effective controls and risk management; and (3) be supported by strong corporate governance including active and effective oversight by the banking organization’s board of directors. Monitoring methods and processes used by a banking organization should be commensurate with the size and complexity of the organization and its use of incentive compensation.

Emergency Economic Stabilization Act of 2008.  In response to unprecedented market turmoil

during the third quarter of 2008, the Emergency Economic Stabilization Act of 2008 (“EESA”) was enacted on October 3, 2008.  EESA authorized the U.S. Treasury to provide up to $700 billion to support the financial services industry.  Pursuant to the EESA, the U.S. Treasury was initially authorized to use $350 billion for the Troubled Asset Relief Program (“TARP”), of which the U.S. Treasury allocated $250 billion to the TARP Capital Purchase Program.

On May 1, 2009, the Company issued preferred stock and a warrant to purchase its common stock to the U.S. Treasury pursuant to the TARP Capital Purchase Program.  The amount of capital raised in that transaction was $14.7 million, approximately three percent of the Company’s risk-weighted assets.  Prior to May 1, 2012, unless the Company has redeemed all such preferred stock or the U.S. Treasury has transferred all such preferred stock to a third party, the consent of the U.S. Treasury will be required for us to, among other things, pay a dividend on the Company’s common stock or repurchase our common stock or outstanding preferred stock except in limited circumstances.  No dividends may be paid on common stock unless dividends have been paid on the preferred stock.  The preferred stock does not have voting rights other than the right to vote as a class on the issuance of any preferred stock ranking senior, any change in its terms or any merger, exchange or similar transaction that would adversely affect its rights.  The U.S. Treasury’s preferred stock will also have the right to elect two directors if dividends have not been paid for six periods.  The Company filed a registration statement on Form S-3 covering the warrant as required under the terms of the TARP investment, on May 29, 2009.  The registration statement was declared effective by the SEC on June 16, 2009.

In addition, as long as any obligation remains outstanding to the U.S. Treasury under the TARP Capital Purchase Program, the Company and the Bank must comply in all respects with the executive compensation and corporate governance standards under EESA and the rules and regulations thereunder.  In compliance with such requirements, each of our senior executive officers agreed in writing to accept the compensation standards under the TARP Capital Purchase Program and thereby cap or eliminate some of their contractual or legal rights.

Small Business Jobs and Credit Act of 2010.  In July 2010, the U.S. Congress passed the Small Business Jobs and Credit Act of 2010, which includes as a part thereof, the establishment of a $30 billion Small Business Lending Fund (SBLF).  The SBLF is a fund created by Congress to be used by the U.S. Treasury to make preferred stock investments in banks and bank holding companies that are not on the FDIC’s troubled bank list to stimulate small business lending.  Eligible banks and holding companies with more than $1 billion in assets but less than $10 billion can receive an investment totaling up to 3% of the institutions risk weighted assets less any amount previously invested in the institution by the U.S. Treasury under the CPP.  The size of the investment can be increased to 5% of risk-weighted assets for institutions under $1 billion in total assets.  The U.S. Treasury’s guidelines related to the SBLF permit participants in the CPP (like us) to refinance securities issued to the U.S. Treasury under the CPP.  However, CPP investments would be required to be paid in full since simultaneous participation in the CPP and the SBLF is not permissible.  Dividends will be payable quarterly on the preferred stock issued to the U.S. Treasury under the SBLF, but unlike dividends owed on preferred stock issued to the U.S. Treasury under the CPP, dividends payable on the preferred stock issued under the SBLF will be non-cumulative, meaning that the issuer can miss a regular dividend payment and not have to subsequently make the payment before it pays the next quarterly dividend.  Accordingly, the preferred stock issued under the SBLF will qualify for Tier 1 capital treatment under the more stringent capital standards imposed under the Dodd-Frank Act.  Although dividends on the preferred stock are non-cumulative, the failure to pay dividends causes certain consequences including prohibitions on repurchasing shares of the issuer’s stock or paying dividends on shares of the issuer’s stock that are pari passu or junior to the shares issued to the U.S. Treasury under the SBLF.  The initial dividend rate on the preferred stock issued under the SBLF program will be 5% but is subject to a reduction to as low as 1% during the first four-and-a-half years after the investment depending on the amount of increase in the institution’s small business lending following its issuance of the preferred stock to the U.S. Treasury.   After the initial four-and-a-half year period the rate will increase to 9%.  Under the SBLF, small business lending means lending as defined by and reported in an eligible institutions’ quarterly call report, where each loan comprising such lending is one of the following types:  (i) commercial and industrial loans; (ii) owner-occupied nonfarm, nonresidential real estate loans; (iii) loans to

finance agricultural production and other loans to farmers; and (iv) loans secured by farmland.  Loans greater than $10 million or to businesses with more than $50 million in revenue are excluded.  If any part of the loan is guaranteed by a U.S. government agency or enterprise, the guaranteed portion is subtracted from the loan amounts.

The Company is considering participating in the SBLF program.  If we participate, we will do so as part of redeeming the preferred stock that we have sold to the U.S. Treasury under the CPP.  If we decide to participate in the SBLF program and are accepted for participation and the proceeds of the U.S. Treasury’s investment are used to redeem the preferred stock we have previously sold to the U.S. Treasury under the CPP, we will no longer be subject to the above-described restrictions and obligations of the CPP, but, rather, will be subject to the restrictions and obligations of the SBLF program.

Sarbanes-Oxley Act of 2002. The Sarbanes-Oxley Act of 2002 implemented a broad range of corporate governance, accounting and reporting measures for companies, like the Company, that have securities registered under the Securities Exchange Act of 1934.  Specifically, the Sarbanes-Oxley Act and the various regulations promulgated under the Act, established, among other things: (i) new requirements for audit committees, including independence, expertise, and responsibilities; (ii) additional responsibilities regarding financial statements for the Chief Executive Officer and Chief Financial Officer of the reporting company; (iii) new standards for auditors and regulation of audits, including independence provisions that restrict non-audit services that accountants may provide to their audit clients; (iv) increased disclosure and reporting obligations for the reporting company and their directors and executive officers, including accelerated reporting of stock transactions and a prohibition on trading during pension blackout periods; and (v) a range of new and increased civil and criminal penalties for fraud and other violations of the securities laws.  In addition, Sarbanes-Oxley required stock exchanges, such as NASDAQ, to institute additional requirements relating to corporate governance in their listing rules.

Section 404 of the Sarbanes-Oxley Act requires the Company to include in its Annual Report on Form 10-K a report by management.  Management’s internal control report must, among other things, set forth management’s assessment of the effectiveness of the Company’s internal control over financial reporting.

Gramm-Leach-Bliley Act.  On November 12, 1999, the Gramm-Leach-Bliley Act was signed into law. Gramm-Leach-Bliley permits commercial banks to affiliate with investment banks.  It also permits bank holding companies which elect financial holding company status to engage in any type of financial activity, including securities, insurance, merchant banking/equity investment and other activities that are financial in nature.  The merchant banking provisions allow a financial holding company to make a controlling investment in any kind of company, financial or commercial.  These new powers allow a bank to engage in virtually every type of activity currently recognized as financial or incidental or complementary to a financial activity.  A commercial bank that wishes to engage in these activities is required to be well capitalized, well managed and have a satisfactory or better Community Reinvestment Act rating.  Gramm-Leach-Bliley also allows subsidiaries of banks to engage in a broad range of financial activities that are not permitted for banks themselves.

USA Patriot Act. The USA Patriot Act became effective on October 26, 2001 and provides for the facilitation of information sharing among governmental entities and financial institutions for the purpose of combating terrorism and money laundering. Among other provisions, the USA Patriot Act permits financial institutions, upon providing notice to the United States Treasury, to share information with one another in order to better identify and report to the federal government activities that may involve money laundering or terrorists’ activities. The USA Patriot Act is considered a significant banking law in terms of information disclosure regarding certain customer transactions. Certain provisions of the USA Patriot Act impose the obligation to establish anti-money laundering programs, including the development of a customer identification program, and the screening of all customers against any government lists of known or suspected terrorists. Although it does create a reporting obligation and compliance costs, the USA Patriot Act has not materially affected the Bank’s products, services or other business activities.

Reporting Terrorist Activities. The Office of Foreign Assets Control (OFAC), which is a division of the Department of the Treasury, is responsible for helping to insure that United States entities do not engage in transactions with “enemies” of the United States, as defined by various Executive Orders and Acts of Congress.  OFAC has sent, and will send, our banking regulatory agencies lists of names of persons and organizations suspected of aiding, harboring or engaging in terrorist acts. If the Bank finds a name on any transaction, account or wire transfer that is on an OFAC list, it must freeze such account, file a suspicious activity report and notify the FBI. The Bank has appointed an OFAC compliance officer to oversee the inspection of its accounts and the filing of any notifications. The Bank actively checks high-risk OFAC areas such as new accounts, wire transfers and customer files. The Bank performs these checks utilizing software, which is updated each time a modification is made to the lists provided by OFAC and other agencies of Specially Designated Nationals and Blocked Persons.

