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Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

Form 10-Q

 

 

Quarterly Report Pursuant to Section 13 or 15(d)

of the Securities Exchange Act of 1934

For the Quarterly Period Ended September 30, 2017

 

 

BANK OF THE JAMES FINANCIAL GROUP, INC.

(Exact Name of Registrant as Specified in Its Charter)

 

 

 

Virginia   001-35402   20-0500300

(State or other jurisdiction of

incorporation or organization)

 

(Commission

file number)

 

(I.R.S. Employer

Identification No.)

828 Main Street, Lynchburg, VA   24504
(Address of principal executive offices)   (Zip Code)

(434) 846-2000

(Registrant’s telephone number, including area code)

 

 

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

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

 

Large accelerated filer      Accelerated filer   
Non-accelerated filer   ☐  (do not check if a smaller reporting company)    Smaller reporting company   
Emerging growth company        

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

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

APPLICABLE ONLY TO CORPORATE ISSUERS

State the number of shares outstanding of each of the issuer’s classes of common equity, as of the latest practicable date: 4,378,436 shares of Common Stock, par value $2.14 per share, were outstanding at November 7, 2017.

 

 

 


Table of Contents

Table of Contents

 

PART I – FINANCIAL INFORMATION

     1  

Item 1.

 

Consolidated Financial Statements

     1  

Item 2.

 

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

     32  

Item 3.

 

Quantitative and Qualitative Disclosures About Market Risk

     51  

Item 4.

 

Controls and Procedures

     51  

PART II – OTHER INFORMATION

     52  

Item 1.

 

Legal Proceedings

     52  

Item 1A.

 

Risk Factors

     52  

Item 2.

 

Unregistered Sales of Equity Securities and Use of Proceeds

     65  

Item 3.

 

Defaults Upon Senior Securities

     65  

Item 4.

 

Mine Safety Disclosures

     65  

Item 5.

 

Other Information

     66  

Item 6.

 

Exhibits

     66  

SIGNATURES

     68  


Table of Contents

PART I – FINANCIAL INFORMATION

 

  Item 1. Consolidated Financial Statements

Bank of the James Financial Group, Inc. and Subsidiaries

Consolidated Balance Sheets

(dollar amounts in thousands, except per share amounts) (2017 unaudited)

 

     September 30,     December 31,  
     2017     2016  

Assets

    

Cash and due from banks

   $ 22,806     $ 16,938  

Federal funds sold

     13,534       11,745  
  

 

 

   

 

 

 

Total cash and cash equivalents

     36,340       28,683  

Securities held-to-maturity (fair value of $3,263 in 2017 and $3,273 in 2016)

     3,282       3,299  

Securities available-for-sale, at fair value

     49,664       40,776  

Restricted stock, at cost

     1,505       1,373  

Loans, net of allowance for loan losses of $6,020 in 2017 and $5,716 in 2016

     493,764       464,353  

Loans held for sale

     1,502       3,833  

Premises and equipment, net

     11,920       10,947  

Interest receivable

     1,596       1,378  

Cash value - bank owned life insurance

     12,932       12,673  

Other real estate owned

     2,639       2,370  

Income taxes receivable

     1,275       1,214  

Deferred tax asset, net

     2,065       2,374  

Other assets

     852       922  
  

 

 

   

 

 

 

Total assets

   $ 619,336     $ 574,195  
  

 

 

   

 

 

 

Liabilities and Stockholders’ Equity

    

Deposits

    

Noninterest bearing demand

   $ 122,201     $ 102,654  

NOW, money market and savings

     255,784       255,429  

Time

     182,530       165,029  
  

 

 

   

 

 

 

Total deposits

     560,515       523,112  

Capital notes

     5,000       —    

Interest payable

     100       88  

Other liabilities

     1,929       1,574  
  

 

 

   

 

 

 

Total liabilities

   $ 567,544     $ 524,774  
  

 

 

   

 

 

 

Commitments and Contingencies

    

Stockholders’ equity

    

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

   $ —       $ —    

Common stock $2.14 par value; authorized 10,000,000 shares; issued and outstanding 4,378,436 as of September 30, 2017 and December 31, 2016

     9,370       9,370  

Additional paid-in-capital

     31,495       31,495  

Retained earnings

     11,930       10,156  

Accumulated other comprehensive (loss)

     (1,003     (1,600
  

 

 

   

 

 

 

Total stockholders’ equity

   $ 51,792     $ 49,421  
  

 

 

   

 

 

 

Total liabilities and stockholders’ equity

   $ 619,336     $ 574,195  
  

 

 

   

 

 

 

See accompanying notes to these consolidated financial statements

 

1


Table of Contents

Bank of the James Financial Group, Inc. and Subsidiaries

Consolidated Statements of Income

(dollar amounts in thousands, except per share amounts) (unaudited)

 

     For the Three Months Ended
September 30,
     For the Nine Months Ended
September 30,
 
     2017      2016      2017      2016  

Interest Income

           

Loans

   $ 5,683      $ 5,227      $ 16,336      $ 15,212  

Securities

           

US Government and agency obligations

     131        104        365        368  

Mortgage backed securities

     71        46        214        166  

Municipals - taxable

     81        63        230        132  

Municipals - tax exempt

     7        10        28        31  

Dividends

     7        6        42        39  

Other (Corporates)

     24        4        81        13  

Interest bearing deposits

     21        13        53        28  

Federal Funds sold

     45        4        81        16  
  

 

 

    

 

 

    

 

 

    

 

 

 

Total interest income

     6,070        5,477        17,430        16,005  
  

 

 

    

 

 

    

 

 

    

 

 

 

Interest Expense

           

Deposits

           

NOW, money market savings

     186        153        530        428  

Time Deposits

     537        457        1,488        1,268  

Federal Funds purchased

     —          —          —          4  

Reverse repurchase agreements

     13        —          13        —    

Capital notes 6% due 4/1/2017

     —          —          —          8  

Capital notes 4% due 1/24/2022

     50        —          137        —    
  

 

 

    

 

 

    

 

 

    

 

 

 

Total interest expense

     786        610        2,168        1,708  
  

 

 

    

 

 

    

 

 

    

 

 

 

Net interest income

     5,284        4,867        15,262        14,297  

Provision for loan losses

     200        145        745        595  
  

 

 

    

 

 

    

 

 

    

 

 

 

Net interest income after provision for loan losses

     5,084        4,722        14,517        13,702  
  

 

 

    

 

 

    

 

 

    

 

 

 

Noninterest income

           

Gain on sales of loans held for sale

     694        593        1,663        1,765  

Service charges, fees and commissions

     479        373        1,377        1,107  

Increase in cash value of life insurance

     86        75        259        205  

Other

     9        30        42        84  

Gain on sales and calls of securities, net

     51        210        113        444  
  

 

 

    

 

 

    

 

 

    

 

 

 

Total noninterest income

     1,319        1,281        3,454        3,605  
  

 

 

    

 

 

    

 

 

    

 

 

 

Noninterest expenses

           

Salaries and employee benefits

     2,538        2,318        7,314        6,717  

Occupancy

     390        333        1,127        970  

Equipment

     360        316        1,146        949  

Supplies

     133        119        390        346  

Professional, data processing, and other outside expense

     735        696        2,112        2,059  

Marketing

     212        178        596        498  

Credit expense

     155        110        456        299  

Other real estate expenses

     42        52        78        57  

FDIC insurance expense

     94        92        285        275  

Other

     255        235        733        723  
  

 

 

    

 

 

    

 

 

    

 

 

 

Total noninterest expenses

     4,914        4,449        14,237        12,893  
  

 

 

    

 

 

    

 

 

    

 

 

 

Income before income taxes

     1,489        1,554        3,734        4,414  

Income tax expense

     474        499        1,172        1,421  
  

 

 

    

 

 

    

 

 

    

 

 

 

Net Income

   $ 1,015      $ 1,055      $ 2,562      $ 2,993  
  

 

 

    

 

 

    

 

 

    

 

 

 

Weighted average shares outstanding - basic

     4,378,436        4,378,436        4,378,436        4,378,436  
  

 

 

    

 

 

    

 

 

    

 

 

 

Weighted average shares outstanding - diluted

     4,378,519        4,378,436        4,378,524        4,378,436  
  

 

 

    

 

 

    

 

 

    

 

 

 

Earnings per common share - basic

   $ 0.23      $ 0.24      $ 0.59      $ 0.68  
  

 

 

    

 

 

    

 

 

    

 

 

 

Earnings per common share - diluted

   $ 0.23      $ 0.24      $ 0.59      $ 0.68  
  

 

 

    

 

 

    

 

 

    

 

 

 

See accompanying notes to these consolidated financial statements

 

2


Table of Contents

Bank of the James Financial Group, Inc. and Subsidiaries

Consolidated Statements of Comprehensive Income

For the Three and Nine Months Ended September 30, 2017 and 2016

(dollar amounts in thousands) (unaudited)

 

     For the Three Months
Ended September 30,
    For the Nine Months
Ended September 30,
 
     2017     2016     2017     2016  

Net Income

   $ 1,015     $ 1,055     $ 2,562     $ 2,993  
  

 

 

   

 

 

   

 

 

   

 

 

 

Other comprehensive income (loss):

        

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

     25     (293     1,019       1,366  

Tax effect

     (9     100     (347     (465

Reclassification adjustment for gains included in net income (1)

     (51     (209     (113     (437

Tax effect (2)

     17     71     38     149
  

 

 

   

 

 

   

 

 

   

 

 

 

Other comprehensive income (loss), net of tax

     (18     (331     597     613
  

 

 

   

 

 

   

 

 

   

 

 

 

Comprehensive income

   $ 997     $ 724     $ 3,159     $ 3,606  
  

 

 

   

 

 

   

 

 

   

 

 

 

 

(1) Gains are included in “gain on sales and calls of 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.

See accompanying notes to these consolidated financial statements

 

3


Table of Contents

Bank of the James Financial Group, Inc. and Subsidiaries

Consolidated Statements of Cash Flows

Nine Months Ended September 30, 2017 and 2016

(dollar amounts in thousands) (unaudited)

 

     For the Nine Months Ended September 30,  
     2017     2016  

Cash flows from operating activities

    

Net Income

   $ 2,562     $ 2,993  

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

    

Depreciation and amortization

     601     579

Net amortization and accretion of premiums and discounts on securities

     280     419

Gain on sales of available-for-sale securities

     (113     (437

Gain on call of held-to-maturity securities

     —         (7

Gain on sales of loans held for sale

     (1,663     (1,765

Provision for loan losses

     745     595

Gain on sale of other real estate owned

     —         (1

Impairment of other real estate owned

     60     50

Increase in cash value of life insurance

     (259     (205

Increase in interest receivable

     (218     (59

Increase in other assets

     69     269

Increase in income taxes receivable

     (61     (130

Increase in interest payable

     12     16

Increase in other liabilities

     355     187

Proceeds from sales of loans held for sale

     63,271       62,491  

Origination of loans held for sale

     (59,277     (61,810
  

 

 

   

 

 

 

Net cash provided by operating activities

   $ 6,364     $ 3,185  
  

 

 

   

 

 

 

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

     (20,728     (31,576

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

     2,655       8,675  

Proceeds from sale of securities available-for-sale

     9,941       19,934  

Purchase of bank owned life insurance

     —         (2,600

Purchase of Federal Reserve Bank stock

     (90     —    

Purchase of Federal Home Loan Bank stock

     (42     (60

Proceeds from sale of other real estate owned

     515     21

Improvements to other real estate owned

     (29     —    

Origination of loans, net of principal collected

     (30,971     (27,761

Purchases of premises and equipment

     (1,574     (752

Proceeds from sale of other assets

     1     —    
  

 

 

   

 

 

 

Net cash (used in) investing activities

   $ (40,322   $ (34,909
  

 

 

   

 

 

 

Cash flows from financing activities

    

Net increase in deposits

   $ 37,403     $ 39,787  

Dividends paid to common stockholders

     (788     (787

Proceeds from sale of 4% capital notes due 1/24/2022

     5,000       —    

Retirement of 6% capital notes due 4/1/2017

     —         (10,000
  

 

 

   

 

 

 

Net cash provided by financing activities

   $ 41,615     $ 29,000  
  

 

 

   

 

 

 

Increase (decrease) in cash and cash equivalents

     7,657       (2,724

Cash and cash equivalents at beginning of period

   $ 28,683     $ 28,655  
  

 

 

   

 

 

 

Cash and cash equivalents at end of period

   $ 36,340     $ 25,931  
  

 

 

   

 

 

 

Non cash transactions

    

Transfer of loans to other real estate owned

   $ 815     $ 475  

Fair value adjustment for securities

     906     929

Cash transactions

    

Cash paid for interest

   $ 2,156     $ 1,692  

Cash paid for taxes

     1,275       1,550  

See accompanying notes to these consolidated financial statements

 

