UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

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

FOR THE

QUARTERLY PERIOD ENDED SEPTEMBER 30, 2020

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

COMMISSION FILE NUMBER: 0-22955

BAY BANKS OF VIRGINIA, INC.

(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)

Virginia	54-1838100
(STATE OR OTHER JURISDICTION OF INCORPORATION OR ORGANIZATION)	(I.R.S. EMPLOYER IDENTIFICATION NO.)

1801 BAYBERRY COURT, SUITE 101

RICHMOND, Virginia 23226

(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE)

(804) 325-3775

(REGISTRANT’S TELEPHONE NUMBER, INCLUDING AREA CODE)

N/A

(FORMER NAME, FORMER ADDRESS, AND FORMER FISCAL YEAR, IF CHANGED SINCE LAST REPORT)

Securities registered pursuant to Section 12(b) of the Act:

Title of each class	Trading Symbol(s)	Name of each exchange on which registered
	None

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, every Interactive Data File required to be submitted 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 such files).    ☒  yes    ☐  no

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

Large accelerated filer	☐	Accelerated filer	☒
Non-accelerated filer	☐	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: 13,329,695 shares of common stock on October 30, 2020.

FORM 10-Q

For the interim period ending September 30, 2020

INDEX

PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS	3
CONSOLIDATED BALANCE SHEETS AS OF SEPTEMBER 30, 2020 (UNAUDITED) AND DECEMBER 31, 2019	3
CONSOLIDATED STATEMENTS OF OPERATIONS FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2020 AND 2019 (UNAUDITED)	4
CONSOLIDATED STATEMENTS OF COMPREHENSIVE (LOSS) INCOME FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2020 AND 2019 (UNAUDITED)	5
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2020 AND 2019 (UNAUDITED)	6
CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2020 AND 2019 (UNAUDITED)	8
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)	9
ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS	30
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK	43
ITEM 4. CONTROLS AND PROCEDURES	43
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS	44
ITEM 1A. RISK FACTORS	44
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS	46
ITEM 3. DEFAULTS UPON SENIOR SECURITIES	46
ITEM 4. MINE SAFETY DISCLOSURES	46
ITEM 5. OTHER INFORMATION	46
ITEM 6. EXHIBITS	47

2

PART I – FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

BAY BANKS OF VIRGINIA, INC.

CONSOLIDATED BALANCE SHEETS

	(unaudited)
(Dollars in thousands, except share data)	September 30, 2020			December 31, 2019 (1)
ASSETS
Cash and due from banks	$	9,324		$	6,096
Interest-earning deposits		50,069			34,358
Federal funds sold		152			1,359
Certificates of deposit		1,266			2,754
Available-for-sale securities, at fair value		87,853			99,454
Restricted securities		5,022			5,706
Loans receivable, net of allowance for loan losses of $12,899 and    $7,562, respectively		1,041,711			916,628
Loans held for sale		2,687			1,231
Premises and equipment, net		17,859			20,141
Accrued interest receivable		4,664			3,035
Other real estate owned, net		1,113			1,916
Bank owned life insurance		20,103			19,752
Goodwill		—			10,374
Mortgage servicing rights		845			935
Core deposit intangible		1,094			1,518
Other assets		7,820			6,666
Total assets	$	1,251,582		$	1,131,923
LIABILITIES
Noninterest-bearing demand deposits	$	190,843		$	137,933
Savings and interest-bearing demand deposits		424,001			382,607
Time deposits		412,837			389,900
Total deposits		1,027,681			910,440
Securities sold under repurchase agreements		1,117			6,525
Federal Home Loan Bank advances		25,000			45,000
Federal Reserve Bank advances		32,637			—
Subordinated notes, net of issuance costs		31,083			31,001
Other liabilities		12,635			12,772
Total liabilities		1,130,153			1,005,738
SHAREHOLDERS’ EQUITY
Common stock ($5 par value; authorized - 30,000,000 shares;    outstanding - 13,342,104 and 13,261,801 shares, respectively) (2)		66,711			66,309
Additional paid-in capital		36,816			36,658
Unearned employee stock ownership plan shares		(1,326	)		(1,525	)
Retained earnings		18,012			24,660
Accumulated other comprehensive income, net		1,216			83
Total shareholders’ equity		121,429			126,185
Total liabilities and shareholders’ equity	$	1,251,582		$	1,131,923

(1) Derived from audited December 31, 2019 Consolidated Financial Statements.

(2) Preferred stock is authorized; however, none was outstanding as of September 30, 2020 and December 31, 2019.

See Notes to Consolidated Financial Statements.

3

BAY BANKS OF VIRGINIA, INC.

CONSOLIDATED STATEMENTS OF OPERATIONS

(unaudited)

	For the Three Months Ended						For the Nine Months Ended
(Dollars in thousands, except per share data)	September 30, 2020			September 30, 2019			September 30, 2020			September 30, 2019
INTEREST INCOME
Loans, including fees	$	11,371		$	11,930		$	34,013		$	34,849
Securities:
Taxable		596			553			1,821			1,725
Tax-exempt		88			113			270			327
Federal funds sold		—			6			2			31
Interest-bearing deposit accounts		6			145			119			432
Certificates of deposit		9			18			37			57
Total interest income		12,070			12,765			36,262			37,421
INTEREST EXPENSE
Deposits		2,104			3,123			7,364			9,019
Securities sold under repurchase agreements		—			4			3			11
Subordinated notes		510			142			1,531			417
Federal Home Loan Bank advances		50			465			374			1,784
Federal Reserve Bank advances		29			—			49			—
Total interest expense		2,693			3,734			9,321			11,231
Net interest income		9,377			9,031			26,941			26,190
Provision for loan losses		869			495			5,673			871
Net interest income after provision for loan losses		8,508			8,536			21,268			25,319
NONINTEREST INCOME
Trust management		220			201			615			621
Service charges and fees on deposit accounts		155			243			529			727
Wealth management		350			185			824			654
Interchange fees, net		149			108			378			330
Other service charges and fees		33			32			94			88
Secondary market sales and servicing		1,082			293			2,015			632
Increase in cash surrender value of bank owned life insurance		117			122			351			362
Net gains (losses) on sales and calls of available-for-sale securities		—			1			29			(1	)
Net gains (losses) on disposition of other assets		12			—			5			(2	)
Net gains (losses) gains on rabbi trust assets		74			—			(76	)		130
Referral fees		86			—			1,052			—
Other		8			15			54			44
Total noninterest income		2,286			1,200			5,870			3,585
NONINTEREST EXPENSE
Salaries and employee benefits		3,801			3,666			11,267			11,532
Occupancy		700			805			2,156			2,510
Data processing		491			541			1,526			1,738
Bank franchise tax		256			209			770			655
Telecommunications and other technology		396			258			1,176			727
FDIC assessments		262			(7	)		557			371
Foreclosed property		22			48			58			110
Consulting		54			156			195			418
Advertising and marketing		47			124			140			300
Directors’ fees		187			148			568			525
Audit and accounting		92			193			402			586
Legal		(210	)		20			135			130
Core deposit intangible amortization		134			164			425			517
Net other real estate owned losses		176			375			256			441
Goodwill impairment		—			—			10,374			—
Merger-related		1,456			—			1,456			—
Other		782			747			1,947			2,108
Total noninterest expense		8,646			7,447			33,408			22,668
Income (loss) before income taxes		2,148			2,289			(6,270	)		6,236
Income tax expense		655			448			378			1,180
Net income (loss)	$	1,493		$	1,841		$	(6,648	)	$	5,056
Basic and diluted earnings (loss) per share	$	0.11		$	0.14		$	(0.51	)	$	0.39

See Notes to Consolidated Financial Statements.

4

BAY BANKS OF VIRGINIA, INC.

CONSOLIDATED STATEMENTS OF COMPREHENSIVE (LOSS) INCOME

(unaudited)

	For the Three Months Ended						For the Nine Months Ended
(Dollars in thousands)	September 30, 2020			September 30, 2019			September 30, 2020			September 30, 2019
Net income (loss)	$	1,493		$	1,841		$	(6,648	)	$	5,056
Other comprehensive income:
Unrealized holding gain on available-for-sale securities arising during the period		63			296			1,463			2,109
Deferred income tax expense on net unrealized gain on available-for-sale securities		(13	)		(62	)		(307	)		(443	)
Reclassification of net (gains) losses on sales and calls of available-for-sale securities recognized in net income		—			(1	)		(29	)		1
Income tax expense on net realized gain on available-for-sale securities		—			—			6			—
Total other comprehensive income		50			233			1,133			1,667
Comprehensive income (loss)	$	1,543		$	2,074		$	(5,515	)	$	6,723

See Notes to Consolidated Financial Statements.

5

BAY BANKS OF VIRGINIA, INC.

CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY

(unaudited)

	For the Nine Months Ended September 30, 2020
										Employee Stock						Accumulated
	Shares of						Additional			Ownership						Other		Total
	Common			Common			Paid-in			Plan			Retained			Comprehensive		Shareholders’
(Dollars in thousands)	Stock			Stock			Capital			Shares			Earnings			Income, net		Equity
Balance at beginning of period		13,261,801		$	66,309		$	36,658		$	(1,525	)	$	24,660		$	83	$	126,185
Net loss		—			—			—			—			(6,648	)		—		(6,648	)
Other comprehensive income, net		—			—			—			—			—			1,133		1,133
Stock options exercised, net		16,689			83			5			—			—			—		88
Director and executive stock grant		21,789			109			55			—			—			—		164
Restricted stock awards		45,105			226			(226	)		—			—			—		—
Shares repurchased pursuant to ESOP		(3,280	)		(16	)		(9	)		—			—			—		(25	)
ESOP collateral release		—			—			—			199			—			—		199
Share-based compensation expense		—			—			333			—			—			—		333
Balance at end of period		13,342,104		$	66,711		$	36,816		$	(1,326	)	$	18,012		$	1,216	$	121,429

	For the Nine Months Ended September 30, 2019
								Unearned
								Employee Stock					Accumulated Other
	Shares of				Additional			Ownership					Comprehensive			Total
	Common		Common		Paid-in			Plan			Retained		Income (Loss),			Shareholders’
(Dollars in thousands)	Stock		Stock		Capital			Shares			Earnings		net			Equity
Balance at beginning of period		13,201,682	$	66,008	$	36,972		$	(1,734	)	$	17,557	$	(1,327	)	$	117,476
Net income		—		—		—			—			5,056		—			5,056
Other comprehensive income, net		—		—		—			—			—		1,667			1,667
Stock options exercised, net		5,173		26		(17	)		—			—		—			9
Director stock grant		18,396		92		56			—			—		—			148
Restricted stock awards		109,051		545		(545	)		—			—		—			—
ESOP collateral release		—		—		—			141			—		—			141
Share-based compensation expense		—		—		315			—			—		—			315
Cumulative effect adjustment of adoption of accounting principle		—		—		—			—			45		—			45
Balance at end of period		13,334,302	$	66,671	$	36,781		$	(1,593	)	$	22,658	$	340		$	124,857

6

	For the Three Months Ended September 30, 2020
									Unearned
									Employee Stock					Accumulated
	Shares of						Additional		Ownership					Other		Total
	Common			Common			Paid-in		Plan			Retained		Comprehensive		Shareholders’
(Dollars in thousands)	Stock			Stock			Capital		Shares			Earnings		Income, net		Equity
Balance at beginning of period		13,334,049		$	66,670		$	36,729	$	(1,394	)	$	16,519	$	1,166	$	119,690
Net income		—			—			—		—			1,493		—		1,493
Other comprehensive income, net		—			—			—		—			—		50		50
Director and executive stock grant		10,055			51			9		—			—		—		60
Restricted stock forfeitures		(2,000	)		(10	)		10		—			—		—		—
ESOP collateral release		—			—			—		68			—		—		68
Share-based compensation expense		—			—			68		—			—		—		68
Balance at end of period		13,342,104		$	66,711		$	36,816	$	(1,326	)	$	18,012	$	1,216	$	121,429

	For the Three Months Ended September 30, 2019
								Unearned
								Employee Stock					Accumulated Other
	Shares of				Additional			Ownership					Comprehensive		Total
	Common		Common		Paid-in			Plan			Retained		Income (Loss),		Shareholders’
(Dollars in thousands)	Stock		Stock		Capital			Shares			Earnings		net		Equity
Balance at beginning of period		13,332,484	$	66,662	$	36,699		$	(1,668	)	$	20,817	$	107	$	122,617
Net income		—		—		—			—			1,841		—		1,841
Other comprehensive income, net		—		—		—			—			—		233		233
Restricted stock awards		1,818		9		(9	)		—			—		—		—
ESOP collateral release		—		—		—			75			—		—		75
Share-based compensation expense		—		—		91			—			—		—		91
Balance at end of period		13,334,302	$	66,671	$	36,781		$	(1,593	)	$	22,658	$	340	$	124,857

See Notes to Consolidated Financial Statements.

7

BAY BANKS OF VIRGINIA, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

(unaudited)

	For the Nine Months Ended
(Dollars in thousands)	September 30, 2020			September 30, 2019
Cash Flows From Operating Activities
Net (loss) income	$	(6,648	)	$	5,056
Adjustments to reconcile net income to net cash provided by operating activities:
Goodwill impairment charge		10,374			—
Depreciation and amortization		1,075			1,279
Net premium amortization on available-for-sale securities		361			397
Amortization of subordinated notes issuance costs		82			13
Amortization of core deposit intangible		425			517
Accretion of fair value adjustment on acquired time deposits		(59	)		(96	)
Accretion of fair value adjustments on acquired loans		(381	)		(993	)
Provision for loan losses		5,673			871
Share-based compensation expense		333			315
Deferred income tax benefit		(590	)		—
Increase in other real estate owned valuation allowance		290			423
(Gains) losses on sale of other real estate owned		(34	)		18
Net (gain) loss on the disposition of fixed and other assets		(5	)		2
Decrease in value of mortgage servicing rights		90			67
Increase in cash surrender value of bank owned life insurance		(351	)		(362	)
Net (gains) losses on sales and calls of available-for-sale securities		(29	)		1
Originations of loans held for sale (HFS)		(147,289	)		(42,847	)
Proceeds from HFS loan sales		147,527			43,411
Gain on HFS sold loans		(1,694	)		(464	)
Increase in other assets and accrued interest receivable		(702	)		(2,914	)
(Decrease) increase in other liabilities		(117	)		4,438
Net cash provided by operating activities		8,331			9,132
Cash Flows From Investing Activities
Proceeds from maturities, calls, and principal paydowns of available-for-sale securities		24,921			8,196
Purchases of available-for-sale securities		(12,227	)		(5,000	)
Purchases of restricted securities, net		684			916
Maturities of certificates of deposit		1,488			248
Decrease in federal funds sold		1,207			533
Net increase in loans		(130,921	)		(30,300	)
Proceeds from sale of other real estate owned		1,093			1,324
Net purchases of premises and equipment		(206	)		(167	)
Net cash used in investing activities		(113,961	)		(24,250	)
Cash Flows From Financing Activities
Increase in demand, savings, and other interest-bearing demand deposits		94,304			23,552
Net increase in time deposits		22,996			28,040
Stock options exercised, net		88			9
Net (decrease) increase in securities sold under repurchase agreements and other borrowings		(5,431	)		164
Shares repurchased pursuant to ESOP		(25	)		—
Decrease in Federal Home Loan Bank advances		(20,000	)		(32,000	)
Increase in Federal Reserve Bank advances		32,637			—
Net cash provided by financing activities		124,569			19,765
Net increase in cash and due from banks		18,939			4,647
Cash and cash equivalents (including interest-earning deposits) at beginning of period		40,454			26,666
Cash and cash equivalents (including interest-earning deposits) at end of period	$	59,393		$	31,313
Supplemental Schedule of Cash Flow Information
Cash paid for:
Interest	$	9,425		$	11,264
Income taxes		650			—
Non-cash investing and financing activities:
Unrealized gain on available-for-sale securities		1,425			2,109
Loans transferred to other real estate owned		546			346
Changes in deferred taxes resulting from other comprehensive income transactions		(301	)		(443	)
Cumulative effect adjustment of adoption of accounting principle		—			(45	)
Employee stock ownership plan transactions		(199	)		(141	)
Director and executive stock grant		164			148

See Notes to Consolidated Financial Statements.

8

Notes to Consolidated Financial Statements (Unaudited)

Note 1: Basis of Presentation

Bay Banks of Virginia, Inc. (the “Company”) is the holding company for Virginia Commonwealth Bank (the “Bank”), for VCB Financial Group, Inc. (the “Financial Group”), and for Steptoes Holdings, LLC (“Steptoes Holdings”). The consolidated financial statements of the Company include the accounts of Bay Banks of Virginia, Inc., the Bank, the Financial Group, and Steptoes Holdings. All significant intercompany accounts and transactions are eliminated upon consolidation.

The Bank is a state-chartered bank, headquartered in Richmond, Virginia, and a member of the Federal Reserve System. It serves businesses, professionals, and consumers through 17 banking offices, located in the greater Richmond region, the Northern Neck region, Middlesex County, and the Hampton Roads region of Virginia. The Bank offers a wide range of deposit and loan products to its retail and commercial customers. A substantial amount of the Bank’s deposits are interest-bearing. The majority of the Bank’s loan portfolio is secured by real estate.

The Financial Group provides management services for personal and corporate trusts, including estate planning, estate settlement, trust administration, and investment and wealth management services. Products and services include revocable and irrevocable living trusts, testamentary trusts, custodial accounts, investment planning, brokerage services, insurance investment managed accounts, and managed and self-directed individual retirement accounts.