Other Safety and Soundness Regulations.  There are a number of obligations and restrictions imposed on depository institutions by federal law and regulatory policy that are designed to reduce potential loss exposure to the depositors of such depository institutions and to the FDIC insurance funds in the event the depository institution becomes in danger of default or is in default.  The Federal banking agencies also have broad powers under current Federal law to take prompt corrective action to resolve problems of insured depository institutions.  The extent of these powers depends upon whether the institution in question is well-capitalized, adequately capitalized, undercapitalized, significantly undercapitalized or critically undercapitalized, as defined by the law.  Federal regulatory authorities also have broad enforcement powers over us, including the power to impose fines and other civil and criminal penalties, and to appoint a receiver in order to conserve the assets of any such institution for the benefit of depositors and other creditors.  Village Bank is currently classified as well capitalized financial institution.

Loans-to-One Borrower. Under applicable laws and regulations the amount of loans and extensions of credit which may be extended by a bank to any one borrower, including related entities, generally may not exceed 15 percent of the sum of the capital, surplus, and loan loss reserve of the institution.

Community Reinvestment.  The requirements of the Community Reinvestment Act (“CRA”) are applicable to the Company.  The CRA imposes on financial institutions an affirmative and ongoing obligation to meet the credit needs of their local communities, including low and moderate income neighborhoods, consistent with the safe and sound operation of those institutions.  A financial institution’s efforts in meeting community credit needs currently are evaluated as part of the examination process pursuant to 12 assessment factors.  These factors also are considered in evaluating mergers, acquisitions and applications to open a branch or facility.

Economic and Monetary Policies.  Our operations are affected not only by general economic conditions, but also by the economic and monetary policies of various regulatory authorities.  In particular, the Federal Reserve regulates money, credit and interest rates in order to influence general economic conditions. These policies have a significant influence on overall growth and distribution of loans, investments and deposits and affect interest rates charged on loans or paid for time and savings deposits.  Federal Reserve monetary policies have had a significant effect on the operating results of commercial banks in the past and are expected to continue to do so in the future.


As of December 31, 2010, the Company and its subsidiaries had a total of 198 full-time employees and 17 part-time employees.  None of the Company’s employees are covered by a collective bargaining agreement.  The Company considers its relations with its employees to be good.

Control by Certain Shareholders

The Company has one shareholder who owns 8.37% of its outstanding Common Stock.  As a group, the Board of Directors and the Company’s Executive Officers control 17.06% of the outstanding

Common Stock of the Company as of March 1, 2010.  Accordingly, such persons, if they were to act in concert, would not have majority control of the Bank and would not have the ability to approve certain fundamental corporate transactions or the election of the Board of Directors.

Additional Information

The Company files annual, quarterly and current reports, proxy statements and other information with the Securities and Exchange Commission.  You may read and copy any reports, statements and other information we file at the SEC’s Public Reference Room at 450 Fifth Street, N.W., Washington, D.C. 20549. Please call the SEC at 1-800-SEC-0330 for further information on the operations of the Public Reference Room. Our SEC filings are also available on the SEC’s Internet site (

The Company’s common stock trades under the symbol “VBFC” on the Nasdaq Capital Market.

The Company’s Internet address is  At that address, we make available, free of charge, the Company’s annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Exchange Act (see “Investor Relations” section of website), as soon as reasonably practicable after we electronically file such material with, or furnish it to, the SEC.

In addition, we will provide, at no cost, paper or electronic copies of our reports and other filings made with the SEC (except for exhibits). Requests should be directed to C. Harril Whitehurst, Jr., Chief Financial Officer, Village Bank and Trust Financial Corp., PO Box 330, Midlothian, VA 23113.

The information on the websites listed above is not and should not be considered to be part of this annual report on Form 10-K and is not incorporated by reference in this document.

An investment in the Company’s common stock is subject to risks inherent to the Company’s business, including the material risks and uncertainties that are described below.  Before making an investment decision, you should carefully consider the risks and uncertainties described below together with all of the other information included or incorporated by reference in this report.  The risks and uncertainties described below are not the only ones facing the Company.  Additional risks and uncertainties that management is not aware of or focused on, or that management currently deems immaterial, may also impair the Company’s business operations.  This report is qualified in its entirety by these risk factors.  If any of the following risks adversely affect the Company’s business, financial condition or results of operations, the value of the Company’s common stock could decline significantly and you could lose all or part of your investment.

The Company’s business may be adversely affected by conditions in the financial markets and economic conditions generally.

From December 2007 through June 2009, the U.S. economy was in recession.  Business activity across a wide range of industries and regions in the U.S. was greatly reduced.  Although economic conditions have begun to improve, certain sectors, such as real estate, remain weak and unemployment remains high.  Local governments and many businesses are still in serious difficulty due to lower consumer spending and the lack of liquidity in the credit markets.  Market conditions also led to the failure or merger of several prominent financial institutions and numerous regional and community-based financial institutions.  These failures, as well as projected future failures, have had a significant negative impact on the capitalization level of the Deposit Insurance Fund of the FDIC, which, in turn, has led to a significant increase in deposit insurance premiums paid by financial institutions.  Such conditions could adversely affect the credit quality of the Company’s loans, and the Company’s results of operations and financial condition.  The Company’s financial performance generally, and in particular the ability of borrowers to pay interest on and repay principal of outstanding loans and the value of collateral securing those loans, as well as demand for loans and other products and services the Company offers, is highly dependent upon on the

business environment in the markets where the Company operates.  While general economic conditions in Virginia and the U.S. began to improve in 2010, there can be no assurance that this improvement will continue.

Improvements in economic indicators disproportionately affecting the financial services industry may lag improvements in the general economy.

Should the stabilization of the U.S. economy lead to a general economic recovery, the improvement of certain economic indicators, such as unemployment and real estate asset values and rents, may nevertheless continue to lag behind the overall economy.  These economic indicators typically affect certain industries, such as real estate and financial services, more significantly.  For example, improvements in commercial real estate fundamentals typically lag broad economic recovery by 12 to 18 months.  The Company’s clients include entities active in these industries.  Furthermore, financial services companies with a substantial lending business are dependent upon the ability of their borrowers to make debt service payments on loans.  Should unemployment or real estate asset values fail to recover for an extended period of time, the Company could be adversely affected.

Our results of operations are significantly affected by the ability of our borrowers to repay their loans.

A significant source of risk is the possibility that losses will be sustained because borrowers, guarantors and related parties may fail to perform in accordance with the terms of their loan agreements.  Most of the Company’s loans are secured but some loans are unsecured.  With respect to the secured loans, the collateral securing the repayment of these loans may be insufficient to cover the obligations owed under such loans.  Collateral values may be adversely affected by changes in economic, environmental and other conditions, including declines in the value of real estate, changes in interest rates, changes in monetary and fiscal policies of the federal government, widespread disease, terrorist activity, environmental contamination and other external events.  In addition, collateral appraisals that are out of date or that do not meet industry recognized standards may create the impression that a loan is adequately collateralized when it is not.  The Company has adopted underwriting and credit monitoring procedures and policies, including regular reviews of appraisals and borrower financial statements, that management believes are appropriate to mitigate the risk of loss.

As of December 31, 2010, approximately 75% of the Company’s loan portfolio consisted of commercial and industrial, construction and commercial real estate loans. These types of loans are generally viewed as having more risk of default than residential real estate loans or consumer loans.  These types of loans are also typically larger than residential real estate loans and consumer loans.  Because the Company’s loan portfolio contains a significant number of commercial and industrial, construction and commercial real estate loans with relatively large balances, the deterioration of one or a few of these loans could cause a significant increase in non-performing loans.  An increase in nonperforming loans could result in a net loss of earnings from these loans, an increase in the provision for loan losses and an increase in loan charge-offs, all of which could have a material adverse effect on the Company’s financial condition and results of operations.  Further, if repurchase and indemnity demands with respect to the Company’s loan portfolio increase, its liquidity, results of operations and financial condition will be adversely affected.

The Company’s allowance for loan losses may be insufficient.

The Company maintains an allowance for loan losses, which is a reserve established through a provision for loan losses charged to expense, that represents management’s best estimate of probable losses that have been incurred within the existing portfolio of loans.  The allowance, in the judgment of management, is necessary to reserve for estimated loan losses and risks inherent in the loan portfolio.

The level of the allowance reflects management’s continuing evaluation of industry concentrations; specific credit risks; loan loss experience; current loan portfolio quality; present economic, political and regulatory conditions and unidentified losses inherent in the current loan portfolio.  The

determination of the appropriate level of the allowance for loan losses inherently involves a high degree of subjectivity and requires the Company to make significant estimates of current credit risks and future trends, all of which may undergo material changes.  Continuing deterioration of economic conditions affecting borrowers, new information regarding existing loans, identification of additional problem loans and other factors, both within and outside the Company’s control, may require an increase in the allowance for loan losses.  In addition, bank regulatory agencies periodically review the Company’s allowance for loan losses and may require an increase in the provision for loan losses or the recognition of further loan charge-offs, based on judgments different than those of management.  Further, if charge-offs in future periods exceed the allowance for loan losses, the Company will need additional provisions to increase the allowance for loan losses.  Any increases in the allowance for loan losses will result in a decrease in net income and, possibly, capital, and may have a material adverse effect on the Company’s financial condition and results of operations.

