10-K 1 d318068d10k.htm FORM 10-K Form 10-K
Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM 10-K

Annual Report Pursuant to Section 13 or 15(d) of the

Securities Exchange Act of 1934

For the Fiscal Year Ended December 31, 2011

 

 

BANK OF THE JAMES FINANCIAL

GROUP, INC.

(Exact Name of Registrant as Specified in Its Charter)

Commission file number 001-35402

 

Virginia   20-0500300

(State or Other Jurisdiction of

Incorporation or Organization)

 

(I.R.S. Employer

Identification No.)

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

(434) 846-2000

(Issuer’s telephone number, including area code)

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

Title of Each Class

 

Name of Exchange on Which Registered

Common Stock, $2.14 par value   The NASDAQ Capital Markets

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

 

 

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

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.    ¨  Yes    x  No

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

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    x  Yes    ¨  No

Indicate by check mark if disclosure of delinquent filers in response to Item 405 of Regulation S-K (§ 229.405) is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  ¨

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

 

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

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

The aggregate value of the voting common equity held by nonaffiliates as of June 30, 2011, the last business day of the registrant’s most recently completed second fiscal quarter, was approximately $16,240,928 based on the price at which the common stock last sold on such day. This price reflects inter-dealer prices without retail mark up, mark down, or commissions, and may not represent actual transactions.

The number of shares outstanding of Common Stock, $2.14 par value as of March 20, 2012 was approximately 3,342,415.

 

 

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the 2012 Proxy Statement for the Annual Meeting of Shareholders, scheduled to be held on May 15, 2012, are incorporated by reference into Part III of this Form 10-K

 

 

 


Table of Contents

Table of Contents

 

PART I

     2   

Item 1.

 

Business

     2   

Item 1A.

 

Risk Factors

     16   

Item 1B.

 

Unresolved Staff Comments

     21   

Item 2.

 

Properties

     21   

Item 3.

 

Legal Proceedings

     23   

Item 4.

 

Mine Safety Disclosure

     23   

PART II

     23   

Item 5.

 

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

     23   

Item 6.

 

Selected Financial Data

     25   

Item 7.

 

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

     25   

Item 7A.

 

Quantitative and Qualitative Disclosure About Market Risk

     50   

Item 8.

 

Financial Statements and Supplementary Data

     50   

Item 9.

 

Changes in and Disagreements With Accountants on Accounting and Financial Disclosure

     103   

Item 9A.

 

Controls and Procedures

     103   

Item 9B.

 

Other Information

     103   

PART III

     103   

Item 10.

 

Directors, Executive Officers and Corporate Governance

     103   

Item 11.

 

Executive Compensation

     104   

Item 12.

 

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

     104   

Item 13.

 

Certain Relationships and Related Transactions, and Director Independence

     104   

Item 14.

 

Principal Accounting Fees and Services

     104   

PART IV

     104   

Item 15.

 

Exhibits and Financial Statement Schedules

     104   

SIGNATURES

     106   


Table of Contents

PART I

 

Item 1. Business

General

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

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

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

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

The Bank was capitalized by more than 2,400 shareholders that wanted a new local bank. These investors provided the initial customer base and are integral to the success of the Bank. Management believes that the key to the Bank’s success lies in providing Bank customers with personalized service while providing products and services that meet their banking needs.

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

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

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

Prior to a restructuring in February 2010, Financial provided securities brokerage services through BOTJ Investment Group, Inc., a wholly-owned subsidiary of Financial. In February 2010, the Bank began providing these services and BOTJ Investment Group, Inc. currently is a non-operating subsidiary of Financial. The Bank, BOTJ Insurance, and BOTJ Investment Group, Inc. are our only subsidiaries and primary assets.

 

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Products and Services

Retail and Commercial Banking

The Bank currently conducts business from nine full-service offices and one limited service office. Four of the full-service offices are located in Lynchburg, Virginia, one full-service location is located in Madison Heights, Virginia, one is located in the Town of Amherst, Virginia, one is located in Forest, Virginia, one is located in the City of Bedford, Virginia and one is located in the Town of Altavista, Virginia. The limited services branch is located in the Westminster-Canterbury facilities in Lynchburg. The Bank established a mortgage loan origination division that conducts business under the name “Bank of the James Mortgage, a Division of Bank of the James.” The mortgage division conducts business primarily from the division’s main office located in the Forest branch of the Bank and an office located in Moneta, Virginia. For a more detailed description of these facilities, see “Item 2. Properties” below.

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

Lending Services. The Bank offers a full range of short- to medium-term commercial and consumer loans. Our primary focus is on making loans to small businesses and consumers in the Region 2000 market area. In addition, we also provide a wide range of real estate finance services. Our primary lending activities are principally directed to our primary market area in the Region 2000 area. Commercial loans include both secured and unsecured loans for working capital (including inventory and receivables), business expansion (including acquisition of real estate and improvements), and purchase of equipment and machinery. Consumer loans include secured and unsecured loans for financing automobiles, home improvements, education and personal investments. Additionally, the Bank originates fixed and floating-rate mortgage loans and real estate construction and acquisition loans. Where appropriate, the Bank attempts to limit interest rate risk through the use of variable interest rates and terms of less than five years.