On August 12, 2020, the Company and Blue Ridge Bankshares, Inc. (“Blue Ridge”) entered into a merger agreement pursuant to which the companies will combine in an all-stock merger (the “Blue Ridge Merger”) to create a leading Virginia-based community bank. Under the terms of the merger agreement, shareholders of the Company will receive 0.50 shares of Blue Ridge common stock for each share of the Company’s common stock they own. Upon completion of the Blue Ridge Merger, the Company’s shareholders will own approximately 54% and Blue Ridge shareholders will own approximately 46% of the combined company’s stock. The Blue Ridge Merger is subject to customary closing conditions, including regulatory approvals and approval from the shareholders of both companies.  The Company anticipates the Blue Ridge Merger will close in the first quarter of 2021.

On April 1, 2017, the Company completed a merger with Virginia BanCorp, Inc. (“Virginia BanCorp”), a bank holding company conducting substantially all of its operations through its subsidiary, Virginia Commonwealth Bank. Immediately following the Company’s merger with Virginia BanCorp, Virginia BanCorp’s subsidiary bank was merged with and into the Company’s banking subsidiary, Bank of Lancaster (collectively, the “Virginia BanCorp Merger”). Bank of Lancaster then changed its name to Virginia Commonwealth Bank.

The accounting and reporting policies of the Company conform to accounting principles generally accepted in the United States of America (“GAAP”) and to the general practices within the banking industry. In management’s opinion, all adjustments necessary for a fair presentation of the consolidated financial statements have been included.

Certain amounts presented in the consolidated financial statements of prior periods have been reclassified to conform to current year presentations. The reclassifications had no effect on net income, net income per share, or shareholders’ equity as previously reported.

All dollar amounts included in the tables in these notes are in thousands, except per share data, unless otherwise stated.

Note 2: Amendments to the Accounting Standards Codification

In December 2019, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2019-12, Income Taxes (Topic 740), which is guidance for the simplification of accounting for income taxes. This ASU removes certain exceptions to the general principals of Accounting Standards Codification (“ASC”) 740, Income Taxes, and simplifies existing guidance to improve consistent application of GAAP. The exceptions removed by this ASU are the exception to the incremental approach for intraperiod tax allocation when there is a loss from continuing operations and income or a gain from other items and the exception to the general methodology for calculating income taxes in an interim period when a year-to-date loss exceeds the anticipated loss for the year. This ASU simplifies the accounting by requiring that an entity recognize a franchise tax that is partially based on income as an income-based tax and account for any incremental amount incurred as a non-income-based tax; requiring that an entity evaluate when a step-up in the tax basis of goodwill should be considered part of the business combination in which the book goodwill was originally recognized and when it should be considered a separate transaction; requiring that an entity reflect the effect of an enacted change in tax laws or rates in the annual effective tax rate computation in the interim period that includes the enactment date; and making minor codification improvements for income taxes related to employee stock ownership plans and investments in qualified affordable housing projects accounted for using the equity method. This ASU is effective for interim and annual reporting periods beginning after December 15, 2020. The Company is currently evaluating the effect that this ASU will have on its consolidated financial statements.

9

In August 2018, the FASB issued ASU 2018-13, Fair Value Measurement (Topic 820), which is guidance for the modifications to fair value measurement disclosure requirements. This ASU removes, modifies, and adds disclosure requirements for ASC 820, Fair Value Measurement (“ASC 820”). The disclosure requirement for the valuation process of Level 3 fair value measurements was removed from ASC 820. This ASU clarifies that the measurement uncertainty disclosure is to communicate information about the uncertainty in measurement as of the reporting date. The disclosure requirements added to ASC 820 were the changes in unrealized gains and losses for the period included in other comprehensive income for the recurring Level 3 fair value measurements held at the end of the reporting period and the range and weighted average of significant unobservable inputs used to develop Level 3 fair value measurements. This ASU was effective for interim and annual reporting periods beginning after December 15, 2019. The additional disclosure requirements are to be applied prospectively and the other modifications will be applied retrospectively. The adoption of this ASU in the first quarter of 2020 did not have a material effect on the Company’s consolidated financial statements.

In June 2016, the FASB issued ASU 2016-13, Financial Instruments – Credit Losses (Topic 326), which is new guidance for the accounting for credit losses on instruments within its scope. This ASU introduces a new model for current expected credit losses (“CECL”), which applies to financial assets subject to credit losses and measured at amortized cost and certain off-balance sheet credit exposures, including loans, held-to-maturity debt securities, loan commitments, financial guarantees, net investments in leases, reinsurance, and trade receivables. The CECL model requires an entity to estimate the credit losses expected over the life of an exposure (or pool of exposures). The estimate of expected credit losses should consider historical information, current information, and reasonable and supportable forecasts, including estimates of prepayments. In addition, this standard will replace the current available-for-sale debt securities other-than-temporary impairment model with an estimate of expected credit losses only when the fair value falls below the amortized cost of the asset. Credit losses on available-for-sale debt securities will be limited to the difference between the security’s amortized cost basis and its fair value. The available-for-sale debt security model will also require the use of an allowance to record estimated credit losses and subsequent recoveries. This ASU also addresses purchased financial assets with credit deterioration. Disclosure requirements are expanded regarding an entity’s assumptions, models, and methods for estimating the allowance for loan losses. On October 16, 2019, the FASB voted to extend the effective date of ASU 2016-13 for smaller reporting companies reporting to the Securities and Exchange Commission (the “SEC”) (including the Company) and non-SEC registrants; therefore, this ASU is effective for interim and annual reporting periods beginning after December 15, 2022. The Company has a CECL cross-functional working group that implemented a third-party CECL software in 2019 and will continue to assess and implement the requirements of ASU 2016-13 by the adoption date.

Note 3: Securities

The aggregate amortized costs and fair values of available-for-sale securities as of the dates stated were as follows.

			Gross		Gross
	Amortized		Unrealized		Unrealized			Fair
September 30, 2020	Cost		Gains		(Losses)			Value
U.S. Government agencies and mortgage backed securities	$	47,598	$	1,277	$	(5	)	$	48,870
State and municipal obligations		18,116		741		(11	)		18,846
Corporate bonds		20,154		74		(91	)		20,137
Total available-for-sale securities	$	85,868	$	2,092	$	(107	)	$	87,853

			Gross		Gross
	Amortized		Unrealized		Unrealized			Fair
December 31, 2019	Cost		Gains		(Losses)			Value
U.S. Government agencies and mortgage backed securities	$	67,491	$	284	$	(178	)	$	67,597
State and municipal obligations		16,238		341		(3	)		16,576
Corporate bonds		15,165		116		—			15,281
Total available-for-sale securities	$	98,894	$	741	$	(181	)	$	99,454

Securities with fair values of $3.5 million and $11.1 million were pledged as collateral for securities sold under repurchase agreements as of September 30, 2020 and December 31, 2019, respectively. As of September 30, 2020 and December 31, 2019, all of the securities pledged for repurchase agreements were state and municipal obligations. All of the repurchase agreements had remaining contractual maturities that were overnight and continuous. Securities sold under repurchase agreements were $1.1 million and $6.5 million as of September 30, 2020 and December 31, 2019, respectively, and are included in liabilities on the consolidated balance sheets. The securities pledged to each agreement are reviewed daily and can be changed at the option of the Bank with minimal risk of loss due to fair value changes.

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The following tables present securities in an unrealized loss position as of September 30, 2020 and December 31, 2019, by period of the unrealized loss and number of securities. The unrealized loss positions were primarily related to interest rate movements and not the credit quality of the issuers. All agency securities and state and municipal securities are investment grade or better, and their losses are considered temporary. Corporate bonds include $1.8 million (amortized cost) of subordinated notes issued by Blue Ridge, which the Company expects it will be required to sell in connection with the Blue Ridge Merger. As of September 30, 2020, unrealized losses on the subordinated notes issued by Blue Ridge and owned by the Company totaled $68 thousand. Other than this anticipated sale, management does not intend to sell nor expect to be required to sell these securities, and all amortized cost bases are expected to be recovered.

			Less than 12 months					12 months or more				Total
September 30, 2020	Number of Securities		Fair Value		Unrealized Loss			Fair Value		Unrealized Loss		Fair Value		Unrealized Loss
U.S. Government agencies and mortgage backed securities		4	$	392	$	(5	)	$	—	$	—	$	392	$	(5	)
Corporate bonds		9		8,680		(91	)		—		—		8,680		(91	)
State and municipal obligations		1		1,194		(11	)		—		—		1,194		(11	)
Total temporarily impaired securities		14	$	10,266	$	(107	)	$	—	$	—	$	10,266	$	(107	)

			Less than 12 months					12 months or more					Total
December 31, 2019	Number of Securities		Fair Value		Unrealized Loss			Fair Value		Unrealized Loss			Fair Value		Unrealized Loss
U.S. Government agencies and mortgage backed securities		38	$	12,356	$	(53	)	$	16,930	$	(125	)	$	29,286	$	(178	)
State and municipal obligations		1		610		(3	)		—		—			610		(3	)
Total temporarily impaired securities		39	$	12,966	$	(56	)	$	16,930	$	(125	)	$	29,896	$	(181	)

The following table presents the amortized cost and fair value by contractual maturity of available-for-sale securities as of the dates stated. Expected maturities may differ from contractual maturities, as issuers may have the right to call or prepay obligations with or without call or prepayment penalties.

	September 30, 2020				December 31, 2019
	Amortized Cost		Fair Value		Amortized Cost		Fair Value
Due in one year or less	$	10,557	$	10,578	$	10,528	$	10,563
Due after one year but less than five years		48,326		49,718		49,586		49,921
Due after five years but less than ten years		19,989		20,453		33,332		33,535
Due after ten years		6,996		7,104		5,448		5,435
Total available-for-sale securities	$	85,868	$	87,853	$	98,894	$	99,454

Restricted Securities

The Company’s investment in Federal Home Loan Bank of Atlanta (“FHLB”) stock totaled $2.1 million and $2.9 million as of September 30, 2020 and December 31, 2019, respectively. The Company also has an investment in the Federal Reserve Bank of Richmond (“FRB”) stock, which totaled $2.7 million and $2.6  million as of September 30, 2020 and December 31, 2019, respectively, and a stock investment in the Bank’s primary correspondent bank totaling $220 thousand as of September 30, 2020 and December 31, 2019. The investments in both FHLB and FRB stock are required investments related to the Bank’s membership with the FHLB and FRB. These securities do not have a readily determinable fair value as their ownership is restricted, and they lack an active market for trading. Additionally, pursuant to charter provisions related to the FHLB and FRB stock, all repurchase transactions of such stock must occur at par. Accordingly, these securities are carried at cost.

Note 4: Loans

Loans are reported at their recorded investment, which is the outstanding principal balance net of any unearned income and costs, such as deferred fees and costs, charge-offs, and discounts or premiums on acquired or purchased loans. Interest on loans is recognized in earnings over the contractual term of the loan and is calculated using the effective interest method on principal amounts outstanding. Loan fees and certain direct origination costs are deferred and recognized as an adjustment of the related loan yield over the contractual term of the loan, adjusted for early pay-offs or principal curtailments, as applicable.

All interest accrued but not collected for loans that are placed on nonaccrual or charged-off are reversed against interest income at the time the loans are placed on nonaccrual or charged-off. Any subsequent interest received on these loans is recognized as interest income under the cash basis method of accounting or applied as a reduction of the principal balance of the loan until the loan qualifies

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for return to accrual status. Generally, a loan is returned to accrual status when all principal and interest amounts contractually due are brought current and future payments are reasonably assured, or the loan becomes well-secured and in the process of collection.

The following table presents a summary of loans as of the dates stated.

	September 30, 2020			December 31, 2019
Mortgage loans on real estate:
Residential first mortgages	$	286,127		$	293,913
Commercial mortgages (non-owner occupied)		282,378			196,143
Construction, land and land development		132,502			126,010
Commercial mortgages (owner occupied)		76,225			82,829
Residential revolving and junior mortgages		29,051			31,893
Commercial and industrial		187,219			181,730
Paycheck Protection Program		56,788			—
Consumer		6,443			11,985
Total loans		1,056,733			924,503
Net unamortized deferred loan fees		(2,123	)		(313	)
Allowance for loan losses		(12,899	)		(7,562	)
Loans receivable, net	$	1,041,711		$	916,628

As of September 30, 2020 and December 31, 2019, the Company had $388.4 million and $369.5 million, respectively, of loans pledged to the FHLB as collateral for borrowings. After adjustments by the FHLB, the total lendable collateral was $289.4 million and $288.8 million as of September 30, 2020 and December 31, 2019, respectively.

Beginning on April 3, 2020, the Company has participated in the Paycheck Protection Program (“PPP”) under the Coronavirus Aid, Relief, and Economic Security Act (“CARES Act”). Through the PPP, which is administered by the Small Business Administration, the federal government partnered with banks, including the Bank, to provide over $650 billion to small businesses to support payrolls and other operating expenses. PPP loans have a two-year term if originated prior to June 5, 2020 or a five-year term if originated on or subsequent to June 5, 2020 and earn interest at 1% per year. Banks originating PPP loans earn a processing fee of 1%, 3%, or 5% of the loan amount, depending on the size of the loan. The Company believes that the majority of these loans will be forgiven in accordance with the terms of the program, and will be paid in full pursuant to the U.S. government guarantee. As of September 30, 2020, the Company’s PPP loan balances were $56.8 million, and the Company had received $2.4 million of processing fees for originating approximately 700 loans. The Company is accounting for the PPP processing fees in accordance with ASC 310-20, Receivable-Nonrefundable Fees and Other Costs, which requires fees, net of costs, to be deferred and amortized as a component of loan yield over the contractual life of the loan, accelerated for prepayments. Of the $2.4 million of processing fees received in the second and third quarters of 2020, approximately $287 thousand and $532 thousand have been recognized as interest income in the three and nine months ended September 30, 2020, respectively.

From the onset of the global COVID-19 pandemic, the Company has proactively addressed the needs of its commercial and individual borrowers by modifying loans allowing for the short-term deferral of principal payments or of principal and interest payments. Pursuant to the CARES Act, banks have the option to temporarily suspend certain requirements of GAAP related to troubled debt restructurings (“TDRs”) for a limited period of time if certain conditions are met, such as the borrower was current as of December 31, 2019 and the modification was due to financial conditions due to the COVID-19 pandemic. All loan modifications made by the Company were made on a good faith basis to borrowers who met the requirements for modifications under the CARES Act. As a result of regulatory and accounting guidance regarding such modifications, the loans are not designated as TDRs, as of September 30, 2020.

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The following table presents, as of September 30, 2020, the loan balances and number by loan type and the percentage these loans comprise within each loan type for which modifications were made.

	Loan Count	Principal Balance		% of Loan Type
Mortgage loans on real estate:
Residential first mortgages	14	$	2,886		1	%
Commercial mortgages (non-owner occupied)	23		47,102		17	%
Construction, land and land development	13		22,879		17	%
Commercial mortgages (owner occupied)	17		10,520		14	%
Residential revolving and junior mortgages	1		257		1	%
Commercial and industrial	87		17,575		9	%
Consumer	2		8		0	%
Total	157	$	101,227		10	%

All loans with COVID-19 Modifications, with the exception of $375 thousand and $509 thousand of loans on nonaccrual and 30-89 days past due, respectively, are reported as current as of September 30, 2020 in the tables that follow.

The following tables present the recorded investment for past due, based upon contractual terms, and nonaccrual loans as of the dates stated. A loan past due 90 days or more is generally placed on nonaccrual unless it is both well-secured and in the process of collection. Loans presented below as 90 days or more past due and still accruing include purchased credit-impaired (“PCI”) loans.

September 30, 2020	30-89 Days Past Due		90 Days or More Past Due and Still Accruing		Nonaccrual		Total Past Due and Nonaccrual		Current		Total Loans
Mortgage loans on real estate:
Residential first mortgages	$	768	$	13	$	2,848	$	3,629	$	282,498	$	286,127
Commercial mortgages (non-owner occupied)		—		128		6,107		6,235		276,143		282,378
Construction, land and land development		484		—		899		1,383		131,119		132,502
Commercial mortgages (owner occupied)		48		21		208		277		75,948		76,225
Residential revolving and junior mortgages		61		—		397		458		28,593		29,051
Commercial and industrial		684		—		6,553		7,237		179,982		187,219
Paycheck Protection Program		—		—		—		—		56,788		56,788
Consumer		23				186		209		6,234		6,443
Total loans	$	2,068	$	162	$	17,198	$	19,428	$	1,037,305	$	1,056,733

December 31, 2019	30-89 Days Past Due		90 Days or More Past Due and Still Accruing		Nonaccrual		Total Past Due and Nonaccrual		Current		Total Loans
Mortgage loans on real estate:
Residential first mortgages	$	3,904	$	16	$	1,403	$	5,323	$	288,590	$	293,913
Commercial mortgages (non-owner occupied)		126		—		433		559		195,584		196,143
Construction, land and land development		77		—		417		494		125,516		126,010
Commercial mortgages (owner occupied)		173		—		587		760		82,069		82,829
Residential revolving and junior mortgages		52		—		724		776		31,117		31,893
Commercial and industrial		570		—		670		1,240		180,490		181,730
Consumer		139		—		242		381		11,604		11,985
Total loans	$	5,041	$	16	$	4,476	$	9,533	$	914,970	$	924,503

The increase in nonaccrual loans as of September 30, 2020 compared to December 31, 2019 was primarily due to loans to borrowers adversely affected by the COVID-19 pandemic. These borrowers exhibited weakness and management believes it is probable the borrowers will be unable to meet the contractual payment terms of their loan agreements. As of September 30, 2020, loans representing a significant amount of the increase in balances were current.

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The following tables include an aging analysis, based upon contractual terms, of the recorded investment of PCI loans included in the tables above as of the dates stated.

