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Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM 10-K

 

 

Annual Report Pursuant to Section 13 or 15(d)

of the Securities Exchange Act of 1934

For the Fiscal Year Ended December 31, 2016

 

 

BANK OF THE JAMES FINANCIAL GROUP, INC.

(Exact Name of Registrant as Specified in Its Charter)

 

 

Commission file number 001-35402

 

Virginia   20-0500300

(State or Other Jurisdiction of

Incorporation or Organization)

 

(I.R.S. Employer

Identification No.)

828 Main Street, Lynchburg, VA   24504
(Address of Principal Executive Offices)   (Zip Code)

(434) 846-2000

(Issuer’s telephone number, including area code)

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

 

Title of Each Class

 

Name of Exchange on Which Registered

Common Stock, $2.14 par value   The NASDAQ Capital Markets

Securities registered under Section 12(g) of the Exchange Act: Common Stock, $2.14 par value

 

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.    ☐  Yes    ☒  No

Indicate by check mark if the registrant is not required to file reports pursuant to Section13 or Section 15(d) of the Act.    ☐  Yes    ☒  No

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 past 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  ☒    No  ☐

Indicate by check mark whether the registrant has submitted electronically 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 (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    ☒  Yes    ☐  No

Indicate by check mark if disclosure of delinquent filers in response to Item 405 of Regulation S-K (§ 229.405) 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 Form 10-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 definition of “large accelerated filer,” “accelerated filer,” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer      Accelerated filer  
Non-accelerated filer      Smaller reporting company  

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

The aggregate value of the voting common equity held by nonaffiliates as of June 30, 2016, the last business day of the registrant’s most recently completed second fiscal quarter, was approximately $48,283,179 based on the price at which the common stock last traded on such day. This price reflects inter-dealer prices without retail mark up, mark down, or commissions, and may not represent actual transactions.

The number of shares outstanding of Common Stock, $2.14 par value as of March 21, 2017 was approximately 4,378,436.

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the 2017 Proxy Statement for the Annual Meeting of Shareholders, scheduled to be held on May 16, 2017, are incorporated by reference into Part III of this Form 10-K

 

 

 


Table of Contents

PART I     

     1  

Item 1.

 

Business

     1  

Item 1A.

 

Risk Factors - Not applicable

     14  

Item 1B.

 

Unresolved Staff Comments

     14  

Item 2.

 

Properties

     15  

Item 3.

 

Legal Proceedings

     17  

Item 4.

 

Mine Safety Disclosures.

     17  

PART II

     18  

Item 5.

 

Market For Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

     18  

Item 6.

 

Selected Financial Data

     20  

Item 7.

 

Management’s Discussion and Analysis of Financial Condition and Results of Operations

     20  

Item 7A.

 

Quantitative and Qualitative Disclosure About Market Risk

     49  

Item 8.

 

Financial Statements and Supplementary Data

     49  

Item 9.

 

Changes in and Disagreements With Accountants on Accounting and Financial Disclosure

     111  

Item 9A.

 

Controls and Procedures

     111  

Item 9B.

 

Other Information

     111  

PART III

     111  

Item 10.

 

Directors, Executive Officers and Corporate Governance

     111  

Item 11.

 

Executive Compensation

     112  

Item 12.

 

Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters

     112  

Item 13.

 

Certain Relationships and Related Transactions, and Director Independence

     112  

Item 14.

 

Principal Accounting Fees and Services

     112  

PART IV

     112  

Item 15.

 

Exhibits, Financial Statement Schedules

     112  

Item 16.

 

Form 10-K Summary

     113  

SIGNATURES

     114  


Table of Contents

PART I

 

Item 1. Business

General

Bank of the James Financial Group, Inc. (“Financial” or the “Company”) is a bank holding company with its headquarters in Lynchburg, Virginia. Financial was incorporated at the direction of Bank of the James (the “Bank” or “Bank of the James”) on October 3, 2003 to serve as a bank holding company of the Bank. Financial acquired all of the shares of the Bank in a statutory share exchange on a one-for-one basis on January 1, 2004.

The Bank is a Virginia banking corporation headquartered in Lynchburg, Virginia. The Bank was incorporated under the laws of the Commonwealth of Virginia as a state chartered bank in 1998 and began banking operations in July 1999. The Bank was organized to engage in general retail and commercial banking business.

The Bank was organized in part as a response to the loss of many of the Central Virginia, Region 2000 area’s (as defined in below) local financial institutions through mergers with larger, non-local banks and bank holding companies. The organizers perceived that local customers who once relied on experienced personal attention were being forced to use 800 numbers, computerized menus, and persons in other localities who were not familiar with their needs.

The Bank opened for business on July 22, 1999 to fill this void left in the Region 2000 market. The Bank’s organizers recognized that an opportunity existed to create a banking institution designed exclusively for a market that expected personalized service. The idea was to build a financial institution staffed with experienced professionals who would place a high value on knowing their customers and serving their distinctive banking needs. This remains our philosophy today.

Management believes that the key to the Bank’s success lies in providing Bank customers with personalized service while providing products and services that meet their banking needs.

The Bank’s principal office is located at 828 Main Street, Lynchburg, Virginia 24504 and its telephone number is (434) 846-2000. The Bank also maintains a website at www.bankofthejames.com.

Financial conducts two principal activities: (1) general retail and commercial banking through Bank of the James; and (2) mortgage brokerage services through Bank of the James, a division of the Bank.

In addition, Financial provides securities brokerage services through BOTJ Investment, a division of the Bank and acts as an agent for insurance and annuity products through BOTJ Insurance, Inc., a wholly-owned subsidiary of the Bank. The operating results of these business operations have not had a material impact on our financial performance and are not considered principal activities of Financial at this time.

The Bank, BOTJ Insurance, and BOTJ Investment Group, Inc., a non-operating subsidiary, are our only subsidiaries and primary assets.

 

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Products and Services

Retail and Commercial Banking

The Bank currently conducts business within Virginia from 13 full-service offices and three limited service offices, one loan production office, and three mortgage production offices. The location of and services provided by each of our facilities is described in full in Item 2 on page 15. The Bank established a mortgage loan origination division that conducts business under the name “Bank of the James Mortgage, a Division of Bank of the James.” The mortgage division conducts business primarily from the division’s main office located in the Forest branch of the Bank. In addition, in 2013 the Bank expanded into Charlottesville with a loan production office (which also houses the limited service branch referenced above) and Roanoke, Virginia with a mortgage/loan production office. For a more detailed description of these facilities, see “Item 2. Properties” below.

Deposit Services. Deposits are a major source of our funding. The Bank offers a full range of deposit services that are typically available in most banks and other financial institutions including checking accounts, savings accounts and other time deposits of various types, ranging from daily money market accounts to longer-term certificates of deposit. The transaction accounts and time certificates are tailored to the Bank’s market area at rates competitive to those offered in the area. In addition, the Bank offers its customers Individual Retirement Accounts (IRAs) and Health Care Savings Accounts (HSAs). All deposit accounts are insured by the Federal Deposit Insurance Corporation (the “FDIC”) up to the maximum amount allowed by law (generally, $250,000 per depositor, subject to aggregation rules). The Bank solicits such accounts from individuals, businesses, associations and organizations, and governmental authorities.

Lending Services. The Bank offers a full range of short- to medium-term commercial and consumer loans. Our primary focus is on making loans to small businesses and consumers in the Region 2000 (Lynchburg, Amherst, Bedford, Campbell) area, Charlottesville, Harrisonburg, and Roanoke. In addition, we also provide a wide range of real estate finance services. 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. Additionally, the Bank originates fixed and floating-rate mortgage loans and real estate construction and acquisition loans. Where appropriate, the Bank attempts to limit interest rate risk through the use of variable interest rates and terms of less than five years.

In general, the Bank offers the following lending services:

 

    Commercial Business Lending. We make loans to small- and medium-sized businesses in Region 2000, Charlottesville, Harrisonburg, and Roanoke for purposes such as purchases of equipment, facilities upgrades, inventory acquisition and various working capital purposes.

 

    Real Estate Construction. We make commercial and residential construction and development loans to customers in our market area.

 

    Commercial Real Estate Mortgage. We make loans to borrowers secured by commercial real estate. In underwriting these types of loans we consider the historic and projected future cash flows of the real estate.

 

    Consumer. We offer various types of secured and unsecured consumer loans, including personal loans, lines of credit, overdraft lines of credit, automobile loans, installment loans, demand loans, and home equity loans. We make consumer loans primarily for personal, family or household purposes.

 

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    Loan Participations. We sell loan participations in the ordinary course of business when a loan originated by us exceeds our legal lending limit or we otherwise want to share risk with another bank. We also purchase loan participations from time to time from other banks in the ordinary course of business, usually without recourse against that bank. Purchased loan participations are underwritten in accordance with our loan policy and represent a source of loan growth.

Other Banking Services. Other services offered by the Bank include safe deposit boxes, traveler’s checks, direct deposit of payroll and social security checks, automatic drafts for various accounts, treasury management services and credit card merchant services. The Bank also is associated with a shared network of automated teller machines (ATMs) that may be used by Bank customers throughout Virginia, the United States, and internationally.

The Bank intends to introduce new products and services desired by the public and as permitted by the regulatory authorities. The Bank remains committed to meeting the challenges that require technology. The Bank provides its customers with access to the latest technological products, such as telephone banking and internet banking, including on-line bill pay. This service allows customers to handle routine transactions using a standard touch tone telephone, applications for mobile devices, and via the internet at the Bank’s website.

Mortgage Banking. The Bank, through Bank of the James Mortgage, a Division of Bank of the James (the “Mortgage Division”) originates conforming and non-conforming home mortgages primarily in the Region 2000 area. As part of the Bank’s overall risk management strategy, the loans originated and closed by the Mortgage Division are pre-sold to major mortgage banking or other financial institutions. Effective April 1, 2011, the Mortgage Division began funding these pre-sold loans. The loans are transferred promptly, typically within 2 to 3 business days, to the buyer for a pre-arranged price. Management believes that there is acceptable risk associated with this arrangement.

Other Activities

We provide brokerage and investment services through the Bank’s Investment division (“Investment”). The Investment division provides securities brokerage services to Bank customers and others through an agreement with Infinex Financial Group, LLC (“Infinex”), a registered broker-dealer. Under our agreement, Infinex operates a service center at 615 Church Street, Lynchburg, Virginia. To date the operating results of the Investment division have not had a material impact on our financial performance.

We provide insurance and annuity products through BOTJ Insurance as an agent for national insurance companies. As of the date hereof, we offer the following insurance products: credit life, life insurance, fixed annuities, and disability insurance. We began providing these services in September 2008. To date the operating results of BOTJ Insurance have not had a material impact on our financial performance.

Employees

As of March 21, 2017, we had approximately 133 full-time equivalent employees. None of our employees are represented by any collective bargaining agreements, and relations with employees are considered excellent. We maintain employee benefit programs that include health insurance, a flexible spending account, a health savings account, and a 401(k) plan.

 

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Location and Market Area

The Bank’s market area primarily consists of Region 2000, which encompasses the seven jurisdictions of the Town of Altavista, Amherst County, Appomattox County, the Town of Bedford, Bedford County, Campbell County, and the City of Lynchburg. Region 2000 supports a diverse, well-rounded economy. U.S. Routes 29, 60, 221, 460 and 501 and State Routes 24 and 40 all pass through the trade area and provide efficient access to other regions of the state. Regional airport service and rail service provide additional transportation channels.

Total population in the market area equals approximately 252,000. According to the U.S. Census, in 2010 the populations of the localities in the Region 2000 market area were approximately as follows: City of Lynchburg – 76,000; Amherst County – 32,000; Appomattox County – 15,000; Bedford County (including the Town of Bedford) – 74,000; Campbell County (including the Town of Altavista) – 55,000. The area is serviced by one daily newspaper and a number of radio and television stations providing diverse media outlets. Median family income in Region 2000 has risen over the past ten years.

Region 2000 has a broad range of services, light industry, and manufacturing plants. Principal service, industrial, research and development employers include: BWX Technologies, Inc. (nuclear fuel); AREVA (nuclear services); Centra Health, Inc. (health care services); C.B. Fleet, Inc. (medical supplies); Pacific Life (life insurance and other financial products); Frito-Lay, Inc. (snack foods); Griffin Pipe Products Co. (ductile iron pipe); R.R. Donnelley Printing Inc. (printed products); as well as six colleges including Randolph College, Sweet Briar College, Liberty University, and Lynchburg College.

In 2013 the Bank expanded into Charlottesville, Virginia (north of Region 2000) with a loan production office which subsequently became a limited service branch and to Roanoke, Virginia (west of Region 2000) with a mortgage production office. As of the first quarter of 2016, the Roanoke office now houses a full time commercial lender within the mortgage production office.

In 2015 the Bank expanded into Harrisonburg, Virginia (northwest of Region 2000) with a full service branch located at 1391 South High Street. The property was previously used as a bank branch by another financial institution.

Even with this expansion outside of Region 2000, the Bank continues to consider its primary market to be Region 2000.

Competition

Retail and Commercial Banking

The banking business is highly competitive. We compete with other commercial banks, savings institutions, credit unions, mortgage banking firms, consumer finance companies, securities brokerage firms, insurance companies, money market mutual funds and other financial institutions operating in the Region 2000 market area and elsewhere. Many of our nonbank competitors are not subject to the same extensive federal regulations that govern federally-insured banks and state regulations governing state chartered banks. As a result, such nonbank competitors may have certain advantages over the Bank in providing certain services.

Virginia law permits statewide branching by banks. Consequently, the Bank’s market area is a highly competitive, highly branched banking market. Competition in the market area for loans to individuals, small businesses, and professional concerns, the Bank’s target market, is keen, and pricing is important. Most of the Bank’s competitors have substantially greater resources and lending limits than the Bank and offer certain services, such as extensive and established branch networks and trust services, that the Bank is not currently providing. Deposit competition is strong and comes from institutions in the market, U.S. Government securities, private issuers of debt obligations and suppliers of other investment alternatives for depositors, among other sources. As a result, the Bank has paid, and may in the future pay, above-market rates to attract deposits.

 

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The adoption of legislation permitting nationwide interstate banking and branching and the use of financial holding companies may also increase competition in the Bank’s market area. See “Supervision and Regulation of Financial” below.

Mortgage Banking

The Mortgage Division competes with large national and regional banks, credit unions, regional mortgage lenders and local mortgage brokers. Following 2008, the mortgage industry experienced consolidation. Despite the consolidation, the competition with regard to price has increased as the remaining participants struggle to achieve volume and profitability. The downturn in the housing markets related to declines in real estate values, increased payment defaults and foreclosures have had a dramatic effect on the secondary market. The guidelines surrounding agency business (i.e., loans sold to Fannie Mae and Freddie Mac) have become much more restrictive and the associated mortgage insurance for loans above 80 percent loan-to-value has continued to tighten. These changes in the conventional market have caused a dramatic increase in government lending and state bond programs. The Mortgage Division competes by attracting the top sales people in the industry, providing an operational infrastructure that manages the guideline changes efficiently and effectively, offering a product menu that is both competitive in loan parameters as well as price, and providing consistently high quality customer service.

The Mortgage Division, like other residential mortgage originators and lenders, would be impacted by the inability of Fannie Mae, Freddie Mac, the FHA or the VA to purchase loans. Although the Mortgage Division sells loans to various intermediaries, the ability of these aggregators to purchase loans would be limited if these government-sponsored entities cease to exist or materially limit their purchases of mortgage loans.

SUPERVISION AND REGULATION

General

Both Financial, as a bank holding company, and the Bank are subject to extensive federal and state laws and regulations. These laws and regulations impose specific requirements or restrictions on and provide for general regulatory oversight of virtually all aspects of our operations. The following briefly summarizes the more significant provisions of applicable federal and state laws, certain regulations and the potential impact of such provisions on Financial and the Bank. These laws and regulations are generally intended to protect depositors, not shareholders. The following summary is qualified by reference to the statutory and regulatory provisions discussed.

Changes in applicable laws or regulations may have a material effect on our business and prospects. Our operations may be affected by legislative changes and the policies of various regulatory authorities. We cannot predict the effect that fiscal or monetary policies, economic control, or new federal or state legislation may have on our business and earnings in the future.

Regulation of Financial

General. Financial is subject to the periodic reporting requirements of the Securities and Exchange Act of 1934, as amended (the “Exchange Act”), including the filing with the Securities and Exchange Commission (the “SEC”) of annual, quarterly and other reports on the financial condition and performance of the organization. Financial is directly affected by the corporate responsibility and accounting reform legislation signed into law on July 30, 2002, known as the Sarbanes-Oxley Act of 2002 (the “SOX Act”), and the related rules and regulations. The SOX Act includes provisions that, among other things, require that periodic reports containing financial statements that are filed with the SEC be accompanied by chief executive officer and chief financial officer certifications as to the accuracy and compliance with law,

 

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additional disclosure requirements and corporate governance and other related rules. Although we are not required to receive an opinion of our external auditors regarding our internal control over financial reporting under section 404 of the SOX Act because of our status as a smaller reporting company, our management’s report on internal control over financial reporting is set forth in Item 8 and incorporated into Item 9A herein. Financial has expended considerable time and money in complying with the SOX Act and expects to continue to incur additional expenses in the future.

Bank Holding Company Act. As a bank holding company registered under the Bank Holding Company Act of 1956 (the “BHCA”), Financial is subject to regulation and examination by the Board of Governors of the Federal Reserve System (the “Federal Reserve Board”). Financial is required to file with the Federal Reserve Board an annual report and such other additional information as the Federal Reserve Board may require pursuant to the BHCA.

The Federal Reserve Board requires a bank holding company to act as a source of financial strength and to take measures to preserve and protect its bank subsidiaries. Financial would be compelled by the Federal Reserve Board to invest additional capital in the event the Bank experiences either significant loan losses or rapid growth of loans or deposits.

The Federal Reserve Board has jurisdiction under the BHCA to approve any bank or non-bank acquisition, merger or consolidation proposed by a bank holding company. The BHCA, and other applicable laws and regulations, generally limit the activities of a bank holding company and its subsidiaries to that of banking, managing or controlling banks, or any other activity that is so closely related to banking or to managing or controlling banks as to be a proper incident thereto.

Since September 1995, the BHCA has permitted bank holding companies from any state to acquire banks and bank holding companies located in any other state, subject to certain conditions, including nationwide and state imposed concentration limits. Banks are also able to branch across state lines, provided certain conditions are met, including that applicable state laws expressly permit such interstate branching. Virginia has adopted legislation that permits branching across state lines, provided there is reciprocity with the state in which the out-of-state bank is based.

Gramm-Leach-Bliley Act of 1999. The Gramm-Leach-Bliley Act (the “GLB Act”) which was effective March 11, 2000, permits bank holding companies to become financial holding companies and thereby affiliate with securities firms and insurance companies and engage in other activities that are financial in nature. A bank holding company may become a financial holding company by filing a declaration that the bank holding company wishes to become a financial holding company if each of its subsidiary banks (i) is well capitalized under regulatory prompt corrective action provisions, (ii) is well managed, and (iii) has at least a satisfactory rating under the Community Reinvestment Act (“CRA”). No regulatory approval will be required for a financial holding company to acquire a company, other than a bank or savings association, engaged in activities that are financial in nature or incidental to activities that are financial in nature, as determined by the Federal Reserve Board.

The GLB Act defines “financial in nature” to include securities underwriting, dealing and market making; sponsoring mutual funds and investment companies; insurance underwriting and agency; merchant banking activities; and activities that the Board has determined to be closely related to banking. Subsidiary banks of a financial holding company must continue to be well capitalized and well managed in order to continue to engage in activities that are financial in nature without regulatory actions or restrictions, which could include divestiture of the financial in nature subsidiary or subsidiaries. In addition, a financial holding company or a bank may not acquire a company that is engaged in activities that are financial in nature unless each of the subsidiary banks of the financial holding company or the bank has a CRA rating of satisfactory or better.

The GLB Act also imposes customer privacy requirements on financial institutions. Financial institutions generally are prohibited from disclosing customer information to non-affiliated third parties,

 

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unless the customer has been given the opportunity to object and has not objected to such disclosure. Financial institutions must disclose their specific privacy policies to their customers annually. Upon making such disclosure, there is no specific restriction on financial institutions disclosing customer information to affiliated parties. Financial institutions must comply with state law, however, if it protects customer privacy more fully than federal law.

The cumulative effect of the GLB Act and other recent bank legislation has caused us to strengthen our staff to handle the procedures required by this additional regulation. The increased staff and operational costs have impacted our profitability. Although the above laws may have a significant impact on the banking industry by promoting, among other things, competition, it is not possible for the management of the Bank to determine, with any degree of certainty, the impact of such laws on the Bank.

Mergers and Acquisitions. The Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994 authorizes the Federal Reserve Board to permit adequately capitalized and adequately managed bank holding companies to acquire all or substantially all of the assets of an out-of-state bank or bank holding company, subject to certain conditions, including nationwide and state concentration limits. Banks also are able to branch across state lines, provided certain conditions are met, including that applicable state law must expressly permit such interstate branching. Virginia law permits branching across state lines, provided there is reciprocity with the state in which the out-of-state bank is based.

Limits on the Payment of Dividends. Financial is a legal entity, separate and distinct from the Bank. Financial currently does not have any significant sources of revenue other than cash dividends paid to it by its subsidiaries. Both Financial and the Bank are subject to laws and regulations that limit the payment of cash dividends, including requirements to maintain capital at or above regulatory minimums. As a bank that is a member of the Federal Reserve System (“state member bank”), the Bank must obtain prior written approval for any cash dividend if the total of all dividends declared in any calendar year would exceed the total of its net profits for that year combined with its retained net profits for the preceding two years.

