10-Q 1 form10q.htm FORM 10-Q 2017 Q1 10-Q
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-Q

(Mark One)
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 2017

or

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

For the transition period from____________ to___________

Commission File Number: 000-12896

OLD POINT FINANCIAL CORPORATION
(Exact name of registrant as specified in its charter)

VIRGINIA
54-1265373
(State or other jurisdiction of incorporation or organization)
(I.R.S. Employer Identification No.)

1 West Mellen Street, Hampton, Virginia 23663
(Address of principal executive offices) (Zip Code)

(757) 728-1200
(Registrant's telephone number, including area code)

Not Applicable
(Former name, former address and former fiscal year, if changed since last report)

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, or a smaller reporting company. See the definitions of "large accelerated filer," "accelerated filer" and "smaller reporting company" in Rule 12b-2 of the Exchange Act.

Large accelerated filer
Accelerated filer
   
Non-accelerated filer
(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 in Rule 12b-2 of the Exchange Act).
Yes       No

Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date.

4,978,337 shares of common stock ($5.00 par value) outstanding as of April 28, 2017



OLD POINT FINANCIAL CORPORATION

FORM 10-Q

INDEX

 
PART I - FINANCIAL INFORMATION
Page
     
Item 1.
1
     
 
1
     
 
2
     
 
3
     
 
4
     
 
5
     
 
6
     
Item 2.
31
     
Item 3.
41
     
Item 4.
41
     
 
PART II - OTHER INFORMATION
 
     
Item 1.
42
     
Item 1A.
42
     
Item 2.
42
     
Item 3.
42
     
Item 4.
43
     
Item 5.
43
     
Item 6.
43
     
 
43






i



PART I – FINANCIAL INFORMATION

Item 1.  Financial Statements.

Old Point Financial Corporation and Subsidiaries
Consolidated Balance Sheets

   
March 31, 2017
   
December 31, 2016
 
   
(dollars in thousands except per share data)
 
   
(unaudited)
       
Assets
           
             
Cash and due from banks
 
$
19,264
   
$
21,885
 
Interest-bearing due from banks
   
563
     
1,667
 
Federal funds sold
   
683
     
2,302
 
Cash and cash equivalents
   
20,510
     
25,854
 
Securities available-for-sale, at fair value
   
195,198
     
199,365
 
Restricted securities
   
977
     
970
 
Loans, net of allowance for loan losses of $8,523 and $8,245
   
625,787
     
595,637
 
Premises and equipment, net
   
38,876
     
39,324
 
Bank-owned life insurance
   
25,404
     
25,206
 
Other real estate owned, net of valuation allowance of $1,026
   
1,067
     
1,067
 
Other assets
   
14,957
     
15,543
 
Total assets
 
$
922,776
   
$
902,966
 
                 
Liabilities & Stockholders' Equity
               
                 
Deposits:
               
Noninterest-bearing deposits
 
$
233,640
   
$
228,641
 
Savings deposits
   
356,175
     
344,452
 
Time deposits
   
203,577
     
211,409
 
Total deposits
   
793,392
     
784,502
 
Overnight repurchase agreements
   
28,128
     
18,704
 
Accrued expenses and other liabilities
   
6,135
     
5,770
 
Total liabilities
   
827,655
     
808,976
 
                 
Commitments and contingencies
               
                 
Stockholders' equity:
               
Common stock, $5 par value, 10,000,000 shares authorized; 4,977,267 and 4,961,258 shares issued and outstanding
   
24,886
     
24,806
 
Additional paid-in capital
   
16,655
     
16,427
 
Retained earnings
   
57,360
     
56,965
 
Accumulated other comprehensive loss, net
   
(3,780
)
   
(4,208
)
Total stockholders' equity
   
95,121
     
93,990
 
Total liabilities and stockholders' equity
 
$
922,776
   
$
902,966
 

See Notes to Consolidated Financial Statements.
- 1 -


Old Point Financial Corporation and Subsidiaries
Consolidated Statements of Income
   
Three Months Ended March 31,
 
   
2017
   
2016
 
   
(unaudited, dollars in thousands except per share data)
 
Interest and Dividend Income:
           
Interest and fees on loans
 
$
6,780
   
$
6,413
 
Interest on due from banks
   
5
     
4
 
Interest on federal funds sold
   
3
     
1
 
Interest on securities:
               
Taxable
   
496
     
548
 
Tax-exempt
   
427
     
384
 
Dividends and interest on all other securities
   
14
     
15
 
Total interest and dividend income
   
7,725
     
7,365
 
                 
Interest Expense:
               
Interest on savings deposits
   
64
     
55
 
Interest on time deposits
   
519
     
517
 
Interest on federal funds purchased, securities sold under agreements to repurchase and other borrowings
   
5
     
6
 
Interest on Federal Home Loan Bank advances
   
0
     
141
 
Total interest expense
   
588
     
719
 
Net interest income
   
7,137
     
6,646
 
Provision for loan losses
   
650
     
150
 
Net interest income, after provision for loan losses
   
6,487
     
6,496
 
                 
Noninterest Income:
               
Income from fiduciary activities
   
966
     
901
 
Service charges on deposit accounts
   
927
     
975
 
Other service charges, commissions and fees
   
1,016
     
1,018
 
Income from bank-owned life insurance
   
198
     
215
 
Gain on sale of available-for-sale securities, net
   
0
     
509
 
Other operating income
   
56
     
47
 
Total noninterest income
   
3,163
     
3,665
 
                 
Noninterest Expense:
               
Salaries and employee benefits
   
5,097
     
5,154
 
Occupancy and equipment
   
1,449
     
1,358
 
Data processing
   
414
     
422
 
FDIC insurance
   
96
     
165
 
Customer development
   
144
     
150
 
Legal and audit expenses
   
174
     
202
 
Other outside service fees
   
199
     
183
 
Employee professional development
   
236
     
148
 
Capital stock tax
   
143
     
135
 
ATM and other losses
   
177
     
87
 
Prepayment fee on Federal Home Loan Bank advance
   
0
     
391
 
Loss on other real estate owned
   
0
     
99
 
Other operating expenses
   
577
     
597
 
Total noninterest expense
   
8,706
     
9,091
 
Income before income taxes
   
944
     
1,070
 
Income tax expense
   
2
     
49
 
Net income
 
$
942
   
$
1,021
 
                 
Basic earnings per share
               
Weighted average shares outstanding
   
4,977,267
     
4,959,009
 
Net income per share of common stock
 
$
0.19
   
$
0.21
 
                 
Diluted earnings per share
               
Weighted average shares outstanding
   
4,991,864
     
4,959,009
 
Net income per share of common stock
 
$
0.19
   
$
0.21
 

See Notes to Consolidated Financial Statements.
- 2 -


Old Point Financial Corporation and Subsidiaries
Consolidated Statements of Comprehensive Income

 
Three Months Ended March 31,
 
 
2017
   
2016
 
 
(unaudited, in thousands)
 
Net income
 
$
942
   
$
1,021
 
Other comprehensive income, net of tax
               
Net unrealized gain on available-for-sale securities
   
428
     
515
 
Other comprehensive income, net of tax
   
428
     
515
 
Comprehensive income
 
$
1,370
   
$
1,536
 

See Notes to Consolidated Financial Statements.
- 3 -


Old Point Financial Corporation and Subsidiaries
Consolidated Statements of Changes in Stockholders' Equity

   
Shares of
Common
Stock
   
Common
Stock
   
Additional
Paid-in
Capital
   
Retained
Earnings
   
Accumulated
Other
Comprehensive
Loss
   
Total
 
   
(unaudited, dollars in thousands except per share data)
 
THREE MONTHS ENDED MARCH 31, 2017
                         
                                     
Balance at beginning of period
   
4,961,258
   
$
24,806
   
$
16,427
   
$
56,965
   
$
(4,208
)
 
$
93,990
 
Net income
   
0
     
0
     
0
     
942
     
0
     
942
 
Other comprehensive income, net of tax
   
0
     
0
     
0
     
0
     
428
     
428
 
Exercise of stock options
   
18,006
     
90
     
271
     
0
     
0
     
361
 
Employee Stock Purchase Plan share issuance
   
773
     
4
     
17
     
0
     
0
     
21
 
Repurchase of common stock related to stock option exercises
   
(2,770
)
   
(14
)
   
(60
)
   
0
     
0
     
(74
)
Cash dividends ($0.11 per share)
   
0
     
0
     
0
     
(547
)
   
0
     
(547
)
                                                 
Balance at end of period
   
4,977,267
   
$
24,886
   
$
16,655
   
$
57,360
   
$
(3,780
)
 
$
95,121
 
                                   
                                   
THREE MONTHS ENDED MARCH 31, 2016
                                 
                                                 
Balance at beginning of period
   
4,959,009
   
$
24,795
   
$
16,392
   
$
55,151
   
$
(3,162
)
 
$
93,176
 
Net income
   
0
     
0
     
0
     
1,021
     
0
     
1,021
 
Other comprehensive income, net of tax
   
0
     
0
     
0
     
0
     
515
     
515
 
Cash dividends ($0.10 per share)
   
0
     
0
     
0
     
(496
)
   
0
     
(496
)
                                                 
Balance at end of period
   
4,959,009
   
$
24,795
   
$
16,392
   
$
55,676
   
$
(2,647
)
 
$
94,216
 

See Notes to Consolidated Financial Statements.
- 4 -


Old Point Financial Corporation and Subsidiaries
Consolidated Statements of Cash Flows

   
Three Months Ended March 31,
 
   
2017
   
2016
 
   
(unaudited, dollars in thousands)
 
CASH FLOWS FROM OPERATING ACTIVITIES
           
Net income
 
$
942
   
$
1,021
 
Adjustments to reconcile net income to net cash provided by operating activities:
               
Depreciation and amortization
   
698
     
667
 
Provision for loan losses
   
650
     
150
 
Net gain on sale of available-for-sale securities
   
0
     
(509
)
Net amortization of securities
   
602
     
514
 
Net gain on disposal of premises and equipment
   
0
     
(10
)
Net loss on write-down/sale of other real estate owned
   
0
     
99
 
Income from bank owned life insurance
   
(198
)
   
(215
)
(Increase) decrease in other assets
   
365
     
(472
)
Increase (decrease) in other liabilities
   
365
     
(16
)
Net cash provided by operating activities
   
3,424
     
1,229
 
                 
CASH FLOWS FROM INVESTING ACTIVITIES
               
Purchases of available-for-sale securities
   
(21,650
)
   
(61,690
)
Proceeds from redemption (cash used in purchases) of restricted securities, net
   
(7
)
   
1,046
 
Proceeds from maturities and calls of available-for-sale securities
   
22,400
     
20,740
 
Proceeds from sales of available-for-sale securities
   
1,000
     
58,361
 
Paydowns on available-for-sale securities
   
2,464
     
3,102
 
(Purchases) paydowns of consumer installment loans, net
   
(4,217
)
   
603
 
Net increase in all other loans (including repayments on student loans)
   
(26,583
)
   
(5,689
)
Proceeds from sales of other real estate owned
   
0
     
399
 
Purchases of premises and equipment
   
(250
)
   
(371
)
Net cash provided by (used in) investing activities
   
(26,843
)
   
16,501
 
                 
CASH FLOWS FROM FINANCING ACTIVITIES
               
Increase (decrease) in noninterest-bearing deposits
   
4,999
     
(9,925
)
Increase (decrease) in savings deposits
   
11,723
     
(9,948
)
Decrease in time deposits
   
(7,832
)
   
(1,919
)
Increase in federal funds purchased, repurchase agreements and other borrowings, net
   
9,424
     
5,828
 
Repayment of Federal Home Loan Bank advances
   
0
     
(25,000
)
Proceeds from exercise of stock options and ESPP issuance
   
382
     
0
 
Repurchase and retirement of common stock
   
(74
)
   
0
 
Cash dividends paid on common stock
   
(547
)
   
(496
)
Net cash provided by (used in) financing activities
   
18,075
     
(41,460
)
                 
Net decrease in cash and cash equivalents
   
(5,344
)
   
(23,730
)
Cash and cash equivalents at beginning of period
   
25,854
     
36,990
 
Cash and cash equivalents at end of period
 
$
20,510
   
$
13,260
 
                 
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION
               
Cash payments for:
               
Interest
 
$
595
   
$
740
 
Income tax
 
$
0
   
$
0
 
                 
SUPPLEMENTAL SCHEDULE OF NONCASH TRANSACTIONS
               
Unrealized gain on securities available-for-sale
 
$
648
   
$
780
 

See Notes to Consolidated Financial Statements.
- 5 -



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

Note 1. General

The accompanying unaudited consolidated financial statements of Old Point Financial Corporation (the Company) and its subsidiaries have been prepared in accordance with U.S. generally accepted accounting principles (GAAP) for interim financial information. All significant intercompany balances and transactions have been eliminated. In the opinion of management, the accompanying unaudited consolidated financial statements contain all adjustments and reclassifications of a normal and recurring nature considered necessary to present fairly the financial positions at March 31, 2017 and December 31, 2016 and the statements of income, comprehensive income, changes in stockholders' equity and cash flows for the three months ended March 31, 2017 and 2016. The results of operations for the interim periods are not necessarily indicative of the results that may be expected for the full year.

These consolidated financial statements should be read in conjunction with the consolidated financial statements and notes thereto included in the Company's 2016 annual report on Form 10-K. Certain previously reported amounts have been reclassified to conform to current period presentation, none of which were material in nature.

PRINCIPLES OF CONSOLIDATION

The consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries, The Old Point National Bank of Phoebus (the Bank) and Old Point Trust & Financial Services N.A. (Trust). All significant intercompany balances and transactions have been eliminated in consolidation. The Company consolidates subsidiaries in which it holds, directly or indirectly, more than 50 percent of the voting rights or where it exercises control. Entities where the Company holds 20 to 50 percent of the voting rights, or has the ability to exercise significant influence, or both, are accounted for under the equity method. As discussed below, the Company consolidates entities deemed to be variable interest entities (VIEs) when it is determined to be the primary beneficiary.

NATURE OF OPERATIONS

Old Point Financial Corporation is a holding company that conducts substantially all of its operations through two subsidiaries, The Old Point National Bank of Phoebus and Old Point Trust & Financial Services, N.A. The Bank serves individual and commercial customers, the majority of which are in Hampton Roads, Virginia. As of March 31, 2017, the Bank had 18 branch offices. The Bank offers a full range of deposit and loan products to its retail and commercial customers. Trust offers a full range of services for individuals and businesses. Products and services include retirement planning, estate planning, financial planning, estate and trust administration, retirement plan administration, tax services and investment management services.

VARIABLE INTEREST ENTITIES

A legal entity is referred to as a VIE if any of the following conditions exist, which are outlined in the Financial Accounting Standards Board (FASB) Accounting Standards Codification (ASC) variable interest accounting guidance (FASB ASC 810-10-15-14): (1) the total equity investment at risk is insufficient to permit the legal entity to finance its activities without additional subordinated financial support from other parties, or (2) the entity has equity investors that cannot make significant decisions about the entity's operations or that do not absorb their proportionate share of the expected losses or receive the expected returns of the entity.

In addition, as specified in VIE accounting guidance (FASB ASC 810-10-25-38), a VIE must be consolidated by the Company if it is deemed to be the primary beneficiary of the VIE, which is the party involved with the VIE that will absorb a majority of the expected losses, receive a majority of the expected residual returns, or both. At March 31, 2017, the Company had no VIEs that were consolidated. The Company did have an interest in one VIE, Old Point Mortgage, LLC (Old Point Mortgage), which was not consolidated because the Company determined that it was not the primary beneficiary.

On September 10, 2007, the Bank entered into a joint venture agreement with Tidewater Mortgage Services, Inc. (TMSI) to provide mortgage origination services through Old Point Mortgage, LLC (OPM), a joint venture between the Bank and TMSI. Per the terms of the joint venture agreement, TMSI and the Bank owned 51% and 49%, respectively, of OPM, and TMSI was the managing member. The parties' entry into this joint venture agreement was disclosed in the Company's current report on Form 8-K filed with the Securities and Exchange Commission (SEC) on September 11, 2007.
- 6 -

On January 13, 2017, the Bank entered into a membership interest purchase agreement (the Purchase Agreement) with TMSI to purchase TMSI's 51% interest in OPM, with the Bank to be the sole member of OPM upon completion of the purchase. The purchase price was equal to the book value of TMSI's capital account based on the Financial Statements of the Company as of March 31, 2017. The parties' entry into the Purchase Agreement was disclosed in the Company's current report on Form 8-K filed with the SEC on January 20, 2017.