September 30, 2020	30-89 Days Past Due		90 Days or More Past Due and Still Accruing		Nonaccrual		Total Past Due and Nonaccrual		Current		Total PCI Loans
Mortgage loans on real estate:
Residential first mortgages	$	39	$	13	$	—	$	52	$	2,381	$	2,433
Commercial mortgages (non-owner occupied)		—		128		—		128		—		128
Construction, land and land development		—		—		—		—		1,368		1,368
Commercial mortgages (owner occupied)		—		21		—		21		203		224
Residential revolving and junior mortgages		—		—		—		—		—		—
Commercial and industrial		—		—		—		—		—		—
Paycheck Protection Program		—		—		—		—		—		—
Consumer		—		—		—		—		37		37
Total purchased credit-impaired loans	$	39	$	162	$	—	$	201	$	3,989	$	4,190

December 31, 2019	30-89 Days Past Due		90 Days or More Past Due and Still Accruing		Nonaccrual		Total Past Due and Nonaccrual		Current		Total PCI Loans
Mortgage loans on real estate:
Residential first mortgages	$	239	$	16	$	—	$	255	$	2,836	$	3,091
Commercial mortgages (non-owner occupied)		126		—		—		126		—		126
Construction, land and land development		—		—		—		—		1,357		1,357
Commercial mortgages (owner occupied)		25		—		—		25		229		254
Residential revolving and junior mortgages		—		—		—		—		—		—
Commercial and industrial		—		—		—		—		—		—
Consumer		—		—		—		—		42		42
Total purchased credit-impaired loans	$	390	$	16	$	—	$	406	$	4,464	$	4,870

The following table presents the changes in accretable yield for PCI loans for the periods stated.

	For the Three Months Ended						For the Nine Months Ended
	September 30, 2020			September 30, 2019			September 30, 2020			September 30, 2019
Balance at beginning of period	$	702		$	858		$	973		$	1,083
Accretion of acquisition accounting adjustment		(64	)		(121	)		(203	)		(305	)
Reclassifications from nonaccretable balance, net		—			6			5			62
Other changes, net		—			250			(137	)		153
Balance at end of period	$	638		$	993		$	638		$	993

Internal Risk Ratings

Loans in the Company’s loan portfolio are risk rated on a periodic basis by experienced credit personnel.

Risk rating categories are as follows:

Pass – Several pass credit risk ratings apply to loans in this category. These ratings are assigned based on varying levels of risk, ranging from credits that are secured by cash or marketable securities to management attention credits that have all characteristics of an acceptable credit risk but warrant more than the normal level of monitoring.

Special Mention – Adverse trends in the borrower’s financial position are evident and warrant management’s close attention for loans risk rated special mention. Any collateral securing loans in this category may not be fully adequate to secure the loan balance.

Substandard – A loan in this category has a well-defined weakness in the primary repayment source that jeopardizes the timely collection of the loan. There is a distinct possibility that a loss may result if the weakness is not corrected.

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Doubtful – Default has already occurred and it is likely that foreclosure or repossession procedures have begun or will begin in the near future. Weaknesses make collection or liquidation in full, based on currently existing information, highly questionable and improbable.

Loss – Uncollectible and of such little value that continuance as an asset is not warranted.

The following tables present the Company’s risk rating of loans by loan type as of the dates stated.

	Grade
September 30, 2020	Pass		Special Mention		Substandard		Doubtful		Total Loans
Residential first mortgages	$	280,760	$	1,890	$	3,477	$	—	$	286,127
Commercial mortgages (non-owner occupied)		236,058		40,084		6,236		—		282,378
Construction, land and land development		103,472		26,764		2,266		—		132,502
Commercial mortgages (owner occupied)		64,993		10,893		339		—		76,225
Residential revolving and junior mortgages		28,140		514		397		—		29,051
Commercial and industrial		166,650		14,607		5,962		—		187,219
Paycheck Protection Program		56,788		—		—		—		56,788
Consumer		5,704		541		198		—		6,443
Total loans	$	942,565	$	95,293	$	18,875	$	—	$	1,056,733

	Grade
December 31, 2019	Pass		Special Mention		Substandard		Doubtful		Total Loans
Residential first mortgages	$	290,322	$	1,091	$	2,500	$	—	$	293,913
Commercial mortgages (non-owner occupied)		195,584		—		559		—		196,143
Construction, land and land development		123,916		—		2,094		—		126,010
Commercial mortgages (owner occupied)		81,936		149		744		—		82,829
Residential revolving and junior mortgages		31,084		86		723		—		31,893
Commercial and industrial		177,608		2,289		1,833		—		181,730
Consumer		11,729		—		256		—		11,985
Total loans	$	912,179	$	3,615	$	8,709	$	—	$	924,503

In March of 2020, the Company downgraded approximately $88.5 million of loans to borrowers in industries highly affected by the COVID-19 pandemic, such as hotels, restaurants, retail, churches, and assisted-living facilities. The majority of the risk rating downgrades due to COVID-19 were from pass grades to special mention, and the majority were in commercial and construction loan types. During the second quarter of 2020, risk ratings for certain loans in these highly affected industries were adjusted as additional information became available. During the third quarter of 2020, an additional $4.7 million of loans were downgraded from pass grades to special mention or substandard.

Note 5: Allowance for Loan Losses

The allowance for loan losses (“ALL”) reflects management’s estimate of probable loan losses inherent in the loan portfolio as of the balance sheet date. Management uses a disciplined process and methodology to establish the ALL each quarter-end. To determine the total ALL, the Company estimates the reserves needed for each homogenous type of the loan category and for any loans analyzed individually for impairment. Depending on the nature of each loan type, considerations include historical loss experience, adverse situations that may affect a borrower’s ability to repay, credit scores, past due history, estimated value of any underlying collateral, prevailing local and national economic conditions, and internal policies and procedures including credit risk management and underwriting. This evaluation is inherently subjective, as it requires estimates that are susceptible to significant revision as conditions change.

The ALL consists of specific, general, and unallocated components. The specific component is determined by identifying impaired loans (as described below) then evaluating each one individually to calculate the amount of impairment. Impaired loans measured individually for impairment generally include (1) any loan risk rated substandard or worse with balances of $400 thousand or more, and (2) all loans designated as TDRs. For the general component of the ALL, the Company collectively evaluates loans not evaluated individually for a specific reserve, plus impaired loans risk rated substandard or worse with balances less than $400 thousand. All loans evaluated collectively are grouped into types, and historical loss experience is calculated and applied to each loan type and the resultant reserve is adjusted for qualitative factors. Qualitative factors include changes in local and national economic indicators, such as unemployment rates, interest rates, gross domestic product growth, and real estate market trends; the level of past due and nonaccrual loans; risk ratings on individual loans; strength of credit policies and procedures; loan officer experience; borrower credit

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scores; and other intrinsic risks related to the types and geographic locations of loans. These qualitative adjustments reflect management’s judgment of risks inherent in the types. An unallocated component is maintained, if needed, to cover uncertainties that could affect management’s estimate of probable losses.  

Loans Evaluated for Impairment

The following table presents the ALL by loans evaluated for impairment individually and collectively by loan type as of the dates stated. PPP loans are included in the commercial and industrial loan balances.

September 30, 2020	Mortgage Loans on Real Estate		Commercial and Industrial		Consumer		Total
Allowance for loan losses applicable to:
Loans individually evaluated for impairment	$	2,036	$	746	$	105	$	2,887
Loans collectively evaluated for impairment		7,551		2,143		318		10,012
Purchased credit-impaired loans		—		—		—		—
Total allowance for loan losses	$	9,587	$	2,889	$	423	$	12,899
Loan balances applicable to:
Loans individually evaluated for impairment	$	12,249	$	5,754	$	105	$	18,108
Loans collectively evaluated for impairment		789,881		238,253		6,301		1,034,435
Purchased credit-impaired loans		4,153		—		37		4,190
Total loans	$	806,283	$	244,007	$	6,443	$	1,056,733
December 31, 2019
Allowance for loan losses applicable to:
Loans individually evaluated for impairment	$	878	$	49	$	112	$	1,039
Loans collectively evaluated for impairment		4,494		1,522		507		6,523
Purchased credit-impaired loans		—		—		—		—
Total allowance for loan losses	$	5,372	$	1,571	$	619	$	7,562
Loan balances applicable to:
Loans individually evaluated for impairment	$	5,502	$	455	$	112	$	6,069
Loans collectively evaluated for impairment		720,458		181,275		11,831		913,564
Purchased credit-impaired loans		4,828		—		42		4,870
Total loans	$	730,788	$	181,730	$	11,985	$	924,503

PPP loans are fully guaranteed by the U.S. government; therefore, the Company recorded no allowance for loan losses for these loans as of September 30, 2020. In future periods, the Company may be required to establish an allowance for loan losses for these loans, if, for example, the U.S. government were to eliminate or reduce the guarantee on individual or groups of PPP loans, which would result in a provision for loan losses charged to earnings.

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The following tables present an analysis of the change in the ALL by loan type for the periods presented.

For the Three Months Ended September 30, 2020	Mortgage Loans on Real Estate			Commercial and Industrial		Consumer			Total
Beginning of period	$	8,863		$	2,626	$	518		$	12,007
Charge-offs		(64	)		—		(47	)		(111	)
Recoveries		72			—		62			134
Provision (recovery of)		716			263		(110	)		869
Ending of period	$	9,587		$	2,889	$	423		$	12,899
For the Three Months Ended September 30, 2019	Mortgage Loans on Real Estate			Commercial and Industrial		Consumer			Total
Beginning of period	$	5,052		$	1,537	$	890		$	7,479
Charge-offs		(209	)		—		(345	)		(554	)
Recoveries		24			1		50			75
Provision		214			114		167			495
Ending of period	$	5,081		$	1,652	$	762		$	7,495
For the Nine Months Ended September 30, 2020	Mortgage Loans on Real Estate			Commercial and Industrial		Consumer			Total
Beginning of period	$	5,372		$	1,571	$	619		$	7,562
Charge-offs		(315	)		—		(303	)		(618	)
Recoveries		84			—		198			282
Provision (recovery of)		4,446			1,318		(91	)		5,673
Ending of period	$	9,587		$	2,889	$	423		$	12,899
For the Nine Months Ended September 30, 2019	Mortgage Loans on Real Estate			Commercial and Industrial		Consumer			Total
Beginning of period	$	4,967		$	1,374	$	1,561		$	7,902
Charge-offs		(368	)		—		(1,163	)		(1,531	)
Recoveries		67			1		185			253
Provision		415			277		179			871
Ending of period	$	5,081		$	1,652	$	762		$	7,495

Provision for loan losses was $5.7 million for the nine months ended September 30, 2020 compared to $871 thousand for the nine months ended September 30, 2019. Provision in 2020 was primarily attributable to qualitative loss factors to provide for losses estimated to have been incurred as of September 30, 2020, as a result of challenges certain borrowers are facing due to the pandemic, evidenced, in part, by loan deferrals and modifications granted to these borrowers, gross loan growth of approximately $71.9 million, excluding PPP loans, and higher specific reserves on impaired loans.

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Impaired Loans

The following table presents the recorded investment and the borrowers’ unpaid principal balances for impaired loans, excluding PCI loans, with the associated ALL amount, if applicable, by loan type as of the dates stated.

	As of September 30, 2020						As of December 31, 2019
	Recorded Investment		Borrowers’ Unpaid Principal Balance		Related Allowance		Recorded Investment		Borrowers’ Unpaid Principal Balance		Related Allowance
With no related allowance:
Residential first mortgages	$	712	$	712	$	—	$	510	$	510	$	—
Commercial mortgages (non-owner occupied)		3,270		3,270		—		—		—		—
Construction, land and land development		15		15		—		17		17		—
Commercial mortgages (owner occupied)		361		361		—		419		419		—
Residential revolving and junior mortgages		—		—		—		—		—		—
Commercial and industrial		1,014		1,014		—		—		—		—
Consumer		—		—		—		—		—		—
Total impaired loans with no related allowance		5,372		5,372		—		946		946		—
With an allowance recorded:
Residential first mortgages		3,585		3,585		763		2,857		2,857		676
Commercial mortgages (non-owner occupied)		2,838		2,838		651		433		433		58
Construction, land and land development		766		766		546		171		171		44
Commercial mortgages (owner occupied)		657		657		31		1,048		1,048		53
Residential revolving and junior mortgages		45		45		45		47		47		47
Commercial and industrial		4,740		4,740		746		455		455		49
Consumer		105		105		105		112		112		112
Total impaired loans with allowance recorded		12,736		12,736		2,887		5,123		5,123		1,039
Total impaired loans:
Residential first mortgages		4,297		4,297		763		3,367		3,367		676
Commercial mortgages (non-owner occupied)		6,108		6,108		651		433		433		58
Construction, land and land development		781		781		546		188		188		44
Commercial mortgages (owner occupied)		1,018		1,018		31		1,467		1,467		53
Residential revolving and junior mortgages		45		45		45		47		47		47
Commercial and industrial		5,754		5,754		746		455		455		49
Consumer		105		105		105		112		112		112
Total impaired loans	$	18,108	$	18,108	$	2,887	$	6,069	$	6,069	$	1,039

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The following table presents the average recorded investment and interest income recognized for impaired loans, excluding PCI loans, by loan type for the periods presented.

	For the Three Months Ended
	September 30, 2020				September 30, 2019
	Average Recorded Investment		Interest Income Recognized		Average Recorded Investment		Interest Income Recognized
With no related allowance:
Residential first mortgages	$	714	$	8	$	1,039	$	14
Commercial mortgages (non-owner occupied)		3,263		23		—		—
Construction, land and land development		15		—		326		1
Commercial mortgages (owner occupied)		363		7		427		6
Residential revolving and junior mortgages		—		—		—		—
Commercial and industrial		1,024		13		—		—
Consumer		—		—		—		—
Total impaired loans with no allowance		5,379		51		1,792		21
With an allowance recorded:
Residential first mortgages		3,595		19		3,039		34
Commercial mortgages (non-owner occupied)		1,635		22		434		3
Construction, land and land development		768		5		175		3
Commercial mortgages (owner occupied)		656		8		1,055		14
Residential revolving and junior mortgages		46		1		128		2
Commercial and industrial		3,561		64		1,344		30
Consumer		108		—		118		2
Total impaired loans with allowance recorded		10,369		119		6,293		88
Total impaired loans:
Residential first mortgages		4,309		27		4,078		48
Commercial mortgages (non-owner occupied)		4,898		45		434		3
Construction, land and land development		783		5		501		4
Commercial mortgages (owner occupied)		1,019		15		1,482		20
Residential revolving and junior mortgages		46		1		128		2
Commercial and industrial		4,585		77		1,344		30
Consumer		108		—		118		2
Total impaired loans	$	15,748	$	170	$	8,085	$	109

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	For the Nine Months Ended
	September 30, 2020				September 30, 2019
	Average Recorded Investment		Interest Income Recognized		Average Recorded Investment		Interest Income Recognized
With no related allowance:
Residential first mortgages	$	519	$	20	$	1,113	$	43
Commercial mortgages (non-owner occupied)		1,632		43		—		—
Construction, land and land development		16		1		330		4
Commercial mortgages (owner occupied)		365		19		405		20
Residential revolving and junior mortgages		—		—		—		—
Commercial and industrial		512		25		—		—
Consumer		—		—		—		—
Total impaired loans with no allowance		3,044		108		1,848		67
With an allowance recorded:
Residential first mortgages		3,262		55		3,181		93
Commercial mortgages (non-owner occupied)		1,034		32		436		30
Construction, land and land development		468		11		224		18
Commercial mortgages (owner occupied)		658		25		1,061		42
Residential revolving and junior mortgages		46		3		397		7
Commercial and industrial		1,918		105		672		30
Consumer		109		—		119		6
Total impaired loans with allowance recorded		7,495		231		6,090		226
Total impaired loans:
Residential first mortgages		3,781		75		4,294		136
Commercial mortgages (non-owner occupied)		2,666		75		436		30
Construction, land and land development		484		12		554		22
Commercial mortgages (owner occupied)		1,023		44		1,466		62
Residential revolving and junior mortgages		46		3		397		7
Commercial and industrial		2,430		130		672		30
Consumer		109		—		119		6
Total impaired loans	$	10,539	$	339	$	7,938	$	293

The following table presents a reconciliation of nonaccrual loans to impaired loans as of the dates stated.

	September 30, 2020			December 31, 2019
Nonaccrual loans	$	17,198		$	4,476
Nonaccrual loans collectively evaluated for impairment		(1,512	)		(1,895	)
Nonaccrual impaired loans		15,686			2,581
TDRs on accrual		2,422			3,270
Other impaired loans on accrual		—			218
Total impaired loans	$	18,108		$	6,069

Troubled Debt Restructurings

In some situations, for economic or legal reasons related to a borrower’s financial condition, the Company may grant a concession to a borrower that it would not otherwise consider. Concessions include new terms that provide for a reduction of the face amount or maturity amount of the debt as stated in the original agreement, a reduction (absolute or contingent) of the stated interest rate for the remaining original life of the loan, and/or an extension of the maturity date or dates at a stated interest rate lower than the current market rate for new debt with similar risk. Concessions granted to a borrower experiencing financial difficulties results in a loan that is subsequently classified as a troubled debt restructuring. Management strives to identify borrowers in financial difficulty early and work with them to modify their loan to more affordable terms before their loan reaches nonaccrual status to minimize the economic loss and to avoid foreclosure or repossession of underlying collateral, if any. TDRs are considered impaired loans and are individually evaluated for impairment for the ALL.

No loans designated as TDRs subsequently defaulted in the twelve months following the restructuring.

The following table presents pre- and post-modification balances for loans newly designated as TDRs for the periods stated.