In general, the Bank offers the following lending services:

 

   

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

 

   

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

 

   

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

 

   

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

 

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

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

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

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

Other Activities

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

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

Employees

As of March 20, 2012, we had approximately 120 full-time equivalent employees. None of our employees are represented by any collective bargaining agreements, and relations with employees are considered excellent. We maintain employee benefit programs that include health insurance, a flexible spending account, and a 401(k) plan.

 

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Location and Market Area

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

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

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

Competition

Retail and Commercial Banking

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

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

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

Mortgage Banking

The Mortgage Division competes with large national and regional banks, credit unions, smaller regional mortgage lenders and small local mortgage brokers. As loan volumes have decreased over the past five years, the industry has seen a consolidation in the number of competitors in the marketplace. However, the competition with regard to price has increased as the remaining participants struggle to achieve volume

 

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and profitability. The downturn in the housing markets related to declines in real estate values, increased payment defaults and foreclosures have had a dramatic effect on the secondary market. The guidelines surrounding agency business (i.e., loans sold to Fannie Mae and Freddie Mac) have become much more restrictive and the associated mortgage insurance for loans above 80 percent loan-to-value has continued to tighten. The jumbo markets have slowed considerably and pricing has increased dramatically. These changes in the conventional market have caused a dramatic increase in government lending and state bond programs. The Mortgage Division competes by attracting the top sales people in the industry, providing an operational infrastructure that manages the guideline changes efficiently and effectively, offering a product menu that is both competitive in loan parameters as well as price, and providing consistently high quality customer service.

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

SUPERVISION AND REGULATION

General

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

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

Regulation of Financial

General. Financial is subject to the periodic reporting requirements of the Securities and Exchange Act of 1934, as amended (the “Exchange Act”), including the filing with the Securities and Exchange Commission (the “SEC”) of annual, quarterly and other reports on the financial condition and performance of the organization. Financial is directly affected by the corporate responsibility and accounting reform legislation signed into law on July 30, 2002, known as the Sarbanes-Oxley Act of 2002 (the “SOX Act”), and the related rules and regulations. The SOX Act includes provisions that, among other things, require that periodic reports containing financial statements that are filed with the SEC be accompanied by chief executive officer and chief financial officer certifications as to the accuracy and compliance with law, additional disclosure requirements and corporate governance and other related rules. Although we are not required to receive an opinion of our external auditors regarding our internal control over financial reporting under section 404 of the SOX Act because of our status as a smaller reporting company, our management’s report on internal control over financial reporting is set forth in Item 8 and incorporated into Item 9A herein. Financial has expended considerable time and money in complying with the SOX Act and expects to continue to incur additional expenses in the future.

Bank Holding Company Act. As a bank holding company registered under the Bank Holding Company Act of 1956 (the “BHCA”), Financial is subject to regulation and examination by the Board of

 

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Governors of the Federal Reserve System (the “Federal Reserve Board”). Financial is required to file with the Federal Reserve Board an annual report and such other additional information as the Federal Reserve Board may require pursuant to the BHCA.

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

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

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

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

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

The GLB Act also imposes customer privacy requirements on financial institutions. Financial institutions generally are prohibited from disclosing customer information to non-affiliated third parties, unless the customer has been given the opportunity to object and has not objected to such disclosure. Financial institutions must disclose their specific privacy policies to their customers annually. Upon making such disclosure, there is no specific restriction on financial institutions disclosing customer information to affiliated parties. Financial institutions must comply with state law, however, if it protects customer privacy more fully than federal law.

The cumulative effect of the GLB Act and other recent bank legislation has caused us to strengthen our staff to handle the procedures required by this additional regulation. The increased staff and operational

 

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costs have impacted our profitability. Although the above laws may have a significant impact on the banking industry by promoting, among other things, competition, it is not possible for the management of the Bank to determine, with any degree of certainty, the impact of such laws on the Bank.

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

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

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

The Dodd-Frank Act

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

 

   

The Dodd-Frank Reform Act changed the assessment base for federal deposit insurance from the amount of insured deposits to consolidated assets less tangible capital, eliminated the ceiling on the size of the DIF and increased the floor applicable to the size of the DIF. The Dodd-Frank Act also made permanent the $250,000 limit for federal deposit insurance and increased the cash limit of Securities Investor Protection Corporation protection from $100,000 to $250,000 and provided unlimited federal deposit insurance until December 31, 2012 for non-interest bearing demand transaction accounts at all insured depository institutions.

 

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

 

   

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

 

   

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

 

   

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

 

   

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

 

   

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

 

   

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

 

   

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

 

   

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

 

   

The Dodd-Frank Reform Act increased the regulation of asset-backed securities, including a requirement that issuers of asset-backed securities retain at least 5% of the risk of the asset-backed securities.