4


Table of Contents

Bank of the James Financial Group, Inc. and Subsidiaries

Consolidated Statements of Changes in Stockholders’ Equity

For the Nine Months Ended September 30, 2017 and 2016

(dollars in thousands, except per share amounts) (unaudited)

 

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

Balance at December 31, 2015

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

 

 

    

 

 

    

 

 

    

 

 

   

 

 

   

 

 

 

Net Income

     —          —          —          2,993       —         2,993  

Dividends paid on common stock ($0.18 per share)

     —          —          —          (787     —         (787

Other comprehensive income

     —          —          —          —         613       613  
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

   

 

 

 

Balance at September 30, 2016

     4,378,436      $ 9,370      $ 31,495      $ 10,126     $ 24     $ 51,015  
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

   

 

 

 

Balance at December 31, 2016

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

 

 

    

 

 

    

 

 

    

 

 

   

 

 

   

 

 

 

Net Income

     —          —          —          2,562       —         2,562  

Dividends paid on common stock ($0.18 per share)

     —          —          —          (788     —         (788

Other comprehensive income

     —          —          —          —         597       597  
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

   

 

 

 

Balance at September 30, 2017

     4,378,436      $ 9,370      $ 31,495      $ 11,930     $ (1,003   $ 51,792  
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

   

 

 

 

See accompanying notes to these consolidated financial statements

 

5


Table of Contents

Notes to Consolidated Financial Statements

Note 1 – Basis of Presentation

The unaudited consolidated financial statements have been prepared by Bank of the James Financial Group, Inc. (“Financial” or the “Company”) pursuant to the rules and regulations of the Securities and Exchange Commission. In management’s opinion the accompanying financial statements, which unless otherwise noted are unaudited, reflect all adjustments, consisting solely of normal recurring accruals, necessary for a fair presentation of the financial information as of September 30, 2017 and for the three and nine months ended September 30, 2017 and 2016 in conformity with accounting principles generally accepted in the United States of America. Additional information concerning the organization and business of Financial, accounting policies followed, and other related information is contained in Financial’s Annual Report on Form 10-K for the year ended December 31, 2016. These financial statements should be read in conjunction with the audited consolidated financial statements and footnotes for the year ended December 31, 2016 included in Financial’s Annual Report on Form 10-K. Results for the three and nine month periods ended September 30, 2017 are not necessarily indicative of the results that may be expected for the year ending December 31, 2017.

The Company’s primary market area consists of the area commonly referred to as 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. Recently, the Company has expanded into Charlottesville, Roanoke, and Harrisonburg.

Financial’s critical accounting policies include the evaluation of the allowance for loan losses which is based on management’s estimate of an amount that is adequate to absorb probable losses inherent in the loan portfolio of Bank of the James (the “Bank”), Financial’s wholly-owned subsidiary. The allowance for loan losses is established through a provision for loan loss based on available information including the composition of the loan portfolio, historical loan losses, specific impaired loans, availability and quality of collateral, age of the various portfolios, changes in local economic conditions, and loan performance and quality of the portfolio. Different assumptions used in evaluating the adequacy of the Bank’s allowance for loan losses could result in material changes in Financial’s financial condition and results of operations. The Bank’s policy with respect to the methodology for determining the allowance for loan losses involves a higher degree of complexity and requires management to make subjective judgments that often require assumptions or estimates about uncertain matters. This critical policy and its assumptions are periodically reviewed with the Board of Directors.

Financial also considers valuation of other real estate owned (OREO) a critical accounting policy. 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. 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.

Note 2 – Use of Estimates

The consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States of America which require management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates.

 

6


Table of Contents

Note 3 – Earnings Per Common Share (EPS)

Currently, only the option shares granted to certain officers and other employees of Financial pursuant to the Amended and Restated Stock Option Plan of 1999 Financial (the “1999 Plan”) are considered in calculating diluted earnings per share. The following is a summary of the earnings per share calculation for the three and nine months ended September 30, 2017 and 2016.

 

     Three Months Ended      Nine Months Ended  
     September 30,      September 30,  
     2017      2016      2017      2016  

Net income

   $ 1,015,000      $ 1,055,000      $ 2,562,000      $ 2,993,000  

Weighted average number of shares

     4,378,436        4,378,436        4,378,436        4,378,436  

Options effect of incremental shares

     83        —          88        —    
  

 

 

    

 

 

    

 

 

    

 

 

 

Weighted average diluted shares

     4,378,519        4,378,436        4,378,524        4,378,436  
  

 

 

    

 

 

    

 

 

    

 

 

 

Basic EPS (weighted avg shares)

   $ 0.23      $ 0.24      $ 0.59      $ 0.68  
  

 

 

    

 

 

    

 

 

    

 

 

 

Diluted EPS (Including Option Shares)

   $ 0.23      $ 0.24      $ 0.59      $ 0.68  
  

 

 

    

 

 

    

 

 

    

 

 

 

The following table sets forth the option shares that were not included in calculating the diluted earnings because their effect was anti-dilutive:

 

     Three Months Ended      Nine Months Ended  
     September 30,      September 30,  
     2017      2016      2017      2016  

Options excluded from calculating diluted EPS because their effect was anti-dilutive

     —          636        —          636  

The foregoing shares were anti-dilutive because the exercise price of the options was greater than the market price on September 30, 2016.

Note 4 – Stock Based Compensation

Accounting standards require companies to recognize the cost of employee services received in exchange for awards of equity instruments, such as stock options and restricted stock, based on the fair value of those awards at the date of grant.

 

7


Table of Contents

Note 4 – Stock Based Compensation (continued)

 

Stock option plan activity for the nine months ended September 30, 2017 is summarized below:

 

                   Weighted         
            Weighted      Average         
            Average      Remaining      Intrinsic  
            Exercise      Contractual      Value  
     Shares      Price      Life (in years)      (in thousands)  

Options outstanding, January 1, 2017

     636    $ 12.79        

Granted

     —          —          

Exercised

     —          —          

Forfeited

     —          —          
  

 

 

          

Options outstanding, September 30, 2017

     636    $ 12.79        0.67      $ 1  
  

 

 

    

 

 

    

 

 

    

 

 

 

Options exercisable, September 30, 2017

     636    $ 12.79        0.67      $ 1  
  

 

 

    

 

 

    

 

 

    

 

 

 

Intrinsic value is calculated by subtracting the exercise price of option shares from the market price of underlying shares as of September 30, 2017 and multiplying that amount by the number of options outstanding. No intrinsic value exists where the exercise price is greater than the market price on a given date.

All compensation expense related to the foregoing stock option plan has been recognized. The Company’s ability to grant additional options shares under the 1999 Plan has expired.

Note 5 – Fair Value Measurements

Determination of Fair Value

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

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

 

8


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Note 5 – Fair Value Measurements (continued)

 

Fair Value Hierarchy

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

 

    Level 1 inputs to the valuation methodology are quoted prices (unadjusted) for identical assets or liabilities in active markets.

 

    Level 2 inputs to the valuation methodology include quoted prices for similar assets and liabilities in active markets, and inputs that are observable for the asset or liability, either directly or indirectly, for substantially the full term of the financial instrument.

 

    Level 3 inputs to the valuation methodology are unobservable and significant to the fair value measurement.

Following is a description of the valuation methodologies used for instruments measured at fair value, as well as the general classification of such instruments pursuant to the valuation hierarchy:

Fair Value on a Recurring Basis

Securities Available-for-Sale

Fair values of securities, excluding restricted investments in Federal Reserve Bank stock, Federal Home Loan Bank stock, and Community Bankers’ Bank stock are based on quoted prices available in an active market. If quoted prices are available, these securities are classified within Level 1 of the valuation hierarchy. Level 1 securities would include highly liquid government bonds, mortgage products and exchange traded equities. If quoted market prices are not available, then fair values are estimated by using pricing models, quoted prices of securities with similar characteristics, or discounted cash flow.

Level 2 securities would include U.S. agency securities, mortgage-backed agency securities, obligations of states and political subdivisions and certain corporate, asset backed and other securities. In certain cases where there is limited activity or less transparency around inputs to the valuation, securities are classified within Level 3 of the valuation hierarchy. Currently, all of the Company’s securities are considered to be Level 2 securities.

The following table summarizes the Company’s financial assets that were measured at fair value on a recurring basis during the period.

Restricted securities noted above are classified as such because their ownership is restricted to certain types of entities and there is no established market for their resale. When the stock is repurchased, the shares are repurchased at the stock’s book value; therefore, the carrying amount of restricted securities approximate fair value. Restricted securities are considered to be Level 2.

 

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Table of Contents

Note 5 – Fair Value Measurements (continued)

 

            Carrying Value at September 30, 2017 (in thousands)  

Description

   Balance as of
September 30,
2017
     Quoted Prices
in Active
Markets for
Identical Assets
(Level 1)
     Significant
Other
Observable
Inputs
(Level 2)
     Significant
Unobservable
Inputs
(Level 3)
 

US Treasuries

   $ 1,874      $ —        $ 1,874      $ —    

US agency obligations

     17,461        —          17,461        —    

Mortgage-backed securities

     14,038        —          14,038        —    

Municipals

     12,298        —          12,298        —    

Corporates

     3,993        —          3,993        —    
  

 

 

    

 

 

    

 

 

    

 

 

 

Total available-for-sale securities

   $ 49,664      $ —        $ 49,664      $ —    
  

 

 

    

 

 

    

 

 

    

 

 

 
            Carrying Value at December 31, 2016 (in thousands)  

Description

   Balance as of
December 31,
2016
     Quoted Prices
in Active
Markets for
Identical Assets
(Level 1)
     Significant
Other
Observable
Inputs
(Level 2)
     Significant
Unobservable
Inputs
(Level 3)
 

US Treasuries

   $ 1,833      $      $ 1,833      $  

US agency obligations

     13,113        —          13,113        —    

Mortgage-backed securities

     12,005        —          12,005        —    

Municipals

     9,947        —          9,947        —    

Corporates

     3,878        —          3,878        —    
  

 

 

    

 

 

    

 

 

    

 

 

 

Total available-for-sale securities

   $ 40,776      $ —        $ 40,776      $ —    
  

 

 

    

 

 

    

 

 

    

 

 

 

Fair Value on a Non-recurring Basis

Impaired loans

Loans are designated as impaired when, in the judgment of management based on current information and events, it is probable that all amounts due according to the contractual terms of the loan agreement will not be collected when due. The measurement of loss associated with impaired loans can be based on either the observable market price of the loan or the fair value of the collateral. Fair value is measured based on the value of the collateral securing the loans. Collateral may be in the form of real estate or business assets including equipment, inventory, and accounts receivable. The vast majority of the collateral is real estate. The value of real estate collateral is determined utilizing an income or market valuation approach based on an appraisal conducted by an independent, licensed appraiser outside of the Bank using observable market data (Level 2). However, in situations where the collateral is a house or building in the process of construction, the appraisal is more than 12 months old, management has determined the fair value of the collateral is further impaired below the appraised value, or the appraisal is not based solely on market comparables adjusted for observable inputs, the value is considered Level 3. The value of business equipment is based upon an outside appraisal if deemed significant, or the net book value on the applicable business’ financial statements if not considered significant using observable market data. Likewise, values for inventory and accounts receivables collateral are based on financial statement balances or aging reports (Level 3). Any fair value adjustments are recorded in the period incurred as provision for loan losses on the Consolidated Statements of Income.

 

10


Table of Contents

Note 5 – Fair Value Measurements (continued)

 

Loans held for sale

Loans held for sale are carried at cost which approximates estimated fair value. These loans currently consist of one-to-four family residential loans originated for sale in the secondary market. Fair value is based on the price secondary markets are currently offering for similar loans using observable market data which is not materially different than cost due to the short duration between origination and sale (Level 2). As such, the Company records fair value adjustments on a nonrecurring basis. No nonrecurring fair value adjustments were recorded on loans held for sale during the period ended September 30, 2017. Gains and losses on the sale of loans are recorded within gains on sales of loans held for sale, net on the Consolidated Statements of Income.

Other real estate owned

Certain assets such as other real estate owned (OREO) are measured at fair value less cost to sell. We believe that the fair value component in its valuation follows the provisions of ASC 820.

Real estate acquired through foreclosure is transferred to OREO. The measurement of loss associated with OREO is based on the fair value of the collateral compared to the unpaid loan balance and anticipated costs to sell the property. The value of OREO property is determined utilizing an income or market valuation approach based on an appraisal conducted by an independent, licensed appraiser outside of the Bank using observable market data (Level 2).

Any fair value adjustments are recorded in the period incurred and expensed against current earnings. However, in situations where the collateral is a house or building in the process of construction, the appraisal is more than 12 months old, management has determined the fair value of the collateral is further impaired below the appraised value, or the appraisal is not based solely on market comparables adjusted for observable inputes, the value is considered Level 3.