On April 20, 2017, the Bank completed its purchase of TMSI's interest in OPM, which terminated the joint venture agreement between TMSI and the Bank and made OPM a wholly-owned subsidiary of the Bank as of that date. OPM's fair value is based on its financials as of March 31, 2017 and was determined by an independent third party. As a result of the fair value calculation, the Company expects to record income of approximately $500 thousand on the purchase in the second quarter of 2017, subject to additional review of the assumptions used in the final valuation report.

The factors that contributed to the goodwill recognition were:
  • The Bank's purchase of TMSI's 51% ownership at book value.
  • The requirement to record the Bank's 49% ownership at fair value.
  • The estimated reduction in operating expense from the elimination of management fees that were being paid to TMSI and the outsourcing of underwriting and secondary market sales.
The Bank will recognize approximately $62 thousand in expenses related to the merger; $50 thousand of the total is related to legal advice, and $12 thousand is related to valuation services. As of March 31, 2017, the Bank had incurred $33 thousand of the merger-related expenses, which were included in legal and other outside service expenses in the Consolidated Statements of Income for 2016 and the first quarter of 2017.

Note 2. Securities

Amortized costs and fair values of securities available-for-sale as of the dates indicated are as follows:

   
Amortized
Cost
   
Gross
Unrealized
Gains
   
Gross
Unrealized
Losses
   
Fair
Value
 
   
(in thousands)
 
March 31, 2017
                       
Obligations of  U.S. Government agencies
 
$
29,483
   
$
0
   
$
(117
)
 
$
29,366
 
Obligations of state and political subdivisions
   
76,058
     
539
     
(754
)
   
75,843
 
Mortgage-backed securities
   
83,347
     
7
     
(1,837
)
   
81,517
 
Money market investments
   
699
     
0
     
0
     
699
 
Corporate bonds and other securities
   
7,498
     
135
     
(8
)
   
7,625
 
Other marketable equity securities
   
100
     
48
     
0
     
148
 
Total
 
$
197,185
   
$
729
   
$
(2,716
)
 
$
195,198
 
                                 
December 31, 2016
                               
U.S. Treasury securities
 
$
20,000
   
$
0
   
$
0
   
$
20,000
 
Obligations of  U.S. Government agencies
   
9,361
     
0
     
(166
)
   
9,195
 
Obligations of state and political subdivisions
   
78,645
     
358
     
(1,016
)
   
77,987
 
Mortgage-backed securities
   
85,649
     
18
     
(1,973
)
   
83,694
 
Money market investments
   
647
     
0
     
0
     
647
 
Corporate bonds and other securities
   
7,598
     
92
     
(12
)
   
7,678
 
Other marketable equity securities
   
100
     
64
     
0
     
164
 
Total
 
$
202,000
   
$
532
   
$
(3,167
)
 
$
199,365
 

- 7 -



The following table summarizes realized gains and losses on the sale of investment securities during the periods indicated:

 
Three Months Ended
 
 
March 31,
 
 
2017
 
2016
 
 
(in thousands)
 
Securities Available-for-sale
           
Realized gains on sales of securities
 
$
0
   
$
548
 
Realized losses on sales of securities
   
0
     
(39
)
Net realized gain (loss)
 
$
0
   
$
509
 

OTHER-THAN-TEMPORARILY IMPAIRED SECURITIES

Management assesses whether the Company intends to sell or it is more-likely-than-not that the Company will be required to sell a security before recovery of its amortized cost basis less any current-period credit losses. For debt securities that are considered other-than-temporarily impaired and that the Company does not intend to sell and will not be required to sell prior to recovery of the amortized cost basis, the Company separates the amount of the impairment into the amount that is credit related (credit loss component) and the amount due to all other factors. The credit loss component is recognized in earnings and is the difference between the security's amortized cost basis and the present value of its expected future cash flows. The remaining difference between the security's fair value and the present value of expected future cash flows is due to factors that are not credit related, which are recognized in other comprehensive income.

The present value of expected future cash flows is determined using the best-estimate cash flows discounted at the effective interest rate implicit to the security at the date of purchase or the current yield to accrete an asset-backed or floating rate security. The methodology and assumptions for establishing the best-estimate cash flows vary depending on the type of security. The asset-backed securities cash flow estimates are based on bond specific facts and circumstances that may include collateral characteristics, expectations of delinquency and default rates, loss severity and prepayment speeds, and structural support, including subordination and guarantees.

The Company has a process in place to identify debt securities that could potentially have a credit or interest-rate related impairment that is other-than-temporary. This process involves monitoring late payments, pricing levels, downgrades by rating agencies, key financial ratios, financial statements, revenue forecasts, and cash flow projections as indicators of credit issues. On a quarterly basis, management reviews all securities to determine whether an other-than-temporary decline in value exists and whether losses should be recognized. Management considers relevant facts and circumstances in evaluating whether a credit or interest-rate related impairment of a security is other-than-temporary. Relevant facts and circumstances considered include: (a) the extent and length of time the fair value has been below cost; (b) the reasons for the decline in value; (c) the financial position and access to capital of the issuer, including the current and future impact of any specific events; and (d) for fixed maturity securities, the Company's intent to sell a security or whether it is more-likely-than-not the Company will be required to sell the security before the recovery of its amortized cost which, in some cases, may extend to maturity, and for equity securities, the Company's ability and intent to hold the security for a period of time that allows for the recovery in value.

The Company has not recorded impairment charges through income on securities for the three months ended March 31, 2017 or the year ended December 31, 2016.
- 8 -


TEMPORARILY IMPAIRED SECURITIES

The following table shows the number of securities with unrealized losses, and the gross unrealized losses and fair value of the Company's investments with unrealized losses that are deemed to be temporarily impaired, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position as of the dates indicated:

 
March 31, 2017
 
 
Less Than Twelve Months
 
More Than Twelve Months
   
Total
 
 
Gross
Unrealized
Losses
 
Fair
Value
 
Gross
Unrealized
Losses
 
Fair
Value
   
Gross
Unrealized
Losses
 
Fair
Value
 
Number
of
Securities
 
 
(dollars in thousands)
 
Securities Available-for-Sale
                           
Obligations of U.S. Government agencies
 
$
117
   
$
29,066
   
$
0
   
$
0
   
$
117
   
$
29,066
     
9
 
Obligations of state and political subdivisions
   
754
     
30,520
     
0
     
0
     
754
     
30,520
     
44
 
Mortgage-backed securities
   
1,837
     
78,173
     
0
     
0
     
1,837
     
78,173
     
23
 
Corporate bonds
   
7
     
1,791
     
1
     
100
     
8
     
1,891
     
13
 
Total securities available-for-sale
 
$
2,715
   
$
139,550
   
$
1
   
$
100
   
$
2,716
   
$
139,650
     
89
 

 
December 31, 2016
 
 
Less Than Twelve Months
 
More Than Twelve Months
 
Total
 
 
Gross
Unrealized
Losses
 
Fair
Value
 
Gross
Unrealized
Losses
 
Fair
Value
 
Gross
Unrealized
Losses
 
Fair
Value
 
Number
of
Securities
 
 
(dollars in thousands)
 
Securities Available-for-Sale
                           
Obligations of U.S. Government agencies
 
$
166
   
$
9,195
   
$
0
   
$
0
   
$
166
   
$
9,195
     
6
 
Obligations of state and political subdivisions
   
1,016
     
38,020
     
0
     
0
     
1,016
     
38,020
     
56
 
Mortgage-backed securities
   
1,973
     
80,680
     
0
     
0
     
1,973
     
80,680
     
23
 
Corporate bonds
   
11
     
1,787
     
1
     
100
     
12
     
1,887
     
13
 
Total securities available-for-sale
 
$
3,166
   
$
129,682
   
$
1
   
$
100
   
$
3,167
   
$
129,782
     
98
 

Certain investments within the Company's portfolio had unrealized losses at March 31, 2017 and December 31, 2016, as shown in the tables above. The unrealized losses were caused by increases in market interest rates. Because the Company does not intend to sell the investments and management believes it is unlikely that the Company will be required to sell the investments before recovery of their amortized cost basis, which may be maturity, the Company does not consider the investments to be other-than-temporarily impaired at March 31, 2017 or December 31, 2016.

Restricted Securities
The restricted security category is comprised of stock in the Federal Home Loan Bank of Atlanta (FHLB) and the Federal Reserve Bank (FRB). These stocks are classified as restricted securities because their ownership is restricted to certain types of entities and the securities lack a market. Therefore, FHLB and FRB stock is carried at cost and evaluated for impairment. When evaluating these stocks for impairment, their value is determined based on the ultimate recoverability of the par value rather than by recognizing temporary declines in value. Restricted stock is viewed as a long-term investment and management believes that the Company has the ability and the intent to hold this stock until its value is recovered.
- 9 -


Note 3. Loans and the Allowance for Loan Losses

The following is a summary of the balances in each class of the Company's loan portfolio as of the dates indicated:

   
March 31, 2017
   
December 31, 2016
 
   
(in thousands)
 
Mortgage loans on real estate:
           
Residential 1-4 family
 
$
95,392
   
$
94,827
 
Commercial
   
287,463
     
285,429
 
Construction
   
23,169
     
23,116
 
Second mortgages
   
17,496
     
17,128
 
Equity lines of credit
   
51,267
     
51,024
 
Total mortgage loans on real estate
   
474,787
     
471,524
 
Commercial loans
   
56,964
     
54,434
 
Consumer loans
   
87,111
     
58,907
 
Other
   
15,448
     
19,017
 
Total loans, net of deferred fees (1)
   
634,310
     
603,882
 
Less: Allowance for loan losses
   
(8,523
)
   
(8,245
)
Loans, net of allowance and deferred fees (1)
 
$
625,787
   
$
595,637
 

(1) Net deferred loan fees totaled $649 thousand and $522 thousand at March 31, 2017 and December 31, 2016, respectively.

Overdrawn deposit accounts are reclassified as loans and included in the Other category in the table above. Overdrawn deposit accounts totaled $585 thousand and $536 thousand at March 31, 2017 and December 31, 2016, respectively.

CREDIT QUALITY INFORMATION

The Company uses internally-assigned risk grades to estimate the capability of borrowers to repay the contractual obligations of their loan agreements as scheduled or at all. The Company's internal risk grade system is based on experiences with similarly graded loans. Credit risk grades are updated at least quarterly as additional information becomes available, at which time management analyzes the resulting scores to track loan performance.

The Company's internally assigned risk grades are as follows:
  • Pass: Loans are of acceptable risk.
  • Other Assets Especially Mentioned (OAEM): Loans have potential weaknesses that deserve management's close attention.
  • Substandard: Loans reflect significant deficiencies due to several adverse trends of a financial, economic or managerial nature.
  • Doubtful: Loans have all the weaknesses inherent in a substandard loan with added characteristics that make collection or liquidation in full based on currently existing facts, conditions and values highly questionable or improbable.
  • Loss: Loans have been identified for charge-off because they are considered uncollectible and of such little value that their continuance as bankable assets is not warranted.
 
- 10 -



The following table presents credit quality exposures by internally assigned risk ratings as of the dates indicated:

Credit Quality Information
As of March 31, 2017
 
   
Pass
   
OAEM
   
Substandard
   
Total
 
   
(in thousands)
 
Mortgage loans on real estate:
                       
Residential 1-4 family
 
$
92,812
   
$
1,125
   
$
1,455
   
$
95,392
 
Commercial
   
262,707
     
9,633
     
15,123
     
287,463
 
Construction
   
22,280
     
157
     
732
     
23,169
 
Second mortgages
   
16,815
     
467
     
214
     
17,496
 
Equity lines of credit
   
50,745
     
386
     
136
     
51,267
 
Total mortgage loans on real estate
   
445,359
     
11,768
     
17,660
     
474,787
 
Commercial loans
   
52,775
     
2,154
     
2,035
     
56,964
 
Consumer loans
   
86,974
     
0
     
137
     
87,111
 
Other
   
15,448
     
0
     
0
     
15,448
 
Total
 
$
600,556
   
$
13,922
   
$
19,832
   
$
634,310
 

Credit Quality Information
As of December 31, 2016
 
   
Pass
   
OAEM
   
Substandard
   
Total
 
   
(in thousands)
 
Mortgage loans on real estate:
                       
Residential 1-4 family
 
$
92,458
   
$
1,138
   
$
1,231
   
$
94,827
 
Commercial
   
260,948
     
10,014
     
14,467
     
285,429
 
Construction
   
22,219
     
162
     
735
     
23,116
 
Second mortgages
   
16,445
     
475
     
208
     
17,128
 
Equity lines of credit
   
50,387
     
500
     
137
     
51,024
 
Total mortgage loans on real estate
   
442,457
     
12,289
     
16,778
     
471,524
 
Commercial loans
   
49,979
     
2,278
     
2,177
     
54,434
 
Consumer loans
   
58,741
     
0
     
166
     
58,907
 
Other
   
19,017
     
0
     
0
     
19,017
 
Total
 
$
570,194
   
$
14,567
   
$
19,121
   
$
603,882
 

As of March 31, 2017 and December 31, 2016, the Company did not have any loans internally classified as Loss or Doubtful.
- 11 -


AGE ANALYSIS OF PAST DUE LOANS BY CLASS

All classes of loans are considered past due if the required principal and interest payments have not been received as of the date such payments were due. Interest and fees continue to accrue on past due loans until the date the loan is placed in nonaccrual status, if applicable. The following table includes an aging analysis of the recorded investment in past due loans as of the dates indicated. Also included in the table below are loans that are 90 days or more past due as to interest and principal and still accruing interest, because they are well-secured and in the process of collection. Loans in nonaccrual status that are also past due are included in the aging categories in the table below.

Age Analysis of Past Due Loans as of March 31, 2017
 
   
30 - 59
Days Past
Due
   
60 - 89
Days Past
Due
   
90 or More
Days Past
Due
   
Total Past
Due
   
Total
Current
Loans (1)
   
Total
Loans
   
Recorded
Investment
> 90 Days
Past Due
and
Accruing
 
   
(in thousands)
 
Mortgage loans on real estate:
                                         
Residential 1-4 family
 
$
618
   
$
123
   
$
391
   
$
1,132
   
$
94,260
   
$
95,392
   
$
0
 
Commercial
   
725
     
3,838
     
305
     
4,868
     
282,595
     
287,463
     
184
 
Construction
   
0
     
0
     
51
     
51
     
23,118
     
23,169
     
51
 
Second mortgages
   
83
     
0
     
53
     
136
     
17,360
     
17,496
     
0
 
Equity lines of credit
   
346
     
109
     
86
     
541
     
50,726
     
51,267
     
0
 
Total mortgage loans on real estate
   
1,772
     
4,070
     
886
     
6,728
     
468,059
     
474,787
     
235
 
Commercial loans
   
362
     
9
     
0
     
371
     
56,593
     
56,964
     
0
 
Consumer loans
   
1,382
     
509
     
2,789
     
4,680
     
82,431
     
87,111
     
2,708
 
Other
   
53
     
6
     
14
     
73
     
15,375
     
15,448
     
14
 
Total
 
$
3,569
   
$
4,594
   
$
3,689
   
$
11,852
   
$
622,458
   
$
634,310
   
$
2,957
 

(1) For purposes of this table, Total Current Loans includes loans that are 1 - 29 days past due.

In the table above, the consumer category includes student loans with principal and interest amounts that are 97 - 98% guaranteed by the federal government.  The past due principal portion of these guaranteed loans totaled $4.3 million at March 31, 2017.

Age Analysis of Past Due Loans as of December 31, 2016
 
   
30 - 59
Days Past
Due
   
60 - 89
Days Past
Due
   
90 or More
Days Past
Due
   
Total Past
Due
   
Total
Current
Loans (1)
   
Total
Loans
   
Recorded
Investment
> 90 Days
Past Due
and
Accruing
 
   
(in thousands)
 
Mortgage loans on real estate:
                                         
Residential 1-4 family
 
$
564
   
$
0
   
$
496
   
$
1,060
   
$
93,767
   
$
94,827
   
$
218
 
Commercial
   
2,280
     
1,625
     
227
     
4,132
     
281,297
     
285,429
     
0
 
Construction
   
162
     
0
     
0
     
162
     
22,954
     
23,116
     
0
 
Second mortgages
   
0
     
200
     
188
     
388
     
16,740
     
17,128
     
58
 
Equity lines of credit
   
394
     
9
     
86
     
489
     
50,535
     
51,024
     
0
 
Total mortgage loans on real estate
   
3,400
     
1,834
     
997
     
6,231
     
465,293
     
471,524
     
276
 
Commercial loans
   
5
     
0
     
86
     
91
     
54,343
     
54,434
     
0
 
Consumer loans
   
1,876
     
713
     
2,684
     
5,273
     
53,634
     
58,907
     
2,603
 
Other
   
41
     
12
     
5
     
58
     
18,959
     
19,017
     
5
 
Total
 
$
5,322
   
$
2,559
   
$
3,772
   
$
11,653
   
$
592,229
   
$
603,882
   
$
2,884
 

(1) For purposes of this table, Total Current Loans includes loans that are 1 - 29 days past due.