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For the Three Months Ended

September 30, 2020

September 30, 2019

Number of Loans

Pre-Modification Outstanding Recorded Investment

Post-Modification Outstanding Recorded Investment

Number of Loans

Pre-Modification Outstanding Recorded Investment

Post-Modification Outstanding Recorded Investment

Commercial mortgages (non-owner occupied) (1)

1

220

220

—

—

—

(1) Modification was an extension of the loan term.

	For the Nine Months Ended
	September 30, 2020						September 30, 2019
	Number of Loans		Pre-Modification Outstanding Recorded Investment		Post-Modification Outstanding Recorded Investment		Number of Loans		Pre-Modification Outstanding Recorded Investment		Post-Modification Outstanding Recorded Investment
Residential first mortgages  (1)		1	$	391	$	391		—	$	—	$	—
Commercial mortgages (owner occupied) (2)		—		—		—		1		48		52
Commercial mortgages (non-owner occupied) (2)		1		220		220		—		—		—

(1) Modification was an interest payment deferral.

(2) Modification was an extension of the loan term.

The following table presents a roll-forward of accruing and nonaccrual TDRs for the period presented.

	Accruing			Nonaccrual			Total
Balance as of December 31, 2019	$	3,270		$	1,352		$	4,622
Charge-offs		(183	)		(327	)		(510	)
Payments and other adjustments		(615	)		(36	)		(651	)
New TDR designation		—			611			611
Release TDR designation		(50	)		—			(50	)
Transfer		—			—			—
Balance as of September 30, 2020	$	2,422		$	1,600		$	4,022

Note 6: Other Real Estate Owned, net

The following table presents the number and carrying values of properties included in other real estate owned (“OREO”) as of the dates stated.

	September 30, 2020				December 31, 2019
	Number of		Carrying		Number of		Carrying
	Properties		Value		Properties		Value
Residential		4	$	228		4	$	302
Land		8		625		13		1,354
Commercial properties		1		260		1		260
Total other real estate owned, net		13	$	1,113		18	$	1,916

One residential mortgage loan of $77 thousand was in the process of foreclosure as of September 30, 2020.

Note 7: Goodwill

The Company’s goodwill resulted from the Merger ($7.6 million) and from the acquisition of five branches during the years 1994 through 2000 ($2.8 million). The Company’s goodwill is tested for potential impairment on at least an annual basis as of September 30, or when a triggering event occurs, in accordance with ASC 350, Intangibles-Goodwill and Other. Management identified that a triggering event occurred in the second quarter of 2020, as a result of the detrimental effect the COVID-19 pandemic has had to the macroeconomic environment, challenges the low interest rate environment has on the banking industry, the decrease in the market value of the Company’s stock, and, in particular, the Company’s stock valuation pursuant to the Blue Ridge Merger. As a result, management performed an impairment analysis and concluded that the Company’s goodwill was impaired, resulting in an impairment charge of $10.4 million, which was recorded in the second quarter of 2020. The goodwill impairment charge is presented as a component of noninterest expense in the Company’s consolidated statements of operations.

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Note 8: Leases

For the three and nine months ended September 30, 2020, operating lease expense totaled $226 thousand and $678 thousand, respectively.  

The following table presents the right-of-use (“ROU”) assets and lease liabilities as of the date stated. ROU assets and lease liabilities are included in other assets and other liabilities, respectively, in the Company’s consolidated balance sheets.  

	September 30, 2020
Operating lease right-of-use assets	$	3,708
Current operating lease liabilities		867
Noncurrent lease liabilities		3,091
Total operating lease liabilities	$	3,958

The following table presents the weighted average remaining lease term and discount rate associated with operating leases as of the date stated.

	September 30, 2020
Weighted average remaining lease term - operating leases	8 years
Weighted average discount rate - operating leases		3.13	%

The following table presents a maturity analysis of operating lease liabilities for the five years ending subsequent to September 30, 2020 and in total thereafter.

2020	$	220
2021		995
2022		619
2023		370
2024		380
Thereafter		1,908
Total		4,492
Less interest		(534	)
Lease liability	$	3,958

The following table presents supplemental cash flow information related to operating leases for the periods stated.

	For the Nine Months Ended
	September 30, 2020		September 30, 2019
Cash paid for amount included in the measurement of lease liabilities:
Operating cash flows from operating leases	$	746	$	744
Right-of-use assets obtained in exchange for new operating lease liabilities		—		1,304

Note 9: Earnings per Share

The following table shows the calculation of basic and diluted earnings per share and the weighted average number of shares outstanding used in computing earnings per share and the effect on the weighted average number of shares outstanding of dilutive potential common stock. Basic earnings per share amounts are computed by dividing net income (the numerator) by the weighted average number of common shares outstanding (the denominator). Diluted earnings per share amounts assume the conversion, exercise, or issuance of all potential common stock instruments, unless the effect is to reduce the loss or increase earnings per common share. Potential dilutive common stock instruments include exercisable stock options and restricted shares. For both computations, the weighted average number of the Company’s employee stock ownership plan (“ESOP”) shares not committed to be released to participant accounts are not assumed to be outstanding.

The weighted average ESOP shares excluded from the computation were 163,036 and 171,613 for the three and nine months ended September 30, 2020, respectively. The weighted average ESOP shares excluded from the computation were 147,383 and 154,376 for the three and nine months ended September 30, 2019, respectively.

For the three months ended September 30, 2020 and the three and nine months ended September 30, 2019, options on and restricted shares totaling 152,047 and 119,047, respectively, were not included in the computation of diluted EPS because their effects would

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have been anti-dilutive. For the nine months ended September 30, 2020, all options on and restricted shares were not included in the computation of diluted earnings per share because their effects would have been anti-dilutive.

	For the Three Months Ended September 30,				For the Nine Months Ended September 30,
	2020		2019		2020			2019
Net income (loss)	$	1,493	$	1,841	$	(6,648	)	$	5,056
Weighted average shares outstanding, basic		13,090,035		13,077,600		13,075,761			13,046,694
Dilutive shares:
Stock options		12,679		32,756		—			33,034
Restricted shares		35,276		22,103		—			12,639
Weighted average shares outstanding, dilutive		13,137,990		13,132,459		13,075,761			13,092,367
Basic and diluted income (loss) per share	$	0.11	$	0.14	$	(0.51	)	$	0.39

Note 10: Borrowings

FRB Borrowings

In the second quarter of 2020, the Company began participating in the Federal Reserve Bank of Richmond’s PPP Liquidity Facility (“PPPLF”), which allows banks to pledge PPP loans as collateral in exchange for advances. The PPPLF advances are at 100% of the PPP loan value and term, have a fixed cost of 35 basis points, and receive favorable regulatory capital treatment. As of September 30, 2020, these FRB borrowings were comprised of six PPPLF advances, totaling $32.6 million with maturities ranging from 553 days to 560 days.

FHLB Borrowings

As of September 30, 2020 and December 31, 2019, the Bank had $25.0 and $45.0 million, respectively, of outstanding FHLB borrowings, consisting of three and four advances, respectively. Advances on the FHLB line are secured by a blanket lien on qualified one-to-four family real estate, commercial real estate, and multifamily residential loans. Immediately available credit as of September 30, 2020 was $252.4 million against a total line of credit of $308.4 million. As of September 30, 2020, the Bank had $31.0 million of letters of credit issued by the FHLB for the benefit of the Virginia Department of the Treasury as collateral for public deposits held by the Bank to comply with the Security of Public Deposits Act. The $31.0 million is not an outstanding borrowing as of September 30, 2020, but does reduce the available credit under the FHLB credit line.

The following table presents information regarding the FHLB advances outstanding as of September 30, 2020.

				Stated			Maturity
	Balance		Originated	Interest Rate			Date
Convertible	$	10,000	2/28/2020		0.56	%	2/28/2030
Fixed rate credit		5,000	9/8/2020		0.24	%	10/8/2020
Fixed rate credit		10,000	9/24/2020		0.22	%	10/23/2020
Total FHLB borrowings	$	25,000

Subordinated Notes

On May 28, 2015, the Company issued $7.0 million of subordinated notes (the “2025 Notes”) with a maturity date of May 28, 2025 and that bear interest, payable on the first of March and September of each year, at a fixed interest rate of 6.50% per year. The Company has the right to redeem the 2025 Notes, in whole or in part, without premium or penalty, at any interest payment date after May 28, 2020, but in all cases in a principal amount with integral multiples of $1,000, plus interest accrued and unpaid through the date of redemption. The 2025 Notes are unsecured, subordinated obligations of the Company and rank junior in right of payment to the Company’s existing and future senior indebtedness. The 2025 Notes qualify as Tier 2 capital for regulatory reporting; however, the amount qualifying as capital is reduced by 20% annually beginning at the quarter end after the first redemption date, which occurred in the second quarter of 2020. The aggregate carrying value of the 2025 Notes, including capitalized, unamortized debt issuance costs, was $6.9 million at both September 30, 2020 and December 31, 2019. For the three and nine months ended September 30, 2020, the effective interest rate on the 2025 Notes was 6.82%. For the three and nine months ended September 30, 2019, the effective interest rate on the 2025 Notes was 6.82%.

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On October 7, 2019, the Company issued $25.0 million in fixed-to-floating rate subordinated notes due 2029 (the “2029 Notes”). The 2029 Notes bear interest at 5.625% per year, beginning October 7, 2019 through October 14, 2024, payable semi-annually in arrears. From October 15, 2024 through October 14, 2029, or up to an early redemption date, the interest rate shall reset quarterly to an interest rate per year equal to the then current three-month Secured Overnight Funding Rate (“SOFR”) (as defined in the 2029 Notes) plus 433.5 basis points, payable quarterly in arrears. The 2029 Notes are unsecured, subordinated obligations of the Company and rank junior in right of payment to the Company’s existing and future senior indebtedness and rank in parity with the 2025 Notes. The 2029 Notes qualify as Tier 2 capital for regulatory reporting. Beginning on October 15, 2024 through maturity, the 2029 Notes may be redeemed, at the Company's option, on any scheduled interest payment date. The 2029 Notes will mature on October 15, 2029. The aggregate carrying value of the 2029 Notes, including capitalized, unamortized debt issuance costs, was $24.2 million and $24.1 million at September 30, 2020 and December 31, 2019, respectively. For both the three and nine months ended September 30, 2020, the effective interest rate on the 2029 Notes was 6.21%.

ESOP Debt

The aggregate carrying value of debt secured by shares of Company stock, issued and outstanding, held in the Company’s ESOP was $1.3 million and $1.5 million as of September 30, 2020 and December 31, 2019, respectively, and was included in other liabilities on the consolidated balance sheets. As of September 30, 2020, the debt was comprised of three fixed rate amortizing notes, which carry an interest rate of 3.25% with maturity dates ranging from March 1, 2025 to November 1, 2026, and two variable rate amortizing notes (interest rate of 5.50% as of September 30, 2020) with maturity dates ranging from June 14, 2024 to December 31, 2027. Shares that collateralize these loans are not allocated to ESOP participants’ accounts.

Note 11: Fair Value Measurements

The Company uses fair value to record certain assets and liabilities and to determine fair value disclosures. Authoritative accounting guidance (ASC 820, Fair Value Measurements (“ASC 820”)) clarifies that fair value of certain assets and liabilities is an exit price, representing the amount that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. Fair value also assumes that the reporting entity would sell the asset or transfer the liability in the principal or most advantageous market.

ASC 820 specifies a hierarchy of valuation techniques based on whether the inputs to those valuation techniques are observable or unobservable. Observable inputs reflect market data obtained from independent sources, while unobservable inputs reflect the Company’s market assumptions. The three levels of the fair value hierarchy based on these two types of inputs are as follows:

Level 1 –	Valuation is based on quoted prices in active markets for identical assets and liabilities.
Level 2 –	Valuation is based on observable inputs including quoted prices in active markets for similar assets and liabilities, quoted prices for identical or similar assets and liabilities in less active markets, and model-based valuation techniques for which significant assumptions can be derived primarily from or corroborated by observable data in the market.
Level 3 –	Valuation is based on model-based techniques that use one or more significant inputs or assumptions that are unobservable in the market.

The following describes the valuation techniques used by the Company to measure certain financial assets and liabilities recorded at fair value on a recurring basis in the financial statements:

Available-for-sale securities: Available-for-sale securities 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. The Company engages a third-party to determine the fair value of its available-for-sale securities.

Rabbi trust assets: The Company established a rabbi trust for the benefit of participants in the Company’s deferred compensation benefit plan. The assets held by the rabbi trust are invested at the direction of the individual participants and are generally invested in marketable investment securities, such as common stocks and mutual funds or short-term investments (e.g., cash) (Level 1). Rabbi trust assets are included in other assets on the consolidated balance sheets.

Mortgage servicing right (“MSR”) assets: The Company currently owns MSR assets from two residential loan portfolios, one serviced for Fannie Mae and one serviced for Freddie Mac. The MSR assets are recorded at fair value on a recurring basis, with changes in fair value recorded in the consolidated statements of operations.

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A third-party model is used to determine fair value, which establishes pools of performing loans, calculates cash flows for each pool, and applies a discount rate to each pool. Loans are segregated into 12 pools based on each loan’s term and seasoning (age). All loans have fixed interest rates. Cash flows are then estimated by utilizing assumed service costs and prepayment speeds. Monthly service costs were assumed to be $6.00 and $6.50 per loan as of September 30, 2020 and December 31, 2019, respectively. Prepayment speeds are determined primarily based on the average interest rate of the loans in each pool. The prepayment scale used is the Public Securities Association (“PSA”) model, where “100% PSA” means prepayments are zero in the first month, then increase by 0.2% of the loan balance each month until reaching 6.0% in month 30. Thereafter, the 100% PSA model assumes an annual prepayment of 6.0% of the remaining loan balance. The average PSA speed assumption in the fair value model is 304% and 187% as of September 30, 2020 and December 31, 2019, respectively. A discount rate of 12.0% and 12.5% was then applied to each pool as of September 30, 2020 and December 31, 2019, respectively. The discount rate is intended to represent the estimated market yield for the highest quality grade of comparable servicing. MSR assets are classified as Level 3.

The following tables present the balances of financial assets and liabilities measured at fair value on a recurring basis as of the dates stated.

			Fair Value Measurements as of September 30, 2020 Using
	Balance as of September 30, 2020		Level 1		Level 2		Level 3
Available-for-sale securities:
U. S. Government agencies and mortgage backed securities	$	48,870	$	—	$	48,870	$	—
State and municipal obligations		18,846		—		18,846		—
Corporate bonds		20,137		—		14,464		5,673
Total available-for-sale securities	$	87,853	$	—	$	82,180	$	5,673
MSR assets	$	845	$	—	$	—	$	845
Rabbi trust assets	$	959	$	959	$	—	$	—

			Fair Value Measurements as of December 31, 2019 Using
	Balance as of December 31, 2019		Level 1		Level 2		Level 3
Available-for-sale securities:
U. S. Government agencies and mortgage backed securities	$	67,597	$	7,024	$	60,573	$	—
State and municipal obligations		16,576		—		16,576		—
Corporate bonds		15,281		2,000		10,631		2,650
Total available-for-sale securities	$	99,454	$	9,024	$	87,780	$	2,650
MSR assets	$	935	$	—	$	—	$	935
Rabbi trust assets	$	1,082	$	1,082	$	—	$	—

The following table presents the change in financial assets valued using Level 3 inputs for the periods stated.

	MSR Assets			Corporate Bonds
Balance as of January 1, 2020	$	935		$	2,650
Purchases		—			1,000
Transfers from Level 2 to Level 3		—			2,028
Fair value adjustments		(90	)		(5	)
Sales		—			—
Balance as of September 30, 2020	$	845		$	5,673

As of September 30, 2020, seven corporate bonds totaling $5.7 million were reported at their respective purchase prices and as Level 3 assets in the fair value hierarchy as there were no observable market prices for similar investments.

Certain assets are measured at fair value on a nonrecurring basis in accordance with GAAP. Adjustments to the fair value of these assets usually result from the application of lower-of-cost-or-market accounting or write-downs of individual assets.

The following describes the valuation techniques used by the Company to measure certain assets recorded at fair value on a nonrecurring basis in the financial statements.

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Impaired Loans: Loans are designated as impaired when, in the judgment of management based on current information and events, it is probable that all amounts due will not be collected according to the contractual terms of the loan agreement. The measurement of loss associated with impaired loans can be based on either the discounted cash flows of the loan or the fair value of the collateral, if any, less estimated costs to sell, if the loan is collateral-dependent. Collateral may be in the form of real estate or business assets including equipment, inventory, and accounts receivable. Any given loan may have multiple types of collateral; however, the majority of the Company’s loan collateral is real estate. The value of real estate collateral is generally determined utilizing a market valuation approach based on an appraisal conducted by an independent, licensed appraiser outside of the Company using observable market data (Level 2). However, if the collateral value is significantly adjusted due to differences in the comparable properties or is discounted by the Company because of lack of marketability, then the fair value is considered Level 3. The value of business equipment is based upon an outside appraisal if deemed significant or the net book value on the applicable business’s financial statements if not considered significant. Likewise, values for inventory and accounts receivables collateral are based on financial statement balances or aging reports (Level 3). Fair value adjustments are recorded in the period incurred as provision for loan losses on the consolidated statements of operations.

Other Real Estate Owned, net: OREO is measured at fair value less estimated costs to sell, generally based on an appraisal conducted by an independent, licensed appraiser, or using other methods such as a brokered price opinion of a third-party real estate agent. If the collateral value is significantly adjusted due to differences in the comparable properties or is discounted by the Company because of lack of marketability, then the fair value is considered Level 3. Fair value adjustments, if any, are recorded in the period incurred and included in other noninterest expense on the consolidated statements of operations.