The following table summarizes the Company’s impaired loans, loans held for sale, and OREO measured at fair value on a nonrecurring basis during the period (in thousands).

 

            Carrying Value at September 30, 2017  

Description

   Balance as of
September 30,
2017
     Quoted Prices in
Active Markets for
Identical Assets
(Level 1)
     Significant Other
Observable Inputs
(Level 2)
     Significant
Unobservable Inputs

(Level 3)
 

Impaired loans*

   $ 2,523      $ —        $ —        $ 2,523  

Loans held for sale

     1,502        —          1,502        —    

Other real estate owned

     2,639        —          —          2,639  

 

* Includes loans charged down to the net realizable value of the collateral.

 

            Carrying Value at December 31, 2016  

Description

   Balance as of
December 31,
2016
     Quoted Prices in
Active Markets for
Identical Assets
(Level 1)
     Significant Other
Observable Inputs
(Level 2)
     Significant
Unobservable
Inputs (Level 3)
 

Impaired loans*

   $ 2,830      $ —        $ —        $ 2,830  

Loans held for sale

     3,833        —          3,833        —    

Other real estate owned

     2,370        —          —          2,370  

 

* Includes loans charged down to the net realizable value of the collateral.

 

11


Table of Contents

Note 5 – Fair Value Measurements (continued)

 

The following table sets forth information regarding the quantitative inputs used to value assets classified as Level 3:

 

    Quantitative information about Level 3 Fair Value Measurements for September 30,  2017
(dollars in thousands)
 
    Fair
Value
   

Valuation Technique(s)

 

Unobservable Input

  Range (Weighted
Average)
 

Assets

       

Impaired loans

  $ 2,523     Discounted appraised value   Selling cost     5% - 10% (6 %) 
     

Discount for lack of marketability and age of appraisal

    0% - 25% (15 %) 
OREO     2,639     Discounted appraised value   Selling cost     5% - 10% (6 %) 
     

Discount for lack of marketability and age of appraisal

    0% - 25% (15 %) 
    Quantitative information about Level 3 Fair Value Measurements for December 31, 2016
(dollars in thousands)
 
    Fair
Value
   

Valuation Technique(s)

 

Unobservable Input

  Range (Weighted
Average)
 

Assets

       

Impaired loans

  $ 2,830     Discounted appraised value   Selling cost     5% - 10% (6 %) 
     

Discount for lack of marketability and age of appraisal

    0% - 25% (15 %) 
OREO     2,370     Discounted appraised value   Selling cost     5% - 10% (6 %) 
     

Discount for lack of marketability and age of appraisal

    0% - 25% (15 %) 

Financial Instruments

Cash, cash equivalents and Federal Funds sold

The carrying amounts of cash and short-term instruments approximate fair values.

Loans

For variable-rate loans that reprice frequently and with no significant change in credit risk, fair values are based on carrying values. Fair values for certain fixed rate loans are based on quoted market prices of similar loans adjusted for differences in loan characteristics. Fair values for other loans such as commercial real estate and commercial and industrial loans are estimated using discounted cash flow analyses, using interest rates currently being offered for loans with similar terms to borrowers of similar credit quality. Fair values of impaired loans are estimated as described above. The carrying values of all loans are considered to be Level 3.

Bank Owned Life Insurance (BOLI)

The carrying amount approximates fair value. The carrying values of all BOLI is considered to be Level 2.

 

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Note 5 – Fair Value Measurements (continued)

 

Deposits

Fair values disclosed for demand deposits (e.g., interest and noninterest checking, savings, and money market accounts) are, by definition, equal to the amount payable on demand at the reporting date (i.e., their carrying amounts). Fair values for fixed rate certificates of deposit are estimated using discounted cash flow analyses that applies interest rates currently being offered on certificates to a schedule of aggregated expected monthly maturities on time deposits. The carrying values of all deposits are considered to be Level 2.

FHLB borrowings

The fair value of FHLB borrowings is estimated using discounted cash flow analysis based on the rates currently offered for borrowings of similar remaining maturities and collateral requirements. The carrying values of all FHLB borrowings are considered to be Level 2.

Short-term borrowings

The carrying amounts of federal funds purchased, borrowings under repurchase agreements, and other short-term borrowings maturing within ninety days approximate fair value. The carrying values of all short-term borrowings are considered to be Level 2.

Capital notes

Fair values of capital notes are based on market prices for debt securities having similar maturity and interest rate characteristics. The carrying values of all capital notes are considered to be Level 2.

Accrued interest

The carrying amounts of accrued interest approximate fair value. The carrying values of all accrued interest is considered to be Level 2.

Off-balance sheet credit-related instruments

Fair values for off-balance sheet, credit-related financial instruments are based on fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the counterparties’ credit standing. Fair value of off-balance sheet credit-related instruments were deemed to be immaterial at September 30, 2017 and December 31, 2016 and therefore are not included in the table below.

 

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Table of Contents

Note 5 – Fair Value Measurements (continued)

 

The estimated fair values, and related carrying or notional amounts, of Financial’s financial instruments are as follows (in thousands):

 

       Fair Value Measurements at September 30, 2017 using  
            Quoted Prices      Significant                
            in Active      Other      Significant         
            Markets for      Observable      Unobservable         
     Carrying      Identical Assets      Inputs      Inputs         
     Amounts      (Level 1)      (Level 2)      (Level 3)      Balance  

Assets

              

Cash and due from banks

   $ 22,806      $ 22,806      $ —        $ —        $ 22,806  

Fed funds sold

     13,534        13,534        —          —          13,534  

Securities

              

Available-for-sale

     49,664        —          49,664        —          49,664  

Held-to-maturity

     3,282        —          3,263        —          3,263  

Restricted stock

     1,505           1,505        —          1,505  

Loans, net

     493,764        —          —          496,875        496,875  

Loans held for sale

     1,502        —          1,502        —          1,502  

Interest receivable

     1,596        —          1,596        —          1,596  

BOLI

     12,932        —          12,932        —          12,932  

Liabilities

              

Deposits

   $ 560,515      $ —        $ 561,450      $ —        $ 561,450  

Capital notes

     5,000        —          5,217        —          5,217  

Interest payable

     100        —          100        —          100  

 

            Fair Value Measurements at December 31, 2016 using  
            Quoted Prices      Significant                
            in Active      Other      Significant         
            Markets for      Observable      Unobservable         
     Carrying      Identical Assets      Inputs      Inputs         
     Amounts      (Level 1)      (Level 2)      (Level 3)      Balance  

Assets

              

Cash and due from banks

   $ 16,938      $ 16,938      $ —        $ —        $ 16,938  

Fed funds sold

     11,745        11,745              11,745  

Securities

              

Available-for-sale

     40,776        —          40,776        —          40,776  

Held-to-maturity

     3,299        —          3,273        —          3,273  

Restricted stock

     1,373        —          1,373           1,373  

Loans, net

     464,353        —          —          468,393        468,393  

Loans held for sale

     3,833        —          3,833        —          3,833  

Interest receivable

     1,378        —          1,378        —          1,378  

BOLI

     12,673        —          12,673        —          12,673  

Liabilities

              

Deposits

   $ 523,112      $ —        $ 524,222      $ —        $ 524,222  

Interest payable

     88        —          88        —          88  

 

14


Table of Contents

Note 5 – Fair Value Measurements (continued)

 

Fair value estimates are made at a specific point in time, based on relevant market information and information about the financial instrument. These estimates do not reflect any premium or discount that could result from offering for sale at one time Financial’s entire holdings of a particular financial instrument. Because no market exists for a significant portion of Financial’s financial instruments, fair value estimates are based on judgments regarding future expected loss experience, current economic conditions, risk characteristics of various financial instruments and other factors. These estimates are subjective in nature and involve uncertainties and matters of significant judgment, and therefore, cannot be determined with precision. Changes in assumptions could significantly affect the estimates.

Fair value estimates are based on existing on-balance-sheet and off-balance-sheet financial instruments without attempting to estimate the value of anticipated future business and the value of assets and liabilities that are not considered financial instruments. Significant assets that are not considered financial assets include deferred income taxes and bank premises and equipment; a significant liability that is not considered a financial liability is accrued post-retirement benefits. In addition, the tax ramifications related to the realization of the unrealized gains and losses can have a significant effect on fair value estimates and have not been considered in the estimates.

Financial assumes interest rate risk (the risk that general interest rate levels will change) as a result of its normal operations. As a result, the fair values of Financial’s financial instruments will change when interest rate levels change, and that change may be either favorable or unfavorable to Financial. Management attempts to match maturities of assets and liabilities to the extent believed necessary to minimize interest rate risk. However, borrowers with fixed rate obligations are less likely to prepay in a rising rate environment and more likely to prepay in a falling rate environment. Conversely, depositors who are receiving fixed rates are more likely to withdraw funds before maturity in a rising rate environment and less likely to do so in a falling rate environment.

Management monitors rates and maturities of assets and liabilities and attempts to minimize interest rate risk by adjusting terms of new loans and deposits and by investing in securities with terms that mitigate Financial’s overall interest rate risk.

Note 6 – Capital Notes

As of December 31, 2015, Financial had $10,000,000 categorized as “Capital Notes” which represented the proceeds of the private placement of $10,000,000 in unregistered debt securities as previously disclosed (the “2012 Notes”). The 2012 Notes bore interest at the rate of 6% per year with interest payable quarterly in arrears. 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 on January 5, 2016.

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 are to 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. Of the proceeds, $3,000,000 was injected into the Bank as equity capital in March 2017. It is anticipated the remaining $2,000,000 will remain at the holding company level for debt service on the 2017 Notes.

 

15


Table of Contents

Note 7 - Securities

The following tables summarize the Bank’s holdings for both securities held-to-maturity and securities available-for-sale as of September 30, 2017 and December 31, 2016 (amounts in thousands):

 

     September 30, 2017  
     Amortized      Gross Unrealized      Fair Value  
     Costs      Gains      (Losses)     

Held-to-Maturity

           

US agency obligations

   $ 3,282      $ 21      $ (40    $ 3,263  
  

 

 

    

 

 

    

 

 

    

 

 

 

Available-for-Sale

           

US Treasuries

     1,955        —          (81      1,874  

US agency obligations

     18,252        6        (797      17,461  

Mortgage-backed securities

     14,263        2        (227      14,038  

Municipals

     12,591        32        (325      12,298  

Corporates

     4,121        —          (128      3,993  
  

 

 

    

 

 

    

 

 

    

 

 

 
   $ 51,182      $ 40      $ (1,558    $ 49,664  
  

 

 

    

 

 

    

 

 

    

 

 

 
     December 31, 2016  
     Amortized      Gross Unrealized      Fair Value  
     Costs      Gains      (Losses)     

Held-to-Maturity

           

US agency obligations

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

 

 

    

 

 

    

 

 

    

 

 

 

Available-for-Sale

           

US Treasuries

     1,952        —          (119      1,833  

US 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  
  

 

 

    

 

 

    

 

 

    

 

 

 

 

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Note 7 – Securities (continued)

 

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 September 30, 2017 and December 31, 2016 (amounts in thousands):

 

     Less than 12 months      More than 12 months      Total  

September 30, 2017

   Fair
Value
     Unrealized
Losses
     Fair
Value
     Unrealized
Losses
     Fair
Value
     Unrealized
Losses
 

Description of securities

                 

Held-to-maturity

                 

US agency obligations

   $ 1,237      $ 40      $ —        $ —        $ 1,237      $ 40  

Available-for-sale

                 

US Treasuries

     1,874        81        —          —          1,874        81  

US agency obligations

     4,935        88        12,520        709        17,455        797  

Mortgage-backed securities

     10,468        195        2,654        32        13,122        227  

Municipals

     5,461        67        3,742        258        9,203        325  

Corporates

     1,978        53        2,015        75        3,993        128  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 25,953      $ 524      $ 20,931      $ 1,074      $ 46,884      $ 1,598  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 
     Less than 12 months      More than 12 months      Total  

December 31, 2016

   Fair
Value
     Unrealized
Losses
     Fair
Value
     Unrealized
Losses
     Fair
Value
     Unrealized
Losses
 

Description of securities

                 

Held-to-maturity

                 

US agency obligations

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

Available-for-sale

                 

US Treasuries

     1,833        119        —          —          1,833        119  

US 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

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

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Management evaluates securities for other-than-temporary impairment at least on a quarterly basis, and may do so more frequently when economic or market concerns warrant such evaluation. Consideration is given to (1) the length of time and the extent to which the fair value has been less than cost, (2) the financial condition and near-term prospects of the issuer, (3) the intent of Financial, if any, to sell the security; (4) whether Financial more likely than not will be required to sell the security before recovering its cost; and (5) whether Financial does not expect to recover the security’s entire amortized cost basis (even if Financial does not intend to sell the security).