Banking regulators have indicated that Virginia banking organizations should generally pay dividends only (1) from net undivided profits of the bank, after providing for all expenses, losses, interest and taxes accrued or due by the bank and (2) if the prospective rate of earnings retention appears consistent with the organization’s capital needs, asset quality and overall financial condition. In addition, the Federal Deposit Insurance Act (FDIA) prohibits insured depository institutions such as the Bank from making capital distributions, including the payment of dividends, if, after making such distribution, the institution would become undercapitalized as defined in the statute. In addition, the Federal Reserve is authorized to determine under certain circumstances relating to the financial condition of a bank that the payment of dividends would be an unsafe and unsound practice and to prohibit payment thereof. The payment of dividends that deplete a bank’s capital base could be deemed to constitute such an unsafe and unsound banking practice. The Federal Reserve has indicated that banking organizations generally pay dividends only out of current operating earnings. In addition, under Virginia law, no dividend may be declared or paid out of a Virginia bank’s paid-in capital. The Bank may be prohibited under Virginia law from the payment of dividends if the Virginia Bureau of Financial Institutions determines that a limitation of dividends is in the public interest and is necessary to ensure the Bank’s financial soundness, and may also permit the payment of dividends not otherwise allowed by Virginia law.

The Dodd-Frank Act

On July 21, 2010, the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Reform Act”) was signed into law. The Dodd-Frank Reform Act represents a significant overhaul of many aspects of the regulation of the financial services industry, although many of its provisions (e.g., the interchange and trust preferred capital limitations) apply to companies that are significantly larger than Financial. The Dodd-Frank Reform Act directs applicable regulatory authorities to promulgate regulations

 

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implementing its provisions, and its effect on Financial and on the financial services industry as a whole will be clarified as those regulations are issued. Major elements of the Dodd-Frank Reform Act include:

 

    The Dodd-Frank Reform Act changed the assessment base for federal deposit insurance from the amount of insured deposits to consolidated assets less tangible capital, eliminated the ceiling on the size of the Deposit Insurance Fund (DIF) and increased the floor applicable to the size of the DIF. The Dodd-Frank Act also made permanent the $250,000 limit for federal deposit insurance and increased the cash limit of Securities Investor Protection Corporation protection from $100,000 to $250,000.

 

    The Dodd-Frank Reform Act repealed the federal prohibitions on the payment of interest on demand deposits, thereby permitting depository institutions to pay interest on business transaction and other accounts.

 

    The Dodd-Frank Reform Act required new disclosure relating to executive compensation and corporate governance.

 

    The Dodd-Frank Reform Act implemented amendments to the Truth in Lending Act aimed at improving consumer protections with respect to mortgage originations, including originator compensation, minimum repayment standards, and prepayment considerations.

 

    The Dodd-Frank Reform Act established the Financial Stability Oversight Council, which will be responsible for identifying and monitoring systemic risks posed by financial firms, activities, and practices.

 

    The Dodd-Frank Reform Act amended the Electronic Fund Transfer Act (EFTA) to, among other things, require that debit card interchange fees must be reasonable and proportional to the actual cost incurred by the issuer with respect to the transaction. In June 2011, the Federal Reserve Board adopted regulations setting the maximum permissible interchange fee as the sum of 21 cents per transaction and 5 basis points multiplied by the value of the transaction, with an additional adjustment of up to one cent per transaction if the issuer implements additional fraud-prevention standards. Although issuers that have assets of less than $10 billion are exempt from the Federal Reserve Board’s regulations that set maximum interchange fees, these regulations are expected to significantly affect the interchange fees that financial institutions with less than $10 billion in assets are able to collect.

 

    The Dodd-Frank Reform Act eliminated (over time) the inclusion of trust preferred securities as a permitted element of Tier 1 capital.

 

    The Dodd-Frank Reform Act created a special regime to allow for the orderly liquidation of systemically important financial companies, including the establishment of an orderly liquidation fund.

 

    The Dodd-Frank Reform Act requires the development of regulations to address derivatives markets, including clearing and exchange trading requirements and a framework for regulating derivatives-market participants.

 

    The Dodd-Frank Reform Act enhanced supervision of credit rating agencies through the Office of Credit Ratings within the SEC.

 

    The Dodd-Frank Reform Act established a Bureau of Consumer Financial Protection, within the Federal Reserve, to serve as a dedicated consumer-protection regulatory body. The Consumer Financial Protection Bureau is responsible for implementing, examining and enforcing compliance with federal consumer financial laws for institutions with more than $10 billion of assets and, to a lesser extent, small institutions. As a smaller institution, most consumer protection aspects of the Dodd-Frank Reform Act will continue to be overseen by the Federal Reserve.

Many aspects of the Dodd-Frank Reform Act are subject to rulemaking and will take effect over several years. As a result, it is difficult to anticipate the overall impact of the act on Financial. Financial continues to evaluate the potential impact of the Dodd-Frank Reform Act.

 

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Economic Emergency Stabilization Act of 2008. In response to the financial crisis affecting the banking system and financial markets and going concern threats to investment banks and other financial institutions, on October 3, 2008, the Emergency Economic Stabilization Act of 2008 (the “EESA”) was signed into law. Through its authority under the EESA, the Treasury announced in October 2008 the Troubled Asset Relief Program—Capital Purchase Program (the “CPP”) a program designed to bolster healthy institutions, like Financial, by making $250 billion of capital available to U.S. financial institutions in the form of preferred stock. Participants in the CPP are subject to executive compensation limits and are encouraged to expand their lending and mortgage loan modifications. Although Financial received preliminary approval from the United States Treasury to participate in the TARP Capital Purchase Program, Financial decided not to participate in the program.

Regardless of our lack of participation in certain programs, governmental intervention and new regulations under these programs could materially and adversely affect our business, financial condition and results of operations.

Incentive Compensation

In June 2010, the Federal Reserve, the Office of the Comptroller of the Currency (OCC) and the FDIC issued a comprehensive final guidance on incentive compensation intended to ensure that the incentive compensation policies of banking organizations do not undermine the safety and soundness of such organizations by encouraging excessive risk-taking. The guidance, which covers all employees that have the ability to materially affect the risk profile of an organization, either individually or as part of a group, is based upon the key principles that a banking organization’s incentive compensation arrangements should (i) provide incentives that do not encourage risk-taking beyond the organization’s ability to effectively identify and manage risks, (ii) be compatible with effective internal controls and risk management, and (iii) be supported by strong corporate governance, including active and effective oversight by the organization’s board of directors.

The Federal Reserve will review, as part of the regular, risk-focused examination process, the incentive compensation arrangements of banking organizations, such as Financial, that are not “large, complex banking organizations.” These reviews will be tailored to each organization based on the scope and complexity of the organization’s activities and the prevalence of incentive compensation arrangements. The findings of the supervisory initiatives will be included in reports of examination. Deficiencies will be incorporated into the organization’s supervisory ratings, which can affect the organization’s ability to make acquisitions and take other actions. Enforcement actions may be taken against a banking organization if its incentive compensation arrangements, or related risk-management control or governance processes, pose a risk to the organization’s safety and soundness and the organization is not taking prompt and effective measures to correct the deficiencies.

The Dodd-Frank Reform Act requires the SEC and the federal bank regulatory agencies to establish joint regulations or guidelines that require financial institutions with assets of at least $1 billion to disclose the structure of their incentive compensation practices and prohibit such institutions from maintaining compensation arrangements that encourage inappropriate risk-taking by providing excessive compensation or that could lead to material financial loss to the financial institution.

Regulation of the Bank

The Bank is a Virginia chartered commercial bank and a state member bank. The Bank’s deposit accounts are insured by the DIF of the FDIC up to the maximum legal limits of the FDIC and it is subject to regulation, supervision and regular examination by the Virginia Bureau of Financial Institutions and the Federal Reserve. The regulations of these various agencies govern most aspects of the Bank’s business, including required reserves against deposits, loans, investments, mergers and acquisitions, borrowings, dividends and location and number of branch offices. The laws and regulations governing the Bank generally have been promulgated to protect depositors and the deposit insurance funds, and not for the purpose of protecting shareholders.

 

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General. As a state-chartered commercial bank, the Bank and its subsidiaries are subject to regulation, supervision and examination by the Federal Reserve and the Virginia State Corporation Commission’s Bureau of Financial Institutions (the “Commission”). As such, the Bank is subject to various statutes and regulations administered by these agencies that govern, among other things, required reserves, investments, loans, lending limits, acquisitions of fixed assets, interest rates payable on deposits, transactions among affiliates and the Bank, the payment of dividends, mergers and consolidations, and establishment of branch offices.

The earnings of the Bank are affected by general economic conditions, management policies and the legislative and governmental actions of the various regulatory authorities, including those referred to above.

FDIC Insurance Premiums. The Bank has deposits that are insured by the Federal Deposit Insurance Corporation (FDIC). FDIC maintains a Deposit Insurance Fund (“DIF”) that is funded by risk-based insurance premium assessments on insured depository institutions. Assessments are determined based upon several factors, including the level of regulatory capital and the results of regulatory examinations. FDIC may adjust assessments if the insured institution’s risk profile changes or if the size of the DIF declines in relation to the total amount of insured deposits. In 2016, the Bank expensed $363,000 in FDIC assessments which compared to $331,000 in 2015. Any increases in FDIC insurance premiums could adversely affect the Bank’s profitability.

Deposits at FDIC-insured institutions are insured up to $250,000 per depositor, subject to aggregation rules.

After giving primary regulators an opportunity to first take action, FDIC may initiate an enforcement action against any depository institution it determines is engaging in unsafe or unsound actions or which is in an unsound condition, and the FDIC may terminate that institution’s deposit insurance.

New Capital Requirements. On June 7, 2012, the Federal Reserve issued a series of proposed rules that would revise and strengthen its risk-based and leverage capital requirements and its method for calculating risk-weighted assets. The rules were proposed to implement the Basel III regulatory capital reforms from the Basel Committee on Banking Supervision and certain provisions of the Dodd-Frank Reform Act. On July 2, 2013, the Federal Reserve approved certain revisions to the proposals and finalized new capital requirements for banking organizations.

Effective January 1, 2015, the final rules required Financial and the Bank to comply with the following new minimum capital ratios: (i) a new common equity Tier 1 capital ratio of 4.5% of risk-weighted assets; (ii) a Tier 1 capital ratio of 6.0% of risk-weighted assets (increased from the previous requirement of 4.0%); (iii) a total capital ratio of 8.0% of risk-weighted assets (unchanged from the previous requirement); and (iv) a leverage ratio of 4.0% of total assets. These are the initial capital requirements, which will be phased in over a five-year period. When fully phased in on January 1, 2019, the rules will require Financial and the Bank to maintain (i) a minimum ratio of common equity Tier 1 to risk-weighted assets of at least 4.5%, plus a 2.5% “capital conservation buffer” (which is added to the 4.5% common equity Tier 1 ratio as that buffer is phased in, effectively resulting in a minimum ratio of common equity Tier 1 to risk-weighted assets of at least 7.0% upon full implementation), (ii) a minimum ratio of Tier 1 capital to risk-weighted assets of at least 6.0%, plus the capital conservation buffer (which is added to the 6.0% Tier 1 capital ratio as that buffer is phased in, effectively resulting in a minimum Tier 1 capital ratio of 8.5% upon full implementation), (iii) a minimum ratio of total capital to risk-weighted assets of at least 8.0%, plus the capital conservation buffer (which is added to the 8.0% total capital ratio as that buffer is phased in, effectively resulting in a minimum total capital ratio of 10.5% upon full implementation), and (iv) a minimum leverage ratio of 4.0%, calculated as the ratio of Tier 1 capital to average assets.

 

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The capital conservation buffer requirement will be phased in beginning January 1, 2016, at 0.625% of risk-weighted assets, increasing each year until fully implemented at 2.5% on January 1, 2019. The capital conservation buffer is designed to absorb losses during periods of economic stress. Banking institutions with a ratio of common equity Tier 1 to risk-weighted assets above the minimum but below the conservation buffer will face constraints on dividends, equity repurchases, and compensation based on the amount of the shortfall.

With respect to the Bank, the rules also revised the “prompt corrective action” regulations pursuant to Section 38 of the FDIA by (i) introducing a common equity Tier 1 capital ratio requirement at each level (other than critically undercapitalized), with the required ratio being 6.5% for well-capitalized status; (ii) increasing the minimum Tier 1 capital ratio requirement for each category, with the minimum ratio for well-capitalized status being 8.0% (as compared to the previous 6.0%); and (iii) eliminating the current provision that provides that a bank with a composite supervisory rating of 1 may have a 3.0% Tier 1 leverage ratio and still be well-capitalized.

The new capital requirements also include changes in the risk weights of assets to better reflect credit risk and other risk exposures. These include a 150% risk weight (up from 100%) for certain high volatility commercial real estate acquisition, development and construction loans and nonresidential mortgage loans that are 90 days past due or otherwise on nonaccrual status, a 20% (up from 0%) credit conversion factor for the unused portion of a commitment with an original maturity of one year or less that is not unconditionally cancellable, a 250% risk weight (up from 100%) for mortgage servicing rights and deferred tax assets that are not deducted from capital, and increased risk-weights (from 0% to up to 600%) for equity exposures.

If the new minimum capital ratios described above had been effective as of December 31, 2015, based on management’s interpretation and understanding of the new rules, Financial would have remained “well capitalized” as of such date.

Transactions with Affiliates. The Bank is subject to the provisions of Section 23A and 23B of the Federal Reserve Act and Federal Reserve Regulation W of the Federal Reserve Bank which place limits on the amount of loans or extensions of credit to affiliates (as defined in the Federal Reserve Act), investments in or certain other transactions with affiliates and on the amount of advances to third parties collateralized by the securities or obligations of affiliates. The law and regulation limit the aggregate amount of transactions with any individual affiliate to ten percent (10%) of the capital and surplus of the Bank and also limit the aggregate amount of transactions with all affiliates to twenty percent (20%) of capital and surplus. Loans and certain other extensions of credit to affiliates are required to be secured by collateral in an amount and of a type described in the regulation, and the purchase of low quality assets from affiliates is generally prohibited. The law and Regulation W also, among other things, prohibit an institution from engaging in certain transactions with certain affiliates (as defined in the Federal Reserve Act) unless the transactions are on terms substantially the same, or at least as favorable to such institution and/or its subsidiaries, as those prevailing at the time for comparable transactions with non-affiliated entities. In the absence of comparable transactions, such transactions may only occur under terms and circumstances, including credit standards that in good faith would be offered to or would apply to non-affiliated companies.

Loans to Insiders. The Bank is subject to the restrictions contained in Section 22(h) of the Federal Reserve Act and the Federal Reserve Board’s Regulation O thereunder on loans to executive officers, directors and principal stockholders. Under Section 22(h), loans to a director, an executive officer or a greater-than-10% stockholder of a bank as well as certain affiliated interests of any of the foregoing may not exceed, together with all other outstanding loans to such person and affiliated interests, the loans-to-one-borrower limit applicable to national banks (generally 15% of the institution’s unimpaired capital and surplus), and all loans to all such persons in the aggregate may not exceed the institution’s unimpaired capital and unimpaired surplus. Regulation O also prohibits the making of loans in an amount greater than $25,000 or 5% of capital and surplus but in any event not over $500,000, to directors, executive officers and greater-than-10% stockholders of a bank, and their respective affiliates, unless such loans are approved in

 

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advance by a majority of the board of directors of the bank with any “interested” director not participating in the voting. Furthermore, Regulation O requires that loans to directors, executive officers and principal stockholders of a bank be made on terms substantially the same as those that are offered in comparable transactions to unrelated third parties unless the loans are made pursuant to a benefit or compensation program that is widely available to all employees of the bank and does not give preference to insiders over other employees. Regulation O also prohibits a depository institution from paying overdrafts over $1,000 of any of its executive officers or directors unless they are paid pursuant to written pre-authorized extension of credit or transfer of funds plans.

All of the Bank’s loans to its and the Company’s executive officers, directors and greater-than-10% stockholders, and affiliated interests of such persons, comply with the requirements of Regulation W and Section 22(h) of the Federal Reserve Act and Regulation O.

Community Reinvestment Act. The Community Reinvestment Act (“CRA”) requires that, in connection with examinations of financial institutions within their respective jurisdictions, the Federal Reserve Board, the Federal Deposit Insurance Corporation, the Office of the Comptroller of the Currency or the Office of Thrift Supervision shall evaluate the record of the financial institutions in meeting the credit needs of their local communities, including low and moderate income neighborhoods, consistent with the safe and sound operation of those institutions. The CRA does not establish specific lending requirements or programs for financial institutions nor does it limit an institution’s discretion to develop the types of products and services that it believes are best suited to its particular community, consistent with the CRA. An institution’s CRA activities are considered in, among other things, evaluating mergers, acquisitions and applications to open a branch or facility, as well as determining whether the institution will be permitted to exercise certain of the powers allowed by the GLB Act. The CRA also requires all institutions to make public disclosure of their CRA ratings. The Bank currently has a CRA rating of “satisfactory.”

Safety and Soundness. The federal banking agencies have broad powers under current federal law to take prompt corrective action to resolve problems of insured depository institutions. The extent of these powers depends upon whether the institutions in question are “well capitalized,” “adequately capitalized,” “undercapitalized,” “significantly undercapitalized,” or “critically undercapitalized,” all such terms are defined under uniform regulations defining such capital levels issued by each of the federal banking agencies. An insured depository institution which is less than adequately capitalized must adopt an acceptable capital restoration plan, is subject to increased regulatory oversight and is increasingly restricted in the scope of its permissible activities. As of December 31, 2016, the Bank was considered “well capitalized.”

Regulatory Enforcement Authority. Applicable banking laws include substantial enforcement powers available to federal banking regulators. This enforcement authority includes, among other things, the ability to assess civil money penalties, to issue cease-and-desist or removal orders and to initiate injunctive actions against banking organizations and institution-affiliated parties. In general, these enforcement actions may be initiated for violations of laws and regulations and unsafe or unsound practices. Other actions or inactions, including the filing of misleading or untimely reports with regulatory authorities, may provide the basis for enforcement action.

Bank Secrecy Act (BSA). Under the Bank Secrecy Act, a financial institution is required to have systems in place to detect certain transactions, based on the size and nature of the transaction. Financial institutions are generally required to report cash transactions involving more than $10,000 to the Treasury. In addition, financial institutions are required to file suspicious activity reports for transactions that involve more than $5,000 and which the financial institution knows, suspects or has reason to suspect, involves illegal funds, is designed to evade the requirements of the BSA or has no lawful purpose.

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

 

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financial institutions, upon providing notice to the United States Treasury, to share information with one another in order to better identify and report to the federal government concerning activities that may involve money laundering or terrorist activities. The USA Patriot Act is considered a significant banking law in terms of information disclosure regarding certain customer transactions. Although it does create a reporting obligation, the USA Patriot Act has not materially affected the Bank’s products, services or other business activities.

Reporting Terrorist Activities. The Federal Bureau of Investigation (“FBI”) has sent, and will send, our banking regulatory agencies lists of the names of persons suspected of involvement in the September 11, 2001, terrorist attacks on New York City and Washington, DC. The Bank has been asked, and may be asked again, to search its records for any relationships or transactions with persons on those lists. If the Bank finds any relationships or transactions, it must file a suspicious activity report and contact the FBI. The Office of Foreign Assets Control (“OFAC”), which is a division of the Department of the Treasury is responsible for helping to ensure 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.

Mortgage Banking Regulation. The Bank’s Mortgage division is subject to the rules and regulations by the Department of Housing and Urban Development (“HUD”), the Federal Housing Administration (the “FHA”), the Department of Veteran Affairs and state regulatory authorities with respect to originating, processing, servicing and selling mortgage loans. Those rules and regulations, among other things, establish standards for loan origination, prohibit discrimination, provide for inspections and appraisals of property, require credit reports on prospective borrowers and, in some cases, restrict certain loan features, and fix maximum interest rates and fees. In addition to other federal laws, mortgage origination activities are subject to the Equal Credit Opportunity Act, Truth-in-Lending Act, Home Mortgage Disclosure Act, the Real Estate Settlement Procedures Act, and the Home Ownership Equity Protection Act, and the regulations promulgated thereunder. These laws prohibit discrimination, require the disclosure of certain basic information to mortgagors concerning credit and settlement costs, limit payment for settlement services to the reasonable value of the services rendered and require the maintenance and disclosure of information regarding the disposition of mortgage applications based on race, gender, geographical distribution and income level.

Check Clearing for the 21st Century Act (Check 21). Check 21 gives “substitute checks,” such as a digital image of a check and copies made from that image, the same legal standing as the original paper check. The major provisions of Check 21 include: allowing check truncation without making it mandatory; demanding that every financial institution communicate to account holders in writing a description of its substitute check processing program and their rights under the law; legalizing substitutions for and replacements of paper checks without agreement from consumers; retaining in place the previously-mandated electronic collection and return of checks between financial institutions only when individual agreements are in place; requiring that when account holders request verification, financial institutions produce the original check (or a copy that accurately represents the original) and demonstrate that the account debit was accurate and valid; and requiring recrediting of funds to an individual’s account on the next business day after a consumer proves that the financial institution has erred. This legislation has not significantly increased our capital spending.

 

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Effect of Governmental Monetary Policies

Our earnings are affected by domestic economic conditions and the monetary and fiscal policies of the United States government and its agencies. The Federal Reserve Bank’s monetary policies have had, and are likely to continue to have, an important impact on the operating results of commercial banks through its power to implement national monetary policy in order, among other things, to curb inflation or combat a recession. The monetary policies of the Federal Reserve Board have major effects upon the levels of bank loans, investments and deposits through its open market operations in United States government securities and through its regulation of the discount rate on borrowings of member banks and the reserve requirements against member bank deposits. It is not possible to predict the nature or impact of future changes in monetary and fiscal policies.

Future Regulatory Uncertainty

Legislative and regulatory proposals regarding changes in banking, and the regulation of banks, federal savings institutions, and other financial institutions and bank and bank holding company powers are being considered by the executive branch of the federal government, Congress and various state governments. Certain of these proposals, if adopted, could significantly change the regulation or operations of banks and the financial services industry. New regulations and statutes are regularly proposed that contain wide-ranging proposals for altering the structures, regulations, and competitive relationships of the nation’s financial institutions.

Because federal regulation of financial institutions changes regularly and is the subject of constant legislative debate, we cannot forecast how federal regulation of financial institutions may change in the future and impact our operations. The current economic environment has required a greater degree of coordination and overlap of the duties and responsibilities of the U.S. Treasury, federal and state banking regulators and the FDIC. We fully expect that the financial institution industry will remain heavily regulated in the near future and that additional laws or regulations may be adopted further regulating specific banking practices. We cannot predict whether or in what form any proposed regulation or statute will be adopted or the extent to which our business may be affected by any new regulation or statute.