In the table above, the consumer category includes student loans with principal and interest amounts that are 97 - 98% guaranteed by the federal government.  The past due principal portion of these guaranteed loans totaled $4.8 million at December 31, 2016.
- 12 -


Although the portion of the student loan portfolio that is 90 days or more past due would normally be considered impaired, the Company does not include these loans in its impairment analysis. Because the federal government has provided guarantees of repayment of these student loans in an amount ranging from 97% to 98% of the total principal and interest of the loans, management does not expect significant increases in past due student loans to have a material effect on the Company.

NONACCRUAL LOANS

The Company generally places commercial loans (including construction loans and commercial loans secured and not secured by real estate) in nonaccrual status when the full and timely collection of interest or principal becomes uncertain, part of the principal balance has been charged off and no restructuring has occurred or the loan reaches 90 days past due, unless the credit is well-secured and in the process of collection.

Under regulatory rules, consumer loans, which are loans to individuals for household, family and other personal expenditures, and consumer loans secured by real estate (including residential 1 - 4 family mortgages, second mortgages, and equity lines of credit) are not required to be placed in nonaccrual status. Although consumer loans and consumer loans secured by real estate are not required to be placed in nonaccrual status, the Company may elect to place these loans in nonaccrual status, if necessary to avoid a material overstatement of interest income. Generally, consumer loans secured by real estate are placed in nonaccrual status only when payments are 120 days past due.

Generally, consumer loans not secured by real estate are placed in nonaccrual status only when part of the principal has been charged off. If a charge-off has not occurred sooner for other reasons, a consumer loan not secured by real estate will generally be placed in nonaccrual status when payments are 120 days past due. These loans are charged off or written down to the net realizable value of the collateral when deemed uncollectible, when classified as a "loss," when repayment is unreasonably protracted, when bankruptcy has been initiated, or when the loan is 120 days or more past due unless the credit is well-secured and in the process of collection.

When management places a loan in nonaccrual status, the accrued unpaid interest receivable is reversed against interest income and the loan is accounted for by the cash basis or cost recovery method, until it qualifies for return to accrual status or is charged off. Generally, loans are returned to accrual status when all the principal and interest amounts contractually due are brought current and future payments are reasonably assured, or when the borrower has resumed paying the full amount of the scheduled contractual interest and principal payments for at least six months.

The following table presents loans in nonaccrual status by class of loan as of the dates indicated:

Nonaccrual Loans by Class
 
   
March 31, 2017
   
December 31, 2016
 
   
(in thousands)
 
Mortgage loans on real estate
           
Residential 1-4 family
 
$
707
   
$
598
 
Commercial
   
10,000
     
6,033
 
Second mortgages
   
53
     
129
 
Equity lines of credit
   
86
     
87
 
Total mortgage loans on real estate
   
10,846
     
6,847
 
Commercial loans
   
105
     
231
 
Consumer loans
   
81
     
81
 
Total
 
$
11,032
   
$
7,159
 

The following table presents the interest income that the Company would have earned under the original terms of its nonaccrual loans and the actual interest recorded by the Company on nonaccrual loans for the periods presented:

 
Three Months Ended March 31,
 
 
2017
   
2016
 
 
(in thousands)
 
Interest income that would have been recorded under original loan terms
 
$
117
   
$
85
 
Actual interest income recorded for the period
   
87
     
38
 
Reduction in interest income on nonaccrual loans
 
$
30
   
$
47
 

- 13 -


TROUBLED DEBT RESTRUCTURINGS

The Company's loan portfolio includes certain loans that have been modified in a troubled debt restructuring (TDR), where economic concessions have been granted to borrowers who are experiencing financial difficulties. These concessions typically result from the Company's loss mitigation activities and could include reduction in the interest rate below current market rates for borrowers with similar risk profiles, payment extensions, forgiveness of principal, forbearance or other actions intended to maximize collection. The Company defines a TDR as nonperforming if the TDR is in nonaccrual status or is 90 days or more past due and still accruing interest at the report date.

When the Company modifies a loan, management evaluates any possible impairment as stated in the impaired loan section below.


The following table presents TDRs during the period indicated, by class of loan.

Troubled Debt Restructurings by Class
 
For the Three Months Ended March 31, 2017
 
(dollars in thousands)
 
   
Number of Modifications
   
Recorded Investment Prior to Modification
   
Recorded Investment After Modification
   
Current Investment on
March 31, 2017
 
Mortgage loans on real estate:                                
Residential 1-4 family
   
1
   
$
142
   
$
142
   
$
142
 
 
Troubled Debt Restructurings by Class
 
For the Three Months Ended March 31, 2016
 
(dollars in thousands)
 
   
Number of Modifications
   
Recorded Investment Prior to Modification
   
Recorded Investment After Modification
   
Current Investment on
March 31, 2016
 
Commercial loans
   
1
   
$
152
   
$
152
   
$
115
 

The loans restructured in the first three months of 2017 and 2016 were given below-market rates for debt with similar risk characteristics. At March 31, 2017 and December 31, 2016, the Company had no outstanding commitments to disburse additional funds on any TDR. At December 31, 2016, the Company had $10 thousand in loans secured by residential 1 - 4 family real estate that were in the process of foreclosure. There were no loans secured by residential 1 - 4 family real estate in the process of foreclosure at March 31, 2017.

In the first quarters of 2017 and 2016, there were no defaulting TDRs where the default occurred within twelve months of restructuring. The Company considers a TDR in default when any of the following occurs: the loan, as restructured, becomes 90 days or more past due; the loan is moved to nonaccrual status following the restructure; the loan is restructured again under terms that would qualify it as a TDR if it were not already so classified; or any portion of the loan is charged off.

All TDRs are factored into the determination of the allowance for loan losses and included in the impaired loan analysis, as discussed below.

IMPAIRED LOANS

A loan is considered impaired when, based on current information and events, it is probable that the Company will be unable to collect all amounts when due from the borrower in accordance with the contractual terms of the loan. Impaired loans include nonperforming loans and loans modified in a TDR. When management identifies a loan as impaired, the impairment is measured based on the present value of expected future cash flows, discounted at the loan's effective interest rate, except when the sole or remaining source of repayment for the loan is the operation or liquidation of the collateral. In these cases, management uses the current fair value of the collateral, less selling costs, when foreclosure is probable, instead of the discounted cash flows. If management determines that the value of the impaired loan is less than the recorded investment in the loan (net of previous charge-offs, deferred loan fees or costs and unamortized premium or discount), impairment is recognized through a specific allocation in the allowance or a charge-off to the allowance.
- 14 -


When the ultimate collectability of the total principal of an impaired loan is in doubt and the loan is in nonaccrual status, all payments are applied to principal under the cost-recovery method. For financial statement purposes, the recorded investment in the loan is the actual principal balance reduced by payments that would otherwise have been applied to interest. When reporting information on these loans to the applicable customers, the unpaid principal balance is reported as if payments were applied to principal and interest under the original terms of the loan agreements. Therefore, the unpaid principal balance reported to the customer would be higher than the recorded investment in the loan for financial statement purposes. When the ultimate collectability of the total principal of the impaired loan is not in doubt and the loan is in nonaccrual status, contractual interest is credited to interest income when received under the cash-basis method.

The following table includes the recorded investment and unpaid principal balances (a portion of which may have been charged off) for impaired loans with the associated allowance amount, if applicable, as of the dates presented. Also presented are the average recorded investments in the impaired loans and the related amount of interest recognized for the periods presented. The average balances are calculated based on daily average balances.

Impaired Loans by Class
 
 
As of March 31, 2017
 
For the three months ended
March 31, 2017
 
     
Recorded Investment
             
 
Unpaid
Principal
Balance
 
Without
Valuation
Allowance
 
With
Valuation
Allowance
 
Associated
Allowance
 
Average
Recorded
Investment
 
Interest
Income
Recognized
 
 
(in thousands)
 
Mortgage loans on real estate:
                       
Residential 1-4 family
 
$
2,451
   
$
1,937
   
$
459
   
$
59
   
$
2,407
   
$
27
 
Commercial
   
16,892
     
11,728
     
4,288
     
674
     
16,232
     
201
 
Construction
   
619
     
527
     
95
     
20
     
620
     
13
 
Second mortgages
   
541
     
255
     
257
     
16
     
539
     
6
 
Equity lines of credit
   
87
     
86
     
0
     
0
     
87
     
0
 
Total mortgage loans on real estate
 
$
20,590
   
$
14,533
   
$
5,099
   
$
769
   
$
19,885
   
$
247
 
Commercial loans
   
1,987
     
507
     
1,392
     
359
     
1,928
     
31
 
Consumer loans
   
81
     
81
     
0
     
0
     
81
     
0
 
Total
 
$
22,658
   
$
15,121
   
$
6,491
   
$
1,128
   
$
21,894
   
$
278
 

Impaired Loans by Class
 
   
As of December 31, 2016
 
For the Year Ended
December 31, 2016
 
       
Recorded Investment
             
   
Unpaid
Principal
Balance
 
Without
Valuation
Allowance
 
With
Valuation
Allowance
 
Associated
Allowance
 
Average
Recorded
Investment
 
Interest
Income
Recognized
 
   
(in thousands)
 
Mortgage loans on real estate:
                         
Residential 1-4 family
 
$
2,496
   
$
1,835
   
$
622
   
$
75
   
$
2,741
   
$
119
 
Commercial
   
16,193
     
11,095
     
4,274
     
415
     
11,885
     
727
 
Construction
   
619
     
528
     
96
     
22
     
496
     
43
 
Second mortgages
   
526
     
309
     
141
     
17
     
511
     
25
 
Equity lines of credit
   
87
     
86
     
0
     
0
     
46
     
3
 
Total mortgage loans on real estate
 
$
19,921
   
$
13,853
   
$
5,133
   
$
529
   
$
15,679
   
$
917
 
Commercial loans
   
1,077
     
0
     
989
     
271
     
827
     
74
 
Consumer loans
   
81
     
81
     
0
     
0
     
68
     
1
 
Total
 
$
21,079
   
$
13,934
   
$
6,122
   
$
800
   
$
16,574
   
$
992
 

- 15 -



MONITORING OF LOANS AND EFFECT OF MONITORING FOR THE ALLOWANCE FOR LOAN LOSSES

Loan officers are responsible for continual portfolio analysis and prompt identification and reporting of problem loans, which includes assigning a risk grade to each applicable loan at its origination and revising such grade as the situation dictates. Loan officers maintain frequent contact with borrowers, which should enable the loan officer to identify potential problems before other personnel. In addition, meetings with loan officers and upper management are held to discuss problem loans and review risk grades. Nonetheless, in order to avoid over-reliance upon loan officers for problem loan identification, the Company's loan review system provides for review of loans and risk grades by individuals who are independent of the loan approval process. Risk grades and historical loss rates (determined by migration analysis) by risk grades are used as a component of the calculation of the allowance for loan losses.

ALLOWANCE FOR LOAN LOSSES

Management has an established methodology to determine the adequacy of the allowance for loan losses that assesses the risks and probable losses inherent in the loan portfolio. The Company segments the loan portfolio into categories as defined by Schedule RC-C of the Federal Financial Institutions Examination Council Consolidated Reports of Condition and Income Form 041 (Call Report).  Loans are segmented into the following pools: commercial, real estate-construction, real estate-mortgage, consumer and other loans. The Company also sub-segments the real estate-mortgage segment into four classes: residential 1-4 family, commercial real estate, second mortgages and equity lines of credit.

The Company uses an internally developed risk evaluation model in the estimation of the credit risk process. The model and assumptions used to determine the allowance are independently validated and reviewed to ensure that the theoretical foundation, assumptions, data integrity, computational processes and reporting practices are appropriate and properly documented.

Each portfolio segment has risk characteristics as follows:
  • Commercial: Commercial loans carry risks associated with the successful operation of a business or project, in addition to other risks associated with the ownership of a business. The repayment of these loans may be dependent upon the profitability and cash flows of the business. In addition, there is risk associated with the value of collateral other than real estate which may depreciate over time and cannot be appraised with as much precision.
  • Real estate-construction: Construction loans carry risks that the project will not be finished according to schedule, the project will not be finished according to budget and the value of the collateral may at any point in time be less than the principal amount of the loan. Construction loans also bear the risk that the general contractor, who may or may not be the loan customer, may be unable to finish the construction project as planned because of financial pressure unrelated to the project.
  • Real estate-mortgage: Residential mortgage loans and equity lines of credit carry risks associated with the continued credit-worthiness of the borrower and changes in the value of the collateral. Commercial real estate loans carry risks associated with the successful operation of a business if owner occupied. If non-owner occupied, the repayment of these loans may be dependent upon the profitability and cash flow from rent receipts.
  • Consumer loans: Consumer loans carry risks associated with the continued credit-worthiness of the borrowers and the value of the collateral. Consumer loans are more likely than real estate loans to be immediately adversely affected by job loss, divorce, illness or personal bankruptcy.
  • Other loans: Other loans are loans to mortgage companies, loans for purchasing or carrying securities, and loans to insurance, investment and finance companies. These loans carry risks associated with the successful operation of a business. In addition, there is risk associated with the value of collateral other than real estate which may depreciate over time, depend on interest rates or fluctuate in active trading markets.
Each segment of the portfolio is pooled by risk grade or by days past due. Consumer loans not secured by real estate and made to individuals for household, family and other personal expenditures are segmented into pools based on days past due, while all other loans, including loans to consumers that are secured by real estate, are segmented by risk grades. A historical loss percentage is then calculated by migration analysis and applied to each pool. The migration analysis applied to all pools is able to track the risk grading and historical performance of individual loans throughout a number of periods set by management, which provides management with information regarding trends (or migrations) in a particular loan segment. At December 31, 2016 and March 31, 2017, management used four twelve-quarter migration periods.

Management also provides an allocated component of the allowance for loans that are specifically identified that may be impaired, and are individually analyzed for impairment. An allocated allowance is established when the present value of expected future cash flows from the impaired loan (or the collateral value or observable market price of the impaired loan) is lower than the carrying value of that loan.
- 16 -


Based on credit risk assessments and management's analysis of qualitative factors, additional loss factors are applied to loan balances. These additional qualitative factors include: economic conditions, trends in growth, loan concentrations, changes in certain loans, changes in underwriting, changes in management and changes in the legal and regulatory environment.

ALLOWANCE FOR LOAN LOSSES BY SEGMENT

The total allowance reflects management's estimate of losses inherent in the loan portfolio at the balance sheet date. The Company considers the allowance for loan losses of $8.5 million adequate to cover loan losses inherent in the loan portfolio at March 31, 2017.

The following table presents, by portfolio segment, the changes in the allowance for loan losses and the recorded investment in loans for the periods presented. Allocation of a portion of the allowance to one category of loans does not preclude its availability to absorb losses in other categories.