Changes in interest rates may have an adverse effect on the Company’s profitability.

The operations of financial institutions such as the Company are dependent to a large degree on net interest income, which is the difference between interest income from loans and investments and interest expense on deposits and borrowings.  An institution’s net interest income is significantly affected by market rates of interest that in turn are affected by prevailing economic conditions, by the fiscal and monetary policies of the federal government and by the policies of various regulatory agencies.  The Federal Reserve Board (FRB) regulates the national money supply in order to manage recessionary and inflationary pressures.  In doing so, the FRB may use techniques such as engaging in open market transactions of U.S. Government securities, changing the discount rate and changing reserve requirements against bank deposits.  The use of these techniques may also affect interest rates charged on loans and paid on deposits.  The interest rate environment, which includes both the level of interest rates and the shape of the U.S. Treasury yield curve, has a significant impact on net interest income.  Like all financial institutions, the Company’s balance sheet is affected by fluctuations in interest rates.  Volatility in interest rates can also result in disintermediation, which is the flow of deposits away from financial institutions into direct investments, such as US Government and corporate securities and other investment vehicles, including mutual funds, which, because of the absence of federal insurance premiums and reserve requirements, generally pay higher rates of return than bank deposit products.  See “Item 7: Management’s Discussion of Financial Condition and Results of Operations” and “Item 7A: Quantitative and Qualitative Disclosure about Market Risk”.

The Bank may not be able to remain well capitalized

Federal regulatory agencies are required by law to adopt regulations defining five capital tiers: well capitalized, adequately capitalized, under capitalized, significantly under capitalized, and critically under capitalized.  The Bank meets the criteria to be categorized as a “well capitalized” institution as of December 31, 2010 and 2009.  However, the Bank may not be able to remain well capitalized for various reasons including a change in the mix of assets or a lack of profitability.  When capital falls below the “well capitalized” requirement, consequences can include: new branch approval could be withheld; more frequent examinations by the FDIC; brokered deposits cannot be renewed without a waiver from the FDIC; and other potential limitations as described in FDIC Rules and Regulations sections 337.6 and 303, and FDIC Act section 29.  In addition, the FDIC insurance assessment increases when an institution falls below the “well capitalized” classification.

Declines in value may adversely impact the investment portfolio.

We have not realized any non-cash, other-than-temporary impairment charges during 2010 as a result of reductions in fair value below original cost of any investments in our investment portfolio.  However, we could be required to record future impairment charges on our investment securities if they suffer any declines in value that are considered other-than-temporary.  Considerations used to determine other-than-temporary impairment status to individual holdings include the length of time the stock has remained in an unrealized loss position, and the percentage of unrealized loss compared to the carrying cost of the stock, dividend reduction or suspension, market analyst reviews and expectations, and other pertinent news that would affect expectations for recovery or further decline.

The Company may not be able to meet the cash flow requirements of its depositors and borrowers or meet its operating cash needs.

Liquidity is the ability to meet cash flow needs on a timely basis at a reasonable cost.  The liquidity of the Company is used to service its debt.  The liquidity of the Bank is used to make loans and leases and to repay deposit liabilities as they become due or are demanded by customers.  Liquidity policies and limits are established by the board of directors.  The overall liquidity position of the Company and the Bank are regularly monitored to ensure that various alternative strategies exist to cover unanticipated events that could affect liquidity.  Funding sources include Federal funds purchased, securities sold under repurchase agreements and non-core deposits. The Bank is a member of the Federal Home Loan Bank of Atlanta, which provides funding through advances to members that are collateralized with mortgage-related assets.

If the Company is unable to access any of these funding sources when needed, we might be unable to meet customers’ needs, which could adversely impact our financial condition, results of operations, cash flows, and level of regulatory-qualifying capital.

Negative perceptions associated with the Company’s continued participation in the U.S. Treasury’s Capital Purchase Program may adversely affect its ability to retain customers, attract investors and compete for new business opportunities.

Several financial institutions which participated in the TARP Capital Purchase Program (“CPP”) have received approval from the U.S. Treasury to exit the program.  These institutions have, or are in the process of, repurchasing the preferred stock and repurchasing or auctioning the warrant issued to the U.S. Treasury as part of the program.  The Company has not yet requested regulatory approval to repurchase the preferred stock and warrant from the U.S. Treasury.  In order to repurchase one or both securities, in whole or in part, the Company must establish that it has satisfied all of the conditions to repurchase and must obtain the approval of the U.S. Treasury.  There can be no assurance that the Company will be able to repurchase these securities from the U.S. Treasury and the consent of the FDIC.  The Company’s customers, employees and counterparties in its current and future business relationships may draw negative implications regarding the strength of the Company as a financial institution based on its continued participation in the program following the exit of one or more of its competitors or other financial institutions.  Any such negative perceptions may impair the Company’s ability to effectively compete with other financial institutions for business or to retain high performing employees.  If this were to occur, the Company’s business, financial condition and results of operations may be adversely affected, perhaps materially.

Government measures to regulate the financial industry, including the recently enacted Dodd-Frank Act, subject us to increased regulation and could aversely affect us.

As a financial institution, we are heavily regulated at the state and federal levels.  As a result of the financial crisis and related global economic downturn that began in 2007, we have faced, and expect to continue to face, increased public and legislative scrutiny as well as stricter and more comprehensive regulation of our financial services practices.  In July 2010, the Dodd-Frank Act was signed into law.  The Dodd-Frank Act includes significant changes in the financial regulatory landscape and will impact all financial institutions, including the Company and the Bank.  Many of the provisions of the Dodd-Frank Act have begun to be or will be implemented over the next several months or years and will be subject both to further rulemaking and the discretion of applicable regulatory bodies.  Because the ultimate impact of the Dodd-Frank Act will depend on future regulatory rulemaking and interpretation, we cannot predict the full effect of this legislation on our businesses, financial condition or results of operations.  Among other things, the Dodd-Frank Act and the regulations implemented thereunder could limit debit card interchange fees, increase FDIC assessments, impose new requirements on mortgage lending, and establish more stringent capital requirements on bank holding companies.  As a result of these and other provisions in the Dodd-Frank Act, we could experience additional costs, as well as limitations on the products and services

we offer and on our ability to efficiently pursue business opportunities, which may adversely affect our businesses, financial condition or results of operations.

Holders of the TARP preferred stock may, under certain circumstances, have the right to elect two directors to our board of directors.

As of December 31, 2010, we are current on payment of dividends on the TARP preferred stock.  In the event that we fail to pay dividends on the TARP preferred stock for an aggregate of six quarterly dividend periods or more (whether or not consecutive), the authorized number of directors then constituting our board of directors will be increased by two.  Holders of the TARP preferred stock, together with the holders of any outstanding parity stock with like voting rights, voting as a single class, will be entitled to elect the two additional members of our board of directors at the next annual meeting (or at a special meeting called for the purpose of electing these directors prior to the next annual meeting) and at each subsequent annual meeting until all accrued and unpaid dividends for all past dividend periods have been paid in full.

We are subject to executive compensation restrictions because of our participation in the CPP, which could limit our ability to recruit and retain executives.

As a participant in the CPP, we are subject to TARP rules and standards governing executive compensation and corporate governance, which generally apply to our Chief Executive Officer, Chief Financial Officer and the next three most highly compensated employees (together, our “senior executive officers”), as well as a number of other employees.  The standards include (i) a requirement to recover any bonus payment to senior executive officers and certain other employees if payment was based on materially inaccurate financial statements or performance metric criteria; (ii) a prohibition on making any golden parachute payments to senior executive officers and certain other employees; (iii) a prohibition on paying or accruing any bonus payment to our most highly compensated employee, subject to limited exceptions; (iv) a prohibition on maintaining any plan for senior executive officers that encourage such officers to take unnecessary and excessive risks that threaten the Company’s value; (v) a prohibition on maintaining any employee compensation plan that encourages the manipulation of reported earnings to enhance the compensation of any employee; and (vi) a prohibition on providing tax gross-ups to senior executive officers and other employees.  These restrictions and standards could limit our ability to recruit and retain executives.  If we lose the services of our key personnel, or are unable to attract additional qualified personnel, our operations may be disrupted and our businesses, financial condition and results of operations may be adversely impacted.

We are subject to Memorandums of Understanding with our regulators, which will require us to dedicate a significant amount of resources and which could otherwise adversely affect us.