 

Item 1A. Risk Factors

Not required for smaller reporting companies.

 

Item 1B. Unresolved Staff Comments

None.

 

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Item 2. Properties

Current Locations and Property

Depending on such factors as cost, availability, and location, we may either lease or purchase our operating facilities. The existing facilities that we have purchased typically have been former branches of other financial institutions. As of February 28, 2017, the Bank conducts its operations from 16 locations, of which we own 7 and lease 9. The following table describes the location and general character of our operating facilities:

 

Address

  

Type of Facility

   Year
Opened
  

Owned/Leased

5204 Fort Avenue

Lynchburg, Virginia

   Full service branch with drive thru and ATM    2000    Owned

4698 South Amherst Highway

Madison Heights, Virginia

   Full service branch with drive thru and ATM    2002    Owned

17000 Forest Road

Forest, Virginia

  

Full service branch with drive thru and ATM

Headquarters for Mortgage Division

   2005    Owned

164 South Main Street

Amherst, Virginia

   Full service branch with drive thru and ATM    2007    Owned

1405 Ole Dominion Blvd.

Bedford, Virginia

   Full service branch with drive thru and ATM    2008    Owned

1110 Main Street

Altavista, Virginia

   Full service branch with drive thru and ATM    2009    Owned

828 Main Street

Lynchburg, Virginia

   Corporate Headquarters; Full service branch with ATM    2004    Leased (1)

615 Church Street

Lynchburg, Virginia

  

Full service branch with drive thru and ATM

Headquarters for Investment and Insurance operations

   1999    Leased (2)

4935 Boonsboro Road,

Suites C and D

Lynchburg, Virginia

   Full service branch with drive thru and ATM    2006    Leased (3)

501 VES Road

Lynchburg, Virginia

   Limited service branch    2010    Leased (4)

1430 Rolkin Court

Suite 203

Charlottesville, Virginia

   Commercial loan origination and mortgage office as well as a limited service branch    2013    Leased (5)

1391 South High Street

Harrisonburg, Virginia

   Full service branch with drive thru and ATM    2015    Owned

250 Pantops Mountain Road

Charlottesville, Virginia

   Limited service branch    2015    Leased (6)

180 Old Courthouse Road

Appomattox, Virginia

   Temporary Full Service Branch with drive thru    2016    Leased (7)

225 Merchant Walk Avenue

Charlottesville, Virginia

   Full service branch with drive thru and ATM    2016    Leased (8)

3562 Electric Road

Roanoke, Virginia

   Full service branch with ATM    2017    Leased (9)

 

(1) Base lease expired July 31, 2014 at which the Bank elected to exercise its first five-year renewal option. The Bank currently has one more five-year renewal option that we may exercise at our discretion subject to the terms and conditions outlined in the lease. The Bank leases this property from Jamesview Investment, LLC, which is wholly-owned by William C. Bryant III, a member of the Board of Directors of both Financial and the Bank.

 

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(2) Base lease expires July 31, 2019. We have one or more renewal options that we may exercise at our discretion subject to the terms and conditions outlined in the lease.
(3) The current term expires on December 31, 2020. The Bank intends to continue operating at this location.
(4) Base lease expires May 31, 2020. The Bank intends to continue operating at this location.
(5) Base lease expires December 31, 2018. We have one renewal option that we may exercise at our discretion subject to the terms and conditions outlined in the lease.
(6) Base lease expires April 30, 2020. We have one or more renewal options that we may exercise at our discretion subject to the terms and conditions outlined in the lease.
(7) This is a land lease for a temporary location. The lease is month-to-month as of March 1, 2017.
(8) Base lease expires October 31, 2026. We have one or more renewal options that we may exercise at our discretion subject to the terms and conditions outlined in the lease.
(9) Base lease expires January 31, 2022. We have one or more renewal options that we may exercise at our discretion subject to the terms and conditions outlined in the lease.

We believe that each of these operating facilities is maintained in good operating condition and is suitable for our operational needs.

 

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Interest in Additional Properties

As discussed in “Management’s Discussion and Analysis—Expansion Plans” in addition to the facilities set forth above, the Bank owns the following properties which are being held for possible expansion:

 

    real property located in the Timberlake Road area of Campbell County (Lynchburg), Virginia. The existing structure located on the property is not suitable for its intended use as a branch bank. Management anticipates that it will be necessary to raze the current structures and replace it with appropriate new construction.

 

    real property located at 5 Village Highway (near the intersection of Routes 501 and 24) in Rustburg, Virginia. The structure on the property has been demolished and removed. The Bank does not anticipate opening a branch at this location prior to 2018.

 

    real property located near the intersection of Confederate Boulevard and Moses Avenue in Appomattox, Virginia. There is no structure on the property. The Bank anticipates construction of a permanent full service location will begin in the spring of 2017. At the completion of construction and upfit, the Bank will relocate its temporary location (180 Old Courthouse Road referenced in the location table above) to this permanent location. The Bank anticipates that construction will be complete in late 2017 or early 2018.

 

    real property located at 45 South Main Street, Lexington, Virginia. The Bank does not anticipate opening a branch at this location prior to 2018.

Management of the Bank continues to look for and evaluate additional locations for future branch growth and will consider opening an additional branch in the next 18 months if a suitable location is available on acceptable terms. The opening of all additional branches is contingent upon the receipt of regulatory approval.

We will use the internet, consistent with applicable regulatory guidelines, to augment our growth plans. We currently offer online account access, bill payment, and account management functions through our website. The Bank recently released an application that enables customers to transact banking business on smartphones and other mobile devices.

 

Item 3. Legal Proceedings

There are no material pending legal proceedings to which the Company is a party or to which the property of the Company is subject.

 

Item 4. Mine Safety Disclosures — Not applicable.

 

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PART II

 

Item 5. Market For Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

Market Prices and Dividends

As of January 25, 2012, the Common Stock of Financial is traded on the NASDAQ Capital Market LLC (NASDAQ) under the symbol “BOTJ.” Prior to this time, the Common Stock of Financial was quoted on the Over the Counter Bulletin Board (OTCBB) under the symbol “BOJF (“BOJF.OB” on some systems) and transactions generally involved a small number of shares. The following table sets forth the quarterly high and low bid prices for each quarter in fiscal 2016 and 2015 for Financial and was obtained from Bloomberg. Management believes this source to be accurate.

 

     Market Prices and Dividends  
     Bid Price ($)         
   High      Low      Dividends ($)  

Fiscal 2016

        

Fourth Quarter

     15.20        12.15        0.06  

Third Quarter

     13.10        11.96        0.06  

Second Quarter

     12.40        11.55        0.06  

First Quarter

     12.61        11.43        0.06  

Fiscal 2015

        

Fourth Quarter

     13.06        10.97        0.06  

Third Quarter

     11.50        10.80        0.06  

Second Quarter

     11.60        10.46        0.05  

First Quarter

     10.97        10.30        0.05  

The quotations reflect inter-dealer prices, without retail mark-up, mark-down or commission and may not represent actual transactions.

As of March 16, 2017 (the most recent date available), the Common Stock traded for $15.20 per share. As of March 21, 2017, there were approximately 4,378,436 shares of Common Stock outstanding, which shares are held by approximately 1,567 active shareholders of record.

Dividend Policy

The Company’s future dividend policy is subject to the discretion of its Board of Directors and will depend upon a number of factors, including future earnings, financial condition, liquidity and capital requirements of both the Company and the Bank, applicable governmental regulations and policies and other factors deemed relevant by its Board of Directors.

The Company is organized under the Virginia Stock Corporation Act, which prohibits the payment of a dividend if, after giving it effect, the corporation would not be able to pay its debts as they become due in the usual course of business or if the corporation’s total assets would be less than the sum of its total liabilities plus the amount that would be needed, if the corporation were to be dissolved, to satisfy the preferential rights upon dissolution of any preferred shareholders.

The Company is a legal entity separate and distinct from its subsidiaries. Its ability to distribute cash dividends will depend primarily on the ability of the Bank to pay dividends to it, and the Bank is subject to laws and regulations that limit the amount of dividends that it can pay. As a state member bank,

 

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the Bank is subject to certain restrictions imposed by the reserve and capital requirements of federal and Virginia banking statutes and regulations. For a discussion of these restrictions, see “Supervision and Regulation of Financial – Limits on the Payment of Dividends.”

On January 17, 2017 Financial declared a cash dividend for the fourth quarter of 2016 of $0.06 per common share. The dividend is payable on March 24, 2017 to shareholders of record at the close of business on March 10, 2017. Financial will evaluate the factors set forth above when making a determination of whether to continue to pay a cash dividend in 2017.

Stock Buyback Plan

In October, 2014, Financial’s board of directors authorized a share repurchase program. The plan, which expired in October, 2015, authorized Financial to buy back up to 100,000 shares of common stock on such terms and conditions as the Company deems favorable. Financial did not repurchase any shares under the plan.

Securities Authorized for Issuance under Equity Compensation Plans

The following table summarizes information concerning Financial’s equity compensation plans at December 31, 2016. All figures have been adjusted to reflect all prior stock dividends declared by Financial. All outstanding stock options have been issued under plans approved by shareholders.

 

Plan Category

  Number of
Shares to be
Issued Upon
Exercise of
Outstanding
Options
    Weighted
Average
Exercise
Price of
Outstanding
Options
    Number of Shares Remaining
Available for Future Issuance
Under Equity Compensation  Plans
(Excluding Shares Reflected in
First Column)
 

Equity compensation plans approved by shareholders - 1999 Stock Option Plan of Bank of the James Financial Group, Inc.

    636     $ 12.79       —    

Equity compensation plans not approved by shareholders

    N/A       N/A       N/A  

Total

    636     $ 12.79       —    

 

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Recent Sales of Unregistered Equity Securities

On December 3, 2015, Financial closed on the sale of 1,000,000 shares of common stock, par value $2.14 at a price of $11.52 per share. Gross proceeds from the sale equaled $11,520,000. Raymond James & Associates, Inc. acted as the placement agent for the sale of the common stock. The proceeds of the sale were used as follows:

 

Commission to Placement Agent

   $ 691,200  

Fees and Expenses

     175,800  

Payment of corporate debt*

     10,000,000  

General corporate purposes

     653,000  
  

 

 

 

Total

   $ 11,520,000  
  

 

 

 

 

* The corporate debt was comprised of the principal amount of notes that Financial issued in the second quarter of 2012 and described in more detail in Note 10 to the Company’s Consolidated Financial Statements included in this filing.

The issuance of shares of Common Stock pursuant to the Private Placement was a private placement to “accredited investors” (as that term is defined under Rule 501 of Regulation D), and is exempt from registration under the Securities Act of 1933 (“Securities Act”), in reliance upon Section 4(2) of the Securities Act and Regulation D Rule 506, as a transaction by an issuer not involving a public offering.

 

Item 6. Selected Financial Data — Not applicable

 

Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations

Management’s Discussion and Analysis of Financial Condition and Results of Operations

The following discussion is intended to assist readers in understanding and evaluating our financial condition and results of operations. You should read this discussion in conjunction with our financial statements and accompanying notes included elsewhere in this report. Because Bank of the James Financial Group, Inc. (“Financial”) has no material operations and conducts no business other than the ownership of its operating subsidiary, Bank of the James (and its divisions and subsidiary), the discussion primarily concerns the business of the Bank. However, for ease of reading and because our financial statements are presented on a consolidated basis, references to “we,” “us,” or “our” refer to Financial, Bank of the James, and their divisions and subsidiaries as appropriate. The comparison of operating results for Financial between the years ended December 31, 2016 and 2015 should be read in the context of both the size and the time frame in which the Bank has been operating.

Cautionary Statement Regarding Forward-Looking Statements

This report contains statements that constitute “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended, and the Private Securities Litigation Reform Act of 1995. The words “believe,” “estimate,” “expect,” “intend,” “anticipate,” “plan” and similar expressions and variations thereof identify certain of such forward-looking statements which speak only as of the dates on which they were made. We undertake no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events, or otherwise. Readers are cautioned that any such forward-looking statements are not guarantees of future performance and involve risks and uncertainties, and that actual results may differ materially from those indicated in the forward-looking statements as a result of various factors. Factors that could cause actual results to differ from the results discussed in the forward-looking statements include, but are not limited to: economic conditions (both generally and more specifically in the markets in which we operate); competition for our customers from other providers of financial services;

 

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government legislation and regulation relating to the banking industry (which changes from time to time and over which we have no control) including but not limited to the Dodd-Frank Wall Street Reform and Consumer Protection Act; changes in the value of real estate securing loans made by the Bank; changes in interest rates; and material unforeseen changes in the liquidity, results of operations, or financial condition of our customers. Other risks, uncertainties and factors could cause our actual results to differ materially from those projected in any forward-looking statements we make.

Overview

Financial is a bank holding company headquartered in Lynchburg, Virginia. Our primary business is retail banking which we conduct through our wholly-owned subsidiary, Bank of the James (which we refer to as the “Bank”). We conduct three other business activities, mortgage banking through the Bank’s Mortgage division (which we refer to as “Mortgage”), investment services through the Bank’s Investment division (which we refer to as “Investment”), and insurance activities through BOTJ Insurance, Inc., a subsidiary of the Bank, (which we refer to as “Insurance”).

Although we intend to increase other sources of revenue, our operating results depend primarily upon the Bank’s net interest income, which is determined by the difference between (i) interest and dividend income on earning assets, which consist primarily of loans, investment securities and other investments, and (ii) interest expense on interest-bearing liabilities, which consist principally of deposits and other borrowings. The Bank’s net income also is affected by its provision for loan losses, as well as the level of its noninterest income, including loan fees and service charges, and its noninterest expenses, including salaries and employee benefits, occupancy expense, data processing expenses, miscellaneous other expenses, franchise taxes, and income taxes.

As discussed in more detail below,

 

    For the year ended December 31, 2016, Financial had net income of $3,286,000, a decrease of $406,000 from net income of $3,692,000, from the year ended December 31, 2015;

 

    For the year ended December 31, 2016, earnings per basic and diluted common share was $0.75, as compared earnings of $1.07 per basic and diluted common share for the year ended December 31, 2015;

 

    Net interest income increased to $19,224,000 for the current year from $17,611,000 for the year ended December 31, 2015;

 

    Noninterest income (exclusive of net gains on sales and calls of securities) increased to $4,301,000 for the year ended December 31, 2016 from $4,144,000 for the year ended December 31, 2015;

 

    Total assets as of December 31, 2016 were $574,195,000 compared to $527,143,000 at the end of 2015, an increase of $47,052,000 or 8.93%;

 

    Net loans (excluding loans held for sale), net of unearned income and allowance for loan loss, increased to $464,353,000 as of December 31, 2016 from $430,445,000 as of the end of December 31, 2015, an increase of 7.88%; and

 

    The net interest margin decreased 1 basis point to 3.77% for 2016, compared to 3.78% for 2015.

 

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The following table sets forth selected financial ratios:

 

     For the Year Ended  
     December 31,  
     2016     2015     2014  

Return on average equity

     6.60     9.78     10.28

Return on average assets

     0.60     0.74     0.76

Dividend yield %

     1.57     1.70     1.46

Average equity to total average assets

     9.16     7.59     7.39

Effect of Economic Trends

Although the U.S. economy continued to improve in 2016, the U.S. economy continued to experience slow growth. Locally, real estate values appear stable and with some increase in valuation. Region 2000 experienced positive trends in housing during 2015 and 2016. In 2016, the Bank continued to experience an increase in loan demand from small and medium size businesses. However, to date in 2017, loan demand from these small and medium size businesses has diminished, which management believes is partially attributable to seasonal demand. Management expects loan demand to increase slightly in the second quarter of 2017 and then remain steady throughout the rest of 2017. Management is unsure what the impact that recent and potential rate increases will be on loan demand. Due to increased asset growth, the Bank’s capital levels decreased slightly, but the Bank remains “well-capitalized” under regulatory standards.

For additional information regarding the local economy and its impact on the Company’s business refer to the Business Section in this 10-K under the caption “Location and Market Area” (Part I. Item 1. Business Section – Location and Market Area).

Management expects economic conditions to continue to improve in 2017, which could result in increased competition for banking services. Financial institutions also face continued heightened levels of scrutiny from federal and state regulators. Financial institutions experienced, and are expected to continue to experience, pressure on credit costs, loan yields, deposit and other borrowing costs, liquidity, and capital.

A variety and wide scope of economic factors affect Financial’s success and earnings. Although interest rate trends are one of the most important of these factors, Financial believes that interest rates cannot be predicted with a reasonable level of confidence and therefore does not attempt to do so with complicated economic models. Management believes that the best defense against wide swings in interest rate levels is to minimize vulnerability at all potential interest rate levels. Rather than concentrate on any one interest rate scenario, Financial prepares for the opposite as well, in order to safeguard margins against the unexpected.

The downward trend in short term interest rates which began in the last quarter of 2007 was due to the actions of the Federal Open Market Committee (“FOMC”) resulting from a deteriorating economy. Since December 2008, the federal funds target rate set by the Federal Reserve had been set at 0.00% to 0.25%. This trend began to reverse in December 2015 when the FOMC raised the target rate by 25 basis points and did so again in December 2016 and in March 2017, which resulted in the current target rate of 0.75% increasing to 1.00%. Long term interest rates have likewise begun to increase and the yield curve remains positively sloped. Although it cannot be certain, as discussed below under “Results of Operations—Net Interest Income” management believes that short term interest rates will either increase or remain stable for the foreseeable future. An increase in long-term interest rates would have an adverse impact on the Mortgage Division, primarily due to reduced refinancing opportunities.

 

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Critical Accounting Policies

Financial’s financial statements are prepared in accordance with accounting principles generally accepted in the United States (GAAP). The financial information contained within our statements is, to a significant extent, based on measures of the financial effects of transactions and events that have already occurred. A variety of factors could affect the ultimate value that is obtained either when earning income, recognizing an expense, recovering an asset or relieving a liability. The Bank uses historical loss factors as one factor in determining the inherent loss that may be present in the loan portfolio. Actual losses could differ significantly from the historical factors that the Bank uses in estimating risk. In addition, GAAP itself may change from one previously acceptable method to another method. Although the economics of Financial’s transactions would be the same, the timing of events that would impact the transactions could change.

The allowance for loan losses is management’s estimate of the losses that may be sustained in our loan portfolio. The allowance is based on two basic principles of accounting: (i) ASC 450, Contingencies, which requires that losses be accrued when they are probable of occurring and are reasonably estimable and (ii) ASC 310, Receivables, which requires that losses on impaired loans be accrued based on the differences between the value of collateral, present value of future cash flows or values that are observable in the secondary market and the loan balance. Guidelines for determining allowances for loan losses are also provided in the SEC Staff Accounting Bulletin No. 102 – “Selected Loan Loss Allowance Methodology and Documentation Issues” and the Federal Financial Institutions Examination Council’s interagency guidance, “Interagency Policy Statement on the Allowance for Loan and Lease Losses” (the “FFIEC Policy Statement”). See “Management Discussion and Analysis Results of Operations – Allowance for Loan Losses and Loan Loss Reserve” below for further discussion of the allowance for loan losses.

In situations where, for economic or legal reasons related to a borrower’s financial condition, management may grant a concession to the borrower that it would not otherwise consider, the related loan is classified as a troubled debt restructuring (“TDR”). Management strives to identify borrowers in financial difficulty early and work with them to modify their loan to more affordable terms before their loans reach nonaccrual status. These modified terms may include rate reductions, principal forgiveness, payment forbearance and other actions intended to minimize the economic loss and to avoid foreclosure or repossession of collateral. In cases where borrowers are granted new terms that provide for a reduction of either interest or principal, management measures any impairment on the restructuring as noted above for impaired loans. The Bank had loans totaling $455,000 and $646,000 that were classified as TDRs as of December 31, 2016 and 2015, respectively.

Management considers historical trends, industry trends, peer comparisons, as well as individual classified impaired loans, in addition to historical experience to evaluate the allowance for loan losses. Our method for determining the allowance for loan losses is discussed more fully under “Provision and Allowance for Loan Losses for the Bank” below.

Other real estate owned (OREO) consists of properties acquired through foreclosure or deed in lieu of foreclosure. These properties are carried at fair value less estimated costs to sell at the date of foreclosure establishing a new cost basis. These properties are subsequently accounted for at the lower of cost or fair value less estimated costs to sell. Losses from the acquisition of property in full or partial satisfaction of loans are charged against the allowance for loan losses. Subsequent write-downs, if any, are charged against expense. Gains and losses on the sales of foreclosed properties are included in determining net income in the year of the sale. Operating costs after acquisition are expensed. The Bank had OREO totaling $2,370,00 and $1,965,000 as of December 31, 2016 and 2015, respectively.

 

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RESULTS OF OPERATIONS

Year Ended December 31, 2016 compared to year ended December 31, 2015

Net Income

The net income for Financial for the year ended December 31, 2016 was $3,286,000 or $0.75 per basic and diluted share compared with net income of $3,692,000 or $1.07 per basic and diluted share for the year ended December 31, 2015. Note 13 of the consolidated financial statements provides additional information with respect to the calculation of Financial’s earnings per share.

The decrease of $406,000 in 2016 net income compared to 2015 was due in large part the following: i) an increase in the loan loss provision of $1,330,000, or 471.63%; and ii) an increase in non-interest expenses of $1,415,000, or 8.75%. These decreases were partially offset by i) an increase in net interest income of $1,613,000, or 9.16%; ii) an increase in non-interest income of $602,000, or 14.36%. As discussed in more detail below, we charged off $759,000 in nonperforming loans during the year ended December 31, 2016 as compared with $615,000 in 2015. The amount of the provision for loan losses was $1,612,000 in the year ended December 31, 2016 as compared to $282,000 in 2015.

These operating results represent a return on average stockholders’ equity of 6.60% for the year ended December 31, 2016 compared to 9.78% for the year ended December 31, 2015. As discussed below, Financial issued $11,520,000 in additional common stock on December 3, 2015. This increased capital and the decline in net income are the primary reasons for a decrease in the return on average stockholders’ equity in 2016 from 2015. The return on average assets for the year ended December 31, 2016 was 0.60% compared to 0.74% in 2015.