 

17


Table of Contents

Note 7 – Securities (continued)

 

At September 30, 2017, the Company did not consider the unrealized losses as other-than-temporary losses due to the nature of the securities involved. As of September 30, 2017, the Bank owned 47 securities in an unrealized loss position that were being evaluated for other than temporary impairment. Eleven of these securities were S&P rated AAA, 33 were rated AA and three were rated A. As of September 30, 2017, 27 of these securities were direct obligations of the U.S. government or government sponsored entities, 15 were municipal issues, and five were investments in domestic corporate issued securities.

Based on the analysis performed by management as mandated by the Bank’s investment policy, management believes the default risk to be minimal. Because management does not intend to sell and it is likely that management will not be required to sell the securities prior to their anticipated recovery, and the decline in fair value is largely due to change in interest rates and other market conditions, no declines currently are deemed to be other-than-temporary.

Gross gains on available-for-sale securities were $51 and $113 during the three and nine month periods ended September 30, 2017 compared to $209 and $437 for the same respective periods in 2016. There were no losses on sales of available-for-sale securities and no sales of held-to-maturity securities during the three and nine month periods ended September 30, 2017 and 2016.

Note 8 – Business Segments

The Company has two reportable business segments: (i) a traditional full service community banking segment and, (ii) a mortgage loan origination business. The community banking business segment includes Bank of the James which provides loans, deposits, investments and insurance to retail and commercial customers throughout Region 2000 and other areas within Central Virginia. The mortgage segment provides a variety of mortgage loan products principally within Region 2000. Mortgage loans are originated and sold in the secondary market through purchase commitments from investors with servicing released. Because of the pre-arranged purchase commitments, there is minimal risk to the Company.

Both of the Company’s reportable segments are service based. The mortgage business is a gain on sale business while the Bank’s primary source of revenue is net interest income. The Bank also provides a referral network for the mortgage origination business. The mortgage business may also be in a position to refer its customers to the Bank for banking services when appropriate.

 

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Table of Contents

Note 8 – Business Segments (continued)

 

Information about reportable business segments and reconciliation of such information to the consolidated financial statements for the three and nine months ended September 30, 2017 and 2016 was as follows (dollars in thousands):

Business Segments

 

     Community
Banking
     Mortgage      Total  

Nine months ended September 30, 2017

        

Net interest income

   $ 15,262      $ —        $ 15,262  

Provision for loan losses

     745        —          745  
  

 

 

    

 

 

    

 

 

 

Net interest income after provision for loan losses

     14,517        —          14,517  

Noninterest income

     1,791        1,663        3,454  

Noninterest expenses

     12,880        1,357        14,237  
  

 

 

    

 

 

    

 

 

 

Income before income taxes

     3,428        306        3,734  

Income tax expense

     1,068        104        1,172  
  

 

 

    

 

 

    

 

 

 

Net income

   $ 2,360      $ 202      $ 2,562  
  

 

 

    

 

 

    

 

 

 

Total assets

   $ 617,720      $ 1,616      $ 619,336  
  

 

 

    

 

 

    

 

 

 

Nine months ended September 30, 2016

        

Net interest income

   $ 14,297      $ —        $ 14,297  

Provision for loan losses

     595        —          595  
  

 

 

    

 

 

    

 

 

 

Net interest income after provision for loan losses

     13,702        —          13,702  

Noninterest income

     1,816        1,789        3,605  

Noninterest expenses

     11,466        1,427        12,893  
  

 

 

    

 

 

    

 

 

 

Income before income taxes

     4,052        362        4,414  

Income tax expense

     1,298        123        1,421  
  

 

 

    

 

 

    

 

 

 

Net income

   $ 2,754      $ 239      $ 2,993  
  

 

 

    

 

 

    

 

 

 

Total assets

   $ 556,824      $ 3,128      $ 559,952  
  

 

 

    

 

 

    

 

 

 
     Community
Banking
     Mortgage      Total  

Three months ended September 30, 2017

        

Net interest income

   $ 5,284      $ —        $ 5,284  

Provision for loan losses

     200        —          200  
  

 

 

    

 

 

    

 

 

 

Net interest income after provision for loan losses

     5,084        —          5,084  

Noninterest income

     625        694        1,319  

Noninterest expenses

     4,321        593        4,914  
  

 

 

    

 

 

    

 

 

 

Income before income taxes

     1,388        101        1,489  

Income tax expense

     438        36        474  
  

 

 

    

 

 

    

 

 

 

Net income

   $ 950      $ 65      $ 1,015  
  

 

 

    

 

 

    

 

 

 

Total assets

   $ 617,720      $ 1,616      $ 619,336  
  

 

 

    

 

 

    

 

 

 

Three months ended September 30, 2016

        

Net interest income

   $ 4,867      $ —        $ 4,867  

Provision for loan losses

     145        —          145  
  

 

 

    

 

 

    

 

 

 

Net interest income after provision for loan losses

     4,722        —          4,722  

Noninterest income

     688        593        1,281  

Noninterest expenses

     3,985        464        4,449  
  

 

 

    

 

 

    

 

 

 

Income before income taxes

     1,425        129        1,554  

Income tax expense

     455        44        499  
  

 

 

    

 

 

    

 

 

 

Net income

   $ 970      $ 85      $ 1,055  
  

 

 

    

 

 

    

 

 

 

Total assets

   $ 556,824      $ 3,128      $ 559,952  
  

 

 

    

 

 

    

 

 

 

 

19


Table of Contents

Note 9 – Loans, allowance for loan losses and OREO

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 into classes, based on the associated risks. 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

A summary of loans, net is as follows (dollars in thousands):

 

     As of:  
     September 30,
2017
     December 31,
2016
 

Commercial

   $ 102,880      $ 88,085  

Commercial real estate

     249,441        237,638  

Consumer

     83,542        85,099  

Residential

     63,921        59,247  
  

 

 

    

 

 

 

Total loans (1)

     499,784        470,069  

Less allowance for loan losses

     6,020        5,716  
  

 

 

    

 

 

 

Net loans

   $ 493,764      $ 464,353  
  

 

 

    

 

 

 

 

(1) Includes net deferred costs and premiums of $903 and $182 as of September 30, 2017 and December 31, 2016, respectively.

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.

 

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Table of Contents

Note 9 – Loans, allowance for loan losses and OREO (continued)

 

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

We segregate loans into the above categories based on the following criteria and 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 provides 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 extremely high.

 

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Note 9 – Loans, allowance for loan losses and OREO (continued)

 

    “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.

Loans on Non-Accrual Status

(dollars in thousands)

 

    As of  
    September 30, 2017     December 31, 2016  

Commercial

  $ 674     $ 915  

Commercial Real Estate:

   

Commercial Mortgages-Owner Occupied

    183       855  

Commercial Mortgages-Non-Owner Occupied

    68       —    

Commercial Construction

    169       256  

Consumer

   

Consumer Unsecured

    —         —    

Consumer Secured

    414       80  

Residential:

   

Residential Mortgages

    765       1,292  

Residential Consumer Construction

    61       67  
 

 

 

   

 

 

 

Totals

  $ 2,334     $ 3,465  
 

 

 

   

 

 

 

We also classify other real estate owned (OREO) as a nonperforming asset. OREO represents real property owned by the Bank either through purchase at foreclosure or received from the borrower through a deed in lieu of foreclosure. OREO increased to $2,639 on September 30, 2017 from $2,370 on December 31, 2016. The following table represents the changes in OREO balance during the nine months ended September 30, 2017 and year ended December 31, 2016.

OREO Changes

(dollars in thousands)

 

     Nine months ended
September 30, 2017
     Year ended
December 31, 2016
 

Balance at the beginning of the year (net)

   $ 2,370      $ 1,965  

Transfers from loans

     815        470  

Capitalized costs

     29        —    

Valuation adjustments

     (60      (45

Sales proceeds

     (515      (21

Gain (loss) on disposition

     —          1  
  

 

 

    

 

 

 

Balance at the end of the period (net)

   $ 2,639      $ 2,370  
  

 

 

    

 

 

 

At September 30, 2017 and December 31, 2016, the Company had $0 and $294 of consumer mortgage loans secured by residential real estate for which foreclosure was in process. The Company held three residential real estate properties carried on the books at a value of $509 in other real estate owned as of September 30, 2017 and no residential real estate property in other real estate owned as of December 31, 2016.

 

22


Table of Contents

Note 9 – Loans, allowance for loan losses and OREO (continued)

 

     Impaired Loans  
     (dollars in thousands)  
     As of and For the Nine Months Ended September 30, 2017  
            Unpaid             Average      Interest  
     Recorded      Principal      Related      Recorded      Income  
2017    Investment      Balance      Allowance      Investment      Recognized  

With No Related Allowance Recorded:

              

Commercial

   $ 783      $ 962      $ —        $ 741      $ 28  

Commercial Real Estate

              

Commercial Mortgages-Owner Occupied

     1,075        1,111        —          2,047        86  

Commercial Mortgage Non-Owner Occupied

     411        417        —          380        15  

Commercial Construction

     —          —          —          —          —    

Consumer

              

Consumer Unsecured

     —          —          —          —          —    

Consumer Secured

     56        56        —          37        2  

Residential

              

Residential Mortgages

     1,451        1,543        —          1,503        38  

Residential Consumer Construction

     —          —          —          —          —    

With An Allowance Recorded:

              

Commercial

   $ 1,675      $ 1,872      $ 1,301      $ 1,598      $ 41  

Commercial Real Estate

              

Commercial Mortgages-Owner Occupied

     1,709        1,709        192        1,648        68  

Commercial Mortgage Non-Owner Occupied

     73        73        19        74        4  

Commercial Construction

     169        685        79        169        —    

Consumer

              

Consumer Unsecured

     2        2        2        1        —    

Consumer Secured

     432        445        305        271        11  

Residential

              

Residential Mortgages

     151        173        4        425        3  

Residential Consumer Construction

     —          —          —          —          —    

Totals:

              

Commercial

   $ 2,458      $ 2,834      $ 1,301      $ 2,339      $ 69  

Commercial Real Estate

              

Commercial Mortgages-Owner Occupied

     2,784        2,820        192        3,695        154  

Commercial Mortgage Non-Owner Occupied

     484        490        19        454        19  

Commercial Construction

     169        685        79        169        —    

Consumer

              

Consumer Unsecured

     2        2        2        1        —    

Consumer Secured

     488        501        305        308        13  

Residential

              

Residential Mortgages

     1,602        1,716        4        1,928        41  

Residential Consumer Construction

     —          —          —          —          —    
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 
   $ 7,987      $ 9,048      $ 1,902      $ 8,894      $ 296  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

23


Table of Contents

Note 9 – Loans, allowance for loan losses and OREO (continued)

 

 

     Impaired Loans  
     (dollars in thousands)  
     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

     —          —          —          16        —    

Consumer Secured

     110        110        110        150        8  

Residential

              

Residential Mortgages

     699        736        83        675        30  

Residential Consumer Construction

     —          —          —          —          —    

Totals:

              

Commercial

   $ 2,219      $ 2,219      $ 1,233      $ 1,700      $ 118  

Commercial Real Estate

              

Commercial Mortgages-Owner Occupied

     4,606        4,695        249        4,283        223  

Commercial Mortgage Non-Owner Occupied

     423        423        20        636        29  

Commercial Construction

     169        657        76        269        —    

Consumer

              

Consumer Unsecured

     —          —          —          16        —    

Consumer Secured

     128        128        110        169        9  

Residential

              

Residential Mortgages

     2,254        2,423        83        2,451        85  

Residential Consumer Construction

     —          —          —          86        —    
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 
   $ 9,799      $ 10,545      $ 1,771      $ 9,610      $ 464  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

24


Table of Contents

Note 9 – Loans, allowance for loan losses and OREO (continued)

 

     Allowance for Loan Losses and Recorded Investment in Loans
(dollars in thousands)
As of and For the Nine Months Ended September 30, 2017
 
           Commercial                    
2017    Commercial     Real Estate     Consumer     Residential     Total  

Allowance for Loan Losses:

          

Beginning Balance

   $ 2,192     $ 2,109     $ 954     $ 461     $ 5,716  

Charge-offs

     (315     (17     (114     (105     (551

Recoveries

     5       24       42       39       110  

Provision

     537       (233     272       169       745  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Ending Balance

   $ 2,419     $ 1,883     $ 1,154     $ 564     $ 6,020  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Ending Balance: Individually evaluated for impairment

   $ 1,301     $ 290     $ 307     $ 4     $ 1,902  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Ending Balance: Collectively evaluated for impairment

     1,118       1,593       847       560       4,118  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Totals:

   $ 2,419     $ 1,883     $ 1,154     $ 564     $ 6,020  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Loans:

          

Ending Balance: Individually evaluated for impairment

   $ 2,458     $ 3,437     $ 490     $ 1,602     $ 7,987  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Ending Balance: Collectively evaluated for impairment

     100,422       246,004       83,052       62,319       491,797  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Totals:

   $ 102,880     $ 249,441     $ 83,542     $ 63,921     $ 499,784  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

25


Table of Contents

Note 9 – Loans, allowance for loan losses and OREO (continued)

 

 

     Allowance for Loan Losses and Recorded Investment in Loans
(dollars in thousands)
As of and For the Year Ended December 31, 2016
 
2016    Commercial     Commercial
Real Estate
    Consumer     Residential     Total  

Allowance for Loan Losses:

          

Beginning Balance

   $ 1,195     $ 1,751     $ 1,073     $ 664     $ 4,683  

Charge-offs

     (328     (156     (275     —         (759

Recoveries

     7       127       44       2       180  

Provision

     1,318       387       112       (205     1,612  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Ending Balance

   $ 2,192     $ 2,109     $ 954     $ 461     $ 5,716  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Ending Balance: Individually evaluated for impairment

   $ 1,233     $ 345     $ 110     $ 83     $ 1,771  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Ending Balance: Collectively evaluated for impairment

     959       1,764       844       378       3,945  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Totals:

   $ 2,192     $ 2,109     $ 954     $ 461     $ 5,716  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Loans:

          

Ending Balance: Individually evaluated for impairment

   $ 2,219     $ 5,198     $ 128     $ 2,254     $ 9,799  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Ending Balance: Collectively evaluated for impairment

     85,866       232,440       84,971       56,993       460,270  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Totals:

   $ 88,085     $ 237,638     $ 85,099     $ 59,247     $ 470,069  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

26


Table of Contents

Note 9 – Loans, allowance for loan losses and OREO (continued)

 

 

    Age Analysis of Past Due Loans as of  
    September 30, 2017  
    (dollars in thousands)  
2017   30-59 Days
Past Due
    60-89 Days
Past Due
    Greater
than
90 Days
    Total Past
Due
    Current     Total
Loans
    Recorded Investment
> 90 Days &
Accruing
 

Commercial

  $ 824     $ —       $ 674     $ 1,498     $ 101,382     $ 102,880     $ —    

Commercial Real Estate:

             

Commercial Mortgages- Owner Occupied

    1,115       —         183       1,298       92,532       93,830       —    

Commercial Mortgages-Non-Owner Occupied

    365       186       68       619       138,148       138,767       —    

Commercial Construction

    —         —         169       169       16,675       16,844       —    

Consumer:

             

Consumer Unsecured

    1       —         —         1       7,107       7,108       —    

Consumer Secured

    469       260       368       1,097       75,337       76,434       —    

Residential:

             

Residential Mortgages

    520       69       483       1,072       53,363       54,435       —    

Residential Consumer Construction

    —         —         61       61       9,425       9,486       —    
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total

  $ 3,294     $ 515     $ 2,006     $ 5,815     $ 493,969     $ 499,784     $ —    
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 
    Age Analysis of Past Due Loans as of  
    December 31, 2016  
    (dollars in thousands)  
2016   30-59 Days
Past Due
    60-89 Days
Past Due
    Greater
than
90 Days
    Total Past
Due
    Current     Total
Loans
    Recorded Investment
> 90 Days &
Accruing
 

Commercial

  $ 283     $ 5     $ 78     $ 366     $ 87,719     $ 88,085     $ —    

Commercial Real Estate:

             

Commercial Mortgages-Owner Occupied

    1,136       72       855       2,063       88,698       90,761       —    

Commercial Mortgages-Non-Owner Occupied

    140       —         —         140       134,262       134,402       —    

Commercial Construction

    —         —         256       256       12,219       12,475       —    

Consumer:

             

Consumer Unsecured

    9       —         —         9       8,558       8,567       —    

Consumer Secured

    531       301       —         832       75,700       76,532       —    

Residential:

             

Residential Mortgages

    539       161       1,063       1,763       49,525       51,288       —    

Residential Consumer Construction

    —         —         67       67       7,892       7,959       —    
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total

  $ 2,638     $ 539     $ 2,319     $ 5,496     $ 464,573     $ 470,069     $ —    
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

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Note 9 – Loans, allowance for loan losses and OREO (continued)

 

     Credit Quality Information - by Class  
     September 30, 2017  
     (dollars in thousands)  
2017    Pass      Monitor      Special
Mention
     Substandard      Doubtful      Totals  

Commercial

   $ 99,555      $ 688      $ 5      $ 2,033      $ 599      $ 102,880  

Commercial Real Estate:

 

              

Commercial Mortgages-Owner Occupied

     83,772        6,758        452        2,848        —          93,830  

Commercial Mortgages-Non Owner Occupied

     136,166        1,918        74        609        —          138,767  

Commercial Construction

     15,631        —          1,044        169        —          16,844  

Consumer

                 

Consumer Unsecured

     7,106        —          —          2        —          7,108  

Consumer Secured

     75,612        93        —          729        —          76,434  

Residential:

                 

Residential Mortgages

     52,237        —          242        1,956        —          54,435  

Residential Consumer Construction

     9,425        —          —          61        —          9,486  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Totals

   $ 479,504      $ 9,457      $ 1,817      $ 8,407      $ 599      $ 499,784  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 
     Credit Quality Information - by Class  
     December 31, 2016  
     (dollars in thousands)  
2016    Pass      Monitor      Special
Mention
     Substandard      Doubtful      Totals  

Commercial

   $ 83,912      $ 1,473      $ 301      $ 1,484      $ 915      $ 88,085  

Commercial Real Estate:

 

              

Commercial Mortgages-Owner Occupied

     83,008        2,975        101        4,677        —          90,761  

Commercial Mortgages-Non Owner Occupied

     129,794        3,525        525        558        —          134,402  

Commercial Construction

     11,774        —          445        256        —          12,475  

Consumer

                 

Consumer Unsecured

     8,567        —          —          —          —          8,567  

Consumer Secured

     76,215        —          —          317        —          76,532  

Residential:

                 

Residential Mortgages

     48,366        —          245        2,677        —          51,288  

Residential Consumer Construction

     7,892        —          —          67        —          7,959  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Totals

   $ 449,528      $ 7,973      $ 1,617      $ 10,036      $ 915      $ 470,069  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

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Note 9 – Loans, allowance for loan losses and OREO (continued)

 

Troubled Debt Restructurings (TDR)

There were no loan modifications that would have been classified as TDRs during the three and nine months ended September 30, 2017 and 2016.

There were no loan modifications classified as TDRs within the last twelve months that defaulted during the three and nine months ended September 30, 2017 and 2016.

At September 30, 2017 and December 31, 2016, the Bank had no outstanding commitments to disburse additional funds on loans classified as TDRs.

Note 10 – Recent accounting pronouncements

In January 2016, the FASB issued ASU 2016-01, “Financial Instruments – Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities.” The amendments in ASU 2016-01, among other things: 1) Requires equity investments (except those accounted for under the equity method of accounting, or those that result in consolidation of the investee) to be measured at fair value with changes in fair value recognized in net income. 2) Requires public business entities to use the exit price notion when measuring the fair value of financial instruments for disclosure purposes. 3) Requires separate presentation of financial assets and financial liabilities by measurement category and form of financial asset (i.e., securities or loans and receivables). 4) Eliminates the requirement for public business entities to disclose the method(s) and significant assumptions used to estimate the fair value that is required to be disclosed for financial instruments measured at amortized cost. The amendments in this ASU are effective for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years. The Company is currently assessing the impact that ASU 2016-01 will have on its consolidated financial statements.

In February 2016, the FASB issued ASU No. 2016-02, “Leases (Topic 842).” Among other things, in the amendments in ASU 2016-02, lessees will be required to recognize the following for all leases (with the exception of short-term leases) at the commencement date: (1) A lease liability, which is a lessee‘s obligation to make lease payments arising from a lease, measured on a discounted basis; and (2) A right-of-use asset, which is an asset that represents the lessee’s right to use, or control the use of, a specified asset for the lease term. Under the new guidance, lessor accounting is largely unchanged. Certain targeted improvements were made to align, where necessary, lessor accounting with the lessee accounting model and Topic 606, Revenue from Contracts with Customers. The amendments in this ASU are effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. Early application is permitted upon issuance. Lessees (for capital and operating leases) and lessors (for sales-type, direct financing, and operating leases) must apply a modified retrospective transition approach for leases existing at, or entered into after, the beginning of the earliest comparative period presented in the financial statements. The modified retrospective approach would not require any transition accounting for leases that expired before the earliest comparative period presented. Lessees and lessors may not apply a full retrospective transition approach. The Company is in the process of gathering and analyzing lease data and will use this this information to assess the impact that ASU 2016-02 will have on its consolidated financial statements.

During June 2016, the FASB issued ASU No. 2016-13, “Financial Instruments – Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments.” The amendments in this ASU, among other things, require the measurement of all expected credit losses for financial assets held at the reporting date based on historical experience, current conditions, and reasonable and supportable forecasts. Financial institutions and other organizations will now use forward-looking information to better inform their credit loss estimates. Many of the loss estimation techniques applied today will still be

 

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Table of Contents

Note 10 – Recent accounting pronouncements (continued)

 

permitted, although the inputs to those techniques will change to reflect the full amount of expected credit losses. In addition, the ASU amends the accounting for credit losses on available-for-sale debt securities and purchased financial assets with credit deterioration. The amendments in this ASU are effective for SEC filers for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2019. The Company is currently assessing the impact that ASU 2016-13 will have on its consolidated financial statements. The Company has been in discussions with its core processor to coordinate a plan for implementation.

During August 2016, the FASB issued ASU No. 2016-15, “Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments”, to address diversity in how certain cash receipts and cash payments are presented and classified in the statement of cash flows. The amendments are effective for fiscal years beginning after December 15, 2017, and interim periods within those fiscal years. The amendments should be applied using a retrospective transition method to each period presented. If retrospective application is impractical for some of the issues addressed by the update, the amendments for those issues would be applied prospectively as of the earliest date practicable. Early adoption is permitted, including adoption in an interim period. The Company does not expect the adoption of ASU 2016-15 to have a material impact on its consolidated financial statements.

During January 2017, the FASB issued ASU No. 2017-01, “Business Combinations (Topic 805): Clarifying the Definition of a Business”. The amendments in this ASU clarify the definition of a business with the objective of adding guidance to assist entities with evaluating whether transactions should be accounted for as acquisitions (or disposals) of assets or businesses. Under the current implementation guidance in Topic 805, there are three elements of a business—inputs, processes, and outputs. While an integrated set of assets and activities (collectively referred to as a “set”) that is a business usually has outputs, outputs are not required to be present. In addition, all the inputs and processes that a seller uses in operating a set are not required if market participants can acquire the set and continue to produce outputs. The amendments in this ASU provide a screen to determine when a set is not a business. If the screen is not met, the amendments (1) require that to be considered a business, a set must include, at a minimum, an input and a substantive process that together significantly contribute to the ability to create output and (2) remove the evaluation of whether a market participant could replace missing elements. The ASU provides a framework to assist entities in evaluating whether both an input and a substantive process are present. The amendments in this ASU are effective for annual periods beginning after December 15, 2017, including interim periods within those annual periods. The amendments in this ASU should be applied prospectively on or after the effective date. No disclosures are required at transition. The Company does not expect the adoption of ASU 2017-01 to have a material impact on its consolidated financial statements.

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

 

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Table of Contents

Note 10 – Recent accounting pronouncements (continued)

 

During March 2017, the FASB issued ASU 2017-07, “Compensation — Retirement Benefits (Topic 715): Improving the Presentation of Net Periodic Pension Cost and Net Periodic Postretirement Benefit Cost.” The amendments in this ASU require an employer that offers defined benefit pension plans, other postretirement benefit plans, or other types of benefits accounted for under Topic 715 to report the service cost component of net periodic benefit cost in the same line item(s) as other compensation costs arising from services rendered during the period. The other components of net periodic benefit cost are required to be presented in the income statement separately from the service cost component. If the other components of net periodic benefit cost are not presented on a separate line or lines, the line item(s) used in the income statement must be disclosed. In addition, only the service cost component will be eligible for capitalization as part of an asset, when applicable. The amendments are effective for annual periods beginning after December 15, 2017, including interim periods within those annual periods. Early adoption is permitted. The Company does not expect the adoption of ASU 2017-07 to have a material impact on its consolidated financial statements.