ALLOWANCE FOR LOAN LOSSES AND RECORDED INVESTMENT IN LOANS
(in thousands)
For the Three Months Ended
March 31, 2017
 
Commercial
   
Real Estate -
Construction
   
Real Estate -
Mortgage (1)
   
Consumer
   
Other
   
Total
 
Allowance for Loan Losses:
                                   
Balance at the beginning of period
 
$
1,493
   
$
846
   
$
5,267
   
$
455
   
$
184
   
$
8,245
 
Charge-offs
   
(138
)
   
0
     
(204
)
   
(33
)
   
(31
)
   
(406
)
Recoveries
   
8
     
0
     
4
     
4
     
18
     
34
 
Provision for loan losses
   
105
     
(259
)
   
463
     
342
     
(1
)
   
650
 
Ending balance
 
$
1,468
   
$
587
   
$
5,530
   
$
768
   
$
170
   
$
8,523
 
Ending balance individually evaluated for impairment
 
$
359
   
$
20
   
$
749
   
$
0
   
$
0
   
$
1,128
 
Ending balance collectively evaluated for impairment
   
1,109
     
567
     
4,781
     
768
     
170
     
7,395
 
Ending balance
 
$
1,468
   
$
587
   
$
5,530
   
$
768
   
$
170
   
$
8,523
 
Loan Balances:
                                               
Ending balance individually evaluated for impairment
 
$
1,899
   
$
622
   
$
19,010
   
$
81
   
$
0
   
$
21,612
 
Ending balance collectively evaluated for impairment
   
55,065
     
22,547
     
432,608
     
87,030
     
15,448
     
612,698
 
Ending balance
 
$
56,964
   
$
23,169
   
$
451,618
   
$
87,111
   
$
15,448
   
$
634,310
 


For the Year Ended
December 31, 2016
 
Commercial
   
Real Estate -
Construction
   
Real Estate -
Mortgage (1)
   
Consumer
   
Other
   
Total
 
Allowance for Loan Losses:
                                   
Balance at the beginning of period
 
$
633
   
$
985
   
$
5,628
   
$
279
   
$
213
   
$
7,738
 
Charge-offs
   
(915
)
   
0
     
(504
)
   
(204
)
   
(147
)
   
(1,770
)
Recoveries
   
79
     
3
     
197
     
28
     
40
     
347
 
Provision for loan losses
   
1,696
     
(142
)
   
(54
)
   
352
     
78
     
1,930
 
Ending balance
 
$
1,493
   
$
846
   
$
5,267
   
$
455
   
$
184
   
$
8,245
 
Ending balance individually evaluated for impairment
 
$
271
   
$
22
   
$
507
   
$
0
   
$
0
   
$
800
 
Ending balance collectively evaluated for impairment
   
1,222
     
824
     
4,760
     
455
     
184
     
7,445
 
Ending balance
 
$
1,493
   
$
846
   
$
5,267
   
$
455
   
$
184
   
$
8,245
 
Loan Balances:
                                               
Ending balance individually evaluated for impairment
 
$
989
   
$
624
   
$
18,362
   
$
81
   
$
0
   
$
20,056
 
Ending balance collectively evaluated for impairment
   
53,445
     
22,492
     
430,046
     
58,826
     
19,017
     
583,826
 
Ending balance
 
$
54,434
   
$
23,116
   
$
448,408
   
$
58,907
   
$
19,017
   
$
603,882
 

(1) The real estate-mortgage segment includes residential 1 – 4 family, commercial real estate, second mortgages and equity lines of credit.
- 17 -


CHANGES IN ACCOUNTING METHODOLOGY

There were no changes in the Company's accounting methodology for the allowance for loan losses in the first three months of 2017.

Note 4. Low-Income Housing Tax Credits

The Company was invested in 4 separate housing equity funds at both March 31, 2017 and December 31, 2016. The general purpose of these funds is to encourage and assist participants in investing in low-income residential rental properties located in the Commonwealth of Virginia; develop and implement strategies to maintain projects as low-income housing; deliver Federal Low Income Housing Credits to investors; allocate tax losses and other possible tax benefits to investors; and preserve and protect project assets.

The investments in these funds were recorded as other assets on the consolidated balance sheets and were $3.8 million and $3.9 million at March 31, 2017 and December 31, 2016, respectively. The expected terms of these investments and the related tax benefits run through 2032. During the three months ended March 31, 2017 and 2016, the Company recognized tax credits and other tax benefits related to these investments of $122 thousand and $126 thousand, respectively. Total projected tax credits to be received for 2017 are $471 thousand, which is based on the most recent quarterly estimates received from the funds. Additional capital calls expected for the funds totaled $2.5 million at both March 31, 2017 and December 31, 2016 and are recorded in accrued expenses and other liabilities on the corresponding consolidated balance sheet. During the quarters ended March 31, 2017 and 2016, the Company recognized amortization expense of $80 thousand and $73 thousand, respectively, which is included within noninterest expense on the consolidated statements of income.

Note 5. Share-Based Compensation

The Company has adopted an employee stock purchase plan and offers share-based compensation through its equity compensation plans. Share-based compensation arrangements include stock options, restricted and unrestricted stock awards, restricted stock units, performance-based awards and stock appreciation rights. Accounting standards require all share-based payments to employees to be valued using a fair value method on the date of grant and to be expensed based on that fair value over the applicable vesting period. The Company accounts for forfeitures during the vesting period as they occur.

There were no equity awards granted in the first three months of 2017.

The Company's 1998 Stock Option Plan, pursuant to which stock options could be granted to key employees and non-employee directors, expired on March 9, 2008.  Stock options that were outstanding on March 9, 2008 remained outstanding in accordance with their terms, but no new awards could be granted under the plan after March 9, 2008. Options to purchase 42,599 shares of common stock were outstanding under the Company's 1998 Stock Option Plan at March 31, 2017. The exercise price of each option equals the market price of the Company's common stock on the date of the grant and each option's maximum term is ten years.

Stock option activity for the three months ended March 31, 2017 is summarized below:

   
Shares
   
Weighted
Average
Exercise
Price
 
Weighted
Average
Remaining
Contractual
Life
(in years)
 
Aggregate
Intrinsic
Value
(in thousands)
 
Options outstanding, January 1, 2017
   
60,605
   
$
20.05
         
Granted
   
0
     
0
         
Exercised
   
(18,006
)
   
20.05
         
Canceled or expired
   
0
     
0
         
Options outstanding, March 31, 2017
   
42,599
   
$
20.05
     
0.54
   
$
430
 
Options exercisable, March 31, 2017
   
42,599
   
$
20.05
     
0.54
   
$
430
 

The aggregate intrinsic value of a stock option in the table above represents the total pre-tax intrinsic value (the amount by which the current fair value of the underlying stock exceeds the exercise price of the option) that would have been received by the option holders had all option holders exercised their options on March 31, 2017. This amount changes based on changes in the fair value of the Company's common stock.

During the three months ended March 31, 2017, the Company received $361 thousand from the exercise of stock options. No options were exercised during the three months ended March 31, 2016.
- 18 -


No options were granted during the three months ended March 31, 2017 or the three months ended March 31, 2016. As of March 31, 2017, all outstanding stock options were fully vested and there was no unrecognized stock-based compensation expense.

The Old Point Financial Corporation 2016 Incentive Stock Plan permits the issuance of up to 300,000 shares of common stock for awards to key employees and non-employee directors of the Company and its subsidiaries in the form of stock options, restricted stock, restricted stock units, stock appreciation rights, stock awards and performance units. The Company did not award any equity compensation under the Incentive Stock Plan during 2016. Also, no equity compensation awards were granted during the three months ended March 31, 2017, although the Company anticipates beginning to award equity compensation to key employees and non-employee directors in 2017. Accordingly, as of March 31, 2017, there were no awards outstanding under the Incentive Stock Plan.

EMPLOYEE STOCK PURCHASE PLAN

Under the Company's Employee Stock Purchase Plan (ESPP), substantially all employees of the Company and its subsidiaries can authorize a specific payroll deduction from their base compensation for the periodic purchase of the Company's common stock. Shares of stock are issued quarterly at a discount to the market price of the Company's stock on the day of purchase, which can range from 0-15% and was set at 5% for 2016 and for the first three months of 2017.

Total stock purchases under the ESPP amounted to 999 shares during 2016. 773 shares were purchased under the ESPP during the three months ended March 31, 2017. At March 31, 2017, the Company had 248,228 remaining shares reserved for issuance under this plan.

Note 6. Pension Plan

The Company provides pension benefits for eligible participants through a non-contributory defined benefit pension plan. The plan was frozen effective September 30, 2006; therefore, no additional participants have been or will be added to the plan since that date. The components of net periodic pension plan cost are as follows for the periods indicated:

Three months ended March 31,
 
2017
   
2016
 
   
(in thousands)
 
Interest cost
 
$
67
   
$
70
 
Expected return on plan assets
   
(94
)
   
(98
)
Amortization of net loss
   
122
     
140
 
Net periodic pension plan cost
 
$
95
   
$
112
 

On November 23, 2016, the Company's Board of Directors voted to terminate the pension plan, effective January 31, 2017. The Company anticipates completing the transfer of all liabilities and administrative responsibilities under the plan by the end of the fourth quarter of 2017. At March 31, 2017, management had not yet determined the amount to be contributed to terminate the pension plan.

Note 7. Stockholders' Equity and Earnings per Share

STOCKHOLDERS' EQUITY – Accumulated Other Comprehensive Loss

The following table presents information on amounts reclassified out of accumulated other comprehensive loss, by category, during the periods indicated:

   
Three Months Ended March 31,
 
Affected Line Item on
   
2017
   
2016
 
Consolidated Statement of Income
Available-for-sale securities
 
(in thousands)
   
Realized gains on sales of securities
 
$
0
   
$
509
 
Gain on sale of available-for-sale securities, net
Tax effect
   
0
     
173
 
Income tax expense
   
$
0
   
$
336
   
- 19 -



The following table presents the changes in accumulated other comprehensive loss, by category, net of tax, for the periods indicated:

 
 
Unrealized Gains (Losses) on Available-for-Sale Securities
   
Defined Benefit Pension Plans
   
Accumulated Other Comprehensive Loss
 
   
(in thousands)
 
                   
Three Months Ended March 31, 2017
                 
                   
Balance at beginning of period
 
(1,739
)
 
(2,469
)
 
(4,208
)
Net change for the period
   
428
     
0
     
428
 
Balance at end of period
 
(1,311
)
 
(2,469
)
 
(3,780
)
                         
                         
Three Months Ended March 31, 2016
                       
                         
Balance at beginning of period
 
(576
)
 
(2,586
)
 
(3,162
)
Net change for the period
   
515
     
0
     
515
 
Balance at end of period
 
(61
)
 
(2,586
)
 
(2,647
)

The following table presents the change in each component of accumulated other comprehensive loss on a pre-tax and after-tax basis for the periods indicated.

 
Three Months Ended March 31, 2017
 
Pretax
 
Tax
 
Net-of-Tax
 
 
(in thousands)
 
             
Unrealized gains on available-for-sale securities:
                 
Unrealized holding gains arising during the period
 
$
648
   
$
220
   
$
428
 
Reclassification adjustment for gains recognized in income
   
0
     
0
     
0
 
Net unrealized gains on securities
   
648
     
220
     
428
 
                         
Total change in accumulated other comprehensive loss, net
 
$
648
   
$
220
   
$
428
 

 
Three Months Ended March 31, 2016
 
Pretax
 
Tax
 
Net-of-Tax
 
 
(in thousands)
 
             
Unrealized gains on available-for-sale securities:
                 
Unrealized holding gains arising during the period
 
$
1,289
   
$
438
   
$
851
 
Reclassification adjustment for gains recognized in income
   
(509
)
   
(173
)
   
(336
)
                         
Total change in accumulated other comprehensive loss, net
 
$
780
   
$
265
   
$
515
 

EARNINGS PER COMMON SHARE

Basic earnings per share is computed by dividing net income by the weighted average number of common shares outstanding during the period. Diluted earnings per share is computed using the weighted average number of common shares outstanding during the period, including the effect of dilutive potential common shares attributable to outstanding stock options. The Company had dilutive shares during the three months ended March 31, 2017; the total dilutive potential common shares was 14,597. The Company did not include an average of 70 thousand potential common shares attributable to outstanding stock options in the diluted earnings per share calculation for the first three months of 2016 because they were antidilutive.
- 20 -



Note 8. Recent Accounting Pronouncements

In January 2016, the FASB issued Accounting Standards Update (ASU) No. 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) Require 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) Require public business entities to use the exit price notion when measuring the fair value of financial instruments for disclosure purposes. 3) Require separate presentation of financial assets and financial liabilities by measurement category and form of financial asset (i.e., securities or loans and receivables). 4) Eliminate 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 public companies 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 currently assessing 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 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 Securities and Exchange Commission (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.

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 public business entities 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.
- 21 -


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 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.

During March 2017, the FASB issued ASU No. 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 No. 201708, "Receivables—Nonrefundable Fees and Other Costs (Subtopic 31020), 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 201708 will have on its (consolidated) financial statements.

Note 9. Fair Value Measurements

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" topics of FASB ASU 2010-06 and FASB ASU 2011-04, the fair value of a financial instrument is the price that would be received in the sale of an asset or transfer of 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 estimate 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 can be a reasonable point within a range that is most representative of fair value under current market conditions.

In estimating the fair value of assets and liabilities, the Company relies mainly on two models. The first model, used by the Company's bond accounting service provider, determines the fair value of securities. Securities are priced based on an evaluation of observable market data, including benchmark yield curves, reported trades, broker/dealer quotes, and issuer spreads. Pricing is also impacted by credit information about the issuer, perceived market movements, and current news events impacting the individual sectors. For assets other than securities and for all liabilities, fair value is determined using the Company's asset/liability modeling software. The software uses current yields, anticipated yield changes, and estimated duration of assets and liabilities to calculate fair value.
- 22 -


In accordance with ASC 820, "Fair Value Measurements and Disclosures," the Company groups its financial assets and financial liabilities generally measured at fair value into three levels, based on the markets in which the assets and liabilities are traded and the reliability of the assumptions used to determine fair value.

Level 1 –
Valuation is based on quoted prices in active markets for identical assets or liabilities that the reporting entity has the ability to access at the measurement date. Level 1 assets and liabilities generally include debt and equity securities that are traded in an active exchange market. Valuations are obtained from readily available pricing sources for market transactions involving identical assets or liabilities.

Level 2 –
Valuation is based on inputs other than quoted prices included within Level 1 that are observable for the asset or liability, either directly or indirectly. The valuation may be based on quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the asset or liability.

Level 3 –
Valuation is based on unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities. Level 3 assets and liabilities include financial instruments whose value is determined using pricing models, discounted cash flow methodologies, or similar techniques, as well as instruments for which determination of fair value requires significant management judgment or estimation.

An instrument's categorization within the valuation hierarchy is based upon the lowest level of input that is significant to the fair value measurement.

ASSETS MEASURED AT FAIR VALUE ON A RECURRING BASIS

Debt and equity securities with readily determinable fair values that are classified as "available-for-sale" are recorded at fair value, with unrealized gains and losses excluded from earnings and reported in other comprehensive income. Securities available-for-sale are recorded at fair value on a recurring basis. Fair value measurement is based upon quoted market prices, when available (Level 1). If quoted market prices are not available, fair values are measured utilizing independent valuation techniques of identical or similar securities for which significant assumptions are derived primarily from or corroborated by observable market data. Third party vendors compile prices from various sources and may determine the fair value of identical or similar securities by using pricing models that consider observable market data (Level 2). 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 available-for-sale securities are considered to be Level 2 securities.
- 23 -


The following table presents the balances of certain assets measured at fair value on a recurring basis as of the dates indicated:

     
Fair Value Measurements at March 31, 2017 Using
 
 
Balance
 
Quoted Prices in
Active Markets
for Identical
Assets
(Level 1)
 
Significant
Other
Observable
Inputs
(Level 2)
 
Significant
Unobservable
Inputs
(Level 3)
 
 
(in thousands)
 
Available-for-sale securities
               
Obligations of  U.S. Government agencies
 
$
29,366
   
$
0
   
$
29,366
   
$
0
 
Obligations of state and political subdivisions
   
75,843
     
0
     
75,843
     
0
 
Mortgage-backed securities
   
81,517
     
0
     
81,517
     
0
 
Money market investments
   
699
     
0
     
699
     
0
 
Corporate bonds
   
7,625
     
0
     
7,625
     
0
 
Other marketable equity securities
   
148
     
0
     
148
     
0
 
Total available-for-sale securities
 
$
195,198
   
$
0
   
$
195,198
   
$
0
 

         
Fair Value Measurements at December 31, 2016 Using
 
   
Balance
   
Quoted Prices in
Active Markets
for Identical
Assets
(Level 1)
   
Significant
Other
Observable
Inputs
(Level 2)
   
Significant
Unobservable
Inputs
(Level 3)
 
   
(in thousands)
 
Available-for-sale securities
                       
U.S. Treasury securities
 
$
20,000
   
$
0
   
$
20,000
   
$
0
 
Obligations of  U.S. Government agencies
   
9,195
     
0
     
9,195
     
0
 
Obligations of state and political subdivisions
   
77,987
     
0
     
77,987
     
0
 
Mortgage-backed securities
   
83,694
     
0
     
83,694
     
0
 
Money market investments
   
647
     
0
     
647
     
0
 
Corporate bonds
   
7,678
     
0
     
7,678
     
0
 
Other marketable equity securities
   
164
     
0
     
164
     
0
 
Total available-for-sale securities
 
$
199,365
   
$
0
   
$
199,365
   
$
0
 

ASSETS MEASURED AT FAIR VALUE ON A NONRECURRING BASIS

Under certain circumstances, adjustments are made to the fair value for assets and liabilities although they are not measured at fair value on an ongoing basis.