Net Interest Income

The fundamental source of Financial’s earnings, net interest income, is defined as the difference between income on earning assets and the cost of funds supporting those assets. The significant categories of earning assets are loans, federal funds sold, and investment securities, while deposits, fed funds purchased, and other borrowings represent interest-bearing liabilities. The level of net interest income is impacted primarily by variations in the volume and mix of these assets and liabilities, as well as changes in interest rates when compared to previous periods of operation.

Interest income increased to $21,568,000 for the year ended December 31, 2016 from $20,302,000 for the year ended December 31, 2015. This increase was due to the interest earned on the increase in loan balances and was mitigated by a decrease in the yields on average earning assets which primarily consist of loans and investment securities, as discussed below.

Net interest income for 2016 increased $1,613,000 to $19,224,000 or 9.16% from net interest income of $17,611,000 in 2015. The growth in net interest income was due primarily to the interest generated from a slight increase in interest rates, increased loan balances and a decrease in our interest expense of $347,000 to $2,344,000 in 2016 from $2,691,000 in 2015. Our interest expense decreased primarily because of the retirement of $10,000,000 in 6% notes that were called in December 2015 and paid off in January 2016. This decrease in interest expense was offset by an increase in the average balances of our time deposits (which typically pay depositors a higher rate of interest than demand accounts) from $137,374,000 during 2015 to $155,346,000 in 2016. The increase was mitigated by the fact that the average interest rate paid on time deposits decreased by 1 basis point during 2016 as compared to 2015. The decrease was also offset in part by an increase in the average balance in interest bearing demand deposit accounts to $127,745,000 in 2016 from $108,139,000 in 2015 along with an increase in the average rate paid on the interest bearing demand deposit accounts to 0.28% in 2016 from 0.24% in 2015.

The net interest margin decreased to 3.77% in 2016 from 3.78% in 2015. The average rate on earning assets decreased 12 basis points from 4.35% in 2015 to 4.23% in 2016 and the average rate on interest-bearing liabilities decreased from 0.72% in 2015 to 0.59% in 2016. Management cannot predict with certainty future interest rate decisions by the FOMC

 

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The following table shows the average balances of total interest earning assets and total interest bearing liabilities for the periods indicated, showing the average distribution of assets, liabilities, stockholders’ equity and related revenue, expense and corresponding weighted average yields and rates. The average balances used in this table and other statistical data were calculated using average daily balances.

 

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Net Interest Margin Analysis

Average Balance Sheets

For the Year Ended December 31, 2016, 2015 and 2014

(dollars in thousands)

 

     2016     2015     2014  
     Average
Balance
Sheet
    Interest
Income/
Expense
     Average
Rates
Earned/
Paid
    Average
Balance
Sheet
    Interest
Income/
Expense
     Average
Rates
Earned/
Paid
    Average
Balance
Sheet
    Interest
Income/
Expense
     Average
Rates
Earned/
Paid
 

ASSETS

                     

Loans, including fees (1)(2)

   $ 451,100     $ 20,356        4.51   $ 417,594     $ 19,291        4.62   $ 365,942     $ 17,447        4.77

Loans AFS

     3,611       125        3.46     2,220       86        3.87     1,499       64        4.27

Federal funds sold

     7,029       34        0.48     7,883       18        0.23     2,052       4        0.19

Interest-bearing bank balances

     6,093       31        0.51     5,197       14        0.27     5,000       13        0.26

Securities (3)

     41,083       976        2.38     32,578       847        2.60     39,093       1,195        3.06

Federal agency equities

     1,243       67        5.39     1,268       67        5.28     1,207       63        5.22

CBB equity

     116       —          0.00     116       —          0.00     116       —          0.00
  

 

 

   

 

 

      

 

 

   

 

 

      

 

 

   

 

 

    

Total earning assets

     510,275       21,589        4.23     466,856       20,323        4.35     414,909       18,786        4.53
    

 

 

        

 

 

        

 

 

    

Allowance for loan losses

     (4,819          (4,705          (5,099     

Non-earning assets

     38,441            34,876            39,651       
  

 

 

        

 

 

        

 

 

      

Total assets

   $ 543,897          $ 497,027          $ 449,461       
  

 

 

        

 

 

        

 

 

      

LIABILITIES AND STOCKHOLDERS’ EQUITY

                     

Deposits

                     

Demand interest bearing

   $ 127,745     $ 352        0.28   $ 108,139     $ 256        0.24   $ 101,337     $ 215        0.21

Savings

     110,422       238        0.22     114,828       253        0.22     126,791       271        0.21

Time deposits

     155,346       1,742        1.12     137,374       1,552        1.13     97,228       1,152        1.18
  

 

 

   

 

 

      

 

 

   

 

 

      

 

 

   

 

 

    

Total interest bearing deposits

     393,513       2,332        0.59     360,341       2,061        0.57     325,356       1,638        0.50

Other borrowed funds

                     

Fed funds purchased

     371       4        1.08     184       2        1.09     963       9        0.93

Other borrowings

     —         —          0.00     2,269       28        1.23     3,444       78        2.26

Capital Notes

     82       8        6.00     10,000       600        6.00     10,000       600        6.00
  

 

 

   

 

 

      

 

 

   

 

 

      

 

 

   

 

 

    

Total interest-bearing liabilities

     393,966       2,344        0.59     372,794       2,691        0.72     339,763       2,325        0.68
    

 

 

        

 

 

        

 

 

    

Non-interest bearing deposits

     98,959            85,853            75,584       

Other liabilities

     1,165            634            909       
  

 

 

        

 

 

        

 

 

      

Total liabilities

     494,090            459,281            416,256       

Stockholders’ equity

     49,807            37,746            33,205       
  

 

 

        

 

 

        

 

 

      

Total liabilities and Stockholders’ equity

   $ 543,897          $ 497,027          $ 449,461       
  

 

 

        

 

 

        

 

 

      

Net interest earnings

     $ 19,245          $ 17,632          $ 16,461     
    

 

 

        

 

 

        

 

 

    

Net interest margin

          3.77          3.78          3.97
       

 

 

        

 

 

        

 

 

 

Interest spread

          3.64          3.63          3.84
       

 

 

        

 

 

        

 

 

 

 

(1) Net deferred loan fees and costs are included in interest income.

 

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(2) Nonperforming loans are included in the average balances. However, interest income and yields calculated do not reflect any accrued interest associated with nonaccrual loans.
(3) The interest income and yields calculated on securities have been tax affected to reflect any tax exempt interest on municipal securities.

 

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Interest income and expenses are affected by fluctuations in interest rates, by changes in the volume of earning assets and interest bearing liabilities, and by the interaction of rate and volume factors. The following table shows the direct causes of the year-to-year changes in components of net interest income on a taxable equivalent basis.

 

     Volume and Rate
(dollars in thousands)
Years Ending December 31,
 
     2016     2015     2014  
     Volume
Effect
    Rate
Effect
    Change
in

Income/
Expense
    Volume
Effect
    Rate
Effect
    Change
in

Income/
Expense
    Volume
Effect
    Rate
Effect
    Change
in
Income/
Expense
 

Loans

   $ 1,606     $ (502   $ 1,104     $ 2,307     $ (441   $ 1,866     $ 1,429     $ (842   $ 587  

Federal funds sold

     (2     18       16       13       1       14       (15     (11     (26

Interest bearing deposits

     3       14       17       1       —         1       13       —         13  

Securities

     191       (62     129       (183     (165     (348     (381     43       (338

Restricted stock

     —         —         —         3       1       4       (2     6       4  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total earning assets

     1,798       (532     1,266       2,141       (604     1,537       1,044       (804     240  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Liabilities:

                  

Demand interest bearing

     50       46       96       13       28       41       17       (9     8  

Savings

     (15     —         (15     (36     18       (18     (15     —         (15

Time deposits

     204       (14     190       446       (46     400       26       (143     (117

Federal funds purchased

     2       —         2       (9     2       (7     6       2       8  

Capital notes

     (592     —         (592     —         —         —         —         —         —    

Other borrowings

     (14     (14     (28     (18     (32     (50     (3     5       2  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total interest-bearing liabilities

   $ (365   $ 18     $ (347   $ 396     $ (30   $ 366     $ 32     $ (146   $ (114
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Change in net interest income

   $ 2,163     $ (550   $ 1,613     $ 1,745     $ (574   $ 1,171     $ 1,013     $ (659   $ 354  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Noninterest Income of Financial

Noninterest income has been and will continue to be an important factor for increasing our profitability. Our management continues to review and consider areas where noninterest income can be increased. Noninterest income (excluding securities gains and losses) consists of income from mortgage originations and sales, service fees, distributions from a title insurance agency in which we have an ownership interest, income from credit and debit card transactions, and fees generated by the investment services of Investment. Service fees consist primarily of monthly service and minimum account balance fees and charges on transactional deposit accounts, treasury management fees, overdraft charges, and ATM service fees.

The Bank, through the Mortgage division originates both conforming, non-conforming consumer residential mortgage, and reverse mortgage loans primarily in the Region 2000 area as well as in Charlottesville, Harrisonburg, and Roanoke. As part of the Bank’s overall risk management strategy, all of the loans originated and closed by the Mortgage division are presold to mortgage banking or other financial institutions. The Mortgage division assumes no credit or interest rate risk on these mortgages.

The Mortgage Division originated 452 mortgage loans, totaling $84,743,000 during the year ended December 31, 2016 as compared with 444 mortgage loans, totaling $78,549,000 in 2015. Income improved with the increased origination volume. We continued to benefit from an improved pricing model that resulted from the migration of the Mortgage Division’s broker relationships to hybrid correspondent in 2013. The hybrid correspondent relationship allows the Bank to close loans in its name before an investor

 

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purchases the loan. By using the Bank’s funds to close the loan (as compared to a broker relationship in which loans are funded by the purchaser of the mortgage), the Bank is able to obtain better pricing due to the slight increase in risk. In 2015 and 2016, the Mortgage Division continued to operate in an environment in which real estate values continued to improve. Loans for new home purchases comprised 57% of the total volume in 2016 as compared to 66% in 2015. For the year ended December 31, 2016, the Mortgage Division accounted for 9.32% of Financial’s total revenue as compared with 9.30% of Financial’s total revenue for the year ended December 31, 2015. Mortgage contributed $558,000 and $549,000 to Financial’s pre-tax net income in 2016 and 2015, respectively. Although management anticipates that residential mortgage rates will remain low by historical standards throughout 2017, management also anticipates that if rates trend higher, the loan mix will continue to shift towards new home purchases and away from refinancing. The Mortgage Division continues to improve its market share in its markets. We opened a new mortgage origination office in Roanoke in October, 2013 and began originating mortgages in Charlottesville in March, 2014. In addition, in the first quarter of 2016, we also hired a new mortgage loan origination officer for the Harrisonburg Market. Management expects that continued historically low rates coupled with the Mortgage Division’s reputation in its markets and our recently-added offices and producers present an opportunity for us to continue to grow the Mortgage Division’s revenue.

Service charges and fees and commissions increased slightly to $1,444,000 for the year ended December 31, 2016 from $1,390,000 for the year ended December 31, 2015.

Our Investment division provides brokerage services through an agreement with a third-party broker-dealer. Pursuant to this arrangement, the third party broker-dealer operates a service center adjacent to one of the branches of the Bank. The center is staffed by dual employees of the Bank and the broker-dealer. Investment receives commissions on transactions generated and in some cases ongoing management fees such as mutual fund 12b-1 fees. The Investment division’s financial impact on our consolidated revenue has been immaterial. Although management cannot predict the financial impact of Investment with certainty, management anticipates it will continue to be an immaterial component of revenue in 2017.

In the third quarter of 2008, we began providing insurance and annuity products to Bank customers and others, through the Bank’s Insurance subsidiary. The Bank has one full-time and one part-time employee that are dedicated to selling insurance products through Insurance. Insurance generates minimal revenue and its financial impact on our consolidated revenue has been immaterial. Management anticipates that Insurance’s impact on noninterest income will remain immaterial in 2017.

Noninterest income, exclusive of gains and losses on the sale and call of securities, increased to $4,301,000 in 2016 from $4,144,000 in 2015. Inclusive of gains and losses on the sale and call of securities, noninterest income increased to $4,795,000 in 2016 from $4,193,000 in 2015. The following table summarizes our noninterest income for the periods indicated.

 

     Noninterest Income
(dollars in thousands)
December 31,
 
     2016      2015  

Gains on sale of loans held for sale

   $ 2,433      $ 2,278  

Service charges, fees and commissions

     1,444        1,390  

Increase in cash value of life insurance

     292        269  

Other

     132        207  

Gain on sales and calls of securities, net

     494        49  
  

 

 

    

 

 

 

Total noninterest income

   $ 4,795      $ 4,193  
  

 

 

    

 

 

 

The increase in noninterest income for 2016 as compared to 2015 was primarily due to an increase in income from gains on loans held for sale and gains on sale of available-for-sale securities.

 

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Noninterest Expense of Financial

Noninterest expenses increased from $16,179,000 for the year ended December 31, 2015 to $17,594,000 for the year ended December 31, 2016. The following table summarizes our noninterest expense for the periods indicated.

 

     Noninterest Expense  
     (dollars in thousands)  
     December 31,  
     2016      2015  

Salaries and employee benefits

   $ 9,230      $ 8,727  

Occupancy

     1,312        1,204  

Equipment

     1,287        1,275  

Supplies

     480        419  

Professional, data processing and other outside expenses

     2,731        2,218  

Marketing

     686        465  

Credit expense

     425        301  

Other real estate expenses

     68        122  

FDIC insurance expense

     363        331  

Other

     1,012        1,003  

Amortization of tax credit investment

     —          114  
  

 

 

    

 

 

 

Total noninterest expense

   $ 17,594      $ 16,179  
  

 

 

    

 

 

 

The increase in non-interest expense was due in large part to an increase in compensation and benefits, professional, occupancy and equipment, marketing, credit, and FDIC insurance. The increase in these costs was partially offset by a decrease in other real estate expenses as well as a decrease in the amortization expense associated with a tax credit investment. Our total personnel expense, net of direct salary costs incurred in originating certain loans (in accordance with current accounting rules), increased to $9,230,000 for the year ended December 31, 2016, from $8,727,000 for the year ended December 31, 2015. Compensation for some employees of the Mortgage Division and Investment is commission-based and therefore subject to fluctuation.

The efficiency ratio, that is the cost of producing each dollar of revenue, is determined by dividing noninterest expense by the sum of net interest income plus noninterest income. Financial’s efficiency ratio decreased from 74.20% in 2015 to 73.25% in 2016, in large part due to the increases in the above revenues.

Income Tax Expense

For the year ended December 31, 2016, Financial had federal income tax expense of $1,527,000, as compared to a federal income tax expense of $1,651,000 in 2015, which equates to effective tax rates of 31.73% and 30.90%, respectively. Our effective rate was lower than the statutory corporate tax rate in both 2016 and 2015 because of federal income tax benefits resulting from the tax treatment of earnings on bank owned life insurance, certain tax free municipal securities, and tax credits. Note 12 of the consolidated financial statements provides additional information with respect to our 2016 federal income tax expense and the deferred tax accounts.

 

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ANALYSIS OF FINANCIAL CONDITION

As of December 31, 2016 and December 31, 2015

General

Our total assets were $574,195,000 at December 31, 2016, an increase of $47,052,000 or 8.93% from $527,143,000 at December 31, 2015, primarily due to an increase in loans and loans available for sale, as well as increases in both securities available-for-sale and securities held to maturity, and an increase in the cash value of bank-owned life insurance. As explained in more detail below, deposits increased from $467,610,000 on December 31, 2015 to $523,112,000 on December 31, 2016. Loans, net of unearned income and allowance, increased to $464,353,000 on December 31, 2016 from $430,445,000 on December 31, 2015.

Loans

Our loan portfolio is the largest and most profitable component of our earning assets. The Bank has comprehensive policies and procedures which cover both commercial and consumer loan origination and management of credit risk. Loans are underwritten in a manner that focuses on the borrower’s ability to repay. Management’s goal is not to avoid risk, but to manage it and to include credit risk as part of the pricing decision for each product.

The Bank’s loan portfolio consists of commercial short-term lines of credit, term loans, mortgage financing and construction loans that are used by the borrower to build or develop real estate properties, and consumer loans. The consumer portfolio includes residential real estate mortgages, home equity lines and installment loans.

Loans, net of unearned income and allowance, increased to $464,353,000 on December 31, 2016 from $430,445,000 on December 31, 2015. Total loans, including loans held for sale increased to $473,902,000 on December 31, 2016 from $437,092,000 on December 31, 2015. The increase in total loans was partially due to enhanced marketing efforts increased penetration into the Charlottesville, Harrisonburg, and Roanoke markets. We anticipate that these offices will continue to add to our loan balances. The increase is also attributed to increased calling and sales efforts by our lenders. Despite these factors, the number of qualified borrowers remains limited and competition for qualified borrowers is increasing. Management expects that the number of qualified borrowers will remain limited until the economy further improves and economic uncertainties subside.

As of December 31, 2016, the Bank had $2,550,000, or 0.54% of its total loans, in non-accrual status compared with $3,406,000, or 0.78% of its total loans, at December 31, 2015. Management is continuing its efforts to reduce non-performing assets through enhanced collection efforts and the liquidation of underlying collateral. The Bank attempts to work with borrowers on a case-by-case basis to attempt to protect the Bank’s interests. However, despite our commitment, a reduction of non-accrual loans can be dependent on improvements in employment, housing, and overall economic conditions at the local, regional and national levels. See “Asset Quality” below.

 

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The following table summarizes the composition of the Bank’s loan portfolio for the periods indicated by dollar amount:

 

     Loan Portfolio  
   (dollars in thousands)  
   December 31,  
     2016      2015      2014      2013      2012  

Commercial

   $ 88,085      $ 76,773      $ 63,259      $ 55,803      $ 55,084  

Commercial real estate

     237,638        217,125        207,262        172,117        153,416  

Consumer

     85,099        81,531        76,380        71,165        70,639  

Residential

     59,247        59,699        52,462        46,095        46,318  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total loans

     470,069        435,128        399,363        345,180        325,457  

Less allowance for loan losses

     5,716        4,683        4,790        5,186        5,535  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Net loans

   $ 464,353      $ 430,445      $ 394,573      $ 339,994      $ 319,922  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

The following table sets forth the maturities of the loan portfolio at December 31, 2016.

 

    

Remaining Maturities of Selected Loans

(dollars in thousands)

 
     At December 31, 2016  
     Less than
One Year
     One to
Five Years
    Greater
than Five
Years
     Total  

Commercial

   $ 23,654      $ 17,604     $ 46,827      $ 88,085  

Commercial real estate

     15,453        49,028       173,157        237,638  

Consumer

     7,683        39,623       37,793        85,099  

Residential

     8,863        15,795       34,589        59,247  
  

 

 

    

 

 

   

 

 

    

 

 

 

Total

   $ 55,653      $ 122,050     $ 292,366      $ 470,069  
  

 

 

    

 

 

   

 

 

    

 

 

 

For maturities over one year:

          

Fixed Rates

   $ 118,454        28.58     

Variable Rates

     295,962        71.42     
  

 

 

         

Total

   $ 414,416          
  

 

 

         

Deposits

We experienced an increase in deposits from $467,610,000 at December 31, 2015 to $523,112,000 at December 31, 2016, for an increase of 11.87%. Noninterest-bearing deposits increased $11,329,000 or 12.41% from $91,325,000 at December 31, 2015 to $102,654,000 at December 31, 2016. The increase in non-interest bearing deposits was due to our increased presence in Charlottesville, Harrisonburg, and Roanoke as well as increased and continued efforts to procure the primary checking accounts of our commercial loan customers. The increase can also be attributed to end of the year real estate and business closings related to our professional settlement accounts. Interest-bearing deposits increased $44,173,000, or 11.74%, from $376,285,000 at December 31, 2015 to $420,458,000 at December 31, 2016. A total of $22,044,000 in brokered certificates of deposit was included in total time deposits at December 31, 2016.

 

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The following table sets forth the average deposit balance and the rates paid on deposits for the years indicated:

 

     Average Deposits and Rates Paid  
     (dollars in thousands)  
     Year Ended December 31,  
     2016     2015     2014  
     Amount      Rate     Amount      Rate     Amount      Rate  

Noninterest-bearing deposits

   $ 98,959        —       $ 85,853        —       $ 75,584        —    
  

 

 

      

 

 

      

 

 

    

Interest-bearing deposits

               

Interest checking

   $ 77,134        0.27   $ 68,686        0.25   $ 61,048        0.22

Money market

     50,611        0.29     39,453        0.21     40,289        0.20

Savings

     110,422        0.22     114,828        0.22     126,791        0.21

Time deposits

               

Less than $100,000 (1)

     72,070        1.07     78,236        1.11     55,664        1.19

Greater than $100,000 (1)

     83,276        1.16     59,138        1.16     41,563        1.18
  

 

 

      

 

 

      

 

 

    

Total interest-bearing deposits

   $ 393,513        0.59   $ 360,341        0.57   $ 325,355        0.50
  

 

 

      

 

 

      

 

 

    

Total deposits

   $ 492,472        $ 446,194        $ 400,939     
  

 

 

      

 

 

      

 

 

    

 

(1) Although the FDIC currently insures accounts up to $250,000, the Bank considers CDs $100,000 and above as high balance CDs and therefore continues to monitor CDs at and above this amount in order to plan for liquidity needs. The total balance in CDs $250,000 and above totaled approximately $38,821,000 at December 31, 2016. Of this amount, $10,000,000 is a brokered CD that comes due on July 24, 2017, $10,044,000 is a brokered CD that comes due on June 17, 2019, and $2,000,000 is a brokered CD that matured in February 2017 and was not renewed.

The following table includes a summary of maturities of CDs greater than $100,000:

 

     Maturities of CD’s Greater than $ 100,000  
     (dollars in thousands)  
     Less than
Three
Months
     Three to
Six
Months
     Six to
Twelve
Months
     Greater
than One
Year
     Total  

At December 31, 2016

   $ 5,828      $ 4,573      $ 17,571      $ 63,516      $ 91,488  

Cash and Cash Equivalents

Cash and cash equivalents increased from $28,655,000 on December 31, 2015 to $28,683,000 on December 31, 2016. Federal funds sold amounted to $11,745,000 on December 31, 2016 compared to $12,703,000 on December 31, 2015. Fluctuations in federal funds sold generally are related to fluctuations in transactional accounts and professional settlement accounts as discussed above, and use of cash and cash equivalents to fund loan growth.