The following tables summarize assets that were measured at fair value on a nonrecurring basis as of the dates stated.

			Fair Value Measurements as of September 30, 2020 Using
	Balance as of September 30, 2020		Level 1		Level 2		Level 3
Impaired loans, net	$	9,849	$	—	$	—	$	9,849
Other real estate owned, net		1,113		—		—		1,113

			Fair Value Measurements as of December 31, 2019 Using
	Balance as of December 31, 2019		Level 1		Level 2		Level 3
Impaired loans, net	$	4,084	$	—	$	—	$	4,084
Other real estate owned, net		1,916		—		—		1,916

The following tables present quantitative information about Level 3 fair value measurements as of the dates stated.

	Balance as of September 30, 2020		Valuation Technique	Unobservable Input	Range (Weighted Average)
Impaired loans, net	$	9,849	Discounted appraised value	Selling Cost Lack of Marketability	7% 13%-93% (23%)
			Discounted cash flows	Discount rate	6%-7% (6%)
			Enterprise Value ("EV")	EV Multiple	7.0-12.9 (7.1)
Other real estate owned, net		1,113	Discounted appraised value	Selling Cost Lack of Marketability	0%-8% (6%) 41%-65% (58%)

Of the $9.8 million of impaired loans as of September 30, 2020, $5.7 million were evaluated for impairment using an EV valuation technique, as the Company owns a percentage of nationally syndicated loans to two publicly traded companies and one private conglomerate. EV is estimated using a multiple of earnings before income taxes, depreciation, and amortization (“EBITDA”). EBITDA estimates were developed based on historical and projected performance of these companies while the EV multiple was derived based on publicly available data of these borrower’s respective peer companies and industries.

	Balance as of December 31, 2019		Valuation Technique	Unobservable Input	Range (Weighted Average)
Impaired loans, net	$	4,084	Discounted appraised value	Selling Cost Lack of Marketability	7% 13%-100% (24%)
			Discounted cash flows	Discount rate	6%-7% (6%)
Other real estate owned, net		1,916	Discounted appraised value	Selling Cost Lack of Marketability	6%-10% (8%) 18%-100% (47%)

26

The carrying values of cash and due from banks, interest-earning deposits, federal funds sold or purchased, noninterest-bearing deposits, savings and interest-bearing deposits, and securities sold under repurchase agreements are payable on demand, or are of such short duration, that carrying value approximates fair value (Level 1).

The carrying values of certificates of deposit, loans held for sale, and accrued interest receivable are payable on demand, or are of such short duration, that carrying value approximates fair value (Level 2).

The carrying value of restricted securities approximates fair value based on the redemption provisions of the issuer.

The fair value of performing loans is estimated by discounting the future cash flows using two sets of data sources. First, recent originations, occurring over the prior twelve months, were evaluated, and second, market data showing originations over the prior three months were evaluated. The selected rate was the greater of the two sources. For all loans other than a selective consumer loan portfolio, credit loss severity rates were calculated using the probability of default and the loss given default percentages derived from market data. For the selective consumer loan portfolio, historical delinquency data were obtained by the servicer of the portfolio. The fair value of impaired loans is measured as described within the Impaired Loans section of this note. The fair value of loans does consider the lack of liquidity and uncertainty in the market that might affect the valuation.

Time deposits are presented at estimated fair value by discounting the future cash flows using recent issuance rates over the prior three months and a market rate analysis of recent offering rates.

The fair value of the Company’s subordinated notes is estimated by utilizing recent issuance rates for subordinated debt offerings of similar issuer size.

The fair value of FHLB advances is estimated by discounting the future cash flows using current interest rates offered for similar advances (Level 2). FRB advances as of September 30, 2020 consist of advances from the PPPLF, which are fixed in rate at 35 basis points annually and have maturity dates that the Company considers to be short-term in nature. As a result, the Company believes that the carrying value of FRB advances approximates fair value (Level 1).

Commitments to extend and standby letters of credit are generally not sold or traded. The estimated fair values of off-balance sheet credit commitments, including standby letters of credit and guarantees written, are not readily available due to the lack of cost-effective and reliable measurement methods for these instruments.

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

27

The following tables summarize financial assets and liabilities at carrying values and estimated fair values on a nonrecurring basis as of the dates stated.

	Carrying Value as of		Fair Value as of		Fair Value Measurements as of September 30, 2020 Using
	September 30, 2020		September 30, 2020		Level 1		Level 2		Level 3
Financial Assets:
Cash and due from banks	$	9,324	$	9,324	$	9,324	$	—	$	—
Interest-earning deposits		50,069		50,069		50,069		—		—
Federal funds sold		152		152		152		—		—
Certificates of deposit		1,266		1,266		—		1,266		—
Restricted securities		5,022		5,022		—		—		5,022
Loans receivable, net		1,041,711		1,041,429		—		—		1,041,429
Loans held for sale		2,687		2,687		—		2,687		—
Accrued interest receivable		4,664		4,664		—		4,664		—
Financial Liabilities:
Noninterest-bearing demand deposits	$	190,843	$	190,843	$	190,843	$	—	$	—
Savings and interest-bearing demand deposits		424,001		424,001		424,001		—		—
Time deposits		412,837		419,752		—		—		419,752
Securities sold under repurchase agreements		1,117		1,117		1,117		—		—
FHLB advances		25,000		24,849		—		24,849		—
FRB advances		32,637		32,637		32,637		—		—
Subordinated notes, net		31,083		33,087		—		—		33,087

	Carrying Value as of		Fair Value as of		Fair Value Measurements as of December 31, 2019 Using
	December 31, 2019		December 31, 2019		Level 1		Level 2		Level 3
Financial Assets:
Cash and due from banks	$	6,096	$	6,096	$	6,096	$	—	$	—
Interest-earning deposits		34,358		34,358		34,358		—		—
Federal funds sold		1,359		1,359		1,359		—		—
Certificates of deposit		2,754		2,754		—		2,754		—
Restricted securities		5,706		5,706		—		—		5,706
Loans receivable, net		916,628		910,678		—		—		910,678
Loans held for sale		1,231		1,231		—		1,231		—
Accrued interest receivable		3,035		3,035		—		3,035		—
Financial Liabilities:
Noninterest-bearing demand deposits	$	137,933	$	137,933	$	137,933	$	—	$	—
Savings and interest-bearing demand deposits		382,607		382,607		382,607		—		—
Time deposits		389,900		392,562		—		—		392,562
Securities sold under repurchase agreements		6,525		6,525		6,525		—		—
FHLB advances		45,000		44,936		—		44,936		—
Subordinated notes, net		31,001		32,552		—		—		32,552

28

Note 12: Changes in Accumulated Other Comprehensive Income (Loss), net

The components of accumulated other comprehensive income (loss), net of deferred income taxes, are presented in the following tables for the periods presented.   

	For the Three Months Ended September 30, 2020
	Net Unrealized Gains on Available-for-Sale Securities		Pension and Post-retirement Benefit Plans			Accumulated Other Comprehensive Income, net
Balance as of July 1, 2020	$	1,520	$	(354	)	$	1,166
Change in net unrealized holding gain on available-for-sale    securities, net of deferred income tax expense of $13		50		—			50
Balance as of September 30, 2020	$	1,570	$	(354	)	$	1,216
	For the Three Months Ended September 30, 2019
	Net Unrealized Gains on Available-for-Sale Securities		Pension and Post-retirement Benefit Plans			Accumulated Other Comprehensive Income, net
Balance as of July 1, 2019	$	182	$	(75	)	$	107
Change in net unrealized holding gain on available-for-sale    securities, net of deferred income tax expense of $62	233			—		233
Balance as of September 30, 2019	$	415	$	(75	)	$	340

	For the Nine Months Ended September 30, 2020
	Net Unrealized Gains on Available-for-Sale Securities			Pension and Post-retirement Benefit Plans			Accumulated Other Comprehensive Income, net
Balance as of January 1, 2020	$	437		$	(354	)	$	83
Change in net unrealized holding gain on available-for-sale    securities, net of deferred tax expense of $307		1,156			—			1,156
Reclassification for previously unrealized net gains recognized    in net income, net of income tax expense of $6		(23	)		—			(23	)
Balance as of September 30, 2020	$	1,570		$	(354	)	$	1,216
	For the Nine Months Ended September 30, 2019
	Net Unrealized Gains (Losses) on Available-for-Sale Securities			Pension and Post-retirement Benefit Plans			Accumulated Other Comprehensive Income (Loss), net
Balance as of January 1, 2019	$	(1,252	)	$	(75	)	$	(1,327	)
Change in net unrealized holding gain on available-for-sale    securities, net of deferred income tax expense of $443		1,667			—			1,667
Balance as of September 30, 2019	$	415		$	(75	)	$	340

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ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following discussion is intended to assist in understanding the results of operations and the financial condition of Bay Banks of Virginia, Inc. (the “Company”), the holding company for Virginia Commonwealth Bank (the “Bank”) and VCB Financial Group, Inc. This discussion should be read in conjunction with the consolidated financial statements and the notes thereto included in Item 1 of this Quarterly Report on Form 10-Q and in the Company’s Annual Report on Form 10-K for the year ended December 31, 2019 (the “2019 Form 10-K”).

ANTICIPATED MERGER WITH BLUE RIDGE BANKSHARES, INC.

On August 12, 2020, the Company and Blue Ridge Bankshares, Inc. (“Blue Ridge”) entered into a definitive merger agreement pursuant to which the companies will combine in an all-stock merger (the “ Blue Ridge Merger”) to create a leading Virginia-based community bank. Under the terms of the merger agreement, shareholders of the Company will receive 0.50 shares of Blue Ridge common stock for each share of the Company’s common stock they own. Upon completion of the Blue Ridge Merger, the Company’s shareholders will own approximately 54% and Blue Ridge shareholders will own approximately 46% of the combined company’s stock. The Blue Ridge Merger is subject to customary closing conditions, including regulatory approvals and approval from the shareholders of both companies. The Company anticipates the Blue Ridge Merger will close in the first quarter of 2021.

STATEMENT REGARDING FORWARD-LOOKING STATEMENTS

This report contains statements concerning the Company’s expectations, plans, objectives, future financial performance, and other statements that are not historical facts. These statements may constitute “forward-looking statements” as defined by federal securities laws. These statements may address issues that involve estimates and assumptions made by management, risks and uncertainties, and actual results could differ materially from historical results or those anticipated by such statements. These forward-looking statements include statements about the Company’s plans, obligations, expectations and intentions, and other statements that are not historical facts. Words such as “anticipates,” “believes,” “intends,” “should,” “expects,” “will,” and variations of similar expressions are intended to identify forward-looking statements. Factors that could have a material adverse effect on the operations and future prospects of the Company include, but are not limited to: the effect of the COVID-19 pandemic, including its potential adverse effect on economic conditions, and the Company’s employees, customers, loan losses, and financial performance; changes in interest rates, general economic conditions, the ability to close the Blue Ridge Merger on the expected terms and schedule; difficulties, delays and unforeseen costs in completing the Blue Ridge Merger and in integrating the Company’s and Blue Ridge’s businesses; the ability to realize cost savings and other benefits of the Blue Ridge Merger; business disruption during the pendency of or following the Blue Ridge Merger; the legislative/regulatory climate, monetary and fiscal policies of the U.S. Government, including policies of the U.S. Treasury and the Board of Governors of the Federal Reserve System (the “Federal Reserve”); the quality or composition of the loan and investment portfolios; demand for loan products; deposit flows; competition; expansion activities; demand for financial services in the Company’s market area; accounting principles, policies, and guidelines; changes in banking, tax, and other laws and regulations and interpretations or guidance thereunder; and other factors detailed in the Company’s publicly filed documents, including the factors described in Item 1A., “Risk Factors,” in the 2019 Form 10-K and in this Quarterly Report on Form 10-Q. These risks and uncertainties should be considered in evaluating the forward-looking statements contained herein, and readers are cautioned not to place undue reliance on such statements, which speak only as of the date they are made.

GENERAL

All dollar amounts included in the tables of this discussion are in thousands, except per share data, unless otherwise stated. There were no changes to the Critical Accounting Policies disclosed in Item 7 of the 2019 Form 10-K.

The principal source of earnings for the Company is net interest income. Net interest income is the amount by which interest income exceeds interest expense. Net interest margin is net interest income expressed as a percentage of average interest-earning assets. Changes in the volume and/or mix of interest-earning assets and interest-bearing liabilities, the associated yields and rates, the level of noninterest-bearing deposits, and the volume of nonperforming assets have an effect on net interest income, net interest margin, and net income.

OVERVIEW OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

• Net income for the three months ended September 30, 2020 and 2019 was $1.5 million and $1.8 million, respectively. Diluted earnings per share was $0.11 for the three months ended September 30, 2020 compared to $0.14 for the three months ended September 30, 2019. Net (loss) income for the nine months ended September 30, 2020 and 2019 was ($6.6) million and $5.1 million, respectively. The results of operations for the nine months ended September 30, 2020 included a $10.4 million charge for the impairment of goodwill. In addition to the goodwill impairment charge, net income (loss) for the three and nine months ended September 30, 2020 included loan loss provision expense of $869 thousand and $5.7 million, respectively, a significant portion of which related to estimated reserve needs as a result of the COVID-19 pandemic. The

30

$10.4 million goodwill impairment charge resulted from a second quarter impairment assessment triggered primarily by the adverse effect the deterioration of the macroeconomic environment due to the COVID-19 pandemic has had on the Company’s market value relative to its book value. For the three months ended September 30, 2020, results included approximately $1.5 million of expenses incurred in connection with the anticipated Blue Ridge Merger.

• Income before income taxes was $2.1 million and $2.3 million for the three months ended September 30, 2020 and 2019, respectively, a decrease of $141 thousand. (Loss) income before income taxes was $(6.3) million and $6.2 million for the nine months ended September 30, 2020 and 2019, respectively, a decrease of $12.5 million, driven primarily by the $10.4 million goodwill impairment charge and higher loan loss provision expense reported in the 2020 period.

• Return (loss) on average assets (annualized) decreased to 0.48% and (0.73%) for the three and nine months ended September 30, 2020, respectively, from 0.66% and 0.61% for the comparable 2019 periods.

• Return (loss) on average equity (annualized) decreased to 4.95% and (7.08%) for the three and nine months ended September 30, 2020, respectively, from 5.97% and 5.65% for the comparable 2019 periods.

• Total assets increased $119.7 million to $1.25 billion as of September 30, 2020 from $1.13 billion as of December 31, 2019.

• Loans, net of allowance for loan losses were $1.04 billion as of September 30, 2020 compared to $916.6 million as of December 31, 2019, an increase of $125.1 million, including $56.8 million of Paycheck Protection Program (“PPP”) loans originated in the second and third quarters of 2020. Excluding PPP loans, net loan growth for the first nine months of 2020 was $68.3 million, an annualized growth rate of 10%.

• The Company has participated in the PPP under the Coronavirus Aid, Relief, and Economic Security Act, closing nearly 700 loans totaling $56.8 million and receiving $2.4 million in processing fees. Of the processing fees received, $287 thousand and $532 thousand were recognized in interest income in the third quarter and year-to-date period ended September 30, 2020, respectively, while the remaining fees were deferred and will be recognized over the life of the loans, accelerated for pre-payments.

• Allowance for loan losses increased $5.3 million to $12.9 million, or 1.22% of gross loans, as of September 30, 2020 from $7.6 million, or 0.82% of gross loans, as of December 31, 2019. The 40 basis point increase in the ratio of allowance for loan losses to total gross loans for the first nine months of 2020 was primarily due to a qualitative loss factor to provide for losses estimated to have been incurred as of September 30, 2020, as a result of challenges certain borrowers are facing due to the pandemic, evidenced, in part, by loan deferrals and modifications granted to these borrowers, gross loan growth, excluding PPP loans, general reserves for higher unemployment rates in the 2020 period, particularly in Virginia, and higher specific reserves on impaired loans.

• Total deposits increased by $117.2 million, or 12.9%, to $1.03 billion as of September 30, 2020 from $910.4 million as of December 31, 2019. Of the $117.2 million increase in deposits in the nine months ended September 30, 2020, $52.9 million and $41.4 million was attributable to higher noninterest-bearing account balances and savings and interest-bearing demand deposit accounts, respectively, the growth of which was partially attributable to PPP loans, which were funded in these accounts.

• The ratio of nonperforming assets to total assets increased to 1.46% as of September 30, 2020 from 0.56% as of December 31, 2019. This increase was primarily attributable to higher nonaccrual loan balances of $12.7 million, mainly commercial and industrial loans and commercial mortgages (non-owner occupied) to borrowers adversely affected by the COVID-19 pandemic.

• Capital levels and regulatory capital ratios for the Bank were above regulatory minimums for well-capitalized banks as of September 30, 2020, with a total capital ratio and tier 1 leverage ratio of 13.68% and 10.47%, respectively.

31

RESULTS OF OPERATIONS

NET INTEREST INCOME AND NET INTEREST MARGIN

The following table presents average interest-earning assets and interest-bearing liabilities, taxable-equivalent yields on such assets, and rates (costs) paid on such liabilities, net interest margin (“NIM”), and net interest spread, as of and for the periods stated. Yields and costs are annualized.