During March 2017, the FASB issued ASU 2017-08, “Receivables—Nonrefundable Fees and Other Costs (Subtopic 310-20), Premium Amortization on Purchased Callable Debt Securities.” The amendments in this ASU shorten the amortization period for certain callable debt securities purchased at a premium. Upon adoption of the standard, premiums on these qualifying callable debt securities will be amortized to the earliest call date. Discounts on purchased debt securities will continue to be accreted to maturity. The amendments are effective for fiscal years beginning after December 15, 2018, and interim periods within those fiscal years. Early adoption is permitted, including adoption in an interim period. Upon transition, entities should apply the guidance on a modified retrospective basis, with a cumulative-effect adjustment to retained earnings as of the beginning of the period of adoption and provide the disclosures required for a change in accounting principle. The Company is currently assessing the impact that ASU 2017-08 will have on its consolidated financial statements.

During May 2017, the FASB issued ASU 2017-09, “Compensation – Stock Compensation (Topic 718): Scope of Modification Accounting.” The amendments provide guidance on determining which changes to the terms and conditions of share-based payment awards require an entity to apply modification accounting under Topic 718. The amendments are effective for annual periods, including interim periods within those annual periods, beginning after December 15, 2017. Early adoption is permitted, including adoption in any interim period, for reporting periods for which financial statements have not yet been issued. The Company is currently assessing the impact that ASU 2017-09 will have on its consolidated financial statements.

During August 2017, the FASB issued ASU 2017-12, “Derivatives and Hedging (Topic 815): Targeted Improvements to Accounting for Hedging Activities.” The amendments in this ASU modify the designation and measurement guidance for hedge accounting as well as provide for increased transparency regarding the presentation of economic results on both the financial statements and related footnotes. Certain aspects of hedge effectiveness assessments will also be simplified upon implementation of this update. The amendments are effective for annual periods, including interim periods within those annual periods, beginning after December 15, 2018. Early adoption is permitted, including adoption in any interim period. The Company does not expect the adoption of ASU 2017-12 to have a material impact on its consolidated financial statements.

 

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Table of Contents
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

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; 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.

GENERAL

Critical Accounting Policies

Bank of the James Financial Group, Inc.’s (“Financial”) 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. We use historical loss ratios as one factor in determining the inherent loss that may be present in our loan portfolio. Actual losses could differ significantly from the historical factors that we use in estimating risk. In addition, GAAP itself may change from one previously acceptable method to another method. Although the economics of our transactions would be the same, the timing of events that would impact our transactions could change.

Financial’s critical accounting policies include the evaluation of the allowance for loan losses which is based on management’s estimate of an amount that is adequate to absorb probable losses inherent in the loan portfolio of the Bank. The allowance for loan losses is established through a provision for loan loss based on available information including the composition of the loan portfolio, historical loan losses, specific impaired loans, availability and quality of collateral, age of the various portfolios, changes in local economic conditions, and loan performance and quality of the portfolio. Different assumptions used in evaluating the adequacy of the Bank’s allowance for loan losses could result in material changes in Financial’s financial condition and results of operations.

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 “Impairment of a Loan”, 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

 

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Table of Contents

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”).

The Bank’s policy with respect to the methodology for determining the allowance for loan losses involves a higher degree of complexity and requires management to make subjective judgments that often require assumptions or estimates about uncertain matters. This critical policy and its assumptions are periodically reviewed with the Board of Directors.

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.

Financial also considers valuation of other real estate owned (OREO) a critical accounting policy. 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. 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.

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 division”), investment services through the Bank’s Investment division (which we refer to as “Investment division”), and insurance activities through BOTJ Insurance, Inc., a subsidiary of the Bank, (which we refer to as “Insurance business”). Of these three other business activities, only the Mortgage division is material to the Bank’s results and operations.

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 is a community-oriented financial institution that provides varied banking services to individuals, small and medium-sized businesses, and professional concerns. Historically, our primary market area has been the Central Virginia, Region 2000 area, 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. Within the past three years, the Bank has begun to expand to other areas in Virginia, specifically Roanoke, Charlottesville, and Harrisonburg. The Bank strives to provide its customers with products comparable to statewide regional banks located in its market area, while maintaining the prompt response time and level of service of a community bank. Management believes this operating strategy has particular appeal in the Bank’s market areas.

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.bank.

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 non-interest income, including loan fees and service charges, and its non-interest expenses, including salaries and employee benefits, occupancy expense, data processing expenses, Federal Deposit Insurance Corporation premiums, expense in complying with the Sarbanes-Oxley Act of 2002, miscellaneous other expenses, franchise taxes, and income taxes.

 

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Table of Contents

The Bank intends to enhance its profitability by increasing its market share in our service areas, providing additional services to its customers, and controlling costs.

The Bank services its banking customers through the following locations in Virginia:

Full Service Branches

 

    The main office located at 828 Main Street in Lynchburg (the “Main Street Office”),

 

    A branch located at 615 Church Street in Lynchburg (the “Church Street Branch”),

 

    A branch located at 5204 Fort Avenue in Lynchburg (the “Fort Avenue Branch”),

 

    A branch located at 4698 South Amherst Highway in Amherst County (the “Madison Heights Branch”),

 

    A branch located at 17000 Forest Road in Forest (the “Forest Branch”),

 

    A branch located at 4935 Boonsboro Road, Suites C and D in Lynchburg (the “Boonsboro Branch”),

 

    A branch located at 164 South Main Street, Amherst, Virginia (the “Amherst Branch”),

 

    A branch located at 1405 Ole Dominion Boulevard in the Town of Bedford, Virginia, located off of Independence Boulevard (the “Bedford Branch”),

 

    A branch located at 1110 Main Street, Altavista, Virginia (the “Altavista Branch”),

 

    A branch located at 1391 South High Street, Harrisonburg, VA (the “Harrisonburg Branch”),

 

    A branch located at 180 Old Courthouse Rd, Appomattox, VA (the “Appomattox Branch”),

 

    A branch located at 225 Merchant Walk Avenue, Charlottesville, VA (the “5th Street Station Branch”), and

 

    A branch located at 3562 Electric Road, Roanoke, VA (the “Roanoke Branch”).

Limited Service Branches

 

    Westminster-Canterbury facilities located at 501 VES Road, Lynchburg, Virginia,

 

    Westminster-Canterbury facilities located at 250 Pantops Mountain Road, Charlottesville, Virginia,

 

    Luxor Office Park LLC, 1430 Rolkin Court Suite 203, Charlottesville, Virginia (the “Charlottesville Branch”).

 

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Table of Contents

Loan Production Offices

 

    Residential mortgage loan production office located at the Forest Branch,

 

    Commercial, consumer and mortgage loan production office located at the Charlottesville Branch.

The Investment division and the Insurance business operate primarily out of offices located at the Church Street Branch.

The Bank continuously evaluates areas located within our service areas to identify additional viable branch locations. Based on this ongoing evaluation, the Bank may acquire one or more additional suitable sites.

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 locations that the Bank currently is considering, including the following properties that we own and are holding for expansion:

 

    Real property located in the Timberlake Road area of Campbell County (Lynchburg), Virginia. The Timberlake 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. The Bank began construction of a permanent full service location in April 2017 and the Bank will open the branch during the fourth quarter of 2017. In connection with the opening, the Bank will relocate its temporary location (180 Old Courthouse Road referenced in the location table above) to this permanent location.

 

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

The Bank estimates that the cost of improvements, furniture, fixtures, and equipment necessary to upfit each property 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 operation.

Except as set forth herein, the Bank does not expect to purchase any significant property or equipment in the upcoming 12 months. Future branch openings are subject to regulatory approval.

OFF-BALANCE SHEET ARRANGEMENTS

The Bank is a party to various financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of our 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 and could impact the overall liquidity and capital resources to the extent customers accept and/or use these commitments.

 

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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:

 

     September 30,
2017
(in thousands)
 

Commitments to extend credit

   $ 100,914  

Letters of Credit

     2,810  
  

 

 

 

Total

   $ 103,724  
  

 

 

 

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 the Bank’s 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. The amount of collateral obtained, if deemed necessary by the Bank upon extension of credit, is based on the Bank’s credit evaluation of the customer.

The Bank has rate lock commitments to originate mortgage loans through its Mortgage Division. 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.

SUMMARY OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following discussion represents management’s discussion and analysis of the financial condition of Financial as of September 30, 2017 and December 31, 2016 and the results of operations of Financial for the three and nine month periods ended September 30, 2017 and 2016. This discussion should be read in conjunction with the financial statements included elsewhere herein.

All financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America.

Financial Condition Summary

September 30, 2017 as Compared to December 31, 2016

Total assets were $619,336,000 on September 30, 2017 compared with $574,195,000 at December 31, 2016, an increase of 7.86%. The increase in total assets was primarily due to growth in the loan portfolio funded by an increase in deposits and the issuance of $5,000,000 of notes (the “2017 Notes”) in a private placement that closed on January 25, 2017.

 

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Total deposits increased from $523,112,000 as of December 31, 2016 to $560,515,000 on September 30, 2017, an increase of 7.15%. The increase resulted in large part from increases in non-interest bearing demand and time deposits and a slight increase in NOW, money market, and savings accounts. NOW, money market, and savings deposits increased from $255,429,000 on December 31, 2016 to $255,784,000 on September 30, 2017. Noninterest bearing demand deposits increased from $102,654,000 on December 31, 2016 to $122,201,000 on September 30, 2017. Time deposits increased from $165,029,000 on December 31, 2016 to $182,530,000 on September 30, 2017.

Total loans, excluding loans held for sale, increased to $499,784,000 on September 30, 2017 from $470,069,000 on December 31, 2016. Loans, excluding loans held for sale and net of deferred fees and costs and the allowance for loan losses, increased to $493,764,000 on September 30, 2017 from $464,353,000 on December 31, 2016, an increase of 6.33%. The following summarizes the position of the Bank’s loan portfolio as of the dates indicated by dollar amount and percentages (dollar amounts in thousands):

 

     September 30, 2017     December 31, 2016  
     Amount      Percentage     Amount      Percentage  

Commercial

   $ 102,880        20.58   $ 88,085        18.74

Commercial Real Estate

     249,441        49.91     237,638        50.55

Consumer

     83,542        16.72     85,099        18.11

Residential

     63,921        12.79     59,247        12.60
  

 

 

    

 

 

   

 

 

    

 

 

 

Total loans

   $ 499,784        100.00   $ 470,069        100.00
  

 

 

    

 

 

   

 

 

    

 

 

 

Total nonperforming assets, which consist of non-accrual loans, loans past due 90 days or more and still accruing, and other real estate owned (“OREO”) decreased to $4,973,000 on September 30, 2017 from $5,835,000 on December 31, 2016. OREO increased to $2,639,000 on September 30, 2017 from $2,370,000 on December 31, 2016. This increase was due to the Bank’s foreclosure on seven properties (including one in the third quarter) in the nine months ended September 30, 2017. Non-performing loans decreased from $3,465,000 at December 31, 2016 to $2,334,000 at September 30, 2017. As discussed in more detail below under “Results of Operations—Allowance for Loan Losses,” management had provided for the anticipated losses on these loans in the allowance for loan losses. Loan payments received on non-accrual loans are first 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 reversed and 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 loan losses charged against earnings.

OREO represents real property acquired by the Bank for debts previously contracted, including through foreclosure, deeds in lieu of foreclosure or repossession. On December 31, 2016, the Bank was carrying six OREO properties on its books at a value of $2,370,000. During the nine months ended September 30, 2017, the Bank acquired seven additional OREO properties and disposed of six OREO properties, and as of September 30, 2017 the Bank is carrying seven OREO properties at a value of $2,639,000. The OREO properties are available for sale and are being actively marketed on the Bank’s website and through other means.

The Bank had loans in the amount of $444,000 at September 30, 2017 classified as performing Troubled Debt Restructurings (“TDRs”) as compared to $455,000 at December 31, 2016. None of these TDRs were included in non-accrual loans. These loans have had their original terms modified to facilitate payment by the borrower. The loans have been classified as TDRs primarily due to a change to interest only payments and the maturity of these modified loans is primarily less than one year.

 

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Cash and cash equivalents increased to $36,340,000 on September 30, 2017 from $28,683,000 on December 31, 2016. Cash and cash equivalents consist of cash due from correspondents, cash in vault, and overnight investments (including federal funds sold). The decrease in cash and cash equivalents was due primarily to a decrease in federal funds sold, the proceeds of which were used to purchase securities available-for-sale. In addition, cash and cash equivalents are subject to routine fluctuations in deposits, including fluctuations in transactional accounts and professional settlement accounts.

Securities held-to-maturity decreased to $3,282,000 on September 30, 2017 from $3,299,000 on December 31, 2016. Securities available-for-sale increased to $49,664,000 on September 30, 2017, from $40,776,000 on December 31, 2016. The increase resulted from the Bank’s desire to build on-balance sheet liquidity and because of a slight increase in interest rates. During the nine months ended September 30, 2017 the Bank received $2,655,000 in proceeds from calls, maturities, and paydowns of securities available-for-sale and $9,941,000 in proceeds from the sale of securities available-for-sale. The Bank purchased $20,728,000 in securities available-for sale during the same period.