Impaired loans
A loan is considered impaired when, based on current information and events, it is probable that the Company will be unable to collect all amounts when due from the borrower in accordance with the contractual terms of the loan. The measurement of fair value and loss associated with impaired loans can be based on the observable market price of the loan, the fair value of the collateral securing the loan, or the present value of the loan's expected future cash flows. Collateral may be in the form of real estate or business assets including equipment, inventory, and accounts receivable, with the vast majority of the collateral in real estate.

The value of real estate collateral is determined utilizing an income, market, or cost valuation approach based on an appraisal conducted by an independent, licensed appraiser outside of the Company. In the case of loans with lower balances, the Company may obtain a real estate evaluation instead of an appraisal. Evaluations utilize many of the same techniques as appraisals, and are typically performed by independent appraisers. Once received, appraisals and evaluations are reviewed by trained staff independent of the lending function to verify consistency and reasonability. Appraisals and evaluations are based on significant unobservable inputs, including but not limited to: adjustments made to comparable properties, judgments about the condition of the subject property, the availability and suitability of comparable properties, capitalization rates, projected income of the subject or comparable properties, vacancy rates, projected depreciation rates, and the state of the local and regional economy. The Company may also elect to make additional reductions in the collateral value based on management's best judgment, which represents another source of unobservable inputs. Because of the subjective nature of collateral valuation, impaired loans are considered Level 3.
- 24 -


Impaired loans may be secured by collateral other than real estate. 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 receivable collateral are based on financial statement balances or aging reports (Level 3). If a loan is not collateral-dependent, its impairment may be measured based on the present value of expected future cash flows, discounted at the loan's effective interest rate. Because the loan is discounted at its effective rate of interest, rather than at a market rate, the loan is not considered to be held at fair value and is not included in the tables below. Collateral-dependent impaired loans allocated to the allowance for loan losses are measured at fair value on a nonrecurring basis. Any fair value adjustments are recorded in the period incurred as part of the provision for loan losses on the Consolidated Statements of Income.

Other Real Estate Owned (OREO)
Loans are transferred to OREO when the collateral securing them is foreclosed on. The measurement of gain or loss associated with OREOs is based on the fair value of the collateral compared to the unpaid loan balance and anticipated costs to sell the property. If there is a contract for the sale of a property, and management reasonably believes the transaction will be consummated in accordance with the terms of the contract, fair value is based on the sale price in that contract (Level 1). If management has recent information about the sale of identical properties, such as when selling multiple condominium units on the same property, the remaining units would be valued based on the observed market data (Level 2). Lacking either a contract or such recent data, management would obtain an appraisal or evaluation of the value of the collateral as discussed above under Impaired Loans (Level 3). After the asset has been booked, a new appraisal or evaluation is obtained when management has reason to believe the fair value of the property may have changed and no later than two years after the last appraisal or evaluation was received. Any fair value adjustments to OREOs below the original book value are recorded in the period incurred and expensed against current earnings.
- 25 -



The following table presents the assets carried on the consolidated balance sheets for which a nonrecurring change in fair value has been recorded. Assets are shown by class of loan and by level in the fair value hierarchy, as of the dates indicated. Certain impaired loans are valued by the present value of the loan's expected future cash flows, discounted at the loan's effective interest rate rather than at a market rate. These loans are not carried on the consolidated balance sheets at fair value and, as such, are not included in the table below.

         
Carrying Value at March 31, 2017 Using
 
   
Fair Value
   
Quoted Prices in Active Markets for Identical Assets
(Level 1)
   
Significant Other Observable Inputs
(Level 2)
   
Significant Unobservable Inputs
(Level 3)
 
   
(in thousands)
 
Impaired loans
                       
Mortgage loans on real estate:
                       
Residential 1-4 family
 
$
400
   
$
0
   
$
0
   
$
400
 
Commercial
   
2,056
     
0
     
0
     
2,056
 
Construction
   
74
     
0
     
0
     
74
 
Total mortgage loans on real estate
 
$
2,530
   
$
0
   
$
0
   
$
2,530
 
Commercial loans
   
1,033
     
0
     
0
     
1,033
 
Total
 
$
3,563
   
$
0
   
$
0
   
$
3,563
 
                                 
Other real estate owned
                               
Construction
 
$
940
   
$
0
   
$
0
   
$
940
 

         
Carrying Value at December 31, 2016 Using
 
   
Fair Value
   
Quoted Prices in Active Markets for Identical Assets
(Level 1)
   
Significant Other Observable Inputs
(Level 2)
   
Significant Unobservable Inputs
(Level 3)
 
   
(in thousands)
 
Impaired loans
                       
Mortgage loans on real estate:
                       
Residential 1-4 family
 
$
400
   
$
0
   
$
0
   
$
400
 
Commercial
   
1,483
     
0
     
0
     
1,483
 
Construction
   
74
     
0
     
0
     
74
 
Total mortgage loans on real estate
 
$
1,957
   
$
0
   
$
0
   
$
1,957
 
Commercial loans
   
718
     
0
     
0
     
718
 
Total
 
$
2,675
   
$
0
   
$
0
   
$
2,675
 
                                 
Other real estate owned
                               
Construction
 
$
940
   
$
0
   
$
0
   
$
940
 
- 26 -


The following table displays quantitative information about Level 3 Fair Value Measurements as of the dates indicated:

Quantitative Information About Level 3 Fair Value Measurements
   
Fair Value at
March 31, 2017
(dollars in thousands)
 
Valuation Techniques
Unobservable Input
 
Range (Weighted Average)
 
Impaired loans
               
Residential 1-4 family real estate
 
$
400
 
Market comparables
Selling costs
   
7.25
%
             
Liquidation discount
   
4.00
%
Commercial real estate
 
$
2,056
 
Market comparables
Selling costs
   
5.38% - 7.25% (6.47
%)
             
Liquidation discount
   
0.00% - 4.01% (2.71
%)
Construction
 
$
74
 
Market comparables
Selling costs
   
7.25
%
             
Liquidation discount
   
4.00
%
Commercial not secured by real estate
 
$
1,033
 
Market comparables
Liquidation discount
   
33.30% - 42.89% (38.52
%)
                     
Other real estate owned
                   
Construction
 
$
940
 
Market comparables
Selling costs
   
7.25
%
             
Liquidation discount
   
0.00
%

Quantitative Information About Level 3 Fair Value Measurements
   
Fair Value at
December 31, 2016
(dollars in thousands)
 
Valuation Techniques
Unobservable Input
 
Range (Weighted Average)
 
Impaired loans
               
Residential 1-4 family real estate
 
$
400
 
Market comparables
Selling costs
   
7.25
%
             
Liquidation discount
   
4.00
%
Commercial real estate
 
$
1,483
 
Market comparables
Selling costs
   
7.25
%
             
Liquidation discount
   
4.00
%
Construction
 
$
74
 
Market comparables
Selling costs
   
7.25
%
             
Liquidation discount
   
4.00
%
Commercial loans
 
$
718
 
Market comparables
Selling costs
   
0.00
%
             
Liquidation discount
   
0.00% - 38.58% (32.40
%)
                     
Other real estate owned
                   
Construction
 
$
940
 
Market comparables
Selling costs
   
7.25
%
             
Liquidation discount
   
0.00
%

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

The following methods and assumptions were used by the Company in estimating fair value disclosures for financial instruments:

CASH AND CASH EQUIVALENTS
The carrying amounts of cash and short-term instruments, including interest-bearing due from banks, approximate fair values.

RESTRICTED SECURITIES
The restricted security category is comprised of FHLB and FRB stock. These stocks are classified as restricted securities because their ownership is restricted to certain types of entities and they lack a market. When the FHLB or FRB repurchases stock, they repurchase at the stock's book value. Therefore, the carrying amounts of restricted securities approximate fair value.

LOANS RECEIVABLE
The fair value of a loan is based on its interest rate in relation to its risk profile, in comparison to what an investor could earn on a different investment with a similar risk profile. Variations in risk tolerance between lenders, and thus in risk pricing, can result in the same loan being priced differently at different institutions. A bank's experience with the type of lending (such as commercial real estate) can also impact its assessment of the riskiness of a loan. A comprehensive picture of competitors' rates in relation to borrower risk profiles is not available. Instead, the Company uses a model which estimates market value based on the loan's interest rate (regardless of its risk level) and rates for debt of similar maturities where market data is available. Since the rate and risk profile are the primary factors in determining the fair value of a loan, both of which are unobservable in the market, the Company classifies loans as Level 3 in the fair value hierarchy. Fair values for non-performing loans are estimated as described above.
- 27 -

BANK-OWNED LIFE INSURANCE
Bank-owned life insurance represents insurance policies on certain current and former officers of the Company. The cash value of the policies is estimated using information provided by the insurance carrier. The insurance carrier uses actuarial data to estimate the value of each policy, based on the age and health of the insured relative to other individuals about whom the carrier has information. Health information can be broken down into quantitative, observable inputs, such as smoking habits, blood pressure, and weight, which, along with the insured's age, can be compared to observable data the insurance carrier has available. The carrier can then estimate the cash value of each policy. Since the cash value represents the amount of cash the Company would receive when the policies are paid, the cash value closely approximates the fair value of the policies. Accordingly, bank-owned life insurance is classified as Level 2.

DEPOSIT LIABILITIES
The fair value of demand deposits, savings and certain money market deposits is the amount payable on demand at the reporting date. The fair value of certificates of deposit is estimated by discounting the future cash flows using the rates currently offered for deposits of similar remaining maturities. Information about the rates paid by other institutions for deposits of similar terms is readily available, and rates are mainly influenced by the term of the deposit itself. As a result, fair value calculations are based on observable inputs, and are classified as Level 2.

SHORT-TERM BORROWINGS
The carrying amounts of federal funds purchased, overnight repurchase agreements, and other short-term borrowings maturing within 90 days approximate their fair values. Since the contractual terms of these borrowings provide all information necessary to calculate the amounts that will be due at maturity, these liabilities are classified as Level 2.

LONG-TERM BORROWINGS
The fair values of the Company's long-term borrowings are estimated based on the current cost to repay the debt in full, discounted to current values and including any prepayment penalties that may apply. As the contractual terms of the borrowing provide all the necessary inputs for this calculation, long-term borrowings are classified as Level 2.

ACCRUED INTEREST
The calculation of accrued interest is based on readily observable information, such as the rate and term of the underlying asset or liability. Since these amounts are expected to be realized quickly (generally within 30 to 90 days), the carrying value approximates fair value and is classified as Level 2.

COMMITMENTS TO EXTEND CREDIT AND IRREVOCABLE LETTERS OF CREDIT
The fair value of commitments is estimated using the fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the present credit-worthiness of the counterparties. For fixed-rate loan commitments, fair value also considers the difference between current levels of interest rates and the committed rates. The fair value of letters of credit is based on fees currently charged for similar agreements or on the estimated cost to terminate them or otherwise settle the obligations with the counterparties at the reporting date. At March 31, 2017 and December 31, 2016, the fair value of fees charged for loan commitments and irrevocable letters of credit was immaterial.
- 28 -


The estimated fair values, and related carrying or notional amounts, of the Company's financial instruments as of the dates indicated are as follows:

         
Fair Value Measurements at March 31, 2017 Using
 
   
Carrying
Value
   
Quoted Prices
in Active
Markets for
Identical Assets
(Level 1)
   
Significant
Other
Observable
Inputs
(Level 2)
   
Significant
Unobservable
Inputs
(Level 3)
 
   
(in thousands)
 
Assets
                       
Cash and cash equivalents
 
$
20,510
   
$
20,510
   
$
0
   
$
0
 
Securities available-for-sale
   
195,198
     
0
     
195,198
     
0
 
Restricted securities
   
977
     
0
     
977
     
0
 
Loans, net of allowances for loan losses
   
625,787
     
0
     
0
     
623,636
 
Bank-owned life insurance
   
25,404
     
0
     
25,404
     
0
 
Accrued interest receivable
   
2,940
     
0
     
2,940
     
0
 
                                 
Liabilities
                               
Deposits
 
$
793,392
   
$
0
   
$
791,995
   
$
0
 
Overnight repurchase agreements
   
28,128
     
0
     
28,128
     
0
 
Accrued interest payable
   
221
     
0
     
221
     
0
 

         
Fair Value Measurements at December 31, 2016 Using
 
   
Carrying
Value
   
Quoted Prices
in Active
Markets for
Identical Assets
(Level 1)
   
Significant
Other
Observable
Inputs
(Level 2)
   
Significant
Unobservable
Inputs
(Level 3)
 
   
(in thousands)
 
Assets
                       
Cash and cash equivalents
 
$
25,854
   
$
25,854
   
$
0
   
$
0
 
Securities available-for-sale
   
199,365
     
0
     
199,365
     
0
 
Restricted securities
   
970
     
0
     
970
     
0
 
Loans, net of allowances for loan losses
   
595,637
     
0
     
0
     
594,190
 
Bank-owned life insurance
   
25,206
     
0
     
25,206
     
0
 
Accrued interest receivable
   
3,189
     
0
     
3,189
     
0
 
                                 
Liabilities
                               
Deposits
 
$
784,502
   
$
0
   
$
783,450
   
$
0
 
Overnight repurchase agreements
   
18,704
     
0
     
18,704
     
0
 
Accrued interest payable
   
228
     
0
     
228
     
0
 

Note 10. Segment Reporting

The Company operates in a decentralized fashion in three principal business segments: The Old Point National Bank of Phoebus (the Bank), Old Point Trust & Financial Services, N. A. (Trust), and the Company as a separate segment (for purposes of this Note, the Parent). Revenues from the Bank's operations consist primarily of interest earned on loans and investment securities and service charges on deposit accounts. Trust's operating revenues consist principally of income from fiduciary activities. The Parent's revenues are mainly fees and dividends received from the Bank and Trust companies. The Company has no other segments.

The Company's reportable segments are strategic business units that offer different products and services. They are managed separately because each segment appeals to different markets and, accordingly, requires different technologies and marketing strategies.
- 29 -


Information about reportable segments, and reconciliation of such information to the consolidated financial statements as of and for the three months ended March 31, 2017 and 2016 follows:

   
Three Months Ended March 31, 2017
 
   
Bank
   
Trust
   
Parent
   
Eliminations
   
Consolidated
 
   
(in thousands)
 
Revenues
                             
Interest and dividend income
 
$
7,708
   
$
17
   
$
1,041
   
$
(1,041
)
 
$
7,725
 
Income from fiduciary activities
   
0
     
966
     
0
     
0
     
966
 
Other income
   
1,955
     
257
     
50
     
(65
)
   
2,197
 
Total operating income
   
9,663
     
1,240
     
1,091
     
(1,106
)
   
10,888
 
                                         
Expenses
                                       
Interest expense
   
588
     
0
     
0
     
0
     
588
 
Provision for loan losses
   
650
     
0
     
0
     
0
     
650
 
Salaries and employee benefits
   
4,255
     
727
     
115
     
0
     
5,097
 
Other expenses
   
3,325
     
264
     
85
     
(65
)
   
3,609
 
Total operating expenses
   
8,818
     
991
     
200
     
(65
)
   
9,944
 
                                         
Income before taxes
   
845
     
249
     
891
     
(1,041
)
   
944
 
                                         
Income tax expense (benefit)
   
(32
)
   
85
     
(51
)
   
0
     
2
 
                                         
Net income
 
$
877
   
$
164
   
$
942
   
$
(1,041
)
 
$
942
 
                                         
Capital expenditures
 
$
250
   
$
0
   
$
0
   
$
0
   
$
250
 
                                         
Total assets
 
$
917,101
   
$
5,880
   
$
95,127
   
$
(95,332
)
 
$
922,776
 

   
Three Months Ended March 31, 2016
 
   
Bank
   
Trust
   
Parent
   
Eliminations
   
Consolidated
 
   
(in thousands)
 
Revenues
                             
Interest and dividend income
 
$
7,351
   
$
14
   
$
1,146
   
$
(1,146
)
 
$
7,365
 
Income from fiduciary activities
   
0
     
901
     
0
     
0
     
901
 
Other income
   
2,503
     
276
     
50
     
(65
)
   
2,764
 
Total operating income
   
9,854
     
1,191
     
1,196
     
(1,211
)
   
11,030
 
                                         
Expenses
                                       
Interest expense
   
719
     
0
     
0
     
0
     
719
 
Provision for loan losses
   
150
     
0
     
0
     
0
     
150
 
Salaries and employee benefits
   
4,362
     
678
     
114
     
0
     
5,154
 
Other expenses
   
3,615
     
261
     
126
     
(65
)
   
3,937
 
Total operating expenses
   
8,846
     
939
     
240
     
(65
)
   
9,960
 
                                         
Income before taxes
   
1,008
     
252
     
956
     
(1,146
)
   
1,070
 
                                         
Income tax expense (benefit)
   
28
     
86
     
(65
)
   
0
     
49
 
                                         
Net income
 
$
980
   
$
166
   
$
1,021
   
$
(1,146
)
 
$
1,021
 
                                         
Capital expenditures
 
$
367
   
$
4
   
$
0
   
$
0
   
$
371
 
                                         
Total assets
 
$
851,716
   
$
5,865
   
$
94,236
   
$
(94,970
)
 
$
856,847
 

The accounting policies of the segments are the same as those described in the summary of significant accounting policies reported in the Company's 2016 annual report on Form 10-K. The Company evaluates performance based on profit or loss from operations before income taxes, not including nonrecurring gains or losses.