	Average Balances, Income and Expense, Yields and Rates
	As of and For the Three Months Ended September 30,
	2020							2019							2020 Compared to 2019
	Average		Income/		Yield/			Average		Income/		Yield/			Income/ Expense			Variance Attributable to (8)
	Balance		Expense		Cost			Balance		Expense		Cost			Variance			Rate			Volume
ASSETS:
Taxable securities	$	83,990	$	596		2.82	%	$	71,752	$	553		3.06	%	$	43		$	(51	)	$	94
Tax-exempt securities (1)		14,558		111		3.04	%		16,086		143		3.53	%		(32	)		(18	)		(14	)
Total securities		98,548		707		2.86	%		87,838		696		3.14	%		11			(69	)		81
Gross loans (2) (3)		1,057,005		11,371		4.28	%		923,606		11,930		5.12	%		(559	)		(2,277	)		1,718
Interest-earning deposits and federal funds sold		35,336		6		0.07	%		28,301		151		2.12	%		(145	)		(182	)		37
Certificates of deposits		1,781		9		2.01	%		3,498		18		2.04	%		(9	)		(0	)		(9	)
Total interest-earning assets	$	1,192,670	$	12,093		4.03	%	$	1,043,243	$	12,795		4.87	%	$	(702	)	$	(2,529	)	$	1,828
Noninterest-earning assets		54,319							62,168
Total average assets	$	1,246,989						$	1,105,411
LIABILITIES:
Savings deposits	$	64,852	$	17		0.10	%	$	57,770	$	40		0.27	%	$	(23	)	$	(28	)	$	5
Demand deposits		86,863		22		0.10	%		71,905		26		0.14	%		(4	)		(9	)		5
Time deposits (4)		407,866		1,743		1.70	%		392,868		2,163		2.18	%		(420	)		(502	)		82
Money market deposits		266,691		322		0.48	%		241,360		894		1.47	%		(572	)		(666	)		94
Total interest-bearing deposits		826,272		2,104		1.01	%		763,903		3,123		1.62	%		(1,019	)		(1,205	)		186
Securities sold under repurchase agreements		1,097		1		0.36	%		6,439		4		0.25	%		(3	)		—			(3	)
Subordinated notes and ESOP debt		32,436		510		6.24	%		8,550		142		6.59	%		367			(29	)		396
FHLB advances		33,370		50		0.60	%		72,500		465		2.54	%		(415	)		(165	)		(250	)
FRB advances		32,637		29		0.35	%		—		—		0.00	%		29			29			—
Total interest-bearing liabilities	$	925,812	$	2,694		1.16	%	$	851,392	$	3,734		1.74	%	$	(1,040	)	$	(1,369	)	$	328
Noninterest-bearing deposits		188,852							123,541
Other noninterest-bearing liabilities		11,755							9,919
Total average liabilities		1,126,419							984,852
Average shareholders' equity		120,570							120,559
Total average liabilities and shareholders' equity	$	1,246,989						$	1,105,411
Net interest income and NIM (5)			$	9,399		3.14	%			$	9,061		3.45	%	$	338		$	(1,160	)	$	1,499
Total cost of funds (6)						0.96	%						1.52	%
Net interest spread (7)						2.88	%						3.13	%

(1) Income and yield on tax-exempt securities assumes a federal income tax rate of 21%.

(2) Includes loan fees and nonaccrual loans.

(3) Includes accretion of fair value discounts on loans acquired in the Virginia BanCorp Merger of $97 thousand and $357 thousand for the three months ended September 30, 2020 and 2019, respectively.

(4) Includes amortization of fair value adjustments on time deposits assumed in the Virginia BanCorp Merger of $17 thousand and $31 thousand for the three months ended September 30, 2020 and 2019, respectively.

(5) Net interest margin is net interest income divided by average interest-earning assets.

(6) Cost of funds is total interest expense divided by total average interest-bearing liabilities and noninterest-bearing deposits.

(7) Net interest spread is the yield on average interest-earning assets less the cost of average interest-bearing liabilities.

(8) Change in income/expense due to both volume and rates has been allocated in proportion to the absolute dollar amounts of the change in each.

32

Interest income, on a taxable-equivalent basis, for the three months ended September 30, 2020 was $12.1 million, a decrease of $702 thousand from the third quarter of 2019, primarily attributable to lower yields on loans and lower accretion of acquired loan discounts in the 2020 period, discussed below. The decline in yields and accretion income was partially offset by higher average balances of interest-earning assets of $1.19 billion in the 2020 period compared to $1.04 billion in the 2019 period, an increase of $149.4 million ($133.4 million attributable to gross loans). Yields on average interest-earning assets were 4.03% and 4.87% for the third quarters of 2020 and 2019, respectively. Yields on average interest-earning assets in the third quarter of 2020 were negatively affected by lower yields on loans originated, including PPP loans, the repricing of variable rate loans, and lower accretion of loans acquired in the Company’s April 2017 merger with Virginia BanCorp, Inc. (“Virginia BanCorp Merger”), which had a negative 10 basis point effect. Accretion of discounts on loans acquired in the Virginia BanCorp Merger was $97 and $357 thousand in the third quarters of 2020 and 2019, respectively.

Average interest-earning assets comprised 95.6% and 94.4% of the Company’s average assets for the three months ended September 30, 2020 and 2019, respectively.

Interest expense for the three months ended September 30, 2020 was $2.7 million, a decrease of $1.04 million from the third quarter of 2019, primarily attributable to lower cost of funds (primarily cost of deposits), which was 0.96% in the 2020 period compared to 1.52% in the 2019 period. The decrease in cost of funds was reflective of the Company’s efforts to reduce deposit rates, and higher average balances noninterest-bearing demand deposit accounts in the 2020 period of $65.3 million. Average interest-bearing liabilities increased by $74.4 million to $925.8 million in the 2020 period from $851.4 million in the 2019 period.

Net interest income, on a taxable-equivalent basis, for the three months ended September 30, 2020, was $9.4 million, an increase of $338 thousand from the three months ended September 30, 2019. Net interest margin was 3.14% for the third quarter of 2020 compared to 3.45% for the third quarter of 2019. The decrease in NIM was primarily attributable to lower yields on loans, partially offset by lower cost of funds.

33

	Average Balances, Income and Expense, Yields and Rates
	As of and For the Nine Months Ended September 30,
	2020							2019							2020 Compared to 2019
	Average		Income/		Yield/			Average		Income/		Yield/			Income/ Expense			Variance Attributable to (8)
	Balance		Expense		Cost			Balance		Expense		Cost			Variance			Rate			Volume
ASSETS:
Taxable securities	$	84,408	$	1,821		2.88	%	$	70,549	$	1,725		3.27	%	$	96		$	(243	)	$	339
Tax-exempt securities (1)		14,802		343		3.10	%		17,436		414		3.17	%		(71	)		(8	)		(63	)
Total securities		99,210		2,164		2.91	%		87,985		2,139		3.25	%		25			(251	)		277
Gross loans (2) (3)		1,007,142		34,013		4.51	%		916,289		34,849		5.08	%		(836	)		(4,295	)		3,459
Interest-earning deposits and federal funds sold		34,836		119		0.46	%		27,088		463		2.29	%		(344	)		(476	)		133
Certificates of deposits		2,415		37		2.05	%		3,653		57		2.09	%		(20	)		(1	)		(19	)
Total interest-earning assets		1,143,603		36,333		4.24	%		1,035,015		37,508		4.85	%	$	(1,175	)	$	(5,022	)	$	3,848
Noninterest-earning assets		63,543							61,893
Total average assets	$	1,207,146						$	1,096,908
LIABILITIES:
Savings deposits	$	61,005	$	74		0.16	%	$	57,648	$	128		0.30	%	$	(54	)	$	(61	)	$	7
Demand deposits		79,833		67		0.11	%		73,727		95		0.17	%		(28	)		(36	)		8
Time deposits (4)		408,990		5,724		1.87	%		382,179		6,036		2.11	%		(312	)		(736	)		424
Money market deposits		263,845		1,499		0.76	%		239,548		2,760		1.54	%		(1,261	)		(1,541	)		280
Total interest-bearing deposits		813,673		7,364		1.21	%		753,102		9,019		1.60	%		(1,655	)		(2,374	)		719
Securities sold under repurchase agreements		2,171		3		0.18	%		6,418		11		0.23	%		(8	)		—			(8	)
Subordinated notes and ESOP debt		32,470		1,531		6.30	%		8,578		417		6.50	%		1,114			(49	)		1,163
FHLB advances		37,354		374		1.34	%		86,015		1,784		2.77	%		(1,410	)		(400	)		(1,010	)
FRB advances		18,492		49		0.35	%		—		—		0.00	%		49			49			-
Total interest-bearing liabilities		904,160		9,321		1.38	%		854,113		11,231		1.76	%	$	(1,910	)	$	(2,774	)	$	863
Noninterest-bearing deposits		166,012							116,055
Other noninterest-bearing liabilities		11,829							7,404
Total average liabilities		1,082,001							977,572
Average shareholders' equity		125,145							119,336
Total average liabilities and shareholders' equity	$	1,207,146						$	1,096,908
Net interest income and NIM (5)			$	27,012		3.16	%			$	26,277		3.39	%	$	735		$	(2,249	)	$	2,985
Total cost of funds (6)						1.16	%						1.55	%
Net interest spread (7)						2.87	%						3.09	%

(1) Income and yield on tax-exempt securities assumes a federal income tax rate of 21%.

(2) Includes loan fees and nonaccrual loans.

(3) Includes accretion of fair value discounts on loans acquired in the Virginia BanCorp Merger of $381 thousand and $993 thousand for the nine months ended September 30, 2020 and 2019, respectively.

(4) Includes amortization of fair value adjustments on time deposits assumed in the Virginia BanCorp Merger of $59 thousand and $96 thousand for the nine months ended September 30, 2020 and 2019, respectively.

(5) Net interest margin is net interest income divided by average interest-earning assets.

(6) Cost of funds is total interest expense divided by total average interest-bearing liabilities and noninterest-bearing deposits.

(7) Net interest spread is the yield on average interest-earning assets less the cost of average interest-bearing liabilities.

(8) Change in income/expense due to both volume and rates has been allocated in proportion to the absolute dollar amounts of the change in each.

34

Interest income, on a taxable-equivalent basis, for the nine months ended September 30, 2020 was $36.3 million, a decrease of $1.2 million from the nine months ended September 30, 2019, primarily attributable to lower yields on loans and lower accretion of acquired loan discounts in the 2020 period. Yields on average interest-earning assets were 4.24% and 4.85% for the nine months ended September 30, 2020 and 2019, respectively. The lower yield on average interest-earning assets in the 2020 period was primarily due to lower yields on loans originated during the period, the repricing of variable rate loans, the addition of lower yielding PPP loans, which had a negative 3 basis point effect on yield, and lower accretion of acquired loan discounts, which had a negative 8 basis point effect on yield. Partially offsetting these negative effects were higher average balances of gross loans in the 2020 period of $90.9 million.

Average interest-earning assets comprised 94.7% and 94.4% of the Company’s total average assets for the nine months ended September 30, 2020 and 2019, respectively.

Interest expense for the nine months ended September 30, 2020 was $9.3 million, a decrease of $1.9 million from the nine months ended September 30, 2019, primarily attributable to lower cost of funds of 1.16% in the 2020 period compared to 1.55% in the 2019 period, partially offset by higher average interest-bearing liabilities of $50.0 million in the 2020 period. Lower cost of funds in the first nine months of 2020 was primarily reflective of the Company’s efforts to reduce deposit rates since mid-2019, lower borrowing costs, particularly Federal Home Loan Bank of Atlanta (“FHLB”) advances, and higher average balances of noninterest-bearing demand accounts of $50.0 million in the 2020 period.

Net interest income, on a taxable-equivalent basis, for the nine months ended September 30, 2020 was $27.0 million, an increase of $735 thousand from $26.2 million for the nine months ended September 30, 2019.

NIM was 3.16% for the first nine months of 2020 compared to 3.39% for the same period in 2019. Lower NIM in the 2020 period was primarily due to lower yields on average interest-earning assets, primarily loans, and lower accretion of acquired loan discounts, partially offset by lower cost of funds.

The Company expects NIM to continue to be negatively affected in the periods subsequent to September 30, 2020, as a result of declines in market interest rates, most notably the federal funds rate, and competition among financial institutions to attract the most credit-worthy borrowers.

PROVISION FOR LOAN LOSSES

Provision for loan losses was $869 thousand and $495 thousand for the three months ended September 30, 2020 and 2019, respectively. Provision for loan losses in the 2020 period was primarily attributable to specific reserves on loans to borrowers adversely effected by the COVID-19 pandemic.

Provision for loan losses was $5.7 million and $871 thousand for the first nine months of 2020 and 2019, respectively. Provision for loan losses in the 2020 period was primarily attributable to qualitative loss factors for increases in state unemployment rates, including Virginia, and for losses estimated to have been incurred as of September 30, 2020 as a result of challenges certain borrowers are facing due to the COVID-19 pandemic, evidenced, in part, by loan deferrals and modifications granted to these borrowers. Also contributing to higher provision in the 2020 period was gross loan growth, excluding PPP loans, of approximately $71.9 million, and higher specific reserves on impaired loans. The Company recorded no provision for loan losses for PPP loans due to the U.S. government guarantee.

35

NONINTEREST INCOME

The following table presents a summary of noninterest income and the dollar and percentage change for the periods presented.

	Three Months Ended
	September 30, 2020		September 30, 2019		$ Change			% Change
Trust management		220		201		19			9.5	%
Service charges and fees on deposit accounts		155		243		(88	)		(36.2	%)
Wealth management		350		185		165			89.2	%
Interchange fees, net		149		108		41			38.0	%
Other service charges and fees		33		32		1			3.1	%
Secondary market sales and servicing		1,082		293		789			269.3	%
Increase in cash surrender value of bank owned life insurance		117		122		(5	)		(4.1	%)
Net gains on sales and calls of available-for-sale securities		—		1		(1	)		(100.0	%)
Net gains on disposition of other assets		12		—		12			100.0	%
Net gains on rabbi trust assets		74		—		74			100.0	%
Referral fees		86		—		86			100.0	%
Other		8		15		(7	)		(46.7	%)
Total noninterest income	$	2,286	$	1,200	$	1,086			90.5	%

	Nine Months Ended
	September 30, 2020			September 30, 2019			$ Change			% Change
Trust management		615			621			(6	)		(1.0	%)
Service charges and fees on deposit accounts		529			727			(198	)		(27.2	%)
Wealth management		824			654			170			26.0	%
Interchange fees, net		378			330			48			14.5	%
Other service charges and fees		94			88			6			6.8	%
Secondary market sales and servicing		2,015			632			1,383			218.8	%
Increase in cash surrender value of bank owned life insurance		351			362			(11	)		(3.0	%)
Net gains (losses) on sales and calls of available-for-sale securities		29			(1	)		30		n/m
Net gains (losses) on disposition of other assets		5			(2	)		7		n/m
Net (losses) gains on rabbi trust assets		(76	)		130			(206	)		(158.5	%)
Referral fees		1,052			—			1,052			100.0	%
Other		54			44			10			22.7	%
Total noninterest income	$	5,870		$	3,585		$	2,285			63.7	%

Higher noninterest income in the three months ended September 30, 2020, compared to the three months ended September 30, 2019, was primarily due to higher secondary market sales and servicing income of $789 thousand, driven by an increase in the demand for purchase money and refinance mortgages, and higher wealth management fee income of $165 thousand. Additionally, the third quarter of 2020 included $86 thousand of fee income for referring loan customers to a third-party financial institution to execute interest rate swaps, while the third quarter of 2019 included no income from such activities. Referral fees are earned at the consummation of the swap transaction on a loan-by-loan bases. The amount earned per transaction is based on the pricing of the particular interest rate swap. Partially offsetting these increases were lower service charges and fees on deposit accounts in the third quarter of 2020 of $88 thousand, primarily due to a lower volume of fee-based deposit transactions.

Higher noninterest income in the nine months ended September 30, 2020, compared to the nine months ended September 30, 2019, was primarily attributable to $1.1 million of fee income for referring loan customers to a third-party financial institution to execute interest rate swaps, while the 2019 period included no income from such activities. Additionally, the first nine months of 2020 period included higher secondary market sales and servicing income of approximately $1.4 million, due to the previously stated reasons. Partially offsetting these increases was a $76 thousand net unrealized loss in the 2020 period compared to a $130 thousand net unrealized gain in the 2019 period on rabbi trust assets held for the benefit of participants in the Company’s deferred compensation plan.

NONINTEREST EXPENSE

The following table presents a summary of noninterest expense and the dollar and percentage change for the periods presented.