Financial’s investment in Federal Home Loan Bank of Atlanta (FHLBA) stock totaled $607,000 at September 30, 2017 and $565,000 at December 31, 2016, an increase of $42,000. This increase is attributable to the FHLBA’s increase in minimum ownership requirements. FHLBA stock is generally viewed as a long-term investment and because there is no market for the stock other than other Federal Home Loan Banks or member institutions, FHLBA stock is viewed as a restricted security. Therefore, when evaluating FHLBA stock for impairment, its value is based on the ultimate recoverability of the par value rather than by recognizing temporary declines in value.

Liquidity and Capital

At September 30, 2017, Financial, on a consolidated basis, had liquid assets of $86,004,000 in the form of cash, interest-bearing and noninterest-bearing deposits with banks, and available-for-sale investments. Of this amount, approximately $12,592,000 (representing current book value) of the available-for-sale securities are pledged as collateral with $9,085,000 pledged as security for public deposits, and $3.507,000 pledged as security on a line of credit the Bank may draw on from time to time to meet liquidity needs. This line of credit currently has a zero balance. Management believes that liquid assets were adequate at September 30, 2017. Management anticipates that additional liquidity will be provided by the growth in deposit accounts and loan repayments at the Bank. In addition, if additional liquidity is needed, the Bank has the ability to purchase federal funds on the open market, borrow from the FHLBA using loans or investments within the Bank’s portfolio as collateral, and to borrow from the Federal Reserve Bank’s discount window.

Management is not aware of any trends, events or uncertainties that are reasonably likely to have a material negative impact on Financial’s short-term or long-term liquidity. Based in part on recent loan growth, the Bank is monitoring liquidity to ensure it is able to fund future loans.

As of December 31, 2015, Financial had $10,000,000 categorized as “Capital Notes” which represents the proceeds of the private placement of $10,000,000 in unregistered debt securities as previously disclosed (the “2012 Notes”). The 2012 Notes bore interest at the rate of 6% per year with interest payable quarterly in arrears. 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 on January 5, 2016.

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 are to mature on January 24, 2022, but are subject to prepayment in whole or in part on or

 

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after January 24, 2018 at Financial’s sole discretion on 30 days written notice to the holders. Of the proceeds, $3,000,000 was injected into the Bank as equity capital in March 2017. It is anticipated the remaining $2,000,000 will remain at the holding company level for debt service on the 2017 Notes and other general corporate purposes.

 

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At September 30, 2017, the Bank had a leverage ratio of approximately 9.25%, a Tier 1 risk-based capital ratio and a CET1 ratio of approximately 11.02% and a total risk-based capital ratio of approximately 12.19%. As of September 30, 2017 and December 31, 2016 the Bank’s regulatory capital levels exceeded those established for well-capitalized institutions. The following table sets forth the minimum capital requirements and the Bank’s capital position as of September 30, 2017 and December 31, 2016:

Bank Level Only Capital Ratios

 

     September 30,      December 31,  
Analysis of Capital (in 000’s)    2017      2016  

Tier 1 capital

     

Common Stock

   $ 3,742      $ 3,742  

Surplus

     22,325        19,325  

Retained earnings

     30,381        27,582  
  

 

 

    

 

 

 

Total Tier 1 capital

   $ 56,448      $ 50,649  
  

 

 

    

 

 

 

Common Equity Tier 1 Capital (CET1)

   $ 56,448      $ 50,649  
  

 

 

    

 

 

 

Tier 2 capital

     

Allowance for loan losses

   $ 6,020      $ 5,716  

Total Tier 2 capital:

   $ 6,020      $ 5,716  
  

 

 

    

 

 

 

Total risk-based capital

   $ 62,468      $ 56,365  
  

 

 

    

 

 

 

Risk weighted assets

   $ 512,307      $ 488,607  

Average total assets

   $ 610,456      $ 566,399  

 

     Actual     Regulatory Benchmarks  
     September 30,
2017
    December 31,
2016
    For Capital
Adequacy
Purposes (1)
    For Well
Capitalized
Purposes
 

Capital Ratios:

        

Tier 1 capital to average total assets

     9.247     8.942     4.000     5.000

Common Equity Tier 1 Ratio

     11.018     10.366     5.750     6.500

Tier 1 risk-based capital ratio

     11.018     10.366     7.250     8.000

Total risk-based capital ratio

     12.193     11.536     9.250     10.000

 

(1) Minimum capital requirements for CET1, Tier 1, and Total Capital ratios include the capital conservation buffer of 1.25%, which is being phased in until January, 2019.

The above tables set forth 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 at September 30, 2017 would be slightly lower than those of the Bank.

In July 2013, the Federal Reserve Board approved a final rule establishing a regulatory capital framework for smaller, less complex financial institutions. The rule implements in the United States the Basel III regulatory capital reforms from the Basel Committee on Banking Supervision and certain changes required by the Dodd-Frank Wall Street Reform and Consumer Protection Act. The phase-in period for this rule began in January 2015. Under the final rule, minimum requirements were increased for both the quantity and quality of capital held by banking organizations. The rule included a new minimum ratio of common equity Tier 1 capital to risk-weighted assets of 4.5% and a common equity Tier 1 capital conservation buffer of 2.5% of risk-weighted assets that applies to all supervised financial institutions. The capital conservation buffer began its phase-in on January 1, 2016 at 0.625% and increases by an additional 0.625% annually until it reaches 2.5% on January 1, 2019. This will result in an effective Tier 1 capital ratio of 8.5% upon full implementation. The capital conservation buffer will limit capital distributions, stock redemptions, and certain discretionary bonuses. Beginning January 1, 2016, failure to maintain the capital conservation buffer will limit the ability of the Bank and Financial to pay dividends, repurchase shares or pay discretionary bonuses. The rule also raised the minimum ratio of Tier 1 capital to risk-weighted assets from 4% to 6% and includes a minimum leverage ratio of 4% for all banking organizations.

 

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Results of Operations

Comparison of the Three and Nine Months Ended September 30, 2017 and 2016

Earnings Summary

Financial had net income including all operating segments of $1,015,000 and $2,562,000 for the three and nine months ended September 30, 2017, compared to $1,055,000 and $2,993,000 for the comparable periods in 2016. Basic and diluted earnings per common share for the three and nine months ended September 30, 2017 were $0.23 and $0.59, respectively, compared to basic and diluted earnings per share of $0.24 and $0.68 for the three and nine months ended September 30, 2016.

The decrease in net income for the three months ended September 30, 2017 as compared to the prior year was due primarily to an increase in the allowance for loan loss provision, an increase in interest expense, and an increase in non-interest expense and was partially offset by an increase in non-interest income. The decrease in net income for the nine months ended September 30, 2017 as compared to the prior year was due primarily to an increase in the allowance for loan loss provision, a decrease in non-interest income, an increase in interest expense, and an increase in non-interest expense. The increases in both periods were partially offset by an increase in interest income. Non-interest expense increased in large part because of the Bank’s recent expansion into Charlottesville, Harrisonburg, and Roanoke. These expansions resulted in increases in personnel expense, occupancy expense, and marketing expense.

These operating results represent an annualized return on average stockholders’ equity of 7.75% and 6.65% for the three and nine months ended September 30, 2017, compared with 8.34% and 8.10% for the three and nine months ended September 30, 2016. This decrease for the three and nine months was a direct result of the decrease in net income. The Company had an annualized return on average assets of 0.66% and 0.58% for the three and nine months ended September 30, 2017 compared with 0.76% and 0.75% for the same periods in 2016. The decrease for the three and nine months ended September 30, 2017 largely resulted from an increase in average assets since September 30, 2016 along with a decrease in net income.

See “Non-Interest Income” below for mortgage business segment discussion.

Interest Income, Interest Expense, and Net Interest Income

Interest income increased to $6,070,000 and $17,430,000 for the three and nine months ended September 30, 2017 from $5,477,000 and $16,005,000 for the same periods in 2016, increases of 10.83% and 8.90%, respectively. Interest income increased primarily because of increased balances in the loan and investment portfolios. The average rate received on earning assets increased from 4.23% to 4.24% for the three months ended September 30, 2017 from the comparable period in 2016 and decreased for the nine months ended September 30, 2017 from 4.26% to 4.20% for the comparable period in 2016. The rate on total average earning assets increased for the three months ended September 30, 2017 as compared to the three months ended September 30, 2016 resulted primarily because the increase in short term rates by the FOMC resulted in increased rates paid to the bank, primarily on floating rate loans.

Interest expense increased to $786,000 and $2,168,000 for the three and nine months ended September 30, 2017 from $610,000 and $1,708,000 for the same periods in 2016, increases of 28.85% and 26.93%, respectively. The increase in interest expense resulted primarily from an increase on the rates paid and balances on deposits along with the interest paid on the 2017 Notes. The Bank’s average rate paid on interest bearing deposits was 0.67% and 0.64% during the three and nine month periods ended September 30, 2017 as compared to 0.61% and 0.58% for the same periods in 2016.

 

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The fundamental source of the Bank’s net revenue is net interest income, which is determined by the difference between (i) interest and dividend income on interest 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. Net interest income for the three and nine months ended September 30, 2017 was $5,284,000 and $15,262,000 as compared to $4,867,000 and $14,297,000 for the same periods in 2016, an increase of 8.57% and 6.75%. The increase in net interest income for the three and nine months ended September 30, 2017 as compared with the comparable periods in 2016 primarily is attributable to the increase in interest income resulting from increased loan balances and, in the third quarter, the previously discussed increase in short term rates by the FOMC. The net interest margin was 3.65% and 3.68% for the three and nine months ended September 30, 2017, as compared to 3.76% and 3.80% for the same periods a year ago.

Financial’s net interest margin analysis and average balance sheets are shown in Schedule I below.

Non-Interest Income

Non-interest income is comprised primarily of fees and charges on transactional deposit accounts, gains on sales of mortgage loans held for sale, commissions on sales of investments and the Bank’s ownership interest in a title insurance agency. Non-interest income increased to $1,319,000 for the three months ended September 30, 2017 from $1,281,000 for the three months ended September 30, 2016.

This increase for the three months ended September 30, 2017 as compared to the same period last year was due primarily due to an increase in gains on sales of loans held for sale from $593,000 for the three months ended September 30, 2016 to $694,000 for the period ended September 30, 2017 as well increases in service charges, fees, and commissions and an increase in the cash value of life insurance from the comparable periods ended September 30, 2016. The increase for the three months ended September 30, 2017 was partially offset by a decrease in gains on sales and calls of securities from $210,000 for the three months ended September 30, 2016 to $51,000 for the same period this year.

Non-interest income decreased to $3,454,000 for the nine months ended September 30, 2017 from $3,605,000 for the nine months ended September 30, 2016. This decrease for the nine months ended September 30, 2017 as compared to the same period last year was due primarily due to a decrease in gains on sales of loans held for sale from $1,765,000 to $1,663,000 as well as a decrease in gains on sales and calls of securities from $444,000 to $113,000 for the same periods this year. The decrease for the nine months ended September 30, 2017 was partially offset by increases in service charges, fees, and commissions and an increase in the cash value of life insurance from the comparable periods ended September 30, 2016. These areas increased due to customer activity and utilization of services and additional purchases of BOLI in the third quarter of 2016.

The Bank, through its Mortgage division, originates both conforming and non-conforming consumer residential mortgage loans in the markets we serve. As part of the Bank’s overall risk management strategy, all of the loans originated and closed by the Mortgage division are presold to major national mortgage banking or financial institutions. The Mortgage division assumes, except in limited circumstances such as first payment default, no credit or interest rate risk on these mortgages.

Purchase mortgage originations totaled $16,860,728 and $39,015,600, or 67.00% and 65.82% respectively, of the total mortgage loans originated in the three and nine months ended September 30, 2017 as compared to $11,921,674 and $38,401,785, or 54.43% and 62.13%, respectively, of the total mortgage loans originated in the same periods in 2016. The increase in amount of purchase mortgage originations for the first nine months of 2017 resulted from the Bank’s increased presence in the Charlottesville, Harrisonburg and Roanoke markets as well as continually favorable longer-term interest rates. However, despite the increase in longer-term rates, refinancing activity continued primarily due to the relatively low interest rate environment as compared to long-term historical interest rate levels. Management anticipates that purchase mortgage originations going forward will represent a majority of mortgage originations as they have in the recent past.