Both the Parent and the Trust companies maintain deposit accounts with the Bank, on terms substantially similar to those available to other customers. These transactions are eliminated to reach consolidated totals.

Note 11. Commitments and Contingencies

There have been no material changes in the Company's commitments and contingencies from those disclosed in the Company's 2016 annual report on Form 10-K.
- 30 -



Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations.

Available Information
The Company maintains a website on the Internet at www.oldpoint.com. The Company makes available free of charge, on or through its website, its proxy statements, annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and any amendments to those reports as soon as reasonably practicable after such material is electronically filed with the Securities and Exchange Commission (SEC). The information available on the Company's Internet website is not part of this Form 10-Q or any other report filed by the Company with the SEC. The public may read and copy any documents the Company files with or furnishes to the SEC at the SEC's Public Reference Room at 100 F Street, N.E., Washington, D.C. 20549. The public may obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. The Company's SEC filings can also be obtained on the SEC's website on the Internet at www.sec.gov.

The following discussion is intended to assist readers in understanding and evaluating the financial condition, changes in financial condition and the results of operations of the Company. The Company consists of the parent company and its wholly-owned subsidiaries, The Old Point National Bank of Phoebus (the Bank) and Old Point Trust & Financial Services, N. A. (Trust), collectively referred to as the Company. This discussion should be read in conjunction with the consolidated financial statements and other financial information contained elsewhere in this report.

Caution About Forward-Looking Statements
In addition to historical information, this report may contain forward-looking statements. For this purpose, any statement that is not a statement of historical fact may be deemed to be a forward-looking statement. These forward-looking statements may include, but are not limited to, statements regarding profitability, including the focus on reducing higher-cost time deposits; the net interest margin; strategies for managing the net interest margin and the expected impact of such efforts; levels and sources of liquidity; the loan portfolio and expected trends in the quality of the loan portfolio; the allowance and provision for loan losses; the effect of a sustained increase in nonperforming assets; the securities portfolio; monetary policy actions of the Federal Open Market Committee; changes in interest rates; interest rate sensitivity; asset quality; levels of net loan charge-offs and nonperforming assets; sales of OREO properties; levels of interest expense; levels and components of noninterest income and noninterest expense; income taxes; expected impact of efforts to restructure the balance sheet; expected yields on the loan and securities portfolios; expected rates on interest-bearing liabilities; expected timing of and expense in connection with the anticipated termination of the pension plan; effect of the purchase of the outstanding interest in Old Point Mortgage, LLC; estimated levels of future tax credits and capital calls in connection with the Company's investment in housing equity funds; market risk; business and growth strategies; investment strategy; and financial and other goals. Forward-looking statements often use words such as "believes," "expects," "plans," "may," "will," "should," "projects," "contemplates," "anticipates," "forecasts," "intends" or other words of similar meaning. These statements can also be identified by the fact that they do not relate strictly to historical or current facts. Forward-looking statements are subject to numerous assumptions, risks and uncertainties, and actual results could differ materially from historical results or those anticipated by such statements.

There are many factors that could have a material adverse effect on the operations and future prospects of the Company including, but not limited to, changes in interest rates and yields; general economic and general business conditions, including unemployment levels; uncertainty over future federal spending or the budget priorities of the new presidential administration, particularly in connection with the Department of Defense, on the Company's service area; the quality or composition of the loan or securities portfolios; changes in the volume and mix of interest-earning assets and interest-bearing liabilities; the effects of management's investment strategy and strategy to manage the net interest margin; the adequacy of the Company's credit quality review processes; the level of nonperforming assets and related charge-offs and recoveries; the performance of the Company's re-opened dealer lending program; the federal government's guarantee of repayment of student loans purchased by the Company; the ability of the Company to diversify its sources of noninterest income; new incentive structure for securities brokerage activities; the local real estate market; volatility and disruption in national and international financial markets; government intervention in the U.S. financial system; application of the Basel III capital standards to the Company and its subsidiaries; FDIC premiums and/or assessments; demand for loan and other banking products and financial services in the Company's primary service area; levels of noninterest income and expense; deposit flows; competition; the use of inaccurate assumptions in management's modeling systems; technology; any interruption or breach of security in the Company's information systems or those of the Company's third party vendors or other service providers; reliance on third parties for key services; adequacy of the allowance for loan losses; and changes in accounting principles, policies and guidelines. The Company could also be adversely affected by monetary and fiscal policies of the U.S. Government, as well as any regulations or programs implemented pursuant to the Dodd-Frank Act or other legislation and policies of the Office of the Comptroller of the Currency, U.S. Treasury and the Federal Reserve Board.

These risks and uncertainties, in addition to the risks and uncertainties identified in the Company's 2016 annual report on Form 10-K, should be considered in evaluating the forward-looking statements contained herein, and readers are cautioned not to place undue reliance on such statements. Any forward-looking statement speaks only as of the date on which it is made, and the Company undertakes no obligation to update any forward-looking statement to reflect events or circumstances after the date on which it is made. In addition, past results of operations are not necessarily indicative of future results.
- 31 -


General
The Company is the parent company of the Bank and Trust. The Bank is a locally managed community bank serving the Hampton Roads localities of Chesapeake, Hampton, Isle of Wight County, Newport News, Norfolk, Virginia Beach, Williamsburg/James City County and York County. The Bank currently has 18 branch offices. Trust is a wealth management services provider.

Critical Accounting Policies and Estimates
As of March 31, 2017, there have been no significant changes with regard to the critical accounting policies and estimates disclosed in the Company's 2016 annual report on Form 10-K. The accounting policy that required management's most difficult, subjective or complex judgments is the Company's allowance for loan losses. The Company's policies for calculating the allowance for loan losses are discussed in this Item 2 and in Note 3 of the Notes to the Consolidated Financial Statements included in this quarterly report on Form 10-Q, and are discussed in further detail in the Company's 2016 annual report on Form 10-K.

Earnings Summary
Net income for the first three months of 2017 was $942 thousand, or $0.19 per diluted share, compared to net income of $1.0 million, or $0.21 per diluted share, for the first three months of 2016. This 7.74% decrease is primarily attributable to a higher provision for loan losses and lower noninterest income, partially offset by higher net interest income and lower noninterest expense.

As discussed in more detail below, during the first three months of 2017, the provision increased compared to the same period in 2016 due to strong loan growth and the deteriorating condition of one long-standing borrowing relationship, and noninterest income decreased compared to the same period in 2016 primarily because the Company did not sell securities during the first three months of 2017.

Net Interest Income
The principal source of earnings for the Company is net interest income. Net interest income is the difference between interest and fees generated by earning assets and interest expense paid to fund them. Changes in the volume and mix of interest-earning assets and interest-bearing liabilities, as well as their respective yields and rates, have a significant impact on the level of net interest income. The net interest margin is calculated by dividing tax-equivalent net interest income by average earning assets. Net interest income, on a fully tax-equivalent basis, was $7.4 million in the first quarter of 2017, an increase of $511 thousand from the first quarter of 2016, due to an increase in tax-equivalent interest income of $380 thousand, or 5.00%, and a decrease in interest expense of $131 thousand, or 18.22%.

The Company experienced strong loan growth, with average total loans increasing $46.0 million when comparing the first three months of 2017 and 2016. While loan yields declined when comparing the same periods, the increase in average balances increased interest income on loans by $365 thousand when comparing the three months ended March 31, 2017 to the same period in 2016. Loan growth was funded primarily through deposit growth, with average deposits growing $54.0 million. Low-cost deposits in particular grew $55.8 million, with higher-cost time deposits decreasing $1.8 million.

Although loan yields in the first three months of 2017 were lower than the same period in 2016, the growth in loan volume helped to offset the effect of this decline. With a higher percent of the Company's assets in loans--the highest yielding category on the Company's balance sheet--the yield on earning assets was essentially flat when comparing the first quarters of 2017 and 2016, declining only 2 basis points between the two quarters. This marginal decline was primarily the result of the decline in loan yields.

Available liquidity held in cash and due from banks, cash flows from the securities portfolio, and the increase in average deposits discussed above covered a $4.7 million decline in average overnight repurchase agreements and an $11.5 million decline in average FHLB advances, in addition to average loan growth. The decrease in average FHLB advances is due to the payoff of an advance in February 2016. As can be seen in the table below, this paid off advance bore a rate significantly higher than other available funding sources in the current rate environment. The payoff of this advance reduced the Company's weighted-average cost of total interest-bearing liabilities from 0.52% in the first three months of 2016 to 0.41% in the first three months of 2017 and increased its net interest margin from 3.62% to 3.69% over the same periods. Management expects that the Company's solid base of low-cost deposits will continue to beneficially impact the net interest margin in 2017.

Management expects that the Company's loan yields will continue to decline, due to intense competition for quality loans and rate reductions on loans currently held in the portfolio. Management also expects that the reduction in loan yields will likely continue throughout 2017, depending on monetary policy actions taken by the Federal Open Market Committee (FOMC). The FOMC raised the target range for the federal funds rate in March 2017, and management currently expects an additional two increases in the remainder of the year. If the FOMC does continue to raise its target range, then management expects that the decline in loan yields will eventually slow as new loans are booked at current market rates. To partially offset this anticipated decline, management has placed an increased focus on managing the Company's mix of liabilities in order to increase low cost funds and reduce high cost funds where possible.
- 32 -

The following table shows an analysis of average earning assets, interest-bearing liabilities and rates and yields for the periods indicated. Nonaccrual loans are included in loans outstanding.

AVERAGE BALANCE SHEETS, NET INTEREST INCOME* AND RATES*
 
   
For the quarter ended March 31,
 
 
 
2017
   
2016
 
         
Interest
               
Interest
       
   
Average
   
Income/
   
Yield/
   
Average
   
Income/
   
Yield/
 
 
 
Balance
   
Expense
   
Rate**
   
Balance
   
Expense
   
Rate**
 
   
(dollars in thousands)
 
ASSETS
                                   
Loans*
 
$
616,357
   
$
6,811
     
4.42
%
 
$
570,344
   
$
6,446
     
4.52
%
Investment securities:
                                               
Taxable
   
107,141
     
496
     
1.85
%
   
116,308
     
548
     
1.88
%
Tax-exempt*
   
72,441
     
647
     
3.57
%
   
67,023
     
582
     
3.47
%
Total investment securities
   
179,582
     
1,143
     
2.55
%
   
183,331
     
1,130
     
2.47
%
Interest-bearing due from banks
   
2,108
     
5
     
0.95
%
   
2,705
     
4
     
0.59
%
Federal funds sold
   
1,598
     
3
     
0.75
%
   
1,637
     
1
     
0.24
%
Other investments
   
970
     
14
     
5.77
%
   
1,446
     
15
     
4.15
%
Total earning assets
   
800,615
   
$
7,976
     
3.98
%
   
759,463
   
$
7,596
     
4.00
%
Allowance for loan losses
   
(8,392
)
                   
(7,836
)
               
Other nonearning assets
   
108,220
                     
111,888
                 
Total assets
 
$
900,443
                   
$
863,515
                 
                                                 
LIABILITIES AND STOCKHOLDERS' EQUITY
                                               
Time and savings deposits:
                                               
Interest-bearing transaction accounts
 
$
28,226
   
$
2
     
0.03
%
 
$
11,015
   
$
1
     
0.04
%
Money market deposit accounts
   
236,060
     
52
     
0.09
%
   
222,633
     
44
     
0.08
%
Savings accounts
   
79,997
     
10
     
0.05
%
   
77,188
     
10
     
0.05
%
Time deposits
   
207,138
     
519
     
1.00
%
   
208,970
     
517
     
0.99
%
Total time and savings deposits
   
551,421
     
583
     
0.42
%
   
519,806
     
572
     
0.44
%
Federal funds purchased, repurchase agreements and other borrowings
   
20,632
     
5
     
0.10
%
   
25,363
     
6
     
0.09
%
Federal Home Loan Bank advances
   
0
     
0
     
0.00
%
   
11,539
     
141
     
4.89
%
Total interest-bearing liabilities
   
572,053
     
588
     
0.41
%
   
556,708
     
719
     
0.52
%
Demand deposits
   
228,062
                     
205,711
                 
Other liabilities
   
5,846
                     
6,626
                 
Stockholders' equity
   
94,482
                     
94,470
                 
Total liabilities and stockholders' equity
 
$
900,443
                   
$
863,515
                 
Net interest margin
         
$
7,388
     
3.69
%
         
$
6,877
     
3.62
%
                                                 
*Computed on a fully tax-equivalent basis using a 34% rate
                                 
**Annualized
                                 

Provision for Loan Losses
The provision for loan losses is a charge against earnings necessary to maintain the allowance for loan losses at a level consistent with management's evaluation of the portfolio. This expense is based on management's estimate of probable credit losses inherent to the loan portfolio. Management's evaluation included credit quality trends, collateral values, discounted cash flow analysis, loan volumes, geographic, borrower and industry concentrations, the findings of internal credit quality assessments and results from external regulatory examinations. These factors, as well as identified impaired loans, historical losses and current economic and business conditions, were used in developing estimated loss factors for determining the loan loss provision. Based on its analysis of the adequacy of the allowance for loan losses, management concluded that the provision was appropriate.

The provision for loan losses was $650 thousand in the first three months of 2017, compared to $150 thousand in the first three months of 2016.
- 33 -


Approximately $300 thousand of the increase in the provision for loan losses in the three months ended March 31, 2017 as compared to the same period in 2016 was due to growth in loans. The remainder of the increase was primarily due to the deteriorating condition of a long-standing borrowing relationship. This was one of two relationships placed on nonaccrual during the first quarter of 2017. Based on changes in the collateral for this relationship, management determined that a specific allocation of $226 thousand was appropriate to cover anticipated future losses.

Net loans charged off as a percent of total loans on an annualized basis were 0.23% for the first three months of 2017, or $372 thousand, compared to 0.06%, or $86 thousand, in the first three months of 2016. Management believes that the level of net charge-offs seen in the first three months of 2017 is generally representative of the level of net charge-offs the Company expects to experience in the remainder of 2017. If the loan relationship described above deteriorates to the point where management believes a charge off is appropriate, then net charge-offs may be higher in the remainder of 2017 than what was experienced in the first quarter. The effect on net income, however, should be minimal, as management has already created a specific allocation for anticipated future losses on this relationship.

Nonperforming assets consist of nonaccrual loans, loans past due 90 days or more and accruing interest, restructured loans that are accruing interest and not performing according to their modified terms, and OREO. See Note 3 of the Notes to the Consolidated Financial Statements included in this quarterly report on Form 10-Q for an explanation of the loan categories. OREO consists of real estate from foreclosures on loan collateral and one former Bank building.

The majority of the loans past due 90 days or more and accruing interest are student loans with principal and interest amounts that are 97 - 98% guaranteed by the federal government. When a loan changes from "past due 90 days or more and accruing interest" status to "nonaccrual" status, the loan is reviewed for impairment. In most cases, if the loan is considered impaired, then the difference between the value of the collateral and the principal amount outstanding on the loan is charged off. If the Company is waiting on an appraisal to determine the collateral's value or is in negotiations with the borrower or other parties that may affect the value of the collateral, management allocates funds to the allowance for loan losses to cover the deficiency, based on information available to management at that time.