In December 2010, the Bank entered into a Memorandum of Understanding with the FDIC and the BFI; in February 2011, the Company entered into an additional Memorandum of Understanding with the Federal Reserve and the BFI.  Among other things, the Memorandums of Understanding require us to develop and submit plans to reduce improve our loan portfolio, reducing our commercial real estate concentration, maintain an appropriate allowance for loan losses, review our management performance, and correct certain violations of law.  In particular, the Company must take corrective action regarding the Company’s sale of its headquarters building at the Watkins Centre to the Bank, which the Reserve Bank has determined was not permitted under Section 23A of the Federal Reserve Act.  This transaction had allowed the Company to repay the outstanding mortgage loan on the building, thereby reducing interest expense and increasing earnings on a consolidated basis; as a result, any corrective action could have an adverse impact on the Company’s results of operations.  The Company has provided a plan to the Federal Reserve which provides that the Company will seek to borrow funds to repurchase the building or effect a sale lease-back transaction with a third party, but cannot know at this time what corrective measure will be taken or what the impact will be.  In addition, the Memorandums of Understand require us to limit asset growth to no more than 5% per year and maintain certain capital ratios higher than those required to be considered “well capitalized.”  The Company has also agreed not to declare or pay and dividends on common stock

or preferred stock, including the TARP preferred, or make any payments on its trust preferred securities.

While subject to the Memorandums of Understanding, we expect that our management and board of directors will be required to focus considerable time and attention on taking corrective actions to comply with the terms.  In addition, certain provisions of the Memorandums of Understanding described above could adversely impact the Company’s businesses and results of operations.

There is also no guarantee that we will successfully address our regulators’ concerns in the Memorandums of Understanding or that we will be able to comply with it.  If we do not comply with the Memorandums of Understanding, we could be subject to further regulatory enforcement actions.

The soundness of other financial institutions could adversely affect us.

Our ability to engage in routine funding transactions could be adversely affected by the actions and commercial soundness of other financial institutions. Financial services institutions are interrelated as a result of trading, clearing, counterparty or other relationships. We have exposure to many different industries and counterparties, and we routinely execute transactions with counterparties in the financial industry. As a result, defaults by, or even rumors or questions about, one or more financial services institutions, or the financial services industry generally, have led to market-wide liquidity problems and could lead to losses or defaults by us or by other institutions. Many of these transactions expose us to credit risk in the event of default of our counterparty or client. In addition, our credit risk may be exacerbated when the collateral held by us cannot be realized upon or is liquidated at prices not sufficient to recover the full amount of the financial instrument exposure due us. There is no assurance that any such losses would not materially and adversely affect our results of operations.

Changes in economic conditions and related uncertainties may have an adverse affect on the Company’s profitability.

Commercial banking is affected, directly and indirectly, by local, domestic, and international economic and political conditions, and by governmental monetary and fiscal policies.  Conditions such as inflation, recession, unemployment, volatile interest rates, tight money supply, real estate values, international conflicts and other factors beyond the Company’s control may adversely affect the potential profitability of the Company.  Any future rises in interest rates, while increasing the income yield on the Company’s earnings assets, may adversely affect loan demand and the cost of funds and, consequently, the profitability of the Company.  Any future decreases in interest rates may adversely affect the Company’s profitability because such decreases may reduce the amounts that the Company may earn on its assets.  A continued recessionary climate could result in the delinquency of outstanding loans. Management does not expect any one particular factor to have a material effect on the Company’s results of operations.  However, downtrends in several areas, including real estate, construction and consumer spending, could have a material adverse impact on the Company’s profitability.

The supervision and regulation to which the Company is subject can be a competitive disadvantage.

The operations of the Company and the Bank are heavily regulated and will be affected by present and future legislation and by the policies established from time to time by various federal and state regulatory authorities.  In particular, the monetary policies of the Federal Reserve have had a significant effect on the operating results of banks in the past, and are expected to continue to do so in the future.  Among the instruments of monetary policy used by the Federal Reserve to implement its objectives are changes in the discount rate charged on bank borrowings and changes in the reserve requirements on bank deposits.  It is not possible to predict what changes, if any, will be made to the monetary polices of the Federal Reserve or to existing federal and state legislation or the effect that such changes may have on the future business and earnings prospects of the Company.

The Company is subject to changes in federal and state tax laws as well as changes in banking and credit regulations, accounting principles and governmental economic and monetary policies.

During the past several years, significant legislative attention has been focused on the regulation and deregulation of the financial services industry.  Non-bank financial institutions, such as securities brokerage firms, insurance companies and money market funds, have been permitted to engage in activities that compete directly with traditional bank business.

The competition the Company faces is increasing and may reduce our customer base and negatively impact the Company’s results of operations.

There is significant competition among banks in the market areas served by the Company.  In addition, as a result of deregulation of the financial industry, the Bank also competes with other providers of financial services such as savings and loan associations, credit unions, consumer finance companies, securities firms, insurance companies, the mutual funds industry, full service brokerage firms and discount brokerage firms, some of which are subject to less extensive regulations than the Company with respect to the products and services they provide.  Some of the Company’s competitors have greater resources than the Corporation and, as a result, may have higher lending limits and may offer other services not offered by our Company.  See “Item 1: Business — Competition.”

Our deposit insurance premium could be substantially higher in the future which would have an adverse effect on our future earnings.

The FDIC insures deposits at FDIC-insured financial institutions, including Village Bank.  The FDIC charges the insured financial institutions premiums to maintain the Deposit Insurance Fund at a certain level.  Current economic conditions have increased bank failures and expectations for further failures, which may result in the FDIC making more payments from the Deposit Insurance Fund and, in connection therewith, raising deposit premiums.  In addition, the deposit insurance limit on FDIC deposit insurance coverage generally has increased to $250,000, which may result in even larger losses to the Deposit Insurance Fund.  These developments have caused an increase to our assessments, and the FDIC may be required to made additional increases to the assessment rates and levy additional special assessments on us.  Higher assessments increase our non-interest expense.  The FDIC also instituted that non-interest bearing transactional accounts at institutions participating in the Transaction Account Guarantee Program are currently fully insured (unlimited coverage).  These programs have placed additional stress on the Deposit Insurance Fund.

In February 2011, the FDIC finalized a rule that increases premiums paid by insured institutions and makes other changes to the assessment system.  The Company is generally unable to control the amount of premiums that it is required to pay for FDIC insurance.  If there are additional bank or financial institution failures the Company may be required to pay even higher FDIC premiums than the recently increased levels.  Any future increases or required prepayments of FDIC insurance premiums may adversely impact its earnings.

Concern of customers over deposit insurance may cause a decrease in deposits.

With the continuing news about bank failures, customers are increasingly concerned about the extent to which their deposits are insured by the FDIC.  Customers may withdraw deposits in an effort to ensure that the amount they have on deposit with us is fully insured.  Decreases in deposits may adversely affect our funding costs and net income.

Fluctuations in the stock market could negatively affect the value of the Company’s common stock.

The Company’s common stock trades under the symbol “VBFC” on the Nasdaq Capital Market. There can be no assurance that a regular and active market for the Common Stock will develop in the foreseeable future.  See “Item 5: Market for Registrant’s Common Equity and Related Stockholder Matters and Issuer Purchases of Equity Securities.”  Investors in the shares of common

stock may, therefore, be required to assume the risk of their investment for an indefinite period of time.  Current lack of investor confidence in large banks may keep investors away from the banking sector as a whole, causing unjustified deterioration in the trading prices of well-capitalized community banks such as the Company.

If the Company fails to maintain an effective system of internal controls, it may not be able to accurately report its financial results or prevent fraud.  As a result, current and potential shareholders could lose confidence in the Company’s financial reporting, which could harm its business and the trading price of its common stock.

The Company has established a process to document and evaluate its internal controls over financial reporting in order to satisfy the requirements of Section 404 of the Sarbanes-Oxley Act of 2002 and the related regulations, which require annual management assessments of the effectiveness of the Company’s internal controls over financial reporting.  In this regard, management has dedicated internal resources, engaged outside consultants and adopted a detailed work plan to (i) assess and document the adequacy of internal controls over financial reporting, (ii) take steps to improve control processes, where appropriate, (iii) validate through testing that controls are functioning as documented and (iv) implement a continuous reporting and improvement process for internal control over financial reporting.  The Company’s efforts to comply with Section 404 of the Sarbanes-Oxley Act of 2002 and the related regulations regarding the Company’s assessment of its internal controls over financial reporting.  The Company’s management and audit committee have given the Company’s compliance with Section 404 a high priority.  The Company cannot be certain that these measures will ensure that the Company implements and maintains adequate controls over its financial processes and reporting in the future.  Any failure to implement required new or improved controls, or difficulties encountered in their implementation, could harm the Company’s operating results or cause the Company to fail to meet its reporting obligations.  If the Company fails to correct any issues in the design or operating effectiveness of internal controls over financial reporting or fails to prevent fraud, current and potential shareholders could lose confidence in the Company’s financial reporting, which could harm its business and the trading price of its common stock.

The Company is subject to a variety of operational risks, including reputational risk, legal and compliance risk, and the risk of fraud or theft by employees or outsiders.

The Company is exposed to many types of operational risks, including reputational risk, legal and compliance risk, the risk of fraud or theft by employees or outsiders, and unauthorized transactions by employees or operational errors, including clerical or record-keeping errors or those resulting from faulty or disabled computer or telecommunications systems.  Negative public opinion can result from its actual or alleged conduct in any number of activities, including lending practices, corporate governance and acquisitions and from actions taken by government regulators and community organizations in response to those activities.  Negative public opinion can adversely affect its ability to attract and keep customers and can expose the Company to litigation and regulatory action.