 

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Despite the recent fluctuations in rates, management anticipates that residential mortgage rates will remain near the current historic lows for the remainder of 2017. Management expects that attractive rates coupled with the Mortgage division’s reputation in Region 2000, steady residential real estate inventory and the recent hiring of additional mortgage loan originators in Roanoke, Harrisonburg and Charlottesville will result in strong mortgage originations through the remainder of 2017. In addition, Management believes that regulatory pressure may result in a decreased number of competitors to the Mortgage division and this could result in an increase in market share. Management also believes that in the event that interest rates rise, revenue from the mortgage segment could be under pressure.

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 the Investment division’s impact on noninterest income will remain immaterial in 2017.

The Bank provides insurance and annuity products to Bank customers and others, through the Bank’s Insurance subsidiary. The Bank has three full-time employees 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.

Non-Interest Expense

Non-interest expense for the three and nine months ended September 30, 2017 increased to $4,914,000 and $14,237,000 from $4,449,000 and $12,893,000, increases of 10.45% and 10.42% from the comparable periods in 2016. These increases resulted from increases for personnel expense primarily related to the expansion into Charlottesville, Harrisonburg, and Roanoke, as well as increases in credit expense, marketing expenses, occupancy expenses, equipment expenses, and supplies expense. Total personnel expense was $2,538,000 and $7,314,000 for the three and nine month periods ended September 30, 2017 as compared to $2,318,000 and $6,717,000 for the same periods in 2016.

Allowance for Loan Losses

The allowance for loan losses represents an amount that, in our judgment, will be adequate to absorb probable losses inherent in the loan portfolio. The provision for loan losses increases the allowance, and loans charged off, net of recoveries, reduce the allowance. The provision to the allowance for loan losses is charged to earnings to bring the total allowance to a level deemed appropriate by management and is based upon two components – specific impairment and general reserves. As discussed below, loans having a risk rating of 7 or below that are 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 when due, are evaluated for specific impairment. The general reserve component is based on an evaluation of general economic conditions, actual and expected credit losses, and loan performance measures. Based on the application of the loan loss calculation, the Bank provided $200,000 and $745,000 to the allowance for loan losses for the three and nine month periods ended September 30, 2017. This compares to the provision of $145,000 and $595,000 for the comparable periods in 2016, representing increases of 37.93% and 25.21%, respectively.

 

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Charged-off loans, which are loans that management deems uncollectible, are charged against the allowance for loan losses and constitute a realized loss. Charged-off loans were $325,000 for the three months ended September 30, 2017 as compared to $114,000 for the comparable period in 2016. While a charged off loan may subsequently be collected, such recoveries generally are realized over an extended period of time. In the three months ended September 30, 2017, the Bank had recoveries of charged off loans of $13,000 as compared with $35,000 for the comparable period in 2016.

In light of the current economic environment, management continues its ongoing assessment of specific impairment in the Bank’s loan portfolio. As set forth in the tables below, the Bank’s allowance arising from the specific impairment evaluation as of September 30, 2017 increased as compared to December 31, 2016.

For the nine months ended September 30, 2017, the Bank had a minimal change in asset quality from December 31, 2016. As shown in the table below, although the total balance in the reserve increased, the allowance for loan losses to total loans decreased slightly to 1.20% as of September 30, 2017 from 1.22% as of December 31, 2016 due to an increase the Bank’s loan balances. The overall balance in the allowance for loan losses increased from $5,716,000 as of December 31, 2016 to $6,020,000 on September 30, 2017. The inherent risks associated with the increasing industry concentrations and commercial real estate concentrations within the portfolio have increased the qualitative portion of the general reserve. Management believes that the current allowance for loan losses is adequate.

The following tables summarize the allowance activity for the periods indicated:

 

    

Allowance for Loan Losses and Recorded Investment in Loans

(dollars in thousands)

 
     As of and For the Nine Months Ended September 30, 2017  
2017    Commercial     Commercial
Real Estate
    Consumer     Residential     Total  

Allowance for Loan Losses:

 

       

Beginning Balance

   $ 2,192     $ 2,109     $ 954     $ 461     $ 5,716  

Charge-offs

     (315     (17     (114     (105     (551

Recoveries

     5       24       42       39       110  

Provision

     537       (233 )(1)      272       169       745  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Ending Balance

   $ 2,419     $ 1,883     $ 1,154     $ 564     $ 6,020  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Ending Balance: Individually evaluated for impairment

   $ 1,301     $ 290     $ 307     $ 4     $ 1,902  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Ending Balance: Collectively evaluated for impairment

     1,118       1,593       847       560       4,118  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Totals:

   $ 2,419     $ 1,883     $ 1,154     $ 564     $ 6,020  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Loans:

 

       

Ending Balance: Individually evaluated for impairment

   $ 2,458     $ 3,437     $ 490     $ 1,602     $ 7,987  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Ending Balance: Collectively evaluated for impairment

     100,422       246,004       83,052       62,319       491,797  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Totals:

   $ 102,880     $ 249,441     $ 83,542     $ 63,921     $ 499,784  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

(1) Despite an increased concentration of loan balances in the commercial real estate segment, the allowance related to the segment decreased which resulted in a decrease in the provision for this category. Management has a process for the ongoing evaluation of our loans and the specific risks associated with concentrations in each segment.

 

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Allowance for Loan Losses and Recorded Investment in Loans

(dollars in thousands)

 
     As of and For the Year Ended December 31, 2016  
2016    Commercial     Commercial
Real Estate
    Consumer     Residential     Total  

Allowance for Loan Losses:

          

Beginning Balance

   $ 1,195     $ 1,751     $ 1,073     $ 664     $ 4,683  

Charge-offs

     (328     (156     (275     —         (759

Recoveries

     7       127       44       2       180  

Provision

     1,318 (2)      387 (2)      112       (205 )(1)      1,612  
  

 

 

   

 

 

     

 

 

   

 

 

 

Ending Balance

   $ 2,192     $ 2,109     $ 954     $ 461     $ 5,716  
  

 

 

   

 

 

     

 

 

   

 

 

 

Ending Balance: Individually evaluated for impairment

   $ 1,233     $ 345     $ 110     $ 83     $ 1,771  
  

 

 

   

 

 

     

 

 

   

 

 

 

Ending Balance: Collectively evaluated for impairment

     959       1,764       844       378       3,945  
  

 

 

   

 

 

     

 

 

   

 

 

 

Totals:

   $ 2,192     $ 2,109     $ 954     $ 461     $ 5,716  
  

 

 

   

 

 

     

 

 

   

 

 

 

Loans:

          

Ending Balance: Individually evaluated for impairment

   $ 2,219     $ 5,198     $ 128     $ 2,254     $ 9,799  
  

 

 

   

 

 

     

 

 

   

 

 

 

Ending Balance: Collectively evaluated for impairment

     85,866       232,440       84,971       56,993       460,270  
  

 

 

   

 

 

     

 

 

   

 

 

 

Totals:

   $ 88,085     $ 237,638     $ 85,099     $ 59,247     $ 470,069  
  

 

 

   

 

 

     

 

 

   

 

 

 

 

(1) The experience within the historical charge-off period used to calculate the allowance has improved which reduced the need for a provision relating to this segment.
(2) The increased concentration of loan balances in the commercial segments resulted in an increase in the provision for these categories. Management has a process for the ongoing evaluation of our loans and the specific risks associated with concentrations in each segment. Specific reserves increases accounted for the majority of the increase related to the commercial segment.

The following sets forth the reconciliation of the allowance for loan loss:

 

     Three months ended
September 30,
(in thousands)
     Nine months ended
September 30,
(in thousands)
 
     2017      2016      2017      2016  

Balance, beginning of period

   $ 6,132      $ 4,887      $ 5,716      $ 4,683  

Provision for loan losses

     200        145        745        595  

Loans charged off

     (325      (114      (551      (492

Recoveries of loans charged off

     13        35        110        167  
  

 

 

    

 

 

    

 

 

    

 

 

 

Net (charge offs)

     (312      (79      (441      (325
  

 

 

    

 

 

    

 

 

    

 

 

 

Balance, end of period

   $ 6,020      $ 4,953      $ 6,020      $ 4,953  
  

 

 

    

 

 

    

 

 

    

 

 

 

 

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No nonaccrual loans were excluded from impaired loan disclosure at September 30, 2017 and December 31, 2016. If interest on these loans had been accrued, such income cumulatively would have approximated $408,000 and $391,000 on September 30, 2017 and December 31, 2016, respectively. Loan payments received on nonaccrual loans are applied to principal. When a loan is placed on nonaccrual 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.

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

We segregate loans into the above categories based on the following criteria and 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

 

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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 provides 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 extremely 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.

Income Taxes

For the three and nine months ended September 30, 2017, Financial had an income tax expense of $474,000 and $1,172,000 as compared to $499,000 and $1,421,000 for the same periods in 2016. This represents an effective tax rate of 31.83% and 31.39% for the three and nine months ended September 30, 2017 as compared with 32.11% and 32.19% for the three and nine months ended September 30, 2016. Our effective rate was lower than the statutory corporate tax rate in both quarters because of federal income tax benefits resulting from the tax treatment of earnings on bank owned life insurance and certain tax free municipal securities. The changes in effective tax rates from year to year are primarily the result of slightly lower pre-tax earnings and relatively comparable levels of these tax-exempt sources of income.

 

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Schedule I

Net Interest Margin Analysis

Average Balance Sheets

For the Quarter Ended September 30, 2017 and 2016

(dollars in thousands)

 

     2017     2016  
    

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)

   $ 493,179     $ 5,654        4.55   $ 460,505     $ 5,186        4.52

Loans held for sale

     3,169       29        3.63     4,082       41        4.03

Fed funds sold

     14,570       45        1.23     7,237       4        0.22

Interest bearing bank balances

     7,000       21        1.19     6,000       13        0.87

Securities (3)

     54,791       318        2.30     40,890       232        2.28

Federal agency equities

     1,389       7        2.00     1,257       6        1.91

CBB equity

     116       —          —         116       —          —    
  

 

 

   

 

 

    

 

 

   

 

 

   

 

 

    

 

 

 

Total earning assets

     574,214       6,074        4.20     520,087       5,482        4.23
    

 

 

    

 

 

     

 

 

    

 

 

 

Allowance for loan losses

     (6,128          (4,963     

Non-earning assets

     44,361            37,223       
  

 

 

        

 

 

      

Total assets

   $ 612,447          $ 552,347       
  

 

 

        

 

 

      

LIABILITIES AND STOCKHOLDERS’ EQUITY

              

Deposits

              

Demand interest bearing

   $ 146,745     $ 129        0.35   $ 130,523     $ 93        0.29

Savings

     104,738       57        0.22     109,028       60        0.22

Time deposits

     177,147       537        1.20     161,781       457        1.13
  

 

 

   

 

 

    

 

 

   

 

 

   

 

 

    

 

 

 

Total interest bearing deposits

     428,630       723        0.67     401,332       610        0.61

Other borrowed funds

              

Repurchase agreements

     2,880       13        1.79     —         —          —    

Capital Notes

     5,000       50        3.97     —         —          —    
  

 

 

   

 

 

    

 

 

   

 

 

   

 

 

    

 

 

 

Total interest-bearing liabilities

     436,510       786        0.71     401,332       610        0.61
    

 

 

    

 

 

     

 

 

    

 

 

 

Non-interest bearing deposits

     122,999            99,839       

Other liabilities

     954            1,016       
  

 

 

        

 

 

      

Total liabilities

     560,463            502,187       

Stockholders’ equity

     51,984            50,160       
  

 

 

        

 

 

      

Total liabilities and Stockholders’ equity

   $ 612,447          $ 552,347       
  

 

 

        

 

 

      

Net interest income

     $ 5,288          $ 4,872     
    

 

 

        

 

 

    

Net interest margin

          3.65          3.76
       

 

 

        

 

 

 

Interest spread

          3.49          3.62
       

 

 

        

 

 

 

 

(1) Net accretion or amortization of 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 non-accrual loans.
(3) The interest income and yields calculated on securities have been tax affected to reflect any tax exempt interest on municipal securities. An assumed income tax rate of 34% was used in the calculation.

 

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Net Interest Margin Analysis

Average Balance Sheets

For the Nine Months Ended September 30, 2017 and 2016

(dollars in thousands)

 

     2017     2016  
    

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)

   $ 480,317     $ 16,266        4.53   $ 446,637     $ 15,115        4.52

Loans held for sale

     2,309       70        4.05     3,615       97        3.59

Federal funds sold

     10,276       81        1.05     5,814       16        0.37

Interest bearing bank balances

     7,000       53        1.01     6,000       28        0.62

Securities (3)

     53,293       932        2.34     39,851       726        2.44

Federal agency equities

     1,331       42        4.22     1,237       39        4.22

CBB equity

     116       —          —         116       —          —    
  

 

 

   

 

 

    

 

 

   

 

 

   

 

 

    

 

 

 

Total earning assets

     554,642       17,444