Investment Securities

The investment securities portfolio of the Bank is used as a source of income and liquidity.

 

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The following table summarizes the fair value of the Bank’s securities portfolio for the periods indicated:

 

     Securities Portfolio
(dollars in thousands)
December 31,
 
     2016      2015      2014  

Held-to-maturity

        

U.S. agency obligations

   $ 3,273      $ 2,649      $ 2,699  
  

 

 

    

 

 

    

 

 

 

Available-for-sale

        

U.S. treasuries

     1,833        —          —    

U.S. agency obligations

     13,113        18,810        13,498  

Mortgage - backed securities

     12,005        10,647        1,982  

Municipals

     9,947        5,034        7,899  

Corporates

     3,878        1,505        1,016  
  

 

 

    

 

 

    

 

 

 

Total available-for-sale

   $ 40,776      $ 35,996      $ 24,395  
  

 

 

    

 

 

    

 

 

 

Deposited funds are generally invested in overnight vehicles, including federal funds sold, until approved loans are funded. The decision to purchase investment securities is based on several factors or a combination thereof, including:

a) The fact that yields on acceptably rated investment securities (S&P “A” rated or better) are significantly better than the overnight federal funds rate;

b) Whether demand for loan funding exceeds the rate at which deposits are growing, which leads to higher or lower levels of surplus cash;

c) Management’s target of maintaining a minimum of 6% of the Bank’s total assets in a combination of federal funds sold and investment securities (aggregate of available-for-sale and held-to-maturity portfolios); and

d) Whether the maturity or call schedule meets management’s asset/liability plan.

Available-for-sale securities (as opposed to held-to-maturity securities) may be liquidated at any time as funds are needed to fund loans. Liquidation of securities may result in a net loss or net gain depending on current bond yields available in the primary and secondary markets and the shape of the U.S. Treasury yield curve. Management is cognizant of its credit standards policy and does not feel pressure to maintain loan growth at the same levels as deposit growth and thus sacrifice credit quality in order to avoid security purchases.

Management has made the decision to maintain a significant portion of its available funds in liquid assets so that funds are available to fund future growth of the loan portfolio. Management believes that this strategy will allow us to maximize interest margins while maintaining appropriate levels of liquidity.

Securities held-to-maturity at carrying cost increased from $2,519,000 as of December 31, 2015 to $3,299,000 as of December 31, 2016. This increase resulted from the purchase of additional held-to-maturity securities and was partially offset by the call of one security and from the amortization of premiums within the held-to-maturity portfolio. The decision to invest in securities held-to-maturity is based on the same factors as the decision to invest in securities available-for-sale except that management invests surplus funds in securities held-to-maturity only after concluding that such funds will not be necessary for liquidity purposes during the term of such security. However, the held-to-maturity securities may be pledged for such purposes as short term borrowings and as collateral for public deposits.

 

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Table of Contents

The portfolio of securities available-for-sale increased to $40,776,000 as of December 31, 2016 from $35,996,000 as of December 31, 2015. The increase is a result of management’s desire to continue to increase on-balance sheet liquidity. During 2016, the Bank purchased $40,464,000 of available-for-sale securities and sold available-for-sale securities totaling $24,637,000. In addition, the Bank realized $9,744,000 from calls, maturities, and paydowns of available-for-sale securities.

The following table shows the maturities of held-to-maturity and available-for-sale securities at amortized cost and fair value at December 31, 2016 and December 31, 2015 and approximate weighted average yields of such securities. Yields on state and political subdivision securities are not shown on a tax equivalent basis. Financial attempts to maintain diversity in its portfolio and maintain credit quality and repricing terms that are consistent with its asset/liability management and investment practices and policies. For further information on Financial’s securities, see Note 4 to the consolidated financial statements included in Item 8 of this Form 10-K.

 

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Table of Contents
     Securities Portfolio Maturity Distribution / Yield Analysis  
     (dollars in thousands)  
     At December 31, 2016  
     Less
than
One
Year
     One to
Five
Years
    Five to
Ten
Years
    Greater
than Ten
Years and
Other
Securities
    Total  

Held-to-maturity

           

U.S. Agency

           

Amortized cost

   $ —        $ 2,015     $ —       $ 1,284     $ 3,299  

Fair value

   $ —        $ 2,080     $ —       $ 1,193     $ 3,273  

Weighted average yield

        4.00       3.18  

Available-for-sale securities

           

U.S. Treasuries

           

Amortized cost

   $ —        $ —       $ 1,952     $ —       $ 1,952  

Fair value

   $ —        $ —       $ 1,833     $ —       $ 1,833  

Weighted average yield

          1.77    

U.S. Agency

           

Amortized cost

   $ —        $ —       $ 3,005     $ 11,328     $ 14,333  

Fair value

   $ —        $ —       $ 2,848     $ 10,266     $ 13,114  

Weighted average yield

          1.78     2.08  

Mortgage Backed Securities

           

Amortized cost

   $ —        $ —       $ 2,594     $ 9,765     $ 12,359  

Fair value

   $ —        $ —       $ 2,555     $ 9,451     $ 12,006  

Weighted average yield

          1.54     2.09  

Municipals

           

Amortized cost

   $ —        $ 551     $ 3,191     $ 6,682     $ 10,424  

Fair value

   $ —        $ 535     $ 3,205     $ 6,206     $ 9,946  

Weighted average yield

        1.80     2.95     2.96  

Corporates

           

Amortized cost

   $ —        $ —       $ 4,132     $ —       $ 4,132  

Fair value

   $ —        $ —       $ 3,877     $ —       $ 3,877  

Weighted average yield

          2.28    

Total portfolio

           

Amortized cost

   $ —        $ 2,566     $ 14,874     $ 29,059     $ 46,499  

Fair value

   $ —        $ 2,615     $ 14,318     $ 27,116     $ 44,049  

Weighted average yield

        3.53     2.12     2.34  

 

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Table of Contents
     Securities Portfolio Maturity Distribution / Yield Analysis  
     (dollars in thousands)  
     At December 31, 2015  
     Less
than
One
Year
     One to
Five
Years
    Five to
Ten
Years
    Greater
than Ten
Years and
Other
Securities
    Total  

Held-to-maturity

           

U.S. Agency

           

Amortized cost

   $ —        $ 2,519     $ —       $ —       $ 2,519  

Fair value

   $ —        $ 2,649     $ —       $ —       $ 2,649  

Weighted average yield

        3.50      

Available-for-sale securities

           

U.S. Agency

           

Amortized cost

   $ —        $ —       $ 8,197     $ 11,409     $ 19,606  

Fair value

   $ —        $ —       $ 7,967     $ 10,843     $ 18,810  

Weighted average yield

          2.32     3.06  

Mortgage Backed Securities

           

Amortized cost

   $ —        $ —       $ 2,036     $ 8,742     $ 10,778  

Fair value

   $ —        $ —       $ 1,979     $ 8,668     $ 10,647  

Weighted average yield

          2.06     1.96  

Municipals

           

Amortized cost

   $ —        $ 479     $ 1,416     $ 3,088     $ 4,983  

Fair value

   $ —        $ 496     $ 1,402     $ 3,136     $ 5,034  

Weighted average yield

        5.60     2.96     3.51  

Corporates

           

Amortized cost

   $ —        $ —       $ 1,521     $ —       $ 1,521  

Fair value

   $ —        $ —       $ 1,505     $ —       $ 1,505  

Weighted average yield

          2.78    

Total portfolio

           

Amortized cost

   $ —        $ 2,998     $ 13,171     $ 23,239     $ 39,408  

Fair value

   $ —        $ 3,145     $ 12,853     $ 22,647     $ 38,645  

Weighted average yield

        3.84     2.40     2.70  

Cash surrender value of bank owned life insurance

On July 1, 2009, the Company funded bank owned life insurance (BOLI) for a small group of its officers, where the Company is the owner and sole beneficiary of the policies. As of December 31, 2016, the BOLI had a cash surrender value of $12,673,000, an increase of $2,892,000 from the cash surrender value of $9,781,000 as of December 31, 2015. A total of $292,000 of the increase resulted from an increase in the cash surrender value relating to the aggregate earnings on all of the BOLI policies and $2,600,000 resulted from additional BOLI purchases. The value of BOLI increases from the cash surrender values of the pool of insurance. The increase in cash surrender value is recorded as a component of noninterest income; however, the Company does not pay tax on increase in cash value. This profitability is used to offset a portion of current and future employee benefit costs. BOLI can be liquidated if necessary with associated tax costs. However, the Company intends to hold this pool of insurance, because it provides income that enhances the Company’s capital position. Therefore, the Company has not provided for deferred income taxes on the earnings from the increase in cash surrender value.

 

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Table of Contents

Liquidity

Liquidity represents the ability of a company to convert assets into cash or cash equivalents without significant loss, and the ability to raise additional funds by increasing liabilities.

The liquidity of Financial depends primarily on Financial’s current assets, available credit, and the dividends paid to it by the Bank. Payment of cash dividends by the Bank is limited by regulations of the Federal Reserve Board and is tied to the regulatory capital requirements. Although Financial’s liquidity is limited, management believes that Financial has sufficient liquidity to meet its current obligations. See “Capital Resources,” below.

The objective of liquidity management for the Bank is to ensure the continuous availability of funds to meet the demands of depositors, investors and borrowers. Liquidity management involves monitoring the Bank’s sources and uses of funds in order to meet the day-to-day cash flow requirements while maximizing profits. Stable core deposits and a strong capital position are the components of a solid foundation for the Bank’s liquidity position. Liquidity management is made more complicated because different balance sheet components are subject to varying degrees of management control. For example, the timing of maturities of securities held-to-maturity is fairly predictable and subject to a high degree of control at the time investment decisions are made. However, net deposit inflows and outflows are far less predictable and are not subject to the same degree of control.

Funding sources for the Bank primarily include paid-in capital and customer-based deposits but also include borrowed funds and cash flow from operations. The Bank has in place several agreements that will provide alternative sources of funding, including, but not limited to, lines of credit, sale of investment securities, purchase of federal funds, advances through the Federal Home Loan Bank of Atlanta (“FHLBA”) and correspondents, and brokered certificate of deposit arrangements. Management believes that the Bank has the ability to meet its liquidity needs.

At December 31, 2016, liquid assets, which include cash, interest-bearing and noninterest-bearing deposits with banks, federal funds sold, and securities available-for-sale totaled $69,459,000 as compared to $64,863,000 at December 31, 2015. Management deems liquidity to be adequate. Investment securities traditionally provide a secondary source of liquidity since they can be converted into cash in a timely manner. However, approximately $12,325,000 (current book value) of these securities are pledged against outstanding debt, public deposits, or lines of credit. Therefore, the related debt would need to be repaid prior to the securities being sold in order for these securities to be converted to cash.

 

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Table of Contents

The following table sets forth non-deposit sources of funding:

 

Funding Sources

(dollars in thousands)

 
     December 31, 2016  

Source

   Capacity      Outstanding      Available  

Federal funds purchased lines (unsecured)

   $ 24,000      $ —        $ 24,000  

Federal funds purchased lines (secured)

     4,452        —          4,452  

Reverse repurchase agreements

     5,000        —          5,000  

Borrowings from FHLB Atlanta (1)

     143,615        —          143,615  
  

 

 

    

 

 

    

 

 

 

Total

   $ 177,067      $ —        $ 177,067  
  

 

 

    

 

 

    

 

 

 

 

(1) Currently the Bank has in place pledged collateral in the amount of approximately $39,500,000 against which $0 was drawn and outstanding on December 31, 2016. Additional collateral would be required to be pledged in order for the full $143,615,000 to be available.

At the end of 2016, approximately 74.80%, or $351,615,000 of the loan portfolio would mature or could reprice within a one-year period. At December 31, 2016, non-deposit sources of available funds totaled $177,067,000, which included $143,615,000 available from the FHLBA.

Capital Resources

Capital adequacy is an important measure of financial stability and performance. Management’s objectives are to maintain a level of capitalization that is sufficient to sustain asset growth and promote depositor and investor confidence.

Regulatory agencies measure capital adequacy utilizing a formula that takes into account the individual risk profiles of financial institutions. The guidelines define capital as Tier 1 (primarily common stockholders’ equity, defined to include certain debt obligations) and Tier 2 (remaining capital generally consisting of a limited amount of subordinated debt, certain hybrid capital instruments and other debt securities, preferred stock and a limited amount of the general valuation allowance for loan losses).

On June 7, 2012, the Federal Reserve issued a series of proposed rules that would revise and strengthen its risk-based and leverage capital requirements and its method for calculating risk-weighted assets. The rules were proposed to implement the Basel III regulatory capital reforms from the Basel Committee on Banking Supervision and certain provisions of the Dodd-Frank Act. On July 2, 2013, the Federal Reserve approved certain revisions to the proposals and finalized new capital requirements for banking organizations.

Effective January 1, 2015, the final rules required Financial and the Bank to comply with the following new minimum capital ratios: (i) a new common equity Tier 1 capital ratio of 4.5% of risk-weighted assets; (ii) a Tier 1 capital ratio of 6.0% of risk-weighted assets (increased from the previous requirement of 4.0%); (iii) a total capital ratio of 8.0% of risk-weighted assets (unchanged from the previous requirement); and (iv) a leverage ratio of 4.0% of total assets. These are the initial capital requirements, which will be phased in over a five-year period. When fully phased in on January 1, 2019, the rules will require Financial and the Bank to maintain (i) a minimum ratio of common equity Tier 1 to risk-weighted assets of at least 4.5%, plus a 2.5% “capital conservation buffer” (which is added to the 4.5% common equity Tier 1 ratio as that buffer is phased in, effectively resulting in a minimum ratio of common equity Tier 1 to risk-weighted assets of at least 7.0% upon full implementation), (ii) a minimum ratio of Tier 1 capital to risk-weighted assets of at least 6.0%, plus the capital conservation buffer (which is added to the 6.0% Tier 1 capital ratio as that buffer is phased in, effectively resulting in a minimum Tier 1 capital ratio of 8.5% upon full implementation), (iii) a minimum ratio of total capital to risk-weighted assets of at least 8.0%, plus the capital conservation buffer (which is added to the 8.0% total capital ratio as that buffer is phased in, effectively resulting in a minimum total capital ratio of 10.5% upon full implementation), and (iv) a minimum leverage ratio of 4.0%, calculated as the ratio of Tier 1 capital to average assets.

 

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The capital conservation buffer requirement was phased in beginning January 1, 2016, at 0.625% of risk-weighted assets, increasing each year until fully implemented at 2.5% on January 1, 2019. The capital conservation buffer is designed to absorb losses during periods of economic stress. Banking institutions with a ratio of common equity Tier 1 to risk-weighted assets above the minimum but below the conservation buffer will face constraints on dividends, equity repurchases, and compensation based on the amount of the shortfall.

With respect to the Bank, the rules also revised the “prompt corrective action” regulations pursuant to Section 38 of the FDIA by (i) introducing a common equity Tier 1 capital ratio requirement at each level (other than critically undercapitalized), with the required ratio being 6.5% for well-capitalized status; (ii) increasing the minimum Tier 1 capital ratio requirement for each category, with the minimum ratio for well-capitalized status being 8.0% (as compared to the previous 6.0%); and (iii) eliminating the current provision that provides that a bank with a composite supervisory rating of 1 may have a 3.0% Tier 1 leverage ratio and still be well-capitalized.

The new capital requirements also include changes in the risk weights of assets to better reflect credit risk and other risk exposures. These include a 150% risk weight (up from 100%) for certain high volatility commercial real estate acquisition, development and construction loans and nonresidential mortgage loans that are 90 days past due or otherwise on nonaccrual status, a 20% (up from 0%) credit conversion factor for the unused portion of a commitment with an original maturity of one year or less that is not unconditionally cancellable, a 250% risk weight (up from 100%) for mortgage servicing rights and deferred tax assets that are not deducted from capital, and increased risk-weights (from 0% to up to 600%) for equity exposures.

The Bank’s regulatory capital levels exceed those established for well-capitalized institutions. If the new minimum capital ratios described above had been effective as of December 31, 2015, based on management’s interpretation and understanding of the new rules, Financial would have remained “well capitalized” as of such date.

 

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The following table (along with Note 17 of the consolidated financial statements) shows the minimum capital requirements and the Bank’s capital position as of December 31, 2016 and 2015.

 

Analysis of Capital for Bank of the James (Bank only)

(dollars in thousands)

 
     December 31,  
     2016      2015  

Tier 1 Capital:

     

Common stock

   $ 3,742      $ 3,742  

Additional paid in capital

     19,325        19,325  

Retained earnings

     27,582        24,711  
  

 

 

    

 

 

 

Total Tier 1 Capital

   $ 50,649      $ 47,778  
  

 

 

    

 

 

 

Common Equity Tier 1 Capital (CET1)

   $ 50,649      $ 47,778  
  

 

 

    

 

 

 

Tier 2 Capital:

     

Allowable portion of allowance for loan losses

   $ 5,716      $ 4,683  

Total Tier 2 Capital

     5,716        4,683  
  

 

 

    

 

 

 

Total risk-based capital

   $ 56,365      $ 52,461  
  

 

 

    

 

 

 

Risk weighted assets

   $ 488,607      $ 446,201  

Average total assets

   $ 566,399      $ 518,096  

 

                 Regulatory Minimums  
     December 31,     Capital
Adequacy (1)
    Well
Capitalized
 
     2016     2015      

Capital Ratios

        

Tier 1 capital to average total assets

     8.94     9.22     4.000     5.000

Common Equity Tier 1 capital

     10.37     10.71     5.125     6.500

Tier 1 risk-based capital ratio

     10.37     10.71     6.625     8.000

Total risk-based capital ratio

     11.54     11.76     8.625     10.000

 

(1) Includes phase in of capital conservation buffer.

During the third quarter of 2012, Financial closed a private placement of unregistered debt securities (the “2012 Offering”) pursuant to which Financial issued $10,000,000 in principal of notes (the “2012 Notes”). The 2012 Notes bore interest at the rate of 6% per year with interest payable quarterly in arrears. The 2012 Notes were scheduled to mature on April 1, 2017, but were subject to prepayment in whole or in part on or after April 1, 2013 at Financial’s sole discretion on 30 days written notice to the holders. The notes were called on December 3, 2015 and paid in full on January 5, 2016 with the proceeds from a private placement of Financial’s common stock discussed in the following paragraph.

On December 3, 2015, Financial closed a private placement of common stock pursuant to which it received gross proceeds of $11,520,000 by selling an aggregate of 1,000,000 shares of Financials’ Common Stock at a price of $11.52 per share, as part of a private placement (the “Common Stock Private Placement”). Financial used $10,000,000 of the proceeds from the Common Stock Private Placement to prepay in full the 2012 Notes.

The proceeds from the Common Stock Private Placement, existing capital, and funds generated from operations provide Financial with sufficient liquidity and capital with which to operate.

 

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On January 25, 2017, Financial closed a private placement of unregistered debt securities (the “2017 Offering”) pursuant to which Financial issued $5,000,000 in principal of notes (the “2017 Notes”). The 2017 Notes bear interest at the rate of 4% per year with interest payable quarterly in arrears. The 2017 Notes mature on January 24, 2022, but are subject to prepayment in whole or in part on or after January 24, 2018 at Financial’s sole discretion on 30 days written notice to the holders. A portion of the proceeds from the sale of the 2017 Notes will be used to provide additional capital to the Bank.

The capital ratios set forth in the above tables state the capital position and analysis for the Bank only. Because total assets on a consolidated basis are less than $1,000,000,000, Financial is not subject to the consolidated capital requirements imposed by the Bank Holding Company Act. Consequently, Financial does not calculate its financial ratios on a consolidated basis. If calculated, the capital ratios for the Company on a consolidated basis would be comparable to the capital ratios of the Bank because the prepayment of the 2012 Notes with the proceeds from the Common Stock Private Placement had the effect of replacing $10,000,000 in debt at the holding company level with equity.

As further described under “Regulation of the Bank – Capital Requirements,” the Basel Committee released in June 2011 a revised framework for the regulation of capital and liquidity of internationally active banking organizations. The new framework is generally referred to as “Basel III”. As discussed above, when full phased in, Basel III will require certain bank holding companies and their bank subsidiaries to maintain substantially more capital, with a greater emphasis on common equity. On July 2, 2013, the Federal Reserve adopted a final rule implementing the Basel III standards and complementary parts of Basel II and Basel 2.5.

Stockholders’ Equity

Stockholders’ equity increased by $1,225,000 from $48,196,000 on December 31, 2015 to $49,421,000 on December 31, 2016 because of the net income of $3,286,000 less cash dividends paid and the adjustment for other comprehensive loss.

ASSET QUALITY

We perform monthly reviews of all delinquent loans and loan officers are charged with working with customers to resolve potential payment issues. We generally classify a loan as nonaccrual when interest is deemed uncollectible or when the borrower is 90 days or more past due. We generally restore a loan if i) a borrower is no longer 90 days past due on the loan and the borrower has demonstrated the capacity to repay the loan for six consecutive months or ii) the loan committee of the Board of Directors determines that a borrower has the capacity to repay the loan.

Non-accrual loans decreased to $2,550,000 on December 31, 2016 from $3,406,000 on December 31, 2015. We have been successful in resolving a significant portion of our problem assets that were a result of the economic downturn, which severely impacted commercial development loans and residential speculative housing construction loans due in part to a decline in the value of the collateral supporting those loans. Management intends to continue to be proactive in quantifying and mitigating the ongoing risk associated with all asset classes. Management has provided for the anticipated losses on its non-accrual loans through specific impairment in the allowance for loan loss.

 

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We also classify other real estate owned (OREO) as a nonperforming asset. OREO is the value of real property acquired by the Bank either at a foreclosure sale of collateral on which the Bank has a lien or by deed in lieu of foreclosure. OREO increased 20.61% to $2,370,000 on December 31, 2016 from $1,965,000 on December 31, 2015. During the twelve months ended December 31, 2016 the Bank acquired four additional OREO properties and disposed of one OREO property. As of December 31, 2016 the Bank is carrying six OREO properties at a value of $2,370,000. The following table represents the changes in OREO balance in 2016 and 2015.