In the case of TDRs, the restructuring may be to modify to an unsecured loan (e.g., a short sale) that the borrower can afford to repay. In these circumstances, the entire balance of the loan would be specifically allocated for, unless the present value of expected future cash flows was more than the current balance on the loan. It would not be charged off if the loan documentation supports the borrower's ability to repay the modified loan.
- 34 -

The following table presents information on nonperforming assets, as of the dates indicated:

NONPERFORMING ASSETS
 
   
March 31,
   
December 31,
   
Increase
 
 
 
2017
   
2016
   
(Decrease)
 
   
(in thousands)
 
Nonaccrual loans
                 
Commercial
 
$
105
   
$
231
   
(126
)
Consumer loans
   
81
     
81
     
0
 
Real estate-mortgage (1)
   
10,846
     
6,847
     
3,999
 
Total nonaccrual loans
 
$
11,032
   
$
7,159
   
$
3,873
 
                         
Loans past due 90 days or more and accruing interest 
                       
Real estate-construction
 
$
51
   
$
0
   
$
51
 
Real estate-mortgage (1)
   
184
     
276
     
(92
)
Consumer loans (2)
   
2,708
     
2,603
     
105
 
Other
   
14
     
5
     
9
 
Total loans past due 90 days or more and accruing interest
 
$
2,957
   
$
2,884
   
$
73
 
                         
Restructured loans 
                       
Commercial
 
$
105
   
$
144
   
(39
)
Real estate-construction
   
95
     
96
     
(1
)
Real estate-mortgage (1)
   
11,545
     
11,616
     
(71
)
Total restructured loans 
 
$
11,745
   
$
11,856
   
(111
)
Less nonaccrual restructured loans (included above)
   
2,845
     
2,838
     
7
 
Less restructured loans currently in compliance (3)
   
8,900
     
9,018
     
(118
)
Net nonperforming, accruing restructured loans
 
$
0
   
$
0
   
$
0
 
                         
Nonperforming loans
 
$
13,989
   
$
10,043
   
$
3,946
 
                         
Other real estate owned
                       
Construction, land development, and other land
 
$
940
   
$
940
   
$
0
 
Former bank building
   
127
     
127
     
0
 
Total other real estate owned
 
$
1,067
   
$
1,067
   
$
0
 
                         
Total nonperforming assets
 
$
15,056
   
$
11,110
   
$
3,946
 
                         

(1) The real estate-mortgage segment includes residential 1 – 4 family, commercial real estate, second mortgages and equity lines of credit. 
(2) Amounts listed include student loans with principal and interest amounts that are 97 - 98% guaranteed by the federal government.  The portion of these guaranteed loans that is past due 90 days or more totaled $2.7 million at March 31, 2017 and $2.6 million at December 31, 2016.
(3) As of March 31, 2017 and December 31, 2016, all of the Company's restructured accruing loans were performing in compliance with their modified terms.

Nonperforming assets as of March 31, 2017 were $15.1 million, $3.9 million higher than nonperforming assets as of December 31, 2016. Nonaccrual loans increased $3.9 million when comparing the balances as of March 31, 2017 to December 31, 2016. Two loan relationships totaling $4.0 million were placed on nonaccrual status in the first quarter of 2017, based on declines in the borrowers' performance and changes in the status of the loans' collateral. The addition of these relationships to nonaccrual was partially offset by the payoff and/or charge-off of other loans that were on nonaccrual status at December 31, 2016. Management has set aside specific allocations on these loans, based on its evaluation of the status of their collateral. Management believes that the collateral on these loans will be sufficient to cover balances for which it has no specific allocation.

The majority of the balance of nonaccrual loans at March 31, 2017 was related to a few large credit relationships. Of the $11.0 million of nonaccrual loans at March 31, 2017, $9.1 million, or approximately 82.49%, was comprised of three credit relationships of $3.7 million, $3.2 million, and $2.2 million. All loans in these relationships have been analyzed to determine whether the cash flow of the borrower and the collateral pledged to secure the loans is sufficient to cover outstanding principal balances. The Company has set aside specific allocations for those loans without sufficient cash flow or collateral.
- 35 -


Loans past due 90 days or more and accruing interest increased $73 thousand. As of March 31, 2017, $2.7 million of the $3.0 million of loans past due 90 days or more and accruing interest were student loans on which the Company expects to experience minimal losses. Because the federal government has provided guarantees of repayment of these student loans in an amount ranging from 97% to 98% of the total principal and interest of the loans, management does not expect even significant increases in past due student loans to have a material effect on the Company. Net of past due government-guaranteed student loans, loans past due 90 days or more and accruing interest decreased $56 thousand.

Total restructured loans decreased by $111 thousand from December 31, 2016 to March 31, 2017 primarily due to paydowns and charge-offs on restructured loans, partially offset by the restructuring of one additional loan. All accruing TDRs are performing in accordance with their modified terms.

OREO remained unchanged during the first three months of 2017. The Company has two properties remaining in OREO; both are under contract, with the sales expected to close in the second quarter of 2017. As discussed in the Noninterest Expense section, management does not anticipate a material loss on either sale.

The majority of the loans that make up the nonaccrual balance have been written down to their net realizable value. If the Company is waiting on an appraisal to determine the collateral's value, management allocates funds to cover the deficiency to the allowance for loan losses based on information available to management at the time. As shown in the table above, the majority of nonaccrual loans at March 31, 2017 and December 31, 2016 were collateralized by real estate.

Management believes the Company has excellent credit quality review processes in place to identify problem loans quickly. This allows management to work with problem loan relationships to identify any payment shortfall and assist these borrowers to improve performance or correct the problems.

As of March 31, 2017, the allowance for loan losses was 56.61% of nonperforming assets and 60.93% of nonperforming loans, compared to 74.21% and 82.10% as of December 31, 2016. As detailed in Note 3 of the Notes to the Consolidated Financial Statements included in this quarterly report on Form 10-Q, the Company saw a decrease of $645 thousand in loans rated other assets especially mentioned and an increase of $711 thousand in loans rated substandard when comparing December 31, 2016 to March 31, 2017, based on internally assigned risk grades. The allowance for loan losses was 1.34% of total loans on March 31, 2017 and 1.37 % of total loans on December 31, 2016.

Allowance for Loan Losses
The allowance for loan losses is based on several components. The first component of the allowance for loan losses is determined based on specifically identified loans that may become impaired. These loans are individually analyzed for impairment and include nonperforming loans and both performing and nonperforming TDRs. This component may also include loans considered impaired for other reasons, such as outdated financial information on the borrower or guarantors or financial problems of the borrower, including operating losses, marginal working capital, inadequate cash flow, or business interruptions. Changes in TDRs and nonperforming loans affect the dollar amount of the allowance. Increases in the impairment allowance for TDRs and nonperforming loans are reflected as an increase in the allowance for loan losses except in situations where the TDR or nonperforming loan does not require a specific allocation (i.e. the present value of expected future cash flows or the collateral value is considered sufficient).

The majority of the Company's TDRs and nonperforming loans are collateralized by real estate. When reviewing loans for impairment, the Company obtains current appraisals when applicable. If the Company is waiting on an appraisal to determine the collateral's value or is in negotiations with the borrower or other parties that may affect the value of the collateral, any loan balance that is in excess of the estimated appraised value is allocated in the allowance. As of March 31, 2017 and December 31, 2016, the impaired loan component of the allowance for loan losses amounted to $1.1 million and $800 thousand, respectively. The increase in this component was mainly due to changes in the collateral of a single loan relationship, discussed under the Provision section above.

Loans past due 60 - 89 days increased in the first quarter of 2017, with the majority of the increase due to the migration of loans from 30 - 59 days past due. Of the loans that are 60 - 89 days past due as of March 31, 2017, the majority have been individually analyzed for impairment, with a specific allocation set aside as management deemed necessary.

The second component of the allowance consists of qualitative factors and includes items such as economic conditions, growth trends, loan concentrations, changes in certain loans, changes in underwriting, changes in management and legal and regulatory changes. For the March 31, 2017 calculation, the qualitative factors which had the most significant impact on the allowance were those affected by changes in the economy and changes in collateral-dependent loans. Continued improvements in the economy allowed for a reduction in the allowance related to this component, which was partially offset by small increases to certain segments of the portfolio due to changes in collateral-dependent loans.
- 36 -


Historical loss is the final component of the allowance for loan losses. The calculation of the historical loss component is conducted on loans evaluated collectively for impairment and uses migration analysis on pooled segments. These segments are based on the loan classifications set by the Federal Financial Institutions Examination Council in the instructions for the Call Report applicable to the Bank. With the December 31, 2016 and March 31, 2017 calculation, the historical loss was based on four migration periods of twelve quarters each.

Consumer loans not secured by real estate and made to individuals for household, family and other personal expenditures are segmented into pools based on whether the loan's payments are current (including loans 1 – 29 days past due), or are 30 – 59 days past due, 60 – 89 days past due, or 90 days or more past due. All other loans, including loans to consumers that are secured by real estate, are segmented by the Company's internally assigned risk grades: substandard, other assets especially mentioned (rated just above substandard), and pass (all other loans). The Company may also assign loans to the risk grades of doubtful or loss, but as of March 31, 2017 and December 31, 2016, the Company had no loans in these categories.

During the first quarter of 2017, loans rated as other assets especially mentioned (OAEM) decreased $645 thousand, while loans rated substandard increased $711 thousand. The decrease in OAEM is not due to migration of loans from OAEM to substandard, which could indicate a decline in the credit quality of the portfolio. The increase in substandard is primarily due to the downgrade of a single loan secured by commercial real estate; this loan was included in the pass pool at December 31, 2016. This loan is also not included in the substandard pool, as it is part of the first component of the allowance discussed above, loans individually analyzed for impairment. Disregarding the effect of this loan's migration from pass to substandard, both OAEM and substandard loans declined in the first quarter of 2017.

On a combined basis, the historical loss and qualitative factor components amounted to $7.4 million as of both March 31, 2017 and December 31, 2016, respectively. Decreases in the historical loss rate and qualitative factors offset the effect of increased loan balances, which would otherwise have resulted in an increase in these combined components when comparing the allowance calculation as of March 31, 2017 to the allowance calculation as of December 31, 2016.

Noninterest Income
Unless otherwise noted, all comparisons in this section are between the three months ended March 31, 2016 and the three months ended March 31, 2017.

Noninterest income decreased $502 thousand or 13.70% to $3.2 million. In the first quarter of 2016, the Company undertook a balance-sheet restructuring that impacts comparisons between the first quarters of 2016 and 2017. Management implemented a new strategy for the investment portfolio and, in connection with this strategy, prepaid an advance from the Federal Home Loan Bank (FHLB), as discussed further below. As a result, the Company recognized gains on the sale of available-for-sale securities of $509 thousand in the first quarter of 2016.

Since the Company sold no securities in the first quarter of 2017, there were no gains recorded. The effect of this difference accounted for the decrease in noninterest income.

Most other categories of noninterest income also experienced decreases, although those other decreases were offset by increases in the following two categories:
  • Income from fiduciary activities (increased $65 thousand, or 7.21%): This category is heavily impacted by the market value of assets under management, and improvements in the stock market during the fourth quarter of 2016 and first quarter of 2017 increased income in this category.
  • Other operating income (increased $9 thousand, or 19.15%): In the first quarter of 2017, management renegotiated its contract with the vendor that provides checks for sale to customers, increasing income in this area. Other operating income was also increased by early withdrawal penalties on CDs, as customers withdrew funds before maturity to take advantage of higher market rates.
The remaining categories of noninterest income decreased, with the largest decrease in service charges on deposit accounts, which decreased $48 thousand, or 4.92%. Increased regulation of overdraft fee income has reduced the Company's income in this category in prior years, a decline that continued in the first quarter of 2017.

In the fourth quarter of 2016, the Company entered into a marketing agreement that will provide an avenue for employees of the Company to make referrals for insurance products. The Company will also assist with marketing and will receive a commission based on referrals, while the operational aspects will be handled by the other party to the marketing agreement. Management expects this agreement to increase noninterest income beginning in the second half of 2017.
- 37 -

In the first quarter of 2017, the Company entered into a membership-interest purchase agreement with Tidewater Mortgage Services, Inc. (TMSI) to purchase TMSI's ownership interest in Old Point Mortgage. The purchase was completed on April 20, 2017, at which point the Bank became the sole member of Old Point Mortgage. In future quarters, Old Point Mortgage will be included in the Company's consolidated financial statements, with its income reported in noninterest income. The purchase agreement was filed as Exhibit 10.1 to the current report on Form 8-K filed by the Company on January 20, 2017. The Company expects to record income on the purchase of approximately $500 thousand in the second quarter of 2017, related to its previously-held equity interest. The exact amount of the income to be recorded is subject to additional review of the assumptions used in the final valuation report.

Noninterest Expense
Unless otherwise noted, all comparisons in this section are between the three months ended March 31, 2016 and the three months ended March 31, 2017.

Noninterest expense decreased $385 thousand or 4.23%, when comparing the three months ended March 31, 2017 to the same period in 2016. This decrease is primarily attributable to the $391 thousand prepayment fee on the FHLB advance in the first quarter of 2016. The prepayment of the FHLB advance also reduced interest expense, as the rate on the advance that we prepaid was significantly higher than other sources of funding available to us in the current rate environment. The effect of the prepayment fee resulted in an overall decrease in noninterest expense, although several categories of noninterest expense experienced increases.

Other than the prepayment fee on the FHLB advance, the largest decreases were in three categories:
  • Salaries and employee benefits (decreased $57 thousand or 1.11%): Applicable accounting rules require the Company to defer a portion of employee costs when loans are booked. The growth in the loan portfolio in the first quarter of 2017 increased the amount of this deferred expense, which lowered the total expense in this category.
  • FDIC insurance (decreased $69 thousand or 41.82%): Beginning in the third quarter of 2016, the FDIC made changes to the way that insurance premiums are calculated. Management expects future quarters to continue at approximately the same rate as the first quarter of 2017.
  • Loss on other real estate owned (decreased $99 thousand or 100.00%): In 2016, the Company worked diligently to sell the properties held in OREO and had only two remaining as of December 31, 2016. While neither property was sold in the first quarter of 2017, both are under contract and expected to close in the second quarter of 2017. Management does not anticipate any material losses from the sales of these properties.
These decreases were offset by increases in other categories, with the largest increases in three categories:
  • Occupancy and equipment (increased $91 thousand or 6.70%): During the past two years, management has worked to improve the Company's disaster recovery plan to minimize business interruptions. Purchases of additional equipment, which must be depreciated, and new service contracts both contributed to the increase in occupancy and equipment.
  • Employee professional development (increased $88 thousand or 59.46%): With the planned retirement of the Company's CFO in the second quarter of 2017, the Company has retained a recruitment firm specializing in executive searches. Expenses for this firm are included in this category of noninterest expense.
  • ATM and other losses (increased $90 thousand or 103.45%): Branch robberies and fraud losses increased this expense in the first quarter of 2017. Management has reviewed its security procedures and made changes where appropriate.
Balance Sheet Review
Unless otherwise noted, all comparisons in this section are between balances at December 31, 2016 and March 31, 2017.

Assets as of March 31, 2017 were $922.8 million, an increase of $19.8 million or 2.19%, with net loans growing $30.2 million. Loan growth was funded in part from available liquidity held in cash and cash equivalents (decreased $5.3 million) and from calls, maturities, and paydowns in the securities portfolio (decreased $4.2 million). On the liabilities side, increases in deposits ($8.9 million) and overnight repurchase agreements ($9.4 million) also provided liquidity to fund loan growth. The net $8.9 million in deposit growth is comprised of an increase in low-cost deposits of $16.7 million and a decrease in higher-cost time deposits of $7.8 million. Management monitors available liquidity closely and adjusts deposit rates according to the Company's needs. As of March 31, 2017, growth in low-cost deposits through the Company's emphasis on relationship banking has been sufficient to fund loan growth.

The majority of the Company's loan growth was in the consumer loans category and was driven by indirect dealer lending. In September 2016, the Company re-opened its dealer lending department. The consumer auto loan portfolio grew $22.6 million in the first quarter of 2017, which management expects will contribute positively to interest income in the future. While there are risks inherent in any new loan program, the Company has hired knowledgeable staff and put in place programs and policies to mitigate those risks. Management is monitoring the allowance for loan losses carefully and will make changes as the portfolio ages.