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	Three Months Ended
	September 30, 2020			September 30, 2019			$ Change			% Change
Salaries and employee benefits	$	3,801		$	3,666		$	135			3.7	%
Occupancy		700			805			(105	)		(13.0	%)
Data processing		491			541			(50	)		(9.2	%)
Bank franchise tax		256			209			47			22.5	%
Telecommunications and other technology		396			258			138			53.5	%
FDIC assessments		262			(7	)		269		n/m
Foreclosed property		22			48			(26	)		(54.2	%)
Consulting		54			156			(102	)		(65.4	%)
Advertising and marketing		47			124			(77	)		(62.1	%)
Directors’ fees		187			148			39			26.4	%
Audit and accounting		92			193			(101	)		(52.3	%)
Legal		(210	)		20			(230	)	n/m
Core deposit intangible amortization		134			164			(30	)		(18.3	%)
Net other real estate owned losses		176			375			(199	)		(53.1	%)
Merger-related		1,456			—			1,456			100.0	%
Other		782			747			35			4.7	%
Total noninterest expense	$	8,646		$	7,447		$	1,199			16.1	%

	Nine Months Ended
	September 30, 2020		September 30, 2019		$ Change			% Change
Salaries and employee benefits		11,267		11,532		(265	)		(2.3	%)
Occupancy		2,156		2,510		(354	)		(14.1	%)
Data processing		1,526		1,738		(212	)		(12.2	%)
Bank franchise tax		770		655		115			17.6	%
Telecommunications and other technology		1,176		727		449			61.8	%
FDIC assessments		557		371		186			50.1	%
Foreclosed property		58		110		(52	)		(47.3	%)
Consulting		195		418		(223	)		(53.3	%)
Advertising and marketing		140		300		(160	)		(53.3	%)
Directors’ fees		568		525		43			8.2	%
Audit and accounting		402		586		(184	)		(31.4	%)
Legal		135		130		5			3.8	%
Core deposit intangible amortization		425		517		(92	)		(17.8	%)
Net other real estate owned losses		256		441		(185	)		(42.0	%)
Goodwill impairment		10,374		—		10,374			100.0	%
Merger-related		1,456		—		1,456			100.0	%
Other		1,947		2,108		(161	)		(7.6	%)
Total noninterest expense	$	33,408	$	22,668	$	10,740			47.4	%

Higher noninterest expense in the three months ended September 30, 2020, compared to the three months ended September 30, 2019, was primarily attributable to merger-related expenses of $1.5 million incurred in connection with the anticipated Blue Ridge Merger, expected to close in the first quarter of 2021. Of the $1.5 million of merger-related expenses reported in the three months ended September 30, 2020, $226 thousand was previously reported as legal expense in the Company’s Forms 10-Q for the periods ended March 31, 2020 and June 30, 2020 and reclassified as merger-related for the three and nine months ended September 30, 2020, resulting in the $210 thousand credit to legal expense. Excluding the $1.5 million in merger-related expenses and the associated reclassification of legal expense, noninterest expenses decreased $483 thousand, or 6.5%, on a comparative period basis. This decline was primarily due to the Company’s efforts to reduce operating costs, including the consolidation of a branch in the first quarter of 2020, partially offset by higher Federal Deposit Insurance Corporation (“FDIC”) assessments in the 2020 period, as the 2019 period included a small bank assessment credit of $171 thousand.

Higher noninterest expense in the nine months ended September 30, 2020, compared to the nine months ended September 30, 2019, was primarily attributable to a goodwill impairment charge of $10.4 million in the second quarter of 2020 and $1.5 million in merger-related expenses. Excluding the goodwill impairment charge and merger-related expenses, noninterest expenses decreased $1.1 million in the first nine months of 2020, or 4.8%, on a comparative period basis. Lower noninterest expense in a number of categories

37

was partially offset by higher telecommunications and other technology expenses and higher FDIC assessments in the 2020 period, as the 2019 period included the small bank FDIC assessment credit, as noted previously.

The following table presents income tax expense and effective income tax rates for the periods presented.

	Three Months Ended						Nine Months Ended
	September 30, 2020			September 30, 2019			September 30, 2020			September 30, 2019
Income tax expense	$	655		$	448		$	378		$	1,180
Effective income tax rate		30.5	%		19.6	%		6.0	%		18.9	%

The effective income tax rate for the three months ended September 30, 2020 was higher than the statutory federal income tax rate of 21% primarily as a result of nondeductible expenses incurred in connection with the anticipated Blue Ridge Merger. Income tax expense and the effective income tax rate for the nine months ended September 30, 2020 were a result of income tax expense before the goodwill impairment charge of $10.4 million, partially offset by an income tax benefit for the reversal of a related deferred tax liability, and the effect of nondeductible Blue Ridge Merger-related expenses.

ASSET QUALITY

Net loans charged-off (recovered) during the third quarter of 2020 totaled ($23) thousand compared to $478 thousand for the third quarter of 2019. This resulted in a decrease in the annualized net charge-off (recovery) ratio to (0.01%) for the third quarter of 2020 compared to 0.21% for the third quarter of 2019. For the nine months ended September 30, 2020, the annualized net charge-off ratio was 0.14% compared to 0.19% for the similar 2019 period. The higher net charge-off ratios for the 2019 periods were primarily attributable to charge-offs of a select portfolio of acquired consumer debt consolidation loans, as previously reported.

The ratio of allowance for loan losses to gross loans was 1.22% as of September 30, 2020 compared to 0.82% as of December 31, 2019, an increase of 40 basis points. The majority of this increase is attributable to qualitative loss factors to provide for losses estimated to have been incurred as of September 30, 2020, as a result of challenges certain borrowers are facing due to the COVID-19 pandemic, evidenced, in part, by loan deferrals and modifications granted to these borrowers, general reserves for higher unemployment rates in the 2020 period, particularly in Virginia, and higher specific reserves on impaired loans. The length of the economic slow-down, including the pace at which the economy recovers once governmental mandates are lifted, could have a material adverse effect on the Company’s asset quality and the amount of ALL required.

In the first quarter of 2020, the Company downgraded risk ratings on $88.5 million of loans to businesses in industries highly affected by the COVID-19 pandemic. During the second quarter of 2020, risk ratings for certain loans in these segments were adjusted as additional information became available. During the third quarter of 2020, an additional $4.7 million of loans were downgraded from pass grades to special mention or substandard. Management believes that these, or a portion of these, loans may require further downgrades and/or other loans to borrowers adversely affected by the COVID-19 pandemic may require risk rating downgrades.

From the onset of the global COVID-19 pandemic, the Company has proactively addressed the needs of its commercial and individual borrowers by modifying loans allowing for the short-term deferral of principal payments or of principal and interest payments. All loan modifications were made on a good faith basis to borrowers who were current in their payments prior to the modifications (“COVID-19 Loan Modifications”). COVID-19 Loan Modifications granted do not necessarily represent that these borrowers will be able to pay amounts deferred or any amounts owed to the Company.

The following table presents, as of September 30, 2020, the loan balances and number by loan type and the percentage these loans comprise within each loan type for which COVID-19 Loan Modifications were made. Of the following balances, $39.5 million were to borrowers in the hotel/motel industry, $18.6 million were to borrowers in the restaurant and restaurant-related industry, and $9.3 million were to borrowers in the retail industry.

	Loan Count		Principal Balance		% of Loan Type
Mortgage loans on real estate:
Residential first mortgages		14	$	2,886	1%
Commercial mortgages (non-owner occupied)		23		47,102	17%
Construction, land and land development		13		22,879	17%
Commercial mortgages (owner occupied)		17		10,520	14%
Residential revolving and junior mortgages		1		257	1%
Commercial and industrial		87		17,575	9%
Consumer		2		8	0%
Total		157	$	101,227	10%

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As of October 31, 2020, $63.8 million of the $101.2 million of loan balances in the table above reached the end of their respective modification periods and had resumed their original contractually scheduled payments.

The following table presents certain asset quality measures as of the dates stated.

	September 30, 2020			December 31, 2019
Loans past due 90 days or more and still accruing (1)	$	—		$	—
Nonaccrual loans (1)		17,198			4,476
Total nonperforming loans		17,198			4,476
Other real estate owned, net		1,113			1,916
Total nonperforming assets	$	18,311		$	6,392
Allowance for loan losses	$	12,899		$	7,562
Gross loans		1,054,610			924,190
Total assets		1,251,582			1,131,923
Allowance for loan losses to gross loans		1.22	%		0.82	%
Allowance for loan losses to nonperforming loans		75.0	%		168.9	%
Nonperforming assets to total assets		1.46	%		0.56	%
Nonperforming loans to gross loans		1.63	%		0.48	%

(1) Excludes PCI loans.

The increase in nonperforming assets from December 31, 2019 to September 30, 2020 was primarily attributable to $12.7 million of higher nonaccrual loan balances, mainly commercial and industrial loans and commercial mortgages (non-owner occupied) to borrowers adversely affected by the COVID-19 pandemic. Of the increase in nonaccrual loan balances, $5.7 million was attributable to nationally-syndicated commercial credits to companies in which the Bank owns a small percentage of the respective loans. The $5.7 million of loans were contractually current as of September 30, 2020; however, the borrowers are experiencing financial strain and the loans were individually evaluated for impairment. As a result, a total of $745 thousand of specific reserves was recorded as of and for the nine months ended September 30, 2020 for these loans. Another $5.6 million of the increase in nonaccrual loans was attributable to commercial mortgages (non-owner occupied) to borrowers in the hotel and retail landlord industries, industries adversely affected by the COVID-19 pandemic. While these loans were contractually current as of September 30, 2020, management believes future debt service capabilities of the borrowers have been negatively affected by lower occupancy rates and the loans were individually evaluated for impairment. As a result, specific reserves totaling $593 thousand were recorded as of and for the nine months ended September 30, 2020 for these loans.

FINANCIAL CONDITION

Total assets increased by $119.7 million to $1.25 billion as of September 30, 2020 from $1.13 billion as of December 31, 2019, primarily due to net loan growth of $125.1 million in the first nine months of 2020, including $56.8 million of PPP Loans, partially offset by the goodwill impairment charge of $10.4 million recorded in the second quarter of 2020.

The following tables present information about the securities portfolio on a taxable-equivalent basis as of the dates stated. As of September 30, 2020 and December 31, 2019, available-for-sale securities represented 7.0% and 8.8% of total assets, respectively.

	September 30, 2020
	Amortized Cost		Fair Value		Weighted Average Life in Years		Weighted Average Yield
U.S. Government agencies and mortgage backed securities	$	47,598	$	48,870		5.1		2.00	%
State and municipal obligations		18,116		18,846		4.8		3.04	%
Corporate bonds		20,154		20,137		6.0		5.18	%
Total available-for-sale securities		85,868		87,853		5.3		2.80	%
Restricted securities		5,022		5,022	n/a			4.98	%
Total securities	$	90,890	$	92,875				2.91	%

39

	December 31, 2019
	Amortized Cost		Fair Value		Weighted Average Life in Years		Weighted Average Yield
U.S. Government agencies and mortgage backed securities	$	67,491	$	67,597		6.1		2.18	%
State and municipal obligations		16,238		16,576		5.4		3.16	%
Corporate bonds		15,165		15,281		3.8		5.61	%
Total available-for-sale securities		98,894		99,454		5.1		2.92	%
Restricted securities		5,706		5,706	n/a			6.30	%
Total securities	$	104,600	$	105,160				3.18	%

The following table presents the composition of loans in dollar amounts and as a percentage of total loans as of the dates stated.

	September 30, 2020						December 31, 2019
	Amount			Percent of Total			Amount			Percent of Total
Mortgage loans on real estate:
Residential first mortgages	$	286,127			27.2	%	$	293,913			31.8	%
Commercial mortgages (non-owner occupied)		282,378			26.7	%		196,143			21.2	%
Construction, land and land development		132,502			12.5	%		126,010			13.6	%
Commercial mortgages (owner occupied)		76,225			7.2	%		82,829			9.0	%
Residential revolving and junior mortgages		29,051			2.7	%		31,893			3.4	%
Commercial and industrial		187,219			17.6	%		181,730			19.7	%
Paycheck Protection Program		56,788			5.4	%		—			0.0	%
Consumer		6,443			0.7	%		11,985			1.3	%
Total loans		1,056,733			100.0	%		924,503			100.0	%
Net unamortized deferred loan fees		(2,123	)					(313	)
Allowance for loan losses		(12,899	)					(7,562	)
Loans receivable, net	$	1,041,711					$	916,628

During the nine months ended September 30, 2020, gross loans increased by $130.4 million, or 14.1%, from December 31, 2019. The largest components of this increase were a $86.2 million increase in commercial mortgages (non-owner occupied) and $56.8 million of PPP loans originated in the second and third quarters of 2020. Net unamortized deferred loan fees increased approximately $1.8 million during the first nine months of 2020, primarily attributable to $2.4 million of PPP loan processing fees received, of which $532 thousand was recognized in interest income in the same period.

The following table presents the Company’s ALL by loan type and the percent of loans in each category to total loans as of the dates stated.

	September 30, 2020					December 31, 2019
	Amount		Percent of loans in each category to total loans			Amount		Percent of loans in each category to total loans
Mortgage loans on real estate	$	9,587		76.3	%	$	5,372		79.0	%
Commercial and industrial		2,889		17.6	%		1,571		19.7	%
Paycheck Protection Program		—		5.4	%		—		0.0	%
Consumer		423		0.7	%		619		1.3	%
Total allowance for loan losses	$	12,899		100.0	%	$	7,562		100.0	%

Allowance for loan losses increased $5.3 million from December 31, 2019 to $12.9 million as of September 30, 2020. The majority of the increase in the first nine months of 2020 was due to qualitative loss factors to estimate the reserve needs, as of period end, for borrowers adversely impacted by the COVID-19 pandemic, including those for which loan payments have been deferred and/or modified. Also contributing to the increase in the allowance for loan losses in the 2020 period was gross loan growth (excluding PPP loans) and higher specific reserves on impaired loans. Due to the full U.S. government guarantee on PPP loans, the Company has recorded no allowance for loan losses. In future periods, the Company may be required to establish an allowance for loan losses for these loans, if, for example, the U.S. government were to eliminate or reduce the guarantee on individual or groups of PPP loans, which would result in a provision for loan losses charged to earnings.  

As of September 30, 2020, other real estate owned (“OREO”) was $1.1 million, consisting of 13 properties (8 of which were land lots), compared to $1.9 million of OREO (18 properties) as of December 31, 2019.

40

As of September 30, 2020, total deposits were $1.03 billion compared to $910.4 million as of December 31, 2019, a $117.2 million increase. Of the increase, $52.9 million was attributable to higher noninterest-bearing deposit account balances, and $41.4 million was attributable to savings and interest-bearing demand deposit accounts, partially attributable to PPP loans, which were funded in these accounts.

Maturities of large denomination time deposits (equal to or greater than $100 thousand) as of September 30, 2020 are presented in the following table.

	Within 3 Months		3-6 Months		6-12 Months		Over 12 Months		Total		Percent of Total Deposits
Time deposits	$	91,632	$	31,254	$	46,697	$	100,295	$	269,878		26.3	%

As of September 30, 2020, the Company had two fixed rate FHLB advances totaling of $15.0 million and one variable rate FHLB advance totaling $10.0 million outstanding. As of December 31, 2019, the Company had three fixed rate FHLB advances totaling $35.0 million and one variable rate FHLB advance of $10.0 million outstanding. Beginning in the third quarter of 2020, the Company accessed the Federal Reserve Bank of Richmond’s (“FRB”) PPP Liquidity Facility (“PPPLF”), which provides funding for PPP loans at a fixed annual rate of 35 basis points over the term the funded PPP loan is outstanding. PPP loans securing the PPPLF are afforded preferential regulatory capital treatment. As of September 30, 2020 the Company had PPPLF advances totaling $32.6 million. The following table presents various information regarding FHLB and FRB advances as of and for the periods presented.

	Nine Months Ended September 30, 2020									Twelve Months Ended December 31, 2019
	Period-End Balance		Highest Month-End Balance		Average Balance		Weighted Average Rate			Period-End Balance		Highest Month-End Balance		Average Balance		Weighted Average Rate
FHLB advances	$	25,000	$	50,000	$	37,354		1.34	%	$	45,000	$	100,000	$	76,181		2.74	%
FRB advances		32,637		33,557		18,492		0.35	%		—		—		—		0.00	%

LIQUIDITY

Liquidity represents an institution’s ability to meet present and future financial obligations (such as commitments to fund loans or meet depositors’ requirements) through either the sale or maturity of existing assets or the acquisition of additional funds through liability management. Liquid assets include cash, interest-earning deposits with other banks, federal funds sold, and investments and loans maturing within one year. The Company’s ability to obtain deposits and purchase funds at favorable rates are major factors for liquidity. Management believes that the Company maintains overall liquidity that is sufficient to satisfy its depositors’ requirements and its customers’ credit needs.

As of September 30, 2020, cash and cash equivalents totaled $59.4 million; investment securities maturing in one year or less totaled $10.6 million; and loans maturing in one year or less totaled $110.0 million. This resulted in a liquidity ratio as of September 30, 2020 of 14.4% compared to 21.5% as of December 31, 2019. The Company determines this ratio by dividing the sum of cash and cash equivalents, and investment securities and loans maturing in one year or less, by total assets.

As of September 30, 2020, the Company had a secured borrowing line with the FHLB of $308.4 million, with $252.4 million available, and unsecured federal funds lines of credit with various correspondent banks totaling $41.0 million. Federal funds lines of credit are uncommitted and can be cancelled at any time by the lending bank. As noted previously, the Company pledged PPP loans for FRB advances of an equal amount. Additional borrowing availability under the PPPLF, with the pledging of additional PPP loans, was approximately $24.2 million, as of September 30, 2020.

As of September 30, 2020, other than the potential effect on liquidity of the COVID-19 pandemic, the Company was not aware of any other known trends, events, or uncertainties that have or are reasonably likely to have a material effect on liquidity. Management has and continues to monitor the effects of the COVID-19 pandemic on the Company’s liquidity. For example, management monitors for unusual changes in deposit balances, access to funding sources, draws, amortization of loan balances, and the various liquidity programs offered by the FRB in response to the pandemic. As of September 30, 2020, management believes the COVID-19 pandemic has not had an adverse effect on the Company’s liquidity.

CAPITAL RESOURCES

Capital resources represent funds, earned or obtained, over which a financial institution can exercise greater long-term control in comparison with deposits and borrowed funds. The adequacy of the Company’s capital is reviewed by management on an ongoing basis with reference to size, composition, and quality of the Company’s resources, and consistency with regulatory requirements and industry standards. Management seeks to maintain a capital structure that will assure an adequate level of capital to support anticipated asset growth and to absorb potential losses yet allows management to effectively leverage its capital to maximize return to shareholders. The Company’s capital, also known as shareholders’ equity, is comprised primarily of outstanding common stock, additional paid-in capital, and retained earnings.