 

OREO Changes

(Dollars in Thousands)

 
     Year Ended December 31,  
     2016      2015  

Balance at the beginning of the year (net)

   $ 1,965      $ 956  

Transfers from Loans

     470        1,425  

Capitalized costs

     —          25  

Valuation Adjustment

     (45      (75

Sales proceeds

     (21      (360

Gain (loss) on disposition

     1        (6
  

 

 

    

 

 

 

Balance at the end of the year (net)

   $ 2,370      $ 1,965  
  

 

 

    

 

 

 

Non-accrual loans plus OREO decreased to $4,920,000 on December 31, 2016 from $5,371,000 on December 31, 2015, a decrease of 8.40%.

We also classify troubled debt restructurings (TDRs) as both performing and nonperforming assets. We measure impaired loans based on the present value of expected future cash flows discounted at the effective interest rate of the loan or, as a practical expedient, at the loan’s observable market price or the fair value of the collateral if the loan is collateral dependent. We maintain a valuation allowance to the extent that the measure of the impaired loan is less than the recorded investment. TDRs occur when we agree to significantly modify the original terms of a loan by granting a concession due to the deterioration in the financial condition of the borrower. TDRs are considered impaired loans. These concessions typically are made for loss mitigation purposes and could include reductions in the interest rate, payment extensions, forgiveness of principal, forbearance or other actions. Performing TDRs decreased to $455,000 on December 31, 2016 from $646,000 on December 31, 2015.

The following table sets forth the number of outstanding TDR contracts and the total amount of the Bank’s TDRs as of December 31, 2016 and 2015.

 

Troubled Debt Restructurings

(Dollars in Thousands)

 
     December 31,  
     2016      2015  

Number of performing TDR contracts

     3        4  

Number of nonperforming TDR contracts

     —          —    
  

 

 

    

 

 

 

Total number of TDR contracts

     3        4  
  

 

 

    

 

 

 

Amount of performing TDR contracts

   $ 455      $ 646  

Amount of nonperforming TDR contracts

     —          —    
  

 

 

    

 

 

 

Total amount of TDRs contracts

   $ 455      $ 646  
  

 

 

    

 

 

 

The amount allocated during the year to the provision for loan losses represents management’s analysis of the existing loan portfolio and credit risks. Management’s policy is to maintain the allowance for loan losses at a level sufficient to absorb the estimated losses inherent in the loan portfolio. Both the amount of the provision and the level of the allowance for loan losses are impacted by many factors, including general economic conditions, actual and expected credit losses, loan performance measures, historical trends and specific conditions of the individual borrower.

In performing its loan loss analysis, the Bank assigns a risk rating to each commercial loan in the Bank’s portfolio.

The Bank’s allowance for loan losses increased 22.06% from $4,683,000 on December 31, 2015 to $5,716,000 on December 31, 2016, primarily due to the impairment discussed in the following paragraph as well as an increase in the general reserves.

 

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Impairment resulting from the individual impairment analysis (ASC 310) increased primarily due to a loan loss provision in the fourth quarter related to one commercial relationship. This relationship involves two outstanding commercial loans with a principal balance on the two notes totaling approximately $915,000. The Bank has had a long-standing relationship with the borrower, who has consistently complied with its obligations as agreed. The Bank has received information related to the borrower’s business that led management to downgrade the loans. After evaluating the Bank’s collateral position and other relevant facts, management deemed these two loans to 100% impaired and therefore the Bank has added the full amount of the loans to the allowance for loan losses. The ultimate amount of the impairment may be lower depending on the amount the Bank ultimately receives from the borrower.

In addition to an increase in individual loan impairment, general reserves (ASC 450) also increased in the commercial segment and commercial real estate segment as related to amplifications in the economic factors regarding increased concentrations involving these asset classes.

As of December 31, 2016 the allowance for loan losses was equal to 1.22% of the total loan portfolio as compared with 1.08% at December 31, 2015.

No nonaccrual loans were excluded from impaired loans at December 31, 2016 and 2015. If interest on these loans had been accrued, such income cumulatively would have approximated $391,000 and $472,000 at December 31, 2016 and December 31, 2015, respectively. Loan payments received on nonaccrual loans are applied to principal. When a loan is placed on non-accrual status there are several negative implications. First, all interest accrued but unpaid at the time of the classification is deducted from the interest income totals for the Bank. Second, accruals of interest are discontinued until it becomes certain that both principal and interest can be repaid. Third, there may be actual losses that necessitate additional provisions for credit losses charged against earnings. These loans were included in the nonperforming loan totals listed below. The following table sets forth the detail of loans charged-off, recovered, and the changes in the allowance for loan losses as of the dates indicated:

 

     Allowance for Loan Losses  
     (dollars in thousands)  
     At December 31,  
     2016      2015      2014      2013      2012  

Balance, beginning of period

   $ 4,683      $ 4,790      $ 5,186      $ 5,535      $ 5,612  

Loans charged-off:

              

Commercial

     328        294        165        19        739  

Commercial real estate

     156        64        187        932        1,061  

Consumer

     275        257        79        126        697  

Residential

     —          —          120        28        102  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total loans charged off

   $ 759      $ 615      $ 551      $ 1,105      $ 2,599  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Recoveries:

              

Commercial

   $ 7      $ 14      $ 51      $ 37      $ 18  

Commercial real estate

     127        122        10        42        129  

Consumer

     44        54        39        137        77  

Residential

     2        36        —          —          9  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total recoveries

   $ 180      $ 226      $ 100      $ 216      $ 233  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Net charge-offs

   $ 579      $ 389      $ 451      $ 889      $ 2,366  

Provision for loan losses

     1,612        282        55        540        2,289  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Balance, end of period

   $ 5,716      $ 4,683      $ 4,790      $ 5,186      $ 5,535  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

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The following table shows the balance and percentage of the Bank’s allowance for loan losses allocated to each major category of loans:

 

     Allocation of Allowance for Loan Losses  
     (dollars in thousands)  
     At December 31,  
     2016     2015     2014     2013     2012  
   Amount      Percent
of Loans
to Total
Loans
    Amount      Percent
of Loans
to Total
Loans
    Amount      Percent
of Loans
to Total
Loans
    Amount      Percent
of Loans
to Total
Loans
    Amount      Percent
of Loans
to Total
Loans
 

Commercial

   $ 2,192        18,74   $ 1,195        17.64   $ 1,235        15.84   $ 1,015        16.17   $ 987        16.93

Commercial – real estate

     2,109        50.55     1,751        49.90     2,194        51.89     2,631        49.86     2,849        47.14

Consumer

     954        18.10     1,073        18.74     812        19.13     935        20.62     1,057        21.70

Residential

     461        12.61     664        13.72     549        13.14     605        13.35     642        14.23
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 
   $ 5,716        100.00   $ 4,683        100.00   $ 4,790        100.00   $ 5,186        100.00   $ 5,535        100.00
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

The following table provides information on the Bank’s nonperforming assets as of the dates indicated:

 

     Nonperforming Assets  
     (dollars in thousands)  
     At December 31,  
     2016     2015     2014     2013     2012  

Nonaccrual loans

   $ 2,550     $ 3,406     $ 3,506     $ 3,066     $ 6,346  

Foreclosed property (OREO)

     2,370       1,965       956       1,451       2,112  

Loans past due 90 days accruing interest

     —         —         —         —         —    
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total nonperforming assets

   $ 4,920     $ 5,371     $ 4,462     $ 4,517     $ 8,458  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Restructured loans – performing portion (TDR)

   $ 455     $ 646     $ 376     $ 564     $ 572  

Allowance for loan losses to period end loans

     1.22     1.08     1.20     1.50     1.70

Nonperforming assets to period end loans

     1.05     1.23     1.13     1.33     2.60

Net charge-offs to average loans

     0.13     0.09     0.12     0.27     0.74

Allowance for loan losses to non-performing loans

     224.16     137.49     136.62     169.15     87.22

Interest Rate Sensitivity

The most important element of asset/liability management is the monitoring of Financial’s sensitivity to interest rate movements. The income stream of Financial is subject to risk resulting from interest rate fluctuations to the extent there is a difference between the amount of Financial’s interest earning assets and the amount of interest bearing liabilities that prepay, mature or reprice in specified periods. Management’s goal is to maximize net interest income with acceptable levels of risk to changes in interest rates. Management seeks to meet this goal by influencing the maturity and re-pricing characteristics of the various lending and deposit taking lines of business and by managing discretionary balance sheet asset and liability portfolios.

Management also is attempting to mitigate interest rate risk by limiting the dollar amount of loans carried on its balance sheet that have fixed rates in excess of five years. To reduce our exposure to interest

 

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rate risks inherent with longer term fixed rate loans, we generally do not hold such mortgages on our books. The Bank established the Mortgage Division to serve potential customers that desired fixed rate loans in excess of five years.

Management monitors interest rate levels on a daily basis and meets in the form of the Enterprise Risk Management and Asset/Liability Committee (“ALCO”) at least quarterly or when a special situation arises (e.g., FOMC unscheduled rate change). The following reports and/or tools are used to assess the current interest rate environment and its impact on Financial’s earnings and liquidity: monthly and year-to-date net interest margin and spread calculations, monthly and year-to-date balance sheet and income statements versus budget (including quarterly interest rate shock analysis), quarterly economic value of equity analysis, a weekly survey of rates offered by other local competitive institutions, and gap analysis which matches maturities or repricing dates of interest sensitive assets to those of interest sensitive liabilities.

Financial currently subscribes to computer simulated modeling tools made available through its consultant, FinPro, Inc., to aid in asset/liability analysis. In addition to monitoring by ALCO, the board is informed of the current asset/liability position and its potential effect on earnings at least quarterly.

Other Borrowings

Financial uses borrowing in conjunction with deposits to fund lending and investing activities. Borrowings include funding of a short-term nature.

Short-term borrowings consist of securities sold under agreements to repurchase, which are secured transactions with customers and generally mature the day following the date sold. As discussed above, the Bank ceased offering sweep accounts to its customers and therefore no longer has short term borrowings in the form repurchase agreements. Short-term borrowings may also include federal funds purchased, which are unsecured overnight borrowings from other financial institutions, which totaled $0 as of December 31, 2016 and December 31, 2015. Unsecured federal funds lines and their respective limits are maintained with the following institutions: Community Bankers’ Bank, $11,000,000, PNC Bank $6,000,000, Suntrust Bank, $3,000,000, and Zions Bank, $4,000,000. In addition, the Bank maintains a $5,000,000 reverse repurchase agreement with Suntrust whereby securities may be pledged as collateral in exchange for funds for a minimum of 30 days with a maximum of 90 days. The Bank also maintains a secured federal funds line with Community Bankers’ Bank whereby it may pledge securities as collateral with no specified minimum or maximum amount or term. The amount outstanding on the Community Bankers’ Bank secured fed funds line was $0 as of December 31, 2016 and 2015.

Long-term borrowings are obtained through the Federal Home Loan Bank of Atlanta (“FHLBA”). The Bank’s remaining available credit through the FHLBA is $143,615,000 as of December 31, 2016, the most recent calculation.

 

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The following information is provided for borrowings balances, rates and maturities:

 

     As of and for the Year Ended
December 31,
 
     2016     2015  

Short Term:

    

Federal funds purchased

    

Balance at end of year

   $ —       $ —    

Maximum month-end outstanding balance

     6,255       814  

Average outstanding balance during the year

     371       184  

Average interest rate during the year

     1.08     1.09

Average interest rate at end of year

     N/A       N/A  

FHLB Borrowings:

    

Federal Home Loan Bank advances

    

Balance at end of year

   $ —       $ —    

Maximum month-end outstanding balance

     —         12,000  

Average outstanding balance during the year

     —         2,269  

Average interest rate during the year

     N/A       1.23

Average interest rate at end of year

     N/A       N/A  

The maximum balance on the FHLBA credit was approximately $0 and $12,000,000 for each of the years ended December 31, 2016 and December 31, 2015.

Off-Balance Sheet Arrangements

At December 31, 2016, the Bank had rate lock commitments to originate mortgage loans through its Mortgage Division amounting to approximately $4,012 and loans held for sale of $3,833. The Bank has entered into corresponding commitments with third party investors to sell each of these loans that close. No other obligation exists. As a result of these contractual relationships with these investors, the Bank is not exposed to losses nor will it realize gains related to its rate lock commitments due to changes in interest rates.

The Bank is a party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments to extend credit and standby letters of credit. Such commitments involve, to varying degrees, elements of credit risk and interest rate risk in excess of the amount recognized in the balance sheets.

The Bank’s exposure to credit loss in the event of nonperformance by the other party to the financial instrument for commitments to extend credit and standby letters of credit is represented by the contractual amount of those instruments. The Bank uses the same credit policies in making commitments and conditional obligations as it does for on-balance sheet instruments. A summary of the Bank’s commitments is as follows:

 

    

Contract Amounts

(dollars in thousands) at

 
     December 31,  
     2016      2015  

Commitments to extend credit

   $ 93,247      $ 90,809  

Standby letters of credit

     3,466        3,097  
  

 

 

    

 

 

 

Total

   $ 96,713      $ 93,906  
  

 

 

    

 

 

 

 

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Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Because many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The amount of collateral obtained, if deemed necessary by the Bank upon extension of credit, is based on its credit evaluation of the customer.

Standby letters of credit are conditional commitments issued by the Bank to guarantee the performance of a customer to a third party. Those letters of credit are primarily issued to support public and private borrowing arrangements. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loans to customers. Collateral is required in instances which the Bank deems necessary.

Management does not anticipate any material losses as a result of these transactions.

The Bank rents, under non-cancelable leases, three of its banking facilities and one mortgage production office. The Bank has liability in the form of minimum annual rental commitments under these leases as follows:

 

Year Ending

   Amount
(in thousands)
 

2017

   $ 632  

2018

     643  

2019

     430  

2020

     173  

2021

     116  

Thereafter

     383  
  

 

 

 
   $ 2,377  
  

 

 

 

Expansion Plans

Subject to regulatory approval, the Bank anticipates opening additional branches during the next two fiscal years. Although numerous factors could influence the Bank’s expansion plans, the following discussion provides a general overview of the additional branch location that the Bank currently is considering.

Developed real property:

45 South Main Street, Lexington, Virginia. In December 2015, the Bank purchased a former bank branch building located at 45 South Main Street, Lexington, Virginia. Management is in the process of determining how much additional investment in the property is necessary in order to open a bank branch/commercial loan office at this location. The Bank has not determined when it will open a branch at this location.

Undeveloped real property:

Timberlake Road Area, Campbell County (Lynchburg), Virginia. As previously disclosed, the Bank has purchased certain real property located at the intersection of Turnpike and Timberlake Roads, Campbell County, Virginia. The Bank has not determined when it will open a branch at this location. The Bank has determined that the existing structure is not suitable for use as a bank branch.

Rustburg, Virginia. In March 2011, the Bank purchased certain real property near the intersection of Routes 501 and 24 in Rustburg, Virginia. The structure on the property has been removed. The Bank has not determined when it will open a branch at this location.

 

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Appomattox, Virginia. In July, 2013 the Bank purchased certain real property located near the intersection of Confederate Boulevard and Moses Avenue for future branch expansion. The Bank has not determined when it will open a branch at this location.

The Bank estimates that the cost of improvements, furniture, fixtures, and equipment necessary to upfit the property at the undeveloped locations will be between $900,000 and $1,500,000 per location.

Although the Bank cannot predict with certainty the financial impact of each new branch, management generally anticipates that each new branch will become profitable within 12 to 18 months of opening.

Recent Accounting Pronouncements

For information regarding recent accounting pronouncements and their effect on us, see “Recent Accounting Pronouncements” in Note 22 to the consolidated financial statements included in Item 8 of this Form 10-K.

 

Item 7A. Quantitative and Qualitative Disclosure About Market Risk

Not applicable

 

Item 8. Financial Statements and Supplementary Data

The following financial statements are filed as a part of this report:

Management’s Annual Report on Internal Control Over Financial Reporting

Report of Independent Registered Public Accounting Firm

Consolidated Financial Statements

Balance Sheets, December 31, 2016 and December 31, 2015

Statements of Income, Years Ended December 31, 2016 and December 31, 2015

Statements of Comprehensive Income, Years Ended December 31, 2016 and December 31, 2015

Statements of Changes in Stockholders’ Equity, Years Ended December 31, 2016 and December 31, 2015

Statements of Cash Flows, Years Ended December 31, 2016 and December 31, 2015

Notes to Consolidated Financial Statements

 

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LOGO

MANAGEMENT’S ANNUAL REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING

Management is responsible for the preparation and fair presentation of the consolidated financial statements included in this annual report. The consolidated financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America and reflect management’s judgments and estimates concerning effects of events and transactions that are accounted for or disclosed.

Management is also responsible for establishing and maintaining adequate internal control over financial reporting. Financial’s internal control over financial reporting includes those policies and procedures that pertain to Financial’s ability to record, process, summarize and report reliable financial data. Management recognizes that there are inherent limitations in the effectiveness of any internal control over financial reporting, including the possibility of human error and the circumvention or overriding of internal control. Accordingly, even effective internal control over financial reporting can provide only reasonable assurance with respect to financial statement preparation. Further, because of changes in conditions, the effectiveness of internal control over financial reporting may vary over time.

In order to ensure that Financial’s internal control over financial reporting is effective, management regularly assesses such controls and did so most recently for its financial reporting as of December 31, 2016. This assessment was based on criteria for effective internal control over financial reporting described in Internal Control Integrated Framework issued by the Committee of Sponsoring Organizations (COSO) in 2013, by the Treadway Commission. Based on this assessment, management has concluded that the internal control over financial reporting was effective as of December 31, 2016.

This annual report does not include an attestation report of Financial’s registered public accounting firm regarding internal control over financial reporting. Management’s report was not subject to attestation by Financial’s registered public accounting firm pursuant to the rules of the Securities and Exchange Commission that permit Financial to provide only management’s report in the annual report.

The Board of Directors, acting through its Audit Committee, is responsible for the oversight of Financial’s accounting policies, financial reporting and internal control. The Audit Committee of the Board of Directors is comprised entirely of outside directors who are independent of management. The Audit Committee is responsible for the appointment and compensation of the independent registered public accounting firm and approves decisions regarding the appointment or removal of Financial’s Internal Auditor. It meets periodically with management, the independent registered public accounting firm and the internal auditors to ensure that they are carrying out their responsibilities. The Audit Committee is also responsible for performing an oversight role by reviewing and monitoring the financial, accounting and auditing procedures of Financial in addition to reviewing Financial’s financial reports. The independent registered public accounting firm and the internal auditors have full and unlimited access to the Audit Committee, with or without management, to discuss the adequacy of internal control over financial reporting, and any other matter which they believe should be brought to the attention of the Audit Committee.

 

/s/ Robert R. Chapman III

   

/s/ J. Todd Scruggs

Chief Executive Officer & President

March 21, 2017

   

Secretary-Treasurer (Principal Financial Officer)

March 21, 2017

 

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LOGO

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Board of Directors and Stockholders

Bank of the James Financial Group, Inc.

Lynchburg, Virginia

We have audited the accompanying consolidated balance sheets of Bank of the James Financial Group, Inc. and subsidiaries as of December 31, 2016 and 2015, and the related consolidated statements of income, comprehensive income, changes in stockholders’ equity, and cash flows for the years then ended. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Bank of the James Financial Group, Inc. and subsidiaries as of December 31, 2016 and 2015, and the results of their operations and their cash flows for the years then ended, in conformity with U.S. generally accepted accounting principles.

 

/s/ Yount, Hyde & Barbour, P.C.