Because the nature of the financial services business involves a high volume of transactions, certain errors may be repeated or compounded before they are discovered and successfully rectified.  The Company’s necessary dependence upon automated systems to record and process its transaction volume may further increase the risk that technical flaws or employee tampering or manipulation of those systems will result in losses that are difficult to detect.  The Company also may be subject to disruptions of its operating systems arising from events that are wholly or partially beyond its control (for example, computer viruses or electrical or telecommunications outages), which may give rise to disruption of service to customers and to financial loss or liability.  The Company is further exposed to the risk that its external vendors may be unable to fulfill their contractual obligations (or will be subject to the same risk of fraud or operational errors by their respective employees as the Company is) and to the risk that its (or its vendors’) business continuity and data security systems prove to be inadequate.  The occurrence of any of these risks could result in a diminished ability of the Company to operate its business, potential liability to clients, reputational damage and regulatory intervention, which could adversely affect its business, financial condition and results of operations, perhaps materially.

The Company relies on other companies to provide key components of its business infrastructure.

Third parties provide key components of the Company’s business infrastructure, for example, system support, and Internet connections and network access.  While the Company has selected these third party vendors carefully, it does not control their actions.  Any problems caused by these third parties, including those resulting from their failure to provide services for any reason or their poor performance of services, could adversely affect its ability to deliver products and services to its customers and otherwise conduct its business.  Replacing these third party vendors could also entail significant delay and expense.

The Company may have to rely on dividends from the Bank.

The Company is a separate and distinct legal entity from its subsidiary bank.  Although the Company has never received any dividends from the Bank, it is entitled to receive dividends in accordance with federal and state regulations.  These federal and state regulations limit the amount of dividends that the Bank may pay to the Company.  In the event the Bank is unable to pay dividends to the Company, the Company may not be able to service debt, pay obligations or pay dividends on the Company’s common stock.  The inability of the Company to receive dividends from the Bank could have a material adverse effect on the Company’s business, financial condition and results of operations.


Our executive and administrative offices are owned by the Bank and are located at 15521 Midlothian Turnpike, Midlothian, Virginia 23113 in Chesterfield County where an 80,000 square foot corporate headquarters and operations center was opened in August 2008.  The Bank currently occupies approximately forty percent of the space, which includes a full service branch location.  The Bank leases the other portions to unrelated parties.  In addition to the branch, the Bank’s wholly-owned subsidiary, Village Bank Mortgage Corporation, also leases space in the building.

In addition to the branch in the corporate headquarters and operations center, the Bank owns 9 full service branch buildings including the land on those buildings and leases an additional five full service branch buildings.  Eight of our branch offices are located in Chesterfield County, with three branch offices in Hanover County, three in Henrico County and one in Powhatan County.

Our properties are maintained in good operating condition and are suitable and adequate for our operational needs.

In the course of its operations, the Company may become a party to legal proceedings.  There are no material pending legal proceedings to which the Company is a party or of which the property of the Company is subject.

Market Information

Shares of the Company’s common stock trade on the Nasdaq Capital Market under the symbol “VBFC”.  The high and low prices of shares of the Company’s common stock for the periods indicated were as follows:

1st quarter
  $ 5.00     $ 3.77  
2nd quarter
    4.95       4.12  
3rd quarter
    5.98       3.85  
4th quarter
    4.43       2.01  
1st quarter
  $ 5.00     $ 2.02  
2nd quarter
    4.24       2.82  
3rd quarter
    2.90       1.40  
4th quarter
    1.98       1.40  


The Company has not paid any dividends on its common stock.  We intend to retain all of our earnings to finance the Company’s operations and we do not anticipate paying cash dividends for the foreseeable future.  Any decision made by the Board of Directors to declare dividends in the future will depend on the Company’s future earnings, capital requirements, financial condition and other factors deemed relevant by the Board.  Banking regulations limit the amount of cash dividends that may be paid without prior approval of the Bank’s regulatory agencies.  Such dividends are limited to the Bank’s accumulated retained earnings.  The Federal Reserve has issued guidelines that bank holding companies should inform and consult with the Federal Reserve in advance of declaring or paying a dividend that exceeds earnings for the period (e.g. .quarter) for which the dividend is being paid or that could result in a material adverse charge to the organization’s capital structure. _In addition, for as long as the U.S. Treasury holds shares of our preferred stock, the consent of the U.S. Treasury will be required prior to the payment of any dividends on our common stock.

We also are subject to a memorandum of understanding with the Federal Reserve Bank of Richmond that we will not pay dividends on our preferred stock, including our Series A preferred Stock, trust preferred securities or common stock without the prior consent of the Federal Reserve Bank of Richmond.  Recent supervisory guidance from the Federal Reserve indicates that Capital Purchas Program recipients that are experiencing financial difficulties generally should eliminate, reduce or defer dividends on Tier 1 capital instruments, including trust preferred, preferred stock or common stock, if the holding company needs to conserve capital for safe and sound operation and to serve as a source of strength to its subsidiaries.


At March 4, 2011, there were approximately 1,726 holders of record of Common Stock.

For information concerning the Company’s Equity Compensation Plans, see “Item 12: Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters”.

Recent Sales of Unregistered Securities


Purchases of Equity Securities

The Company did not repurchase any of its Common Stock during the fourth quarter of 2010.

Performance Graph

The following graph shows the yearly percentage change in the Company’s cumulative total shareholder return on its common stock from December 31, 2005 to December 31, 2010 compared with the NASDAQ Composite Index and peer group indexes based on asset size.

Period Ending
Village Bank and Trust Financial Corp.
NASDAQ Composite
SNL Bank $250M-$500M
SNL Bank $500M-$1B

The following consolidated selected financial data is derived from the Company’s audited financial statements for the five years ended December 31, 2010.  This information should be read in conjunction with the following Management’s Discussion and Analysis of Financial Condition and Results of Operations and the consolidated statements and notes thereto.

Year Ended December 31,
Balance Sheet Data
At year-end
  $ 591,779,215     $ 601,993,355     $ 572,407,993     $ 393,263,999     $ 291,217,760  
Loans, net of unearned income
    453,866,801       467,568,547       470,722,286       327,343,013       241,051,025  
Investment securities
    53,597,174       54,857,211       24,300,962       13,711,399       12,787,644  
    -       -       7,422,141       689,108       689,108  
    499,012,193       498,285,124       466,232,043       339,297,258       253,309,881  
    41,679,430       52,593,521       57,726,898       24,736,569       9,859,265  
Stockholders' equity
    48,320,194       47,848,091       46,162,574       26,893,299       25,644,115  
Number of shares outstanding
    4,238,416       4,230,628       4,229,372       2,575,985       2,562,088  
Average for the year
    603,760,108       600,034,107       442,604,327       337,750,179       246,562,178  
Stockholders' equity
    49,801,210       56,089,455       31,067,165       27,798,307       22,278,897  
Weighted average shares outstanding
    4,237,735       4,230,462       3,013,175       2,569,529       2,269,092  
Income Statement Data
Interest income
  $ 30,181,838     $ 33,195,973     $ 29,072,146     $ 25,665,235     $ 19,019,111  
Interest expense
    10,885,413       16,407,679       15,969,783       13,806,715       8,786,600  
Net interest income
    19,296,425       16,788,294       13,102,363       11,858,520       10,232,511  
Provision for loan losses
    4,842,000       13,220,000       2,005,633       1,187,482       796,006  
Noninterest income
    10,990,667       8,285,100       4,184,727       2,666,956       2,482,793  
Goodwill impairment
    -       7,422,141       -       -       -  
Noninterest expense
    23,303,156       20,915,735       14,572,271       11,821,232       9,817,089  
Income tax expense (benefit)
    711,627       (3,879,386 )     241,097       515,699       702,990  
Net income (loss)
    1,430,309       (12,605,096 )     468,089       1,001,063       1,399,219  
Preferred stock dividends and
amortization of discount
    881,402       590,151       -       -       -  
Net income (loss) available to
common shareholders
  $ 548,907     $ (13,195,247 )   $ 468,089     $ 1,001,063     $ 1,399,219  
Per Share Data
Earnings (loss) per share - basic
  $ 0.13     $ (3.12 )   $ 0.16     $ 0.39     $ 0.62  
Earnings (loss) per share - diluted
  $ 0.13     $ (3.12 )   $ 0.16     $ 0.37     $ 0.59  
Book value at year-end
  $ 7.87     $ 7.81     $ 10.91     $ 10.44     $ 10.01  
Performance Ratios
Return on average assets
    0.24 %     (2.10 )%     0.11 %     0.30 %     0.57 %
Return on average equity
    2.87 %     (22.47 )%     1.51 %     3.60 %     6.28 %
Net interest margin(2)
    3.57 %     3.13 %     3.27 %     3.80 %     4.48 %
    76.94 %     83.42 %     84.30 %     81.38 %     77.21 %
Loans to deposits
    90.95 %     93.84 %     100.96 %     96.48 %     95.16 %
Equity to assets
    8.17 %     7.95 %     8.06 %     6.84 %     8.81 %
Asset Quality Ratios
ALLL to loans at year-end
    1.61 %     2.25 %     1.29 %     1.06 %     1.06 %
ALLL to nonaccrual loans
    35.98 %     40.61 %     71.05 %     134.20 %     91.12 %
Nonperforming assets to total assets
    5.47 %     6.17 %     2.00 %     0.73 %     0.96 %
Nonperforming loans to total loans
    7.13 %     7.95 %     2.43 %     0.87 %     1.16 %
Net charge-offs to average loans
    1.74 %     1.83 %     0.49 %     0.10 %     0.08 %
(1) Certain December 31, 2009 amounts have been revised. See Note 2 to the consolidated financial statements.
(2) Net interest margin is computed by dividing net interest income for the period by average interest earning assets.
(3) Efficiency ratio is computed by dividing noninterest expense by the sum of net interest income and noninterest income. The
goodwill impairment write-off is excluded in 2009 from noninterest expense.