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Shareholders’ equity is primarily affected by net income and net unrealized gains or losses on available-for-sale securities, net of taxes. The available-for-sale securities portfolio is reported at fair value with unrealized gains or losses, net of taxes, recognized as accumulated other comprehensive income on the Company’s consolidated balance sheets. Another factor affecting accumulated other comprehensive income is changes in the fair value of the Company’s pension and post-retirement benefit plans and changes in said plan obligations. Shareholders’ equity before accumulated other comprehensive income, net of taxes, was $120.2 million as of September 30, 2020 compared to $126.1 million as of December 31, 2019. The decrease of $5.9 million was primarily attributable to the ($6.6) million net loss for the nine months ended September 30, 2020, including the $9.8 million after-tax goodwill impairment charge. Accumulated other comprehensive income, net of taxes, increased by $1.1 million from December 31, 2019 to September 30, 2020, due to an increase in net unrealized gains, net of taxes, in the Company’s available-for-sale securities portfolio.

Book value per share of the Company’s common stock, including accumulated other comprehensive income, net of tax, decreased to $9.10 as of September 30, 2020 from $9.51 as of December 31, 2019. This decrease was primarily attributable to the net loss of ($6.6) million for the nine months ended September 30, 2020, which included the goodwill impairment charge.

The Company and the Bank are subject to minimum regulatory capital ratios as defined by the Federal Reserve. As of September 30, 2020, the Company and the Bank’s capital ratios continue to be in excess of regulatory minimums and the Bank was “well capitalized” by these guidelines.

The Bank is subject to capital rules adopted by federal bank regulators implementing the Basel III regulatory capital reforms adopted by the Basel Committee, and certain changes required by the Dodd-Frank Act. These rules require the Bank to comply with the following minimum capital ratios: (i) a Common Equity Tier 1 capital ratio of 4.5% of risk-weighted assets; (ii) a Tier 1 capital ratio of 6.0% of risk-weighted assets; (iii) a total capital ratio of 8.0% of risk-weighted assets; and (iv) a leverage ratio of 4.0% of average adjusted assets. The following additional capital requirements related to the capital conservation buffer (promulgated by the Basel III regulatory capital rules) require the Bank to maintain (i) a minimum ratio of Common Equity Tier 1 to risk-weighted assets of at least 4.5%, plus a 2.5% “capital conservation buffer” (resulting in a minimum ratio of Common Equity Tier 1 to risk-weighted assets of 7.0%), (ii) a minimum ratio of Tier 1 capital to risk-weighted assets of at least 6.0%, plus the 2.5% capital conservation buffer (resulting in a minimum Tier 1 capital ratio of 8.5%), and (iii) a minimum ratio of total capital ratio of at least 8.0%, plus the 2.5% capital conservation buffer (resulting in a minimum total capital ratio of 10.5%). The capital conservation buffer is designed to absorb losses during periods of economic stress. Banking institutions with a ratio of Common Equity Tier 1 to risk-weighted assets above the minimum but below the conservation buffer will be subject to constraints on dividends, equity repurchases, and discretionary compensation paid to certain officers, based on the amount of the shortfall. As of September 30, 2020 and December 31, 2019, capital ratios of the Bank were in excess of the regulatory conservation buffer levels.

The following tables present capital ratios for the Bank, minimum capital ratios required with conservation buffer, and ratios defined as “well capitalized” by the Bank’s regulators as of the dates stated.

As of September 30, 2020	Actual Ratio			Minimum Capital Requirement Ratio with Conservation Buffer			Minimum to be Well Capitalized
Total risk-based capital		13.68	%		10.50	%		10.00	%
Tier 1 capital		12.43	%		8.50	%		8.00	%
Common equity tier 1		12.43	%		7.00	%		6.50	%
Tier 1 leverage ratio		10.47	%		4.00	%		5.00	%

As of December 31, 2019	Actual Ratio			Minimum Capital Requirement Ratio with Conservation Buffer			Minimum to be Well Capitalized
Total risk-based capital		13.07	%		10.50	%		10.00	%
Tier 1 capital		12.26	%		8.50	%		8.00	%
Common equity tier 1		12.26	%		7.00	%		6.50	%
Tier 1 leverage ratio		10.42	%		4.00	%		5.00	%

OFF BALANCE SHEET COMMITMENTS AND CONTINGENCIES

In the normal course of business, the Company offers various financial products to our customers to meet their credit and liquidity needs. These instruments may involve elements of liquidity, credit, and interest rate risk in excess of the amount recognized in the Company’s consolidated balance sheets. The Company’s exposure to credit loss in the event of nonperformance by the other party to the financial instruments for commitments to extend credit and stand-by letters of credit is represented by the contractual amount of these instruments. Subject to normal credit standards and risk monitoring procedures, the Company makes contractual commitments to extend credit. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since many of the commitments may expire without being completely drawn upon, the total commitment amounts do not necessarily represent future cash requirements. Conditional commitments are issued by the Company in the form of performance stand-by letters of credit, which guarantee the performance of a customer to a third party. The credit risk of issuing letters of credit is essentially the same as that involved in extending loans to customers.

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The following table presents off balance sheet commitments as of the dates stated.

	September 30, 2020		December 31, 2019
Total loan commitments outstanding	$	172,304	$	164,751
Stand-by letters of credit		6,778		6,118

CONTRACTUAL OBLIGATIONS

There have been no material changes outside the ordinary course of business to the contractual obligations disclosed in the Company’s 2019 Form 10-K.

RECENT ACCOUNTING PRONOUNCEMENTS

Refer to Note 2, Amendments to the Accounting Standards Codification, in the Notes to the Consolidated Financial Statements contained in Item 1 of this report, for information related to the adoption of amendments to the Accounting Standards Codification.

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Not required.

ITEM 4. CONTROLS AND PROCEDURES

EVALUATION OF DISCLOSURE CONTROLS AND PROCEDURES

As of the end of the period to which this report relates, the Company has carried out an evaluation, under the supervision and with the participation of the Company’s management, including the Company’s Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of the Company’s disclosure controls and procedures pursuant to Rule 13a-14 of the Securities Exchange Act of 1934 (the “Exchange Act”). 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 objectives of the disclosure controls and procedures are met. The design of any disclosure control and procedure is also 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 conditions. Based upon the evaluation, the Company’s Chief Executive Officer and Chief Financial Officer concluded that the Company’s disclosure controls and procedures are effective in ensuring that information required to be disclosed by the Company in the reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified by the Securities and Exchange Commission’s reports and forms, and that such information is accumulated and communicated to management, including its Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding disclosure, as of September 30, 2020.

CHANGES IN INTERNAL CONTROLS OVER FINANCIAL REPORTING

There was no change to the Company’s internal control over financial reporting during the three months ended September 30, 2020 that materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.

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PART II - OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

In the ordinary course of its operations, the Company is a party to various legal proceedings. Based upon information currently available, management believes that such legal proceedings, in the aggregate, will not have a material adverse effect on the business, financial condition, or results of operations of the Company.

ITEM 1A. RISK FACTORS

Other than as set forth below, there have been no material changes to the risk factors disclosed in the 2019 Form 10-K.

Combining Blue Ridge and the Company may be more difficult, costly or time-consuming than we expect.

The success of the Blue Ridge Merger will depend, in part, on Blue Ridge’s ability to realize the anticipated benefits and cost savings from combining the businesses of Blue Ridge and the Company and to combine the businesses of Blue Ridge and the Company in a manner that permits growth opportunities and cost savings to be realized without materially disrupting the existing customer relationships of the Company or decreasing revenues due to loss of customers. However, to realize these anticipated benefits and cost savings, Blue Ridge must successfully combine the businesses of Blue Ridge and the Company. If Blue Ridge is not able to achieve these objectives, the anticipated benefits and cost savings of the Blue Ridge Merger may not be realized fully or at all or may take longer to realize than expected.

Blue Ridge and the Company have operated, and, until the completion of the Blue Ridge Merger, will continue to operate, independently. The success of the Blue Ridge Merger will depend, in part, on Blue Ridge’s ability to successfully combine the businesses of Blue Ridge and the Company. To realize these anticipated benefits, after the completion of the Blue Ridge Merger, Blue Ridge expects to integrate the Company’s business into its own. The integration process in the Blue Ridge Merger could result in the loss of key employees, the disruption of each party’s ongoing business, inconsistencies in standards, controls, procedures and policies that affect adversely either party’s ability to maintain relationships with customers and employees or achieve the anticipated benefits of the Blue Ridge Merger. The loss of key employees could adversely affect Blue Ridge’s ability to successfully conduct its business in the markets in which the Company now operates, which could have an adverse effect on Blue Ridge’s financial results and the value of its common stock. If Blue Ridge experiences difficulties with the integration process, the anticipated benefits of the Blue Ridge Merger may not be realized fully or at all, or may take longer to realize than expected. As with any merger of financial institutions, there also may be disruptions that cause Blue Ridge and the Company to lose customers or cause customers to withdraw their deposits from the Company’s or Blue Ridge’s banking subsidiaries, or other unintended consequences that could have a material adverse effect on Blue Ridge’s results of operations or financial condition after the Blue Ridge Merger. These integration matters could have an adverse effect on the Company during this transition period and on Blue Ridge for an undetermined period after consummation of the Blue Ridge Merger.

The Blue Ridge Merger may distract management of the Company from its other responsibilities.

The Blue Ridge Merger could cause the management of the Company to focus its time and energies on matters related to the Blue Ridge Merger that otherwise would be directed to its business and operations. Any such distraction on the part of the Company’s management, if significant, could affect its ability to service existing business and develop new business and adversely affect the business and earnings of the Company before the Blue Ridge Merger, or the business and earnings of Blue Ridge after the Blue Ridge Merger.

Termination of the merger agreement with Blue Ridge could negatively impact the Company.

Each of the Company’s and Blue Ridge’s obligation to consummate the Blue Ridge Merger remains subject to a number of conditions, and there can be no assurance that all of the conditions will be satisfied, or that the Blue Ridge Merger will be completed on the proposed terms, within the expected timeframe, or at all. Any delay in completing the Blue Ridge Merger could cause us not to realize some or all of the benefits that we expect to achieve if the Blue Ridge Merger is successfully completed within its expected timeframe. If the merger agreement with Blue Ridge is terminated, the Company’s business may be impacted adversely by the failure to pursue other beneficial opportunities due to the focus of management on the Blue Ridge Merger, without realizing any of the anticipated benefits of completing the Blue Ridge Merger. Additionally, if the merger agreement is terminated, the market price of the Company’s common stock could decline to the extent that the current market prices reflect a market assumption that the Blue Ridge Merger will be completed. If the merger agreement is terminated under certain circumstances, including circumstances involving a change in recommendation by the Company’s board of directors, the Company may be required to pay to Blue Ridge a termination fee of $4.0 million.

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In addition, the Company has incurred and will incur substantial expenses in connection with the negotiation and completion of the transactions contemplated by the merger agreement. If the Blue Ridge Merger is not completed, the Company would have to recognize these expenses and would have committed substantial time and resources by management, without realizing the expected benefits of the Blue Ridge Merger. In addition, failure to consummate the Blue Ridge Merger also may result in negative reactions from the financial markets or from our customers, vendors and employees. If the Blue Ridge Merger is not completed, these risks may materialize and could have a material adverse effect on the Company’s stock price, business and cash flows, financial condition and results of operations.

The merger agreement limits the ability of the Company to pursue alternatives to the Blue Ridge Merger.

The merger agreement contains “no-shop” provisions that, subject to limited exceptions, limit the ability of the Company to discuss, facilitate or commit to competing third-party proposals to acquire all or a significant part of the Company. In addition, under certain circumstances, if the merger agreement is terminated and the Company, subject to certain restrictions, consummates a similar transaction other than the Blue Ridge Merger, the Company must pay to Blue Ridge a termination fee of $4.0 million. These provisions might discourage a potential competing acquiror that might have an interest in acquiring all or a significant part of the Company from considering or proposing the acquisition even if it were prepared to pay consideration, with respect to the Company, with a higher per share market price than that proposed in the Blue Ridge Merger.

The Company will be subject to business uncertainties and contractual restrictions while the Blue Ridge Merger is pending.

Uncertainty about the effect of the Blue Ridge Merger on employees and customers may have an adverse effect on the Company. These uncertainties may impair the Company’s ability to attract, retain and motivate key personnel until the Blue Ridge Merger is completed, and could cause customers and others that deal with the Company to seek to change existing business relationships with the Company. Retention of certain employees by the Company may be challenging while the Blue Ridge Merger is pending, as certain employees may experience uncertainty about their future roles with the Company or the combined company following the Blue Ridge Merger. If key employees depart because of issues relating to the uncertainty and difficulty of integration or a desire not to remain with the Company or the combined company following the Blue Ridge Merger, the Company’s business, or the business of the combined company following the Blue Ridge Merger, could be harmed. In addition, the Company has agreed to operate its business in the ordinary course prior to the closing of the Blue Ridge Merger and from taking certain specified actions until the Blue Ridge Merger occurs, and the merger agreement restricts the Company from taking other specified actions until the Blue Ridge Merger occurs without the consent of Blue Ridge. These restrictions may prevent the Company from pursuing attractive business opportunities that may arise prior to the completion of the Blue Ridge Merger.

The ongoing COVID-19 pandemic and measures intended to prevent its spread may adversely affect the Company’s business, financial condition, and operations; the extent of such impacts are highly uncertain and difficult to predict.

Global health and economic concerns relating to the COVID-19 outbreak and government actions taken to reduce the spread of the virus have had a material adverse impact on the macroeconomic environment, and the outbreak has significantly increased economic uncertainty. The pandemic has resulted in federal, state and local authorities, including those who govern the markets in which the Company operates, implementing numerous measures to try to contain the virus. These measures, including shelter-in-place orders and business limitations and shutdowns, have significantly contributed to rising unemployment and negatively affected consumer and business spending.

The COVID-19 outbreak has adversely affected and is likely to continue to adversely affect the Company’s employees and operations and the operations of its customers and business partners. In particular, the Company may experience adverse effects due to a number of operational factors impacting the Company or the Company’s customers or business partners, including but not limited to:

• credit losses resulting from financial stress experienced by the Bank’s borrowers, especially those operating in industries most impacted by government measures to contain the spread of the virus;

• operational failures, disruptions, or inefficiencies due to changes in Company’s normal business practices necessitated by the Company’s internal measures to protect the Company’s employees and government-mandated measures intended to slow the spread of the virus;

• possible business disruptions experienced by the Company’s vendors and business partners in carrying out work that supports the Company’s operations;

• decreased demand for the Company’s products and services due to economic uncertainty, volatile market conditions, and temporary business closures;

• any financial liability, credit losses, litigation costs, or reputational damage resulting from the Bank’s origination of PPP loans; and

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• heightened levels of cyber and payment fraud, as cyber criminals try to take advantage of the disruption and increased online activity brought about by the pandemic.

The extent to which the pandemic affects the Company’s business, liquidity, financial condition, and operations will depend on future developments, which are highly uncertain and are difficult to predict, including, but not limited to, its duration and severity, the actions to contain it or treat its impact, and how quickly and to what extent normal economic and operating conditions can resume. In addition, the rapidly changing and unprecedented nature of COVID-19 heightens the inherent uncertainty of forecasting future economic conditions and their impact on the Bank’s loan portfolio, thereby increasing the risk that the assumptions, judgments, and estimates used to determine the allowance for loan losses and other estimates are incorrect. Further, the Bank’s loan modification program could delay or make it difficult to identify the extent of asset quality deterioration during the short-term deferral period. As a result of these and other conditions, the ultimate impact of the pandemic is highly uncertain and subject to change, and the Company cannot predict the full extent of the effects on the Company’s business or operations. To the extent any of the foregoing risks or other factors that develop as a result of COVID-19 materialize, it could exacerbate the risk factors discussed in the Company’s Annual Report on Form 10-K for the year ended December 31, 2019, or otherwise materially and adversely affect the Company’s business, liquidity, financial condition, and results of operations.  

ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

None to report.

ITEM 3. DEFAULTS UPON SENIOR SECURITIES

None to report.

ITEM 4. MINE SAFETY DISCLOSURES

Not applicable.

ITEM 5. OTHER INFORMATION

None to report.

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ITEM 6. EXHIBITS

2.1	Agreement and Plan of Reorganization, dated as of August 12, 2020, between Blue Ridge Bankshares, Inc. and Bay Banks of Virginia, Inc. (included as Exhibit 2.1 to the Company’s Current Report on Form 8-K filed August 17, 2020 and incorporated herein by reference).
31.1	Certification of Chief Executive Officer Pursuant to Rule 13a-14(a) as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
31.2	Certification of Chief Financial Officer Pursuant to Rule 13a-14(a) as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
32.1	Certification Pursuant to 18 U.S.C. Section 1350 as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
101	The following materials from the Company’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2020, formatted in Inline Extensible Business Reporting Language (iXBRL): (i) Consolidated Balance Sheets as of September 30, 2020 and December 31, 2019, (ii) Consolidated Statements of Operations for the three and nine months ended September 30, 2020 and 2019, (iii) Consolidated Statements of Comprehensive (Loss) Income for the three and nine months ended September 30, 2020 and 2019, (iv) Consolidated Statements of Changes in Shareholders’ Equity for the three and nine months ended September 30, 2020 and 2019, (v) Consolidated Statements of Cash Flows for the nine months ended September 30, 2020 and 2019, and (vi) Notes to Consolidated Financial Statements.
104	The cover page from the Company’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2020, formatted in Inline XBRL (included with Exhibit 101).

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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.

	Bay Banks of Virginia, Inc.
	(Registrant)
November 6, 2020	By:	/s/ Randal R. Greene
		Randal R. Greene
		President and Chief Executive Officer
		(Principal Executive Officer)
	By:	/s/ Judy C. Gavant
		Judy C. Gavant
		Executive Vice President and Chief Financial Officer
		(Principal Financial Officer)

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