Winchester, Virginia

March 21, 2017

 

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BANK OF THE JAMES FINANCIAL GROUP, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(dollars in thousands, except per share data)

 

 

 

     December 31,  
     2016      2015  

Assets

     

Cash and due from banks

   $ 16,938      $ 15,952  

Federal funds sold

     11,745        12,703  
  

 

 

    

 

 

 

Total cash and cash equivalents

     28,683        28,655  

Securities held-to-maturity (fair value of $3,273 in 2016 and $2,649 in 2015)

     3,299        2,519  

Securities available-for-sale, at fair value

     40,776        35,996  

Restricted stock, at cost

     1,373        1,313  

Loans, net of allowance for loan losses of $5,716 in 2016 and $4,683 in 2015

     464,353        430,445  

Loans held for sale

     3,833        1,964  

Premises and equipment, net

     10,947        10,007  

Interest receivable

     1,378        1,248  

Cash value - bank owned life insurance

     12,673        9,781  

Other real estate owned

     2,370        1,965  

Income taxes receivable

     1,214        1,096  

Deferred tax asset, net

     2,374        1,399  

Other assets

     922        755  
  

 

 

    

 

 

 

Total assets

   $ 574,195      $ 527,143  
  

 

 

    

 

 

 

Liabilities and Stockholders’ Equity

     

Deposits

     

Noninterest bearing demand

   $ 102,654      $ 91,325  

NOW, money market and savings

     255,429        232,864  

Time

     165,029        143,421  
  

 

 

    

 

 

 

Total deposits

     523,112        467,610  

Capital notes

     —          10,000  

Interest payable

     88        61  

Other liabilities

     1,574        1,276  
  

 

 

    

 

 

 

Total liabilities

   $ 524,774      $ 478,947  
  

 

 

    

 

 

 

Commitments and Contingencies

     

Stockholders’ equity

     

Preferred stock; authorized 1,000,000 shares; none issued and outstanding

   $ —        $ —    

 

52

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BANK OF THE JAMES FINANCIAL GROUP, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(dollars in thousands, except per share data)

 

 

 

     December 31,  
     2016     2015  

Common stock $2.14 par value; authorized 10,000,000 shares; issued and outstanding 4,378,436 as of December 31, 2016 and 2015

     9,370       9,370  

Additional paid-in-capital

     31,495       31,495  

Retained earnings

     10,156       7,920  

Accumulated other comprehensive (loss)

     (1,600     (589
  

 

 

   

 

 

 

Total stockholders’ equity

   $ 49,421     $ 48,196  
  

 

 

   

 

 

 

Total liabilities and stockholders’ equity

   $ 574,195     $ 527,143  
  

 

 

   

 

 

 

 

53

See Notes to Consolidated Financial Statements


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BANK OF THE JAMES FINANCIAL GROUP, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF INCOME

(dollars in thousands, except per share amounts)

 

 

 

     For the Year Ended  
     December 31,  
     2016      2015  

Interest Income

     

Loans

   $ 20,481      $ 19,377  

Securities

     

US Government and agency obligations

     479        570  

Mortgage backed securities

     201        95  

Municipals - taxable

     199        108  

Municipals - tax exempt

     41        42  

Dividends

     67        67  

Other (Corporates)

     35        11  

Interest bearing deposits

     31        14  

Federal Funds sold

     34        18  
  

 

 

    

 

 

 

Total interest income

     21,568        20,302  
  

 

 

    

 

 

 

Interest Expense

     

Deposits

     

NOW, money market savings

     590        509  

Time Deposits

     1,742        1,552  

Federal Funds purchased

     4        2  

FHLB borrowings

     —          28  

Capital notes

     8        600  
  

 

 

    

 

 

 

Total interest expense

     2,344        2,691  
  

 

 

    

 

 

 

Net interest income

     19,224        17,611  

Provision for loan losses

     1,612        282  
  

 

 

    

 

 

 

Net interest income after provision for loan losses

     17,612        17,329  
  

 

 

    

 

 

 

Noninterest income

     

Gain on sales of loans held for sale

     2,433        2,278  

Service charges, fees and commissions

     1,444        1,390  

Increase in cash value of life insurance

     292        269  

Other

     132        207  

Gain on sales and calls of securities, net

     494        49  
  

 

 

    

 

 

 

Total noninterest income

     4,795        4,193  
  

 

 

    

 

 

 

 

54

See Notes to Consolidated Financial Statements


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BANK OF THE JAMES FINANCIAL GROUP, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF INCOME

(dollars in thousands, except per share amounts)

 

 

 

     For the Year Ended  
     December 31,  
     2016      2015  

Noninterest expenses

     

Salaries and employee benefits

     9,230        8,727  

Occupancy

     1,312        1,204  

Equipment

     1,287        1,275  

Supplies

     480        419  

Professional, data processing, and other outside expense

     2,731        2,218  

Marketing

     686        465  

Credit expense

     425        301  

Other real estate expenses

     68        122  

FDIC insurance expense

     363        331  

Other

     1,012        1,003  

Amortization of tax credit investment

     —          114  
  

 

 

    

 

 

 

Total noninterest expenses

     17,594        16,179  
  

 

 

    

 

 

 

Income before income taxes

     4,813        5,343  

Income tax expense

     1,527        1,651  
  

 

 

    

 

 

 

Net Income

   $ 3,286      $ 3,692  
  

 

 

    

 

 

 

Weighted average shares outstanding - basic and diluted

     4,378,436        3,451,409  
  

 

 

    

 

 

 

Earnings per common share - basic

   $ 0.75      $ 1.07  
  

 

 

    

 

 

 

Earnings per common share - diluted

   $ 0.75      $ 1.07  
  

 

 

    

 

 

 

 

55

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BANK OF THE JAMES FINANCIAL GROUP, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(dollars in thousands)

 

 

 

     For the Year Ended
December 31,
 
     2016     2015  

Net Income

   $ 3,286     $ 3,692  
  

 

 

   

 

 

 

Other comprehensive income (loss)

    

Unrealized gains (losses) on securities available-for-sale

     (1,044     (255

Tax effect

     354       87  

Reclassification adjustment for gains included in net income (1)

     (487     (49

Tax effect (2)

     166       17  
  

 

 

   

 

 

 

Other comprehensive income (loss), net of tax

     (1,011     (200
  

 

 

   

 

 

 

Comprehensive income

   $ 2,275     $ 3,492  
  

 

 

   

 

 

 

 

(1) Gains are included in “gain on sale of available-for-sale securities, net” on the consolidated statements of income.
(2) The tax effect on these reclassifications is reflected in “income tax expense” on the consolidated statements of income.

 

56

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BANK OF THE JAMES FINANCIAL GROUP, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY

(dollars in thousands except per share amounts)

 

 

 

     Total Shares
Outstanding
     Common
Stock
     Additional
Paid-in
Capital
     Retained
Earnings
    Accumulated
Other
Comprehensive
(Loss)
    Total  

Balance at December 31, 2014

     3,371,616      $ 7,215      $ 22,919      $ 5,031     $ (389   $ 34,776  
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

   

 

 

 

Net Income

     —          —          —          3,692       —         3,692  

Dividends paid on common stock ($0.22 per share)

     —          —          —          (803     —         (803

Net proceeds from issuance of 1,000,000 shares of common stock

     1,000,000        2,140        8,513        —         —         10,653  

Exercise of stock options

     6,820        15        63        —         —         78  

Other comprehensive loss

     —          —          —          —         (200     (200
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

   

 

 

 

Balance at December 31, 2015

     4,378,436      $ 9,370      $ 31,495      $ 7,920     $ (589   $ 48,196  
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

   

 

 

 

Net Income

     —          —          —          3,286       —         3,286  

Dividends paid on common stock ($0.24 per share)

     —          —          —          (1,050     —         (1,050

Other comprehensive loss

     —          —          —          —         (1,011     (1,011
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

   

 

 

 

Balance at December 31, 2016

     4,378,436      $ 9,370      $ 31,495      $ 10,156     $ (1,600   $ 49,421  
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

   

 

 

 

 

57

See Notes to Consolidated Financial Statements


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BANK OF THE JAMES FINANCIAL GROUP, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(dollars in thousands)

 

 

 

     For the Year Ended December 31,  
     2016     2015  

Cash flows from operating activities

    

Net Income

   $ 3,286     $ 3,692  

Adjustments to reconcile net income to net cash provided by operating activities:

    

Depreciation and amortization

     767       767  

Net amortization and accretion of premiums and discounts on securities

     276       110  

(Gain) on sales of available-for-sale securities

     (487     (49

(Gain) on call of held-to-maturity securities

     (7     —    

(Gain) on sales of loans held for sale

     (2,433     (2,278

Provision for loan losses

     1,612       282  

(Gain) loss on sale of other real estate owned

     (1     6  

(Benefit) for deferred income taxes

     (455     (74

Amortization of tax credit investment

     —         114  

(Increase) in cash value of life insurance

     (292     (269

(Increase) in interest receivable

     (130     (2

(Increase) in other assets

     (167     (154

(Increase) in income taxes receivable

     (118     (151

Increase in interest payable

     27       3  

Increase (decrease) in other liabilities

     298       (69

Proceeds from sales of loans held for sale

     85,307       79,893  

Origination of loans held for sale

     (84,743     (78,549

Valuation adjustment on other real estate owned

     45       75  
  

 

 

   

 

 

 

Net cash provided by operating activities

   $ 2,785     $ 3,347  
  

 

 

   

 

 

 

Cash flows from investing activities

    

Purchases of securities held-to-maturity

   $ (1,290   $ —    

Proceeds from maturities and calls of securities held-to-maturity

     500       —    

Purchases of securities available-for-sale

     (40,464     (27,019

Proceeds from maturities, calls and paydowns of securities available-for-sale

     9,744       1,622  

Proceeds from sale of securities available-for-sale

     24,637       13,440  

Purchases of bank owned life insurance

     (2,600     —    

(Purchase) redemption of Federal Home Loan Bank stock

     (60     426  

Proceeds from sale of other real estate owned

     21       360  

Origination of loans, net of principal collected

     (35,990     (37,579

Capital improvements to other real estate owned

     —         (25

Purchases of premises and equipment

     (1,707     (1,512
  

 

 

   

 

 

 

Net cash (used in) investing activities

   $ (47,209   $ (50,287
  

 

 

   

 

 

 

 

58

See Notes to Consolidated Financial Statements


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BANK OF THE JAMES FINANCIAL GROUP, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(dollars in thousands)

 

 

 

     For the Year Ended December 31,  
     2016     2015  

Cash flows from financing activities

    

Net increase in deposits

   $ 55,502     $ 68,113  

Net (decrease) in federal funds purchased

     —         (3,189

Net (decrease) in Federal Home Loan Bank advances

     —         (12,000

Dividends paid to common stockholders

     (1,050     (803

Proceeds from sale of 1,000,000 shares of common equity

     —         10,653  

Retirement of capital notes

     (10,000     —    

Proceeds from exercise of stock options

     —         78  
  

 

 

   

 

 

 

Net cash provided by financing activities

   $ 44,452     $ 62,852  
  

 

 

   

 

 

 

Increase in cash and cash equivalents

     28       15,912  

Cash and cash equivalents at beginning of period

   $ 28,655     $ 12,743  
  

 

 

   

 

 

 

Cash and cash equivalents at end of period

   $ 28,683     $ 28,655  
  

 

 

   

 

 

 

Non cash transactions

    

Transfer of loans to other real estate owned

   $ 470     $ 1,425  

Fair value adjustment for securities

     (1,531     (304

Cash transactions

    

Cash paid for interest

   $ 2,317     $ 2,688  

Cash paid for taxes

     2,100       1,875  

 

59

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Table of Contents

BANK OF THE JAMES FINANCIAL GROUP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2016 and 2015

(dollars in thousands, except per share data)

 

 

Note 1 – Organization

Bank of the James Financial Group, Inc. (“Financial” or the “Company”), a Virginia corporation, was organized in 2003 and is registered as a bank holding company under the Bank Holding Company Act of 1956, as amended. Financial is headquartered in Lynchburg, Virginia. Financial conducts its business activities through the branch offices and loan production offices of its wholly owned subsidiary bank, Bank of the James (the “Bank”), the Bank’s wholly-owned subsidiary, BOTJ Insurance, Inc. (“BOTJ-Ins.”), and through the Bank’s two divisions, Bank of the James Mortgage division (“Mortgage division”) and BOTJ Investment Services division (“Investment Services division”). The Mortgage division originates conforming and non-conforming home mortgages primarily in the Region 2000 area, which includes the counties of Amherst, Appomattox, Bedford and Campbell (which includes the Town of Altavista) the Town of Bedford, and the City of Lynchburg, Virginia. Financial exists primarily for the purpose of holding the stock of its subsidiaries, the Bank and such other subsidiaries as it may acquire or establish. Financial also has one wholly-owned non-operating subsidiary.

Bank of the James was incorporated on October 23, 1998, and began banking operations on July 22, 1999. The Bank is a Virginia chartered bank and is engaged in lending and deposit gathering activities in Region 2000 and other markets in Central Virginia. It operates under the laws of Virginia and the Rules and Regulations of the Federal Reserve System and the Federal Deposit Insurance Corporation. The Bank’s locations consist of five branches (one of which is a limited service branch) in Lynchburg, Virginia, one in Forest, Virginia which includes the Mortgage Division, one in Madison Heights, Virginia, one in the Town of Amherst, Virginia, one in the Town of Bedford, Virginia, one in the Town of Altavista, Virginia, and one in the Town of Appomattox. The Bank also operates one full service branch, two limited service branches and a loan production office in Charlottesville, Virginia, a full service branch in Harrisonburg, Virginia, and a full service branch in Roanoke, Virginia.

Note 2 - Summary of significant accounting policies

Consolidation

The consolidated financial statements include the accounts of Bank of the James Financial Group, Inc. and its wholly owned subsidiaries. All material intercompany balances and transactions have been eliminated in consolidation.

Basis of presentation and use of estimates

The preparation of the consolidated financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent liabilities at the date of the financial statements, as well as the amounts of income and expenses during the reporting period. Actual results could differ from those estimates. Material estimates that are particularly susceptible to significant change in the near term relate to the determination of the allowance for loan losses and valuation of other real estate owned.

Cash and cash equivalents

Cash and cash equivalents include cash and balances due from banks and federal funds sold, all of which mature within ninety days. Generally, federal funds are purchased and sold for one-day periods.

 

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BANK OF THE JAMES FINANCIAL GROUP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2016 and 2015

(dollars in thousands, except per share data)

 

 

 

Note 2 - Summary of significant accounting policies (continued)

 

Securities

Certain debt securities that management has the positive intent and ability to hold to maturity are classified as “held-to-maturity” and recorded at amortized cost. Trading securities are recorded at fair value with changes in fair value included in earnings. Securities not classified as held-to-maturity or trading, including equity securities with readily determinable fair values, are classified as “available-for-sale” and recorded at fair value, with unrealized gains and losses excluded from earnings and reported in other comprehensive income (loss). Purchase premiums and discounts are recognized in interest income using the interest method over the terms of the securities. Gains and losses on the sale of securities are recorded on the trade date and are determined using the specific identification method.

Impairment of securities occurs when the fair value of a security is less than its amortized cost. For debt securities, impairment is considered other-than-temporary and recognized in its entirety in net income if either (1) the Bank intends to sell the security or (2) it is more likely than not that the Bank will be required to sell the security before recovery of its amortized cost basis. If, however, the Bank does not intend to sell the security and it is not more likely than not that the Bank will be required to sell the security before recovery, the Bank must determine what portion of the impairment is attributable to a credit loss, which occurs when the amortized cost of the security exceeds the present value of the cash flows expected to be collected from the security. If there is no credit loss, there is no other-than temporary impairment. If there is a credit loss, other-than-temporary impairment exists, and the credit loss must be recognized in net income and the remaining portion of impairment must be recognized in other comprehensive income.

For equity securities, impairment is considered to be other-than-temporary based on our ability and intent to hold the investment until a recovery of fair value. Other-than-temporary impairment of an equity security results in a write-down that must be included in net income. We regularly review each investment security for other-than-temporary impairment based on criteria that include the extent to which cost exceeds market price, the duration of that market decline, the financial health of and specific prospects for the issuer, our best estimate of the present value of cash flows expected to be collected from debt securities, our intention with regard to holding the security to maturity, and the likelihood that we would be required to sell the security before recovery.

Restricted investments

As members of the Federal Reserve Bank (FRB) and the Federal Home Loan Bank of Atlanta (FHLBA), the Bank is required to maintain certain minimum investments in the common stock of the FRB and FHLBA. Required levels of investment are based upon the Bank’s capital and a percentage of qualifying assets. The Bank also maintains stock ownership in Community Bankers’ Bank (CBB). The investment in CBB is minimal and is not mandated but qualifies the Bank for preferred pricing on services offered by CBB. Based on liquidation restrictions, all of these investments are carried at cost.

Loans

Financial makes real estate, commercial and consumer loans to customers. A substantial portion of the loan portfolio is represented by real estate loans collateralized by real estate within Region 2000. The ability of Financial’s debtors to honor their contracts is dependent upon the real estate and general economic conditions in the area.

Loans that management has the intent and ability to hold for the foreseeable future or until maturity or pay-off generally are reported at their outstanding unpaid principal balances adjusted for charge-offs, the allowance for loan losses, and any deferred fees or costs on originated loans. Interest income is accrued on the unpaid principal balance. Loan origination fees, net of certain direct origination costs, are deferred and recognized as an adjustment of the related loan yield using the interest method.

 

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BANK OF THE JAMES FINANCIAL GROUP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2016 and 2015

(dollars in thousands, except per share data)

 

 

 

Note 2 - Summary of significant accounting policies (continued)

 

Past due status

Past due status is based on the contractual terms of the loan. In all cases, loans are placed on non-accrual and potentially charged-off at an earlier date if collection of principal or interest is considered doubtful.

Non-accrual status

Financial stops accruing interest on a loan at the time the loan is 90 days past due unless the credit is well-secured and in process of collection. At the time the loan is placed on non-accrual status, all previously accrued but not collected interest is reversed against interest income. While the loan is classified as non-accrual, any payments collected are accounted for using the cost-recovery method which requires the entire amount of the payment to be applied directly to principal, until qualifying for return to performing status. Loans may be, but are not always, returned to performing status when all the principal and interest amounts contractually due are brought current (within 90 days past due), future payments are reasonably assured, and contractually required payments have been made on a timely basis for at least six consecutive months.

Charge-off

At the time a loan is placed on non-accrual status, it is generally reevaluated for expected loss and a specific reserve, if not already assigned, is established against the loan. Consumer term loans are typically charged-off no later than 120 days whereas consumer revolving credit loans are typically charged-off no later than 180 days. Although the goal for commercial and commercial real estate loans is for charge off no later than 180 days, a commercial or commercial real estate loan may not be fully charged off until there is reasonable certainty that no additional workout efforts, troubled debt restructurings or any other types of concession can or will be made by Financial.

Loans Held for Sale

Loans originated and intended for sale in the secondary market are sold, servicing released, and carried at the lower of cost or fair value, which is determined in the aggregate based on sales commitments to permanent investors or on current market rates for loans of similar quality and type. In addition, the Company requires a firm purchase commitment from a permanent investor before a loan can be closed, thus limiting interest rate risk. The amount of interest rate lock commitments is currently an immaterial amount.

Allowance for loan losses

The allowance for loan losses is established as losses estimated to have occurred through a provision for loan losses charged to earnings. Loan losses are charged against the allowance when management believes the uncollectibility of a loan balance is confirmed. Subsequent recoveries, if any, are credited to the allowance.

The allowance for loan losses is evaluated on a regular basis by management and is based upon management’s periodic review of the collectibility of the loans in light of historical experience, the nature and volume of the loan portfolio, adverse situations that may affect the borrower’s ability to repay, estimated value of any underlying collateral and prevailing economic conditions. This evaluation is inherently subjective as it requires estimates that are susceptible to significant revision as more information becomes available.

 

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BANK OF THE JAMES FINANCIAL GROUP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2016 and 2015

(dollars in thousands, except per share data)

 

 

 

Note 2 - Summary of significant accounting policies (continued)

 

The allowance consists of specific, historical and general components. The specific component relates to loans that are classified as doubtful or substandard. For such loans that are also classified as impaired, an allowance is established when the collateral value of the impaired loan or discounted cash flows is lower than the carrying value of that loan. The historical component covers non-classified loans and is based on historical loss experience adjusted for qualitative factors. A general component is maintained to cover uncertainties that could affect management’s estimate of probable losses. The general component of the allowance reflects the margin of imprecision inherent in the underlying assumptions used in the methodologies for estimating specific and general losses in the portfolio. The qualitative factors used to derive the general component of the allowance may include but are not limited to:

 

  1. Known improvement or deterioration in certain classes of loans or collateral;

 

  2. Trends in portfolio volume, maturity, or composition;

 

  3. Volume and trends in delinquencies and non-accruals;

 

  4. Local economic and industrial conditions;

 

  5. Lending, charge-off, and collection policies; and

 

  6. Experience, ability, and depth of lending staff.

A loan is considered impaired when, based on current information and events, it is probable that Financial will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. Factors considered by management in determining impairment include payment status, collateral value, and the probability of collecting scheduled principal and interest payments when due. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired. Management determines the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrower’s prior payment record, and the amount of the shortfall in relation to the principal and interest owed. Impairment is measured on a loan by loan basis by evaluating the discounted cash flows or fair value of the underlying collateral, if the loan is collateral dependent.

Management considers the following four components when calculating its loan loss reserve requirement:

 

    In accordance with current accounting rules (ASC 310) and the Bank’s impairment methodology, the Bank performs an individual impairment analysis on all loans having a principal balance greater than $100,000 (unless related to another classified relationship or a TDR) with a risk rating of substandard, doubtful, and loss (our internal risk ratings of 7 through 9). The Bank also performs individual loan analysis and assesses potential future losses associated with those relationships risk rated as special mention (our internal risk rating of 6).

 

    In accordance with current accounting rules (ASC 450), the Bank examines historical charge-off data by segment in order to determine a portion of the reserve related to homogeneous pools. The Bank updates its historical charge-off data quarterly and adjusts the reserve accordingly.

 

    The Bank applies various risk factors, including, for example, levels of trends in delinquencies, current and expected economic conditions, and levels of and trends in recoveries of prior charge-offs.

 

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BANK OF THE JAMES FINANCIAL GROUP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2016 and 2015

(dollars in thousands, except per share data)

 

 

 

Note 2 - Summary of significant accounting policies (continued)

 

    The Bank applies factors to determine the method by which to determine the general reserve for inherent losses related to the loan pool, including, for example, loan concentrations, policy and procedure changes, national and local economic trends and conditions, and overall portfolio quality.

Troubled debt restructurings

In situations where, for economic or legal reasons related to a borrower’s financial condition, management may grant a concession to the borrower that it would not otherwise consider, the related loan is classified as a troubled debt restructuring (“TDR”). Management strives to identify borrowers in financial difficulty early and work with them to modify their loan to more affordable terms before their loans reach nonaccrual status. These modified terms may include rate reductions, principal forgiveness, payment forbearance and other actions intended to minimize the economic loss and to avoid foreclosure or repossession of collateral. In cases where borrowers are granted new terms that generally (although not required to be considered a TDR) provide for a reduction of either interest or principal, management measures any impairment on the restructuring as noted above for impaired loans. The Bank had $455 and $646 classified as TDRs as of December 31, 2016 and 2015, respectively.

Premises, equipment and depreciation

Premises and equipment, including leasehold improvements, are stated at cost less accumulated depreciation. Depreciation is provided over the estimated useful lives of the respective assets on the straight-line basis, which range from 3 to 7 years for equipment and 10 to 39.5 years for buildings and improvements. Leasehold improvements are amortized over a term which includes the remaining lease term and probable renewal periods. Land is carried at cost and is not depreciable. Expenditures for major renewals and betterments are capitalized and those for maintenance and repairs are charged to operating expenses as incurred.

Bank owned life insurance

Financial has purchased life insurance policies on certain key employees. Bank owned life insurance is recorded at the amount that can be realized under the insurance contract at the balance sheet date, which is the cash surrender value.

Other real estate owned

Other real estate owned consists of properties acquired through foreclosure or deed in lieu of foreclosure. These properties are carried at fair value less estimated costs to sell at the date of foreclosure establishing a new cost basis. These properties are subsequently accounted for at the lower of cost or fair value less estimated costs to sell. Losses from the acquisition of property in full or partial satisfaction of loans are charged against the allowance for loan losses. Subsequent write-downs, if any, are charged against expense. Gains and losses on the sales of foreclosed properties are included in determining net income in the year of the sale. Operating costs after acquisition are expensed.