The following discussion is intended to assist readers in understanding and evaluating the financial condition, changes in financial condition and the results of operations of the Company, consisting of the parent company and its wholly-owned subsidiary, the Bank. This discussion should be read in conjunction with the consolidated financial statements and other financial information contained elsewhere in this report.

Caution About Forward-Looking Statements

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

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

the risks of changes in interest rates on levels, composition and costs of deposits, loan demand, and the values and liquidity of loan collateral, securities, and interest sensitive assets and liabilities;
changes in assumptions underlying the establishment of allowances for loan losses, and other estimates;
changes in market conditions, specifically declines in the residential and commercial real estate market, volatility and disruption of the capital and credit markets, soundness of other financial institutions we do business with;
risks inherent in making loans such as repayment risks and fluctuating collateral values;
changes in operations of Village Bank Mortgage Corporation as a result of the activity in the residential real estate market;
legislative and regulatory changes, including the Financial Reform Act and other changes in banking, securities, and tax laws and regulations and their application by our regulators, and changes in scope and cost of FDIC insurance and other coverages;
exposure to repurchase loans sold to investors for which borrowers failed to provide full and accurate information on or related to their loan application or for which appraisals have not been acceptable or when the loan was not underwritten in accordance with the loan program specified by the loan investor;
the effects of future economic, business and market conditions;
governmental monetary and fiscal policies;
changes in accounting policies, rules and practices;
maintaining capital levels adequate to remain well capitalized;
reliance on our management team, including our ability to attract and retain key personnel;
competition with other banks and financial institutions, and companies outside of the banking industry, including those companies that have substantially greater access to capital and other resources;
demand, development and acceptance of new products and services;
problems with technology utilized by us;
changing trends in customer profiles and behavior; and
other factors described from time to time in our reports filed with the SEC.

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


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

Although we endeavor to minimize the credit risk inherent in the Company’s loan portfolio, we must necessarily make various assumptions and judgments about the collectability of the loan portfolio based on our experience and evaluation of economic conditions.  If such assumptions or judgments prove to be incorrect, the current allowance for loan losses may not be sufficient to cover loan losses and additions to the allowance may be necessary, which would have a negative impact on net income.  Over the last two years, the Company has recorded record provisions for loan losses due primarily to loans collateralized by real estate located in its principal market area.

There is intense competition in all areas in which the Company conducts its business. The Company competes with banks and other financial institutions, including savings and loan associations, savings banks, finance companies, and credit unions.  Many of these competitors have substantially greater resources and lending limits and provide a wider array of banking services.  To a limited extent, the Company also competes with other providers of financial services, such as money market mutual funds, brokerage firms, consumer finance companies and insurance companies.  Competition is based on a number of factors, including prices, interest rates, services, availability of products and geographic location.

Effect of Economic Trends

The twelve months ended December 31, 2010 continue to reflect the tumultuous economic conditions which have negatively impacted the liquidity and credit quality of financial institutions in the United States.  Concerns regarding increased credit losses from the weakening economy have negatively affected capital and earnings of most financial institutions.  Financial institutions have experienced significant declines in the value of collateral for real estate loans, heightened credit losses, which have resulted in record levels of non-performing assets, charge-offs and foreclosures. In addition, hundreds of financial institutions failed or merged with other institutions during 2008, 2009, and 2010, and two of the government sponsored housing enterprises were placed into conservatorship with the U.S. Government in 2008.

Liquidity in the debt markets remains low in spite of efforts by Treasury and the Federal Reserve to inject capital into financial institutions.  The federal funds rate set by the Federal Reserve has remained at 0.25% since December 2008, following a decline from 4.25% to 0.25% during 2008 through a series of seven rate reductions.

The Treasury Department, the FDIC and other governmental agencies continue to enact rules and regulations to implement the EESA, the TARP, the Recovery Act and related economic recovery programs, many of which contain limitations on the ability of financial institutions to take certain actions or to engage in certain activities if the financial institution is a participant in the CPP or related programs.  Future regulations, or enforcement of the terms of programs already in place, may require financial institutions to raise additional capital and result in the conversion of preferred equity issued under TARP or other programs to common equity.  There can be no assurance as to the actual impact of the EESA, the SBLF, the Dodd-Frank Act or any other governmental program on the financial markets.

The weak economic conditions are expected to continue into 2011.  Financial institutions likely will continue to experience heightened credit losses and higher levels of non-performing assets, charge-offs and foreclosures.  In light of these conditions, financial institutions also face heightened levels of
scrutiny from federal and state regulators.  These factors negatively influenced, and likely will continue to negatively influence, earning asset yields at a time when the market for deposits is intensely competitive.  As a result, financial institutions experienced, and are expected to continue to experience, pressure on credit costs, loan yields, deposit and other borrowing costs, liquidity, and capital.

Results of Operations

The following presents management’s discussion and analysis of the financial condition of the Company at December 31, 2010 and 2009, and results of operations for the Company for the years ended December 31, 2010, 2009 and 2008.  This discussion should be read in conjunction with the Company’s audited Financial Statements and the notes thereto appearing elsewhere in this Annual Report.

Income Statement Analysis


We recorded net income of $1,430,000 and $548,907 net income available to common shareholders, or $0.13 per fully diluted share, in 2010, compared to a net loss of $12,605,000 and a net loss of $13,195,247, or $3.12 per fully diluted share, in 2009, and net income of $468,000, or $0.16 per fully diluted share, in 2008.  The increase in earnings in 2010 is attributable to the increase in our net interest margin, from 3.13% for 2009 to 3.57% for 2010, as well as a decrease in the provision for loan losses of $8,378,000, from $13,220,000 in 2009 to $4,842,000 in 2010.  The increase in our net interest margin is attributable to a significant decline in our cost of funds which declined from 3.27% for the year ended 2009 to 2.15% for the year ended 2010.  The decrease in the provision for loan losses is due to a slowing of the deterioration of asset quality.  We started recording large provisions for loan losses in February 2009 which continued through the end of 2009.  However, although provisions for loan losses are down from 2009 levels, they are still at historic highs as the poor economy continues to have an affect on asset quality.

At the beginning of 2010, our expectations for the business environment were as follows:

The economy would remain depressed and, as this continued to have an effect on our borrowers, we could see an increase in nonperforming assets.
Loan demand would not be strong.
Interest rates would remain at historic lows.
It would be very difficult for us to access the capital markets to increase our capital.

Based on these expectations, our business strategy was to restrict our growth, focus on managing nonperforming assets, and to reprice and/or restructure our deposits and borrowings to reduce our overall cost of funds.  Given an inability to raise capital, we also wanted to restructure our balance sheet to reduce our risk-weighted assets thereby improving our capital ratios.  This strategy had the following results:

Our total assets at year-end 2010 amounted to $591,779,000, a $10,214,000 decline from total assets of $601,993,000 at the end of 2009.  In addition, as loan demand remained weak, we were able to restructure the make-up of our assets to lower risk-weighted assets for regulatory purposes thereby improving our total risk-weighted asset ratio for the Bank from 11.29% at the end of 2009 to 12.11% at the end of 2010.  We lowered our risk-weighted assets primarily by purchasing investment securities with risk weightings of 0% or 20%.
As expected, nonperforming assets increased in the first half of 2010 as the economy remained depressed, reaching a high of $45,329,000, or 7.5% of total assets, at May 31, 2010 from $37,192,000, or 6.2% of total assets, at December 31, 2009.  However, as a result of our focus on managing nonperforming assets, we were able to reduce their amount
to $32,352,000, or 5.5% of total assets, at December 31, 2010.
The cost of funds declined from 3.27% for 2009 to 2.15% for 2010 resulting in an improvement in our net interest margin from 3.13% for 2009 to 3.57% for 2010.  The decline in our cost of funds was a result of being able to reprice maturing long term certificates of deposit at the low interest rates in 2010.

The results of our strategy coupled with a somewhat improving economy had a significant effect on our profitability.  The Company had net income of $1,430,000 in 2010 as compared to a net loss of $12,605,000 in 2009, including a goodwill impairment charge of $7,422,141, and net income of $468,000 in 2008.  Our net interest income increased from $16,788,000 in 2009 to $19,296,000 in 2010.  Additionally, the provision for loan losses declined from $13,220,000 in 2009 to $4,842,000 in 2010.