Consumer loans were also increased by the purchase of $4.2 million in consumer installment loans. The Company maintains a dedicated reserve account funded by the seller of the consumer installment loans. The balance in the reserve account averages 10 - 12% of the outstanding principal balance of these purchased consumer loans. Any loan losses in this portfolio are covered first by the reserve account; loans are charged against the allowance for loan losses only if the funds available in the reserve account are not sufficient.
- 38 -


Other than consumer loans, the largest increases in the loan portfolio were in commercial loans, both secured by real estate and not. This growth is as a result of improvements in quality loan demand in the Company's market area. Management expects growth in these segments to continue during the remainder of 2017. As part of its strategy to grow the loan portfolio, the Company entered into an agreement with TMSI to purchase TMSI's ownership interest in OPM. For a detailed discussion of the purchase, see the Noninterest Income section above.

Average assets for the first three months of 2017 were $900.4 million compared to $863.5 million for the first three months of 2016, an increase of $36.9 million or 4.28%. Comparing the first three months of 2017 to the first three months of 2016, strong average deposit growth of $54.0 million funded average loan growth of $46.0, an $11.5 million decrease in average FHLB advances, and a $4.7 million decrease in overnight repurchase agreements.

The Company's holdings of "Alt-A" type mortgage loans such as adjustable rate and nontraditional type loans were inconsequential, amounting to less than 1.00% of the Company's loan portfolio as of March 31, 2017.

The Company does not have a formal program for subprime lending. The Company is required by law to comply with the requirements of the Community Reinvestment Act (the CRA), which imposes on financial institutions an affirmative and ongoing obligation to meet the credit needs of their local communities, including low- and moderate-income borrowers. In order to comply with the CRA and meet the credit needs of its local communities, the Company finds it necessary to make certain loans with subprime characteristics.

For the purposes of this discussion, a "subprime loan" is defined as a loan to a borrower having a credit score of 660 or below. The majority of the Company's subprime loans are to customers in the Company's local market area. The following table details the Company's loans with subprime characteristics that were secured by 1-4 family first mortgages, 1-4 family open-end loans (i.e., equity lines of credit) and 1-4 family junior lien loans (e.g., second mortgages) for which the Company has recorded a credit score in its system.

Loans Secured by 1 - 4 Family First Mortgages,
 
1 - 4 Family Open-end and 1 - 4 Family Junior Liens
 
As of March 31, 2017
 
(dollars in thousands)
 
             
   
Amount
   
Percent
 
Subprime
 
$
21,666
     
13.68
%
Non-subprime
   
136,727
     
86.32
%
   
$
158,393
     
100.00
%
                 
Total loans
 
$
634,310
         
                 
Percentage of Real Estate-Secured Subprime Loans to Total Loans
     
3.42
%

In addition to the subprime loans secured by real estate discussed above, as of March 31, 2017, the Company had an additional $6.1 million in subprime consumer loans that were either not government guaranteed, were unsecured or were secured by collateral other than real estate. Together with the subprime loans secured by real estate, the Company's total subprime loans as of March 31, 2017 were $27.8 million, amounting to 4.38% of the Company's total loans at March 31, 2017.

Additionally, the Company has no investments secured by "Alt-A" type mortgage loans such as adjustable rate and nontraditional type mortgages or subprime loans.

Capital Resources
Total stockholders' equity as of March 31, 2017 was $95.1 million, an increase of $1.1 million or 1.20% from $94.0 million at December 31, 2016.
- 39 -


For purposes of the Basel III Final Rules (i) common equity Tier 1 capital (CET1) consists principally of common stock (including surplus) and retained earnings; (ii) Tier 1 capital consists principally of CET1 plus non-cumulative preferred stock and related surplus, and certain grandfathered cumulative preferred stock and trust preferred securities; and (iii) Tier 2 capital consists principally of qualifying subordinated debt and preferred stock, and limited amounts of the allowance for loan losses. Total Capital is Tier 1 plus Tier 2 capital. Each regulatory capital classification is subject to certain adjustments and limitations, as implemented by the Basel III Final Rules. The Basel III Final Rules also implement a "countercyclical capital buffer," generally designed to absorb losses during periods of economic stress and to be imposed when national regulators determine that excess aggregate credit growth becomes associated with a buildup of systemic risk. The Basel III Final Rules are discussed in detail in the Company's 2016 annual report on Form 10-K.

The following is a summary of the Company's capital ratios at March 31, 2017. As shown below, these ratios were all well above the regulatory minimum levels, and demonstrate that the Company's capital position remains strong.

 
 
2017
       
 
 
Regulatory
       
 
 
Minimums
   
March 31, 2017
 
Common Equity Tier 1 Capital
   
5.750
%
   
12.82
%
Tier 1 Capital
   
7.250
%
   
12.82
%
Tier 1 Leverage
   
4.000
%
   
10.98
%
Total Capital
   
9.250
%
   
13.93
%

Book value per share was $19.11 at March 31, 2017 as compared to $19.00 at March 31, 2016. Cash dividends were $547 thousand or $0.11 per share in the first three months of 2017 and $496 thousand or $0.10 per share in the first three months of 2016.

Liquidity
Liquidity is the ability of the Company to meet present and future financial obligations through either the sale or maturity of existing assets or the acquisition of additional funds through liability management. Liquid assets include cash, interest-bearing deposits with banks, federal funds sold, investments in securities and loans maturing within one year. The Company's internal sources of such liquidity are deposits, loan and investment repayments and securities available-for-sale. As of March 31, 2017, the Bank's unpledged, available-for-sale securities totaled $119.3 million. The Company's primary external source of liquidity is advances from the FHLB.

A major source of the Company's liquidity is its large, stable deposit base. In addition, secondary liquidity sources are available through the use of borrowed funds if the need should arise, including secured advances from the FHLB. As of the end of the first quarter of 2017, the Company had $207.4 million in FHLB borrowing availability based on loans and securities currently available for pledging. The Company believes that the availability at the FHLB is sufficient to meet future cash-flow needs. The Company also has available short-term, unsecured borrowed funds in the form of federal funds lines of credit with correspondent banks. As of the end of the first quarter of 2017, the Company had $55.0 million available in federal funds lines to address any short-term borrowing needs.

As disclosed in the Company's consolidated statements of cash flows, net cash provided by operating activities was $3.4 million, net cash used in investing activities was $26.8 million and net cash provided by financing activities was $18.1 million for the three months ended March 31, 2017. Combined, this contributed to a $5.3 million decrease in cash and cash equivalents for the three months ended March 31, 2017.

Management is not aware of any market or institutional trends, events or uncertainties that are expected to have a material effect on the liquidity, capital resources or operations of the Company. Nor is management aware of any current recommendations by regulatory authorities that would have a material effect on liquidity, capital resources or operations.

As a result of the Company's management of liquid assets, the availability of borrowed funds and the ability to generate liquidity through liability funding, management believes that the Company maintains overall liquidity sufficient to satisfy its depositors' requirements and to meet its customers' future borrowing needs.

Notwithstanding the foregoing, the Company's ability to maintain sufficient liquidity may be affected by numerous factors, including economic conditions nationally and in the Company's markets. Depending on its liquidity levels, its capital position, conditions in the capital markets and other factors, the Company may from time to time consider the issuance of debt, equity, other securities or other possible capital markets transactions, the proceeds of which could provide additional liquidity for the Company's operations.

Contractual Obligations
In the normal course of business there are various outstanding contractual obligations of the Company that will require future cash outflows. In addition, there are commitments and contingent liabilities, such as commitments to extend credit that may or may not require cash outflows.
- 40 -


As of March 31, 2017, there have been no material changes outside the ordinary course of business in the Company's contractual obligations disclosed in the Company's 2016 annual report on Form 10-K.

Off-Balance Sheet Arrangements
As of March 31, 2017, there were no material changes in the Company's off-balance sheet arrangements disclosed in the Company's 2016 annual report on Form 10-K.

Item 3. Quantitative and Qualitative Disclosures About Market Risk.

An important element of earnings performance and the maintenance of sufficient liquidity is proper management of the interest sensitivity gap. The interest sensitivity gap is the difference between interest sensitive assets and interest sensitive liabilities in a specific time interval. This gap can be managed by re-pricing assets or liabilities, which are variable rate instruments, by replacing an asset or liability at maturity or by adjusting the interest rate during the life of the asset or liability. Matching the amounts of assets and liabilities maturing in the same time interval helps to offset interest rate risk and to minimize the impact of rising or falling interest rates on net interest income.

The Company determines the overall magnitude of interest sensitivity risk and then formulates policies governing asset generation and pricing, funding sources and pricing, and off-balance sheet commitments. These decisions are based on management's expectations regarding future interest rate movements, the state of the national and regional economy, and other financial and business risk factors. The Company uses computer simulations to measure the effect of various interest rate scenarios on net interest income. This modeling reflects interest rate changes and the related impact on net interest income and net income over specified time horizons.

Based on scheduled maturities only, the Company was liability sensitive at the one-year time frame as of March 31, 2017. It should be noted, however, that non-maturing deposit liabilities, which consist of money market, savings and interest-bearing and noninterest-bearing checking accounts, are less interest sensitive than other market driven deposits. At March 31, 2017, non-maturing deposit liabilities totaled $589.8 million or 74.34% of total deposit liabilities.

In a rising rate environment, changes in these deposit rates have historically lagged behind the changes in earning asset rates, thus mitigating the impact from the liability sensitivity position indicated by the static gap analysis. Income simulation analysis allows the Company to reflect the expected differences in re-pricing behavior among various assets and liabilities to more reliably measure the potential effects on income from changes in the interest rate environment.  Utilizing this income simulation methodology, the model reveals that the Company is asset sensitive at the one-year time frame as of March 31, 2017.

When the Company is liability sensitive, net interest income should improve if interest rates fall since liabilities will reprice faster than assets (depending on the optionality or prepayment speeds of the assets). Conversely, if interest rates rise, net interest income should decline. When the Company is asset sensitive, net interest income should improve if interest rates rise and fall if rates fall.

The most likely scenario represents the rate environment as management forecasts it to occur. Management uses a "static" test to measure the effects of changes in interest rates on net interest income. This test assumes that management takes no steps to adjust the balance sheet to respond to the rate change by re-pricing assets/liabilities, as discussed in the first paragraph of this section.

Under the rate environment forecasted by management, rate changes in 50 to 100 basis point increments are applied to assess the impact on the Company's earnings at March 31, 2017. The rate change model assumes that these changes will occur gradually over the course of a year. The model reveals that a 50 basis point ramped decrease in rates would cause an approximate annual decrease of 0.21% in net interest income. The model reveals that a 50 basis point ramped rise in rates would cause an approximate annual increase of 0.15% in net interest income and that a 100 basis point ramped rise in rates would cause an approximate annual increase of 0.37% in net interest income.

Item 4. Controls and Procedures.

Disclosure Controls and Procedures. Management evaluated, with the participation of the Company's Chief Executive Officer and Chief Financial Officer, the effectiveness of the Company's disclosure controls and procedures (as defined in Rule 13a-15(e) under the Securities Exchange Act of 1934, as amended (the Exchange Act)) as of the end of the period covered by this report. Based on that evaluation, the Company's Chief Executive Officer and Chief Financial Officer concluded that the Company's disclosure controls and procedures are effective as of the end of the period covered by this report to ensure that information required to be disclosed in the reports that the Company files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC's rules and forms and that such information is accumulated and communicated to management, including the Company's Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure.
- 41 -


In designing and evaluating its disclosure controls and procedures, management recognized that disclosure controls and procedures, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the disclosure controls and procedures are met. The design of any disclosure controls and procedures also is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions.

Internal Control over Financial Reporting. Management is responsible for establishing and maintaining adequate internal control over financial reporting (as defined in Rule 13a-15(f) under the Exchange Act). No changes in the Company's internal control over financial reporting occurred during the fiscal quarter ended March 31, 2017 that have materially affected, or are reasonably likely to materially affect, the Company's internal control over financial reporting. Because of its inherent limitations, a system of internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

PART II - OTHER INFORMATION

Item 1. Legal Proceedings.

There are no pending legal proceedings to which the Company, or any of its subsidiaries, is a party or to which the property of the Company or any of its subsidiaries is subject that, in the opinion of management, may materially impact the financial condition of the Company.

Item 1A. Risk Factors.

There have been no material changes in the risk factors faced by the Company from those disclosed in the Company's 2016 annual report on Form 10-K.

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds.

Pursuant to the Company's equity compensation plans, participants may pay the exercise price of certain awards or satisfy tax withholding requirements associated with awards by surrendering shares of the Company's common stock that the participants already own. Shares surrendered by participants of these plans are repurchased at current market value pursuant to the terms of the applicable awards. During the quarter ended March 31, 2017, the Company repurchased 2,770 shares related to the exercise of awards.

During the quarter ended March 31, 2017, the Company did not repurchase any shares pursuant to the Company's stock repurchase program.

The following table summarizes repurchases of the Company's common stock that occurred during the three months ended March 31, 2017 in connection with the exercise of stock options. 

Period
 
Total Number of Shares Purchased (1)
   
Average Price Paid Per Share
   
Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs
   
Maximum Number of Shares that May Yet Be Purchased Under the Plans or Programs
 
January 1, 2017-January 31, 2017
   
2,501
   
$
26.40
     
n/a
     
n/a
 
February 1, 2017-February 28, 2017
   
269
     
28.38
     
n/a
     
n/a
 
March 1, 2017-March 31, 2017
   
0
     
0
     
n/a
     
n/a
 
                                 
Total
   
2,770
   
$
26.59
                 

(1) These shares were repurchased in connection with payment of the exercise price upon the exercise of stock options. Accordingly, these shares are not included in the calculation of the 248,063 shares that may yet be purchased under the Company's stock repurchase program. The Company is authorized to repurchase, during any given calendar year, up to an aggregate of 5 percent of the shares of the Company's common stock outstanding as of January 1 of that calendar year.

Item 3. Defaults Upon Senior Securities.

None.
- 42 -


Item 4. Mine Safety Disclosures.

None.

Item 5. Other Information.

The Company has made no changes to the process by which security holders may recommend nominees to its board of directors, which is discussed in the Company's Proxy Statement for the Company's 2017 Annual Meeting of Stockholders.

Item 6. Exhibits.

Exhibit No.
 
Description
3.1
 
Articles of Incorporation of Old Point Financial Corporation, as amended effective June 22, 2000 (incorporated by reference to Exhibit 3.1 to Form 10-K filed March 12, 2009)
     
3.1.1
 
Articles of Amendment to Articles of Incorporation of Old Point Financial Corporation, effective May 26, 2016 (incorporated by reference to Exhibit 3.1.1 to Form 8-K filed May 31, 2016)
     
3.2
 
Bylaws of Old Point Financial Corporation, as amended and restated August 9, 2016 (incorporated by reference to Exhibit 3.2 to Form 10-Q filed August 10, 2016)
     
10.16
 
Membership Interest Purchase Agreement dated January 13, 2017 between Tidewater Mortgage Services, Inc. and The Old Point National Bank of Phoebus (incorporated by reference to Exhibit 10.1 to Form 8-K filed January 20, 2017)
     
10.17
 
Retirement Agreement, Waiver and General Release by and among Laurie D. Grabow and Old Point Financial Corporation, The Old Point National Bank of Phoebus and Old Point Trust & Financial Services, N.A., dated March 10, 2017 (incorporated by reference to Exhibit 10.17 to Form 10-K filed March 15, 2017)
     
31.1
 
Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
     
31.2
 
Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
     
32.1
 
Certification of Chief Executive Officer and Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
     
101
 
The following materials from Old Point Financial Corporation's quarterly report on Form 10-Q for the quarter ended March 31, 2017, formatted in XBRL (Extensible Business Reporting Language), filed herewith: (i) Consolidated Balance Sheets (unaudited for March 31, 2017), (ii) Consolidated Statements of Income (unaudited), (iii) Consolidated Statements of Comprehensive Income (unaudited), (iv) Consolidated Statements of Changes in Stockholders' Equity (unaudited), (v) Consolidated Statements of Cash Flows (unaudited), and (vi) Notes to Consolidated Financial Statements (unaudited)


SIGNATURES

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

   
OLD POINT FINANCIAL CORPORATION
       
May 9, 2017
 
/s/Robert F. Shuford, Sr.
 
   
Robert F. Shuford, Sr.
 
   
Chairman, President & Chief Executive Officer
 
   
(Principal Executive Officer)
 
       
May 9, 2017
 
/s/Laurie D. Grabow
 
   
Laurie D. Grabow
 
   
Chief Financial Officer & Senior Vice President/Finance
 
   
(Principal Financial & Accounting Officer)
 

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