Transfers of financial assets

Transfers of financial assets are accounted for as sales, when control over the assets has been surrendered. Control over transferred assets is deemed to be surrendered when (1) the assets have been isolated from the Bank – put presumptively beyond reach of the transferor and its creditors, even in bankruptcy or other receivership, (2) the transferee obtains the right (free of conditions that constrain it from taking advantage of that right) to pledge

 

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BANK OF THE JAMES FINANCIAL GROUP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2016 and 2015

(dollars in thousands, except per share data)

 

 

 

Note 2 - Summary of significant accounting policies (continued)

 

or exchange the transferred assets, and (3) the Bank does not maintain effective control over the transferred assets through an agreement to repurchase them before their maturity or the ability to unilaterally cause the holder to return specific assets.

Fair Value of Financial Instruments

Fair values of financial instruments are estimated using relevant market information and other assumptions, as more fully disclosed in a separate note. Fair value estimates involve uncertainties and matters of significant judgment regarding interest rates, credit risk, prepayments, and other factors, especially in the absences of broad markets for particular items. Changes in assumptions or in market conditions could significantly affect these estimates.

Operating Segments

While the chief decision-makers monitor the revenue streams of the various products and services, operations are managed and financial performance evaluated on a Company-wide basis. Operating segments are aggregated into one as operating results for all segments are similar. Accordingly, all of the financial service operations are considered by management to be aggregated in one reportable operating segment.

Retirement Plans

Employee 401(k) and profit sharing expense is the amount of matching contributions. Deferred compensation and supplemental retirement plan expense allocates the benefits over years of service.

Income taxes

Deferred income tax assets and liabilities are determined using the liability (or balance sheet) method. Under this method, the net deferred tax asset or liability is determined based on the tax effects of the temporary differences between the book and tax bases of the various balance sheet assets and liabilities and gives current recognition to changes in tax rates and laws.

When tax returns are filed, it is highly certain that some positions taken would be sustained upon examination by the taxing authorities, while others are subject to uncertainty about the merits of the position taken or the amount of the position that would be ultimately sustained. The benefit of a tax position is recognized in the financial statements in the period during which, based on all available evidence, management believes it is more likely than not that the position will be sustained upon examination, including the resolution of appeals or litigation processes, if any. Tax positions taken are not offset or aggregated with other positions. Tax positions that meet the more-likely-than-not recognition threshold are measured as the largest amount of tax benefit that is more than 50 percent likely of being realized upon settlement with the applicable taxing authority. The portion of the benefits associated with tax positions taken that exceeds the amount measured as described above is reflected as a liability for unrecognized tax benefits in the accompanying consolidated balance sheets along with any associated interest and penalties that would be payable to the taxing authorities upon examination.

Interest and penalties associated with unrecognized tax benefits are classified as additional income taxes in the consolidated statements of income. At December 31, 2016 and 2015, there were no liabilities recorded for unrecognized tax benefits.

 

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BANK OF THE JAMES FINANCIAL GROUP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2016 and 2015

(dollars in thousands, except per share data)

 

 

 

Note 2 - Summary of significant accounting policies (continued)

 

Stock options

Current accounting guidance requires the costs resulting from all share-based payments to employees be recognized in the financial statements. Stock-based compensation is estimated at the date of grant, using the Black-Scholes option valuation model for determining fair value, and recognized over the option’s vesting period. As of December 31, 2016, all compensation expense related to the Company’s option plan had been recognized. The Company’s ability to grant additional option shares under the 1999 Plan has expired.

Earnings per common share

Basic earnings per common share represents income available to common stockholders divided by the weighted-average number of common shares outstanding during the period. Diluted earnings per common share reflects additional common shares that would have been outstanding if dilutive potential common shares had been issued, as well as any adjustment to income that would result from the assumed issuance. Potential common shares that may be issued by the Company relate solely to outstanding stock options, and are determined using the treasury stock method.

Reclassification

Management has made certain immaterial reclassifications to the prior year financial statements to conform to the 2016 presentation.

Comprehensive income

Comprehensive income consists of net income and other comprehensive income (loss). Other comprehensive income (loss) includes unrealized gains (losses) on available-for-sale securities.

Marketing

The Company expenses advertising costs as incurred. Advertising expenses were $686 and $466 for 2016 and 2015, respectively.

Note 3 - Restrictions on cash

To comply with Federal Reserve regulations, the Bank is required to maintain certain average cash reserve balances. The daily average cash reserve requirements were approximately $6,733 and $5,562 for the weeks including December 31, 2016 and 2015, respectively.

 

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BANK OF THE JAMES FINANCIAL GROUP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2016 and 2015

(dollars in thousands, except per share data)

 

 

 

Note 4 - Securities

A summary of the amortized cost and fair value of securities, with gross unrealized gains and losses, follows:

 

     December 31, 2016  
     Amortized      Gross Unrealized      Fair  
     Cost      Gains      Losses      Value  

Held-to-maturity

           

U.S. agency obligations

   $ 3,299      $ 65      $ (91    $ 3,273  
  

 

 

    

 

 

    

 

 

    

 

 

 

Available-for-sale

           

U.S. Treasuries

   $ 1,952      $ —        $ (119    $ 1,833  

U.S. agency obligations

     14,332        5        (1,224      13,113  

Mortgage-backed securities

     12,358        —          (353      12,005  

Municipals

     10,426        55        (534      9,947  

Corporates

     4,132        —          (254      3,878  
  

 

 

    

 

 

    

 

 

    

 

 

 
   $ 43,200      $ 60      $ (2,484    $ 40,776  
  

 

 

    

 

 

    

 

 

    

 

 

 

 

     December 31, 2015  
     Amortized      Gross Unrealized      Fair  
     Cost      Gains      Losses      Value  

Held-to-maturity

           

U.S. agency obligations

   $ 2,519      $ 130      $ —        $ 2,649  
  

 

 

    

 

 

    

 

 

    

 

 

 

Available-for-sale

           

U.S. agency obligations

   $ 19,606      $ 3      $ (799    $ 18,810  

Mortgage-backed securities

     10,778        4        (135      10,647  

Municipals

     4,984        84        (34      5,034  

Corporates

     1,521        —          (16      1,505  
  

 

 

    

 

 

    

 

 

    

 

 

 
   $ 36,889      $ 91      $ (984    $ 35,996  
  

 

 

    

 

 

    

 

 

    

 

 

 

 

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BANK OF THE JAMES FINANCIAL GROUP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2016 and 2015

(dollars in thousands, except per share data)

 

 

 

Note 4 –Securities (continued)

 

Temporarily Impaired Securities

The following tables show the gross unrealized losses and fair value of the Bank’s investments with unrealized losses that are not deemed to be other-than-temporarily impaired, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position, at December 31, 2016 and 2015:

 

December 31, 2016    Less than 12 months      More than 12 months      Total  
     Fair      Unrealized      Fair      Unrealized      Fair      Unrealized  
     Value      Losses      Value      Losses      Value      Losses  

Held-to-maturity

                 

U.S. agency obligations

   $ 1,193      $ 91      $ —        $ —        $ 1,193      $ 91  

Available-for-sale

                 

U.S. Treauries

     1,833        119        —          —          1,833        119  

U.S. agency obligations

     13,109        1,224        —          —          13,109        1,224  

Mortgage-backed securities

     11,331        353        —          —          11,331        353  

Municipals

     7,170        534        —          —          7,170        534  

Corporates

     3,878        254        —          —          3,878        254  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total temporarily impaired securities

   $ 38,514      $ 2,575      $ —        $ —        $ 38,514      $ 2,575  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

December 31, 2015    Less than 12 months      More than 12 months      Total  
     Fair      Unrealized      Fair      Unrealized      Fair      Unrealized  
     Value      Losses      Value      Losses      Value      Losses  

Available-for-sale

                 

U.S. agency obligations

   $ 7,160      $ 353      $ 10,650      $ 446      $ 17,810      $ 799  

Mortgage-backed securities

     6,726        77        1,979        58        8,705        135  

Municipals

     2,341        25        503        9        2,844        34  

Corporates

     1,505        16        —          —          1,505        16  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total temporarily impaired securities

   $ 17,732      $ 471      $ 13,132      $ 513      $ 30,864      $ 984  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

U.S. Treasuries. The unrealized losses on these two investments in U.S. Treasuries at December 31, 2016 were caused by an increase in interest rates. The contractual terms of those investments do not permit the issuer to settle the securities at a price less than the amortized cost bases of the investments. Because the Bank does not intend to sell the investments and it is not more likely than not that the Bank will be required to sell the investments before recovery of their amortized cost bases, which may be maturity, the Bank does not consider those investments to be other-than-temporarily impaired at December 31, 2016. Each of these two investments carries a Moody’s investment grade rating of A.

 

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2016 and 2015

(dollars in thousands, except per share data)

 

 

 

U.S. agency obligations. The unrealized losses on the 10 investments in U.S. agency obligations at December 31, 2016 were caused by an increase in interest rates. The contractual terms of those investments do not permit the issuer to settle the securities at a price less than the amortized cost bases of the investments. Because the Bank does not intend to sell the investments and it is not more likely than not that the Bank will be required to sell the investments before recovery of their amortized cost bases, which may be maturity, the Bank does not consider those investments to be other-than-temporarily impaired at December 31, 2016. Each of these 10 investments carries an S&P investment grade rating of AA.

Mortgage-backed securities. The unrealized loss on the seven investments in U.S. government agency mortgage-backed securities at December 31, 2016 was caused by an increase in interest rates. The contractual terms of those investments does not permit the issuer to settle the securities at a price less than the amortized cost basis of the investments. Because the Bank does not intend to sell the investments and it is not more likely than not that the Bank will be required to sell the investments before recovery of the amortized cost basis, which may be maturity, the Bank does not consider those investments to be other-than-temporarily impaired at December 31, 2016. Each of these seven investments carries an S&P investment grade rating of AA.

Municipals. The unrealized losses on the 13 investments in municipal obligations at December 31, 2016 were caused by an increase in interest rates. The contractual terms of those investments do not permit the issuer to settle the securities at a price less than the amortized cost bases of the investments. Because the Bank does not intend to sell the investments and it is not more likely than not that the Bank will be required to sell the investments before recovery of their amortized cost bases, which may be maturity, the Bank does not consider those investments to be other-than-temporarily impaired at December 31, 2016. Each of these 13 investments carries an S&P investment grade rating of AA or above.

Corporates. The unrealized losses on the five investments in domestic corporate issued securities at December 31, 2016 were caused by an increase in interest rates. The contractual terms of those investments does not permit the issuer to settle the securities at a price less than the amortized cost basis of the investments. Because the Bank does not intend to sell the investments and it is not more likely than not that the Bank will be required to sell the investments before recovery of the amortized cost basis, which may be maturity, the Bank does not consider those investments to be other-than-temporarily impaired at December 31, 2016. Each of these five investments carries an S&P investment grade rating of AA.

The amortized costs and fair values of securities at December 31, 2016, by contractual maturity, are shown below. Expected maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.

 

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BANK OF THE JAMES FINANCIAL GROUP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2016 and 2015

(dollars in thousands, except per share data)

 

 

 

Note 4 – Securities (continued)

 

     Held-to-Maturity      Available-for-Sale  
     Amortized      Fair      Amortized      Fair  
     Cost      Values      Cost      Values  

Due in one year or less

   $ —        $ —        $ —        $ —    

Due after one year through five years

     2,015        2,080        551        535  

Due after five years through ten years

     —          —          14,874        14,318  

Due after ten years

     1,284        1,193        27,775        25,923  
  

 

 

    

 

 

    

 

 

    

 

 

 
   $ 3,299      $ 3,273      $ 43,200      $ 40,776  
  

 

 

    

 

 

    

 

 

    

 

 

 

The Bank received $24,637 in proceeds from sales of securities available-for-sale in 2016. Gross realized gains amounted to $487 and gross realized losses amounted to $0. The Bank received $13,440 in proceeds from sales of securities available-for-sale in 2015. Gross realized gains amounted to $52 and gross realized losses amounted to $3.

At December 31, 2016 and 2015, securities with a carrying value of $11,756 and $11,582, respectively, were pledged as collateral for public deposits and for other purposes as required or permitted by law.

 

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2016 and 2015

(dollars in thousands, except per share data)

 

 

 

Note 5 - Loans and allowance for loan losses

The allowance represents an amount that, in management’s judgment, will be adequate to absorb any losses on existing loans that may become uncollectible. Management’s judgment in determining the level of the allowance is based on evaluations of the collectability of loans while taking into consideration such factors as trends in delinquencies and charge-offs, changes in the nature and volume of the loan portfolio, current economic conditions that may affect a borrower’s ability to repay and the value of collateral, overall portfolio quality and review of specific potential losses. This evaluation is inherently subjective, as it requires estimates that are susceptible to significant revision as more information becomes available.

Management has an established methodology used to determine the adequacy of the allowance for loan losses that assesses the risks and losses inherent in the loan portfolio. For purposes of determining the allowance for loan losses, the Bank has segmented certain loans in the portfolio by product type. Within these segments, the Bank has sub-segmented its portfolio by classes within the segments, based on the associated risks within these classes. The classifications set forth below do not correspond directly to the classifications set forth in the call report (Form FFIEC 041). Management has determined that the classifications set forth below are more appropriate for use in identifying and managing risk in the loan portfolio.

 

Loan Segments:

   Loan Classes:

Commercial

  

Commercial and industrial loans

Commercial real estate

  

Commercial mortgages – owner occupied

Commercial mortgages – non-owner occupied

Commercial construction

Consumer

  

Consumer unsecured

Consumer secured

Residential

  

Residential mortgages

Residential consumer construction

 

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2016 and 2015

(dollars in thousands, except per share data)

 

 

 

Note 5 - Loans and allowance for loan losses (continued)

 

The evaluation also considers the following risk characteristics of each loan segment:

 

    Commercial loans carry risks associated with the successful operation of a business because the repayment of these loans may be dependent upon the profitability and cash flows of the business or project. In addition, there is risk associated with the value of collateral other than real estate which may depreciate over time and cannot be appraised with as much precision.

 

    Commercial real estate loans carry risks associated with a real estate project and other risks associated with the ownership of real estate. In addition, for real estate construction loans there is a risk that the project will not be finished according to schedule, the project will not be finished according to budget and the value of the collateral may, at any point in time, be less than the principal amount of the loan. Construction loans also bear the risk that the general contractor, who may or may not be a loan customer, may be unable to finish the construction project as planned because of financial pressure unrelated to the project.

 

    Consumer loans carry risks associated with the continued credit-worthiness of the borrower and the value of the collateral (e.g., rapidly-depreciating assets such as automobiles), or lack thereof. Consumer loans are more likely than real estate loans to be immediately adversely affected by job loss, divorce, illness or personal bankruptcy. Unsecured consumer loans carry additional risks associated with the continued credit-worthiness of borrowers who may be unable to meet payment obligations.

 

    Residential mortgage and construction loans carry risks associated with the continued credit-worthiness of the borrower and changes in the value of the collateral. Equity lines of credit carry risks associated with the continued credit-worthiness of the borrower and changes in the value of the collateral.

The Bank’s internal risk rating system is in place to grade commercial and commercial real estate loans. Category ratings are reviewed periodically by lenders and the credit review area of the Bank based on the borrower’s individual situation. Additionally, internal and external monitoring and review of credits are conducted on an annual basis.

Below is a summary and definition of the Bank’s risk rating categories:

 

RATING 1    Excellent
RATING 2    Above Average
RATING 3    Satisfactory
RATING 4    Acceptable / Low Satisfactory
RATING 5    Monitor
RATING 6    Special Mention
RATING 7    Substandard
RATING 8    Doubtful
RATING 9    Loss

 

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BANK OF THE JAMES FINANCIAL GROUP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2016 and 2015

(dollars in thousands, except per share data)

 

 

 

Note 5 - Loans and allowance for loan losses (continued)

 

Based on the above criteria, we segregate loans into the above categories for special mention, substandard, doubtful and loss from non-classified, or pass rated, loans. We review the characteristics of each rating at least annually, generally during the first quarter. The characteristics of these ratings are as follows:

 

  “Pass.” These are loans having risk ratings of 1 through 4. Pass loans are to persons or business entities with an acceptable financial condition, appropriate collateral margins, appropriate cash flow to service the existing loan, and an appropriate leverage ratio. The borrower has paid all obligations as agreed and it is expected that this type of payment history will continue. When necessary, acceptable personal guarantors support the loan.

 

  “Monitor.” These are loans having a risk rating of 5. Monitor loans have currently acceptable risk but may have the potential for a specific defined weakness in the borrower’s operations and the borrower’s ability to generate positive cash flow on a sustained basis. The borrower’s recent payment history may currently or in the future be characterized by late payments. The Bank’s risk exposure is mitigated by collateral supporting the loan. The collateral is considered to be well-margined, well maintained, accessible and readily marketable.

 

  “Special Mention.” These are loans having a risk rating of 6. Special Mention loans have weaknesses that deserve management’s close attention. If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the asset or in the Bank’s credit position at some future date. Special Mention loans are not adversely classified and do not expose an institution to sufficient risk to warrant adverse classification. These loans do warrant more than routine monitoring due to a weakness caused by adverse events.

 

  “Substandard.” These are loans having a risk rating of 7. Substandard loans are considered to have specific and well-defined weaknesses that jeopardize the viability of the Bank’s credit extension. The payment history for the loan has been inconsistent and the expected or projected primary repayment source may be inadequate to service the loan. The estimated net liquidation value of the collateral pledged and/or ability of the personal guarantor(s) to pay the loan may not adequately protect the Bank. There is a distinct possibility that the Bank will sustain some loss if the deficiencies associated with the loan are not corrected in the near term. A substandard loan would not automatically meet our definition of impaired unless the loan is significantly past due and the borrower’s performance and financial condition provide evidence that it is probable that the Bank will be unable to collect all amounts due.

 

  “Doubtful.” These are loans having a risk rating of 8. Doubtful rated loans have all the weaknesses inherent in a loan that is classified substandard but with the added characteristic that the weaknesses make collection or liquidation in full, on the basis of currently existing facts, conditions, and values, highly questionable and improbable. The possibility of loss is high.

 

  “Loss.” These are loans having a risk rating of 9. Loss rated loans are not considered collectible under normal circumstances and there is no realistic expectation for any future payment on the loan. Loss rated loans are fully charged off.

 

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BANK OF THE JAMES FINANCIAL GROUP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2016 and 2015

(dollars in thousands, except per share data)

 

 

 

Note 5 - Loans and allowance for loan losses (continued)

 

The Bank grants primarily commercial, real estate, and installment loans to customers throughout its market area, which consists primarily of Region 2000 which includes the counties of Amherst, Appomattox, Bedford and Campbell, the Town of Bedford, and the City of Lynchburg, Virginia. The real estate portfolio can be affected by the condition of the local real estate market. The commercial and installment loan portfolio can be affected by the local economic conditions.

A summary of loans, net is as follows:

 

     December 31,  
     2016      2015  

Commercial

   $ 88,085      $ 76,773  

Commercial real estate

     237,638        217,125  

Consumer

     85,099        81,531  

Residential

     59,247        59,699  
  

 

 

    

 

 

 

Total loans (1)

     470,069        435,128  

Less allowance for loan losses

     5,716        4,683  
  

 

 

    

 

 

 

Net loans

   $ 464,353      $ 430,445  
  

 

 

    

 

 

 

 

(1) Includes net deferred loan costs of $182 and $263, respectively.

The amount of overdrafts reclassified as loans was $54 and $17 as of December 31, 2016 and 2015, respectively.

The Company’s officers, directors and their related interests have various types of loan relationships with the Bank. The total outstanding balances of these related party loans at December 31, 2016 and 2015 were $15,869 and $16,674 respectively. During 2016, new loans and advances amounted to $1,186 and repayments amounted to $1,991. It should be noted that the beginning balance as of December 31, 2015 was adjusted upward to account for the existing loan relationships maintained by individuals who were newly designated as executive officers in 2016 as defined by Regulation O.

 

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BANK OF THE JAMES FINANCIAL GROUP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2016 and 2015

(dollars in thousands, except per share data)

 

 

 

Note 5 - Loans and allowance for loan losses (continued)

 

The following tables set forth information regarding impaired and non-accrual loans as of December 31, 2016 and 2015:

Loans on Non-Accrual Status

 

     As of December 31,  
     2016      2015  

Commercial

   $ 915      $ 483  

Commercial Real Estate:

     

Commercial Mortgages-Owner Occupied

     855        799  

Commercial Mortgages-Non-Owner Occupied

     —          514  

Commercial Construction

     256        367  

Consumer

     

Consumer Unsecured

     —          31  

Consumer Secured

     80        269  

Residential:

     

Residential Mortgages

     1,292        695  

Residential Consumer Construction

     67        248  
  

 

 

    

 

 

 

Totals

   $ 3,465      $ 3,406  
  

 

 

    

 

 

 

 

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BANK OF THE JAMES FINANCIAL GROUP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2016 and 2015

(dollars in thousands, except per share data)

 

 

 

Note 5 - Loans and allowance for loan losses (continued)

 

     Impaired Loans  
     As of and for the Year Ended December 31, 2016  
            Unpaid             Average      Interest  
     Recorded      Principal      Related      Recorded      Income  
2016    Investment      Balance      Allowance      Investment      Recognized  

With No Related Allowance Recorded:

              

Commercial

   $ 698      $ 698      $ —        $ 349      $ 37  

Commercial Real Estate

              

Commercial Mortgages-Owner Occupied

     3,019        3,077        —          3,051        142  

Commercial Mortgage Non-Owner Occupied

     349        349        —          263        23  

Commercial Construction

     —          —          —          14        —    

Consumer

              

Consumer Unsecured

     —          —          —          —          —    

Consumer Secured

     18        18        —          19        1  

Residential

              

Residential Mortgages

     1,555        1,687        —          1,776        55  

Residential Consumer Construction

     —          —          —          86        —    

With an Allowance Recorded:

              

Commercial

   $ 1,521      $ 1,521      $ 1,233      $ 1,351      $ 81  

Commercial Real Estate

              

Commercial Mortgages-Owner Occupied

     1,587        1,618        249        1,232        81  

Commercial Mortgage Non-Owner Occupied

     74        74        20        373        6  

Commercial Construction

     169        657        76        255        —    

Consumer

              

Consumer Unsecured