Notwithstanding this improvement in profitability, the economy continued to affect our results.  Prior to 2009, much of our internal growth was driven by lending on real estate.  As a result, the material decline in real estate values experienced in 2009 and 2010 had a significant adverse effect on the growth and profitability of the Company.  At December 31, 2010, 90.5% of our loan portfolio was collateralized by real estate.  Declines in real estate values can reduce projected cash flows from commercial properties and the ability of borrowers to use home equity to support borrowings and increase the loan-to-value ratios of loans previously made by us, thereby weakening collateral coverage and increasing the possibility of a loss in the event of default.  In addition, delinquencies, foreclosures and losses generally increase during economic slowdowns or recessions.

The decline in our profitability in 2009 was attributable to four significant increases in expenses from 2008 to 2009 as follows:

Provision for loan losses
  $ 13,220,000     $ 2,005,633     $ 11,214,367  
Goodwill impairment
    7,422,141       -       7,422,141  
Expenses related to
foreclosed real estate
    1,475,338       165,455       1,309,883  
FDIC insurance premium
    1,366,612       400,394       966,218  
                    $ 20,912,609  

All of these increases in expenses are attributable primarily to the recessionary economy that dominated 2009.  The increases in the provision for loan losses and in expenses related to foreclosed real estate reflect the difficulties that many of our borrowers experienced with their ability to repay our loans to them.  The write-off of goodwill was based on our annual evaluation of the value of goodwill which was performed by an independent third party.  Goodwill was considered fully impaired at December 31, 2009 primarily because the value of the Company’s stock, and thus its overall value, declined significantly in 2009 as did many other banks’ stock.  The increase in the FDIC insurance premium was related to the losses the FDIC incurred in 2009 in closing 140 banks as it sought to restore the DIF to a desirable level.  Total assets of failed banks in 2009 totaled $170.9 billion with the loss to the DIF of $4.6 billion.

Net interest income

Net interest income, which represents the difference between interest earned on interest-earning assets and interest incurred on interest-bearing liabilities, is the Company’s primary source of earnings.  Net interest income can be affected by changes in market interest rates as well as the level and composition of assets, liabilities and shareholders’ equity.  Net interest spread is the difference between the average rate earned on interest-earning assets and the average rate paid on interest-bearing liabilities.  The net yield on interest-earning assets (“net interest margin”) is calculated by dividing tax equivalent net interest income by average interest-earning assets.  Generally, the net interest margin will exceed the net interest spread because a portion of interest-earning assets are funded by various noninterest-bearing sources, principally noninterest-bearing

deposits and shareholders’ equity.

Net interest income increased to $19,296,000 in 2010 from $16,788,000 in 2009 and $13,102,000 in 2008.  In 2010 we experienced a turnaround in the decline of our net interest margin, which increased from 3.13% in 2009 to 3.57% in 2010.  This increase in net interest margin is directly attributable to a decline of 1.22% in the average rate paid on deposits, from 3.20% in 2009 to 1.98% in 2010.  With interest rates remaining at historic lows the last two years, we have been able to reduce the rate paid on deposits as well as increase our noninterest-bearing deposits.

For the two years prior to 2010, net interest income as a percentage of average assets steadily declined, from 3.5% in 2007 to 3.0% in 2008 and to 2.8% in 2009.  The growth in net interest income had not kept pace with the growth of the Company.  This was attributable to a declining net interest margin, from 3.80% in 2007 to 3.27% in 2008 and to 3.13% in 2009.  This declining net interest margin resulted from declines in short-term interest rates that started in 2007 and continued into 2008.  A significant portion of our loan portfolio, the primary source of revenue to Village Bank, has interest rates that adjust according to the direction of short-term interest rates.  Accordingly, as short-term rates were reduced by the Federal Reserve, the income from our loan portfolio was reduced.  While the reduction of short-term interest rates also reduced the rates we pay on deposits, our largest expense, the reduction in interest rates paid on deposits was slower than the reduction of interest rates on our loan portfolio as our deposits generally do not reprice as quickly as our loans.  Consequently, our net interest income, the primary source of our earnings, was negatively impacted as short-term interest rates were reduced by the Federal Reserve.

In 2009, average interest-earning assets grew significantly by $135,350,000, or 34%.  This increase in interest-earning assets was due primarily to the growth of our loan portfolio.  In 2010, average interest-earning assets increased by only $4,535,000, or 0.8%.  This lack of growth in average interest-earning assets in 2010 was due to our minimal growth strategy as discussed previously.  While the amount of interest-earning assets remained flat in 2010, the average yield on interest-earning assets decreased to 5.59% in 2010 from 6.19% in 2009 and 7.26% in 2008.  This decline in the average yield on interest-earning assets reflects the impact of the recessionary economy.  First, loans with higher interest rates in many cases have paid off or defaulted.  Second, we have decreased rates to some loan customers to better reflect the current interest rate environment and in some limited cases to facilitate workouts on nonperforming loans.  And third, the lost interest on nonaccrual loans amounted to $1,242,000 in 2010 which reduced the yield on interest-earning assets by .22% (22 basis points).

Our average interest-bearing liabilities increased by $5,277,000, or 1.05%, in 2010 and by $120,065,000, or 31%, in 2009.  The significant increase in average interest-bearing liabilities in 2009 was due to growth in average deposits of $111,034,000.  The lack of growth in 2010 reflects our strategy of reducing the rates paid on interest-bearing deposits and borrowings discussed previously.  The average cost of interest-bearing liabilities decreased to 2.15% in 2010, from 3.27% in 2009 and 4.18% in 2008.  The significant decrease in our cost of funds in 2010 and 2009 was a result of decreases in short-term interest rates by the Federal Reserve in 2007 and 2008 which remained at historic lows through 2010.  See “Interest rate sensitivity” on page 50 for further discussion of the repricing of assets and liabilities.

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

Average Balance Sheets
(In thousands)
Year Ended December 31, 2010
Year Ended December 31, 2009
Year Ended December 31, 2008
  $ 35,214     $ 2,235       6.35 %   $ 47,607     $ 2,959       6.22 %   $ 39,275     $ 2,034       5.18 %
Real estate - residential
    97,533       6,522       6.69 %     89,386       5,802       6.49 %     61,416       5,291       8.62 %
Real estate - commercial
    253,409       16,111       6.36 %     230,621       15,591       6.76 %     160,019       10,968       6.85 %
Real estate - construction
    66,222       2,593       3.92 %     99,103       6,038       6.09 %     105,732       8,965       8.48 %
    10,987       786       7.15 %     10,642       788       7.40 %     7,779       657       8.45 %
Gross loans
    463,365       28,247       6.10 %     477,359       31,178       6.53 %     374,221       27,915       7.46 %
Investment securities
    36,066       1,087       3.01 %     33,174       1,458       4.40 %     12,125       699       5.76 %
Loans held for sale
    16,820       793       4.71 %     10,305       533       5.17 %     3,721       225       6.05 %
Federal funds and other
    24,157       55       0.23 %     15,034       27       0.18 %     10,455       233       2.23 %
Total interest earning assets
    540,408       30,182       5.59 %     535,872       33,196       6.19 %     400,522       29,072       7.26 %
Allowance for loan losses
    (9,722 )                     (8,367 )                     (4,309 )                
Cash and due from banks
    13,103                       15,998                       8,179                  
Premises and equipment, net
    27,630                       27,880                       23,951                  
Other assets
    32,341                       28,651                       14,261                  
Total assets
  $ 603,760                     $ 600,034                     $ 442,604                  
Interest bearing deposits
Interest checking
    34,521       336       0.97 %     26,530       443       1.67 %   $ 12,735     $ 159       1.25 %
Money market
    98,762       1,077       1.09 %     69,267       1,242       1.79 %     28,215       561       1.99 %
    10,081       80       0.79 %     7,009       85       1.21 %     6,891       193       2.80 %
    315,205       7,604       2.41 %     347,698       12,664       3.64 %     291,629       13,435       4.61 %
Total deposits
    458,569       9,097       1.98 %     450,504       14,434       3.20 %     339,470       14,348       4.23 %
Long-tern debt - trust
preferred securities
    8,764       346       3.95 %     8,764       392       4.47 %     8,764       508       5.80 %
FHLB advances
    28,425       864       4.22 %     26,348       970       4.22 %     20,620       834       4.22 %
Other borrowings
    11,473       578       1.77 %     16,337       612       1.77 %     13,034       280       1.77 %
Total interest bearing liabilities
    507,231       10,885       2.15 %     501,953       16,408       3.27 %     381,888       15,970       4.18 %
Noninterest bearing deposits
    44,495                       39,626                       27,657                  
Other liabilities
    2,233                       2,366                       1,992                  
Total liabilities
    553,959                       543,945                       411,537                  
Equity capital
    49,801                       56,089                       31,067                  
Total liabilities and capital
  $ 603,760                     $ 600,034                     $ 442,604                  
Net interest income before
provision for loan losses
          $ 19,297                     $ 16,788                     $ 13,102          
Interest spread - average yield
on interest earning assets,
less average rate on
interest bearing liabilities
                    3.44 %                     2.93 %                     3.08 %
Net interest margin
(net interest income
expressed as a percentage
of average earning assets)
                    3.57 %                     3.13 %                     3.27 %

Interest income and interest expense are affected by changes in both average interest rates and average volumes of interest-earning assets and interest-bearing liabilities.  The following table analyzes changes in net interest income attributable to changes in the volume of interest-sensitive assets and liabilities compared to changes in interest rates.  Nonaccrual loans are included in average loans outstanding. The changes in interest due to both rate and volume have been allocated to changes due to volume and changes due to rate in proportion to the relationship of the absolute dollar amounts of the changes in each.

Rate/Volume Analysis
(In thousands)
2010 vs. 2009
2009 vs. 2008
Increase (Decrease)
Increase (Decrease)
Due to Changes in
Due to Changes in
Interest income
  $ (291 )   $ (2,380 )   $ (2,671 )   $ 6,333     $ (2,762 )   $ 3,571  
Investment securities
    142       (513 )     (371 )     879       (120 )     759  
Fed funds sold and other
    19       9       28       187       (393 )     (206 )
Total interest income
    (130 )     (2,884 )     (3,014 )     7,399       (3,275 )     4,124  
Interest expense
Interest checking
    279       (385 )     (106 )     217       66       283  
Money market accounts
    (2,066 )     1,902       (164 )     731       (48 )     683  
Savings accounts
    (24 )     19       (5 )     3       (110 )     (107 )
Certificates of deposit
    (1,097 )     (3,965 )     (5,062 )     8,613       (9,386 )     (773 )
Total deposits
    (2,908 )     (2,429 )     (5,337 )     9,564       (9,478 )     86  
Long-term debt
    -       (46 )     (46 )     -       (116 )     (116 )
FHLB Advances
    87       (193 )     (106 )     201       (65 )     136  
Other borrowings
    (34 )     -       (34 )     332       -       332  
Total interest expense
    (2,854 )     (2,668 )     (5,523 )     10,097       (9,659 )     438  
Net interest income
  $ 2,725     $ (216 )   $ 2,509     $ (2,698 )   $ 6,384     $ 3,686  
Note: the combined effect on interest due to changes in both volume and rate, which cannot be
separately identified, has been allocated proportionately to the change due to volume
and the change due to rate.

Provision for loan losses

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

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

Profitability had been negatively impacted by historic provisions for loan losses the last three years.  The provision for loan losses increased from $2,006,000 in 2008 to $13,220,000 in 2009 and down to $4,342,000 in 2010.  Prior to 2008, the largest provision we recorded was $1,187,000 in 2007.  The significant provisions for loan losses the last three years reflect the impact of the recessionary economy and borrowers’ ability to repay loans.  The decrease in the provision for loans losses in 2010 reflects management’s recognition of higher provisions in previous periods attributable to the Bank’s nonperforming assets and the decline in loans outstanding.  However, overall asset quality continues to be a concern as there continues to be uncertainty in the economy and the level of
nonperforming assets remains significant.  We believe there is reason for optimism regarding our current asset quality however, as the amount of nonperforming assets declined by 13% in 2010 from 2009.  The deterioration in asset quality has occurred primarily in loans secured by real estate, which represent 91% of our total loan portfolio at December 31, 2010.

Noninterest income

Noninterest income includes service charges and fees on deposit accounts, fee income related to loan origination, and gains and losses on sale of mortgage loans and securities held for sale.  Over the last three years the most significant noninterest income item has been gain on loan sales generated by Village Bank Mortgage, representing 57% in 2008, 70% in 2009 and 63% in 2010 of total noninterest income.  Noninterest income amounted to $4,185,000 in 2008, $8,285,000 in 2009 and $10,991,000 in 2010.

The increase in noninterest income in 2010 of $2,706,000 is primarily attributable to an increase in gain on sale of loans of $1,176,000, and gains on the sale of assets (land behind one of our branches and sales and calls of investment securities available for sale) of $1,012,000.  The increased gain on sale of loans resulted from an increase in loan production by our mortgage company, from $252 million in 2009 to $285 million in 2010.  Despite the depressed economic conditions in 2010, our mortgage banking subsidiary has experienced a significant increase in loan production as a result of the addition of a loan production office in Northern Virginia as well as improved performance from some of our existing loan originators.  We expect the mortgage company to continue to increase loan production in 2011 as we have been able to attract new loan officers with successful track records.

The increase in noninterest income in 2009 of $4,100,000 is primarily attributable to an increase in gain on sale of loans of $3,447,000 and increased service charges and fees on transactional deposit accounts of $452,000.  The gain on sale of loans resulted from an increase in loan production by our mortgage company from $100 million in loan closings in 2008 to $252 million in 2009.

Noninterest expense

Noninterest expense includes all expenses of the Company with the exception of interest expense on deposits and borrowings, provision for loan losses and income taxes.  Some of the primary components of noninterest expense are salaries and benefits, and occupancy and equipment costs.  Over the last three years, the most significant noninterest expense item has been salaries and benefits, representing 55%, 50% and 53% of noninterest expense (excluding the write-off of goodwill in 2009) in 2008, 2009 and 2010, respectively.  Noninterest expense increased from $14,572,000 in 2008, to $28,338,000 in 2009 and decreased to $23,303,000 in 2010.  In 2009 the write-off of all goodwill of $7,422,141 was included in noninterest expense.  This was a one time expense as we no longer have any goodwill.

The decrease in noninterest expense of $5,035,000 in 2010 resulted from the goodwill write-off of $7,422,000 in 2009. Not taking the goodwill write-off into consideration noninterest expense increased by $2,387,000.  The increase resulted primarily from increases in salaries and benefits of $1,861,000 and other real estate owned expenses of $218,000.

The increase in noninterest expense of $13,766,000 in 2009 resulted from the goodwill write-off of $7,422,000 as well as increases in expenses related to foreclosed assets of $1,310,000 and the FDIC insurance premium of $966,000.  Other growth related increases in noninterest expense in 2009 were increases in salaries and benefits of $2,500,000, occupancy of $493,000, loan underwriting expense of $430,000, data processing of $159,000 and equipment of $126,000.

Income taxes

Applicable income tax expense on 2010 earnings amounted to $712,000, resulting in an effective tax rate of 33.2%, compared with an income tax benefit of $(3,879,000), or 23.5%, in 2009 and $241,000, or 34.0%, in 2008. The effective tax rate in 2010 and 2008 are comparable.  The effective
tax rate of the benefit in 2009 was lower due to the non-deductibility of the goodwill impairment charge of $7,422,000 offset by the recognition of a net operating loss carryforward of $1,546,000 related to the acquisition of River City Bank.

Management has assessed the realization of deferred tax assets, and believes that the generation of future taxable income during the periods in which those temporary differences become deductible will be sufficient to realize those assets.  Accordingly, no valuation allowance related to deferred tax assets is needed.

Commercial banking organizations conducting business in Virginia are not subject to Virginia income taxes.  Instead, they are subject to a franchise tax based on bank capital.  The Bank recorded a franchise tax expense of $358,000, $355,000 and $180,000 for 2010, 2009 and 2008, respectively.

Balance Sheet Analysis

Investment securities

At December 31, 2010 and 2009, all of our investment securities were classified as available-for-sale.  Investment securities classified as available for sale may be sold in the future, prior to maturity. These securities are carried at fair value.  Net aggregate unrealized gains or losses on these securities are included, net of taxes, as a component of shareholders’ equity.  Given the generally high credit quality of the portfolio, management expects to realize all of its investment upon market recovery or, the maturity of such instruments and thus believes that any impairment in value is interest rate related and therefore temporary.  Available for sale securities included net unrealized losses of $397,000 at December 31, 2010 and net unrealized gains of $97,000 at December 31, 2009.  As of December 31, 2010, management does not have the intent to sell any of the securities classified as available for sale and management believes that it is more likely than not that the Company will not have to sell any such securities before a recovery of cost.

Sales and calls of investment securities increased from $15,373,000 in 2009 to $51,123,000 in 2010.  This increase was attributable to calls on higher interest rate securities as well as sales of securities to realize gains in value.

The following table presents the composition of our investment portfolio at the dates indicated.


Investment Securities Available-for-Sale
(Dollars in thousands)
December 31, 2010
US Treasuries
One to five years
  $ 28,000     $ 28,017     $ -     $ 28,017       0.22 %
US Government Agencies
Five to ten years
    3,000       3,000       (111 )     2,889       2.00 %
Mortgage-backed securities
One to five years
    686       703       21       724       4.90 %
More than ten years
    14,410       14,796       33       14,829       2.86 %
    15,096       15,499       54       15,553       5.39 %
More than ten years
    6,000       6,060       (337 )     5,723       4.69 %
Other investments
More than ten years
    1,418       1,418       (3 )     1,415       0.69 %
Total investment securities
  $ 53,514     $ 53,994     $ (397 )   $ 53,597       2.31 %