 

   

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

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

 

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

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

Incentive Compensation

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

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

The Dodd-Frank Act requires the SEC and the federal bank regulatory agencies to establish joint regulations or guidelines that require financial institutions with assets of at least $1 billion to disclose the structure of their incentive compensation practices and prohibit such institutions from maintaining compensation arrangements that encourage inappropriate risk-taking by providing excessive compensation or that could lead to material financial loss to the financial institution. The SEC and the federal bank regulatory agencies proposed such regulations in March 2011, which may become effective before the end of 2012. If the regulations are adopted in the form initially proposed, they will impose limitations on the manner in which Financial may structure compensation for its executives only if Financial’s total consolidated assets exceed $1 billion. These proposed regulations incorporate the three principles discussed in the June 2010 comprehensive final guidance on incentive compensation that was issued by the Federal Reserve, the OCC and the FDIC in June 2010.

 

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Regulation of the Bank

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

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

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

FDIC Insurance Premiums. The Bank has deposits that are insured by the Federal Deposit Insurance Corporation (FDIC). FDIC maintains a Deposit Insurance Fund (“DIF”) that is funded by risk-based insurance premium assessments on insured depository institutions. Assessments are determined based upon several factors, including the level of regulatory capital and the results of regulatory examinations. FDIC may adjust assessments if the insured institution’s risk profile changes or if the size of the DIF declines in relation to the total amount of insured deposits. In 2011, the Bank expensed $661,000 in FDIC assessments which was a material decrease from $902,000 in 2010. It is anticipated that assessments may increase in the future to offset demands on the DIF from banks that fail in the troubled economy. Such increases could adversely affect the Bank’s profitability.

On October 3, 2008, the FDIC announced that deposits at FDIC-insured institutions would be insured up to at least $250,000. It was extended to December 31, 2013, and then permanently.

FDIC announced its Transaction Account Guarantee Program on October 14, 2008. The Transaction Account Guarantee Program, which is a part of the Temporary Liquidity Guarantee Program, provides full coverage for noninterest bearing deposit accounts of FDIC-insured institutions that elected to participate. The Bank elected to participate in this program and opted to continue in the program. There are increased DIF assessments for program participants.

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

Capital Requirements. The Federal Reserve Board and the FDIC have adopted risk based capital adequacy guidelines pursuant to which they assess the adequacy of capital in examining and supervising banks and bank holding companies and in analyzing bank regulatory applications. Risk-based capital requirements determine the adequacy of capital based on the risk inherent in various classes of assets and off-balance sheet items.

Under the risk-based capital requirements of these federal bank regulatory agencies, the Bank is required to maintain a minimum ratio of total capital to risk-weighted assets of at least 8.0 percent and a minimum ratio of Tier 1 capital to risk-weighted assets of at least 4.0 percent. At least half of the total capital must be Tier 1 capital, which includes common equity, retained earnings and qualifying perpetual

 

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preferred stock, less certain intangibles and other adjustments. The remainder may consist of Tier 2 capital, such as a limited amount of subordinated and other qualifying debt (including certain hybrid capital instruments), other qualifying preferred stock and a limited amount of the general loan loss allowance. The total risk-based capital ratio of the Bank as of December 31, 2011 and December 31, 2010 was 11.37% and 10.51%, respectively, exceeding the minimums required.

In December 2010, the Basel Committee on Banking Supervision (the “Basel Committee”) released its final framework for strengthening international capital and liquidity regulation, now officially identified by the Basel Committee as “Basel III.” Basel III, when implemented by the U.S. banking agencies and fully phased-in, will require bank holding companies and their bank subsidiaries to maintain substantially more capital, with a greater emphasis on common equity. Implementation is presently scheduled to be phased in between 2014 and 2019, although it is possible that implementation may be delayed as a result of multiple factors including the current condition of the banking industry within the U.S. and abroad.

The Basel III final capital framework, among other things, (i) introduces as a new capital measure “Common Equity Tier 1” (CET1), (ii) specifies that Tier 1 capital consists of CET1 and “Additional Tier 1 capital” instruments meeting specified requirements, (iii) defines CET1 narrowly by requiring that most adjustments to regulatory capital measures be made to CET1 and not to the other components of capital and (iv) expands the scope of the adjustments as compared to existing regulations.

When fully phased in on January 1, 2019, Basel III requires banks to maintain (i) as a newly adopted international standard, a minimum ratio of CET1 to risk-weighted assets of at least 4.5%, plus a 2.5% “capital conservation buffer” (which is added to the 4.5% CET1 ratio as that buffer is phased in, effectively resulting in a minimum ratio of CET1 to risk-weighted assets of at least 7%), (ii) a minimum ratio of Tier 1 capital to risk-weighted assets of at least 6.0%, plus the capital conservation buffer (which is added to the 6.0% Tier 1 capital ratio as that buffer is phased in, effectively resulting in a minimum Tier 1 capital ratio of 8.5% upon full implementation), (iii) a minimum ratio of Total (that is, Tier 1 plus Tier 2) capital to risk-weighted assets of at least 8.0%, plus the capital conservation buffer (which is added to the 8.0% total capital ratio as that buffer is phased in, effectively resulting in a minimum total capital ratio of 10.5% upon full implementation) and (iv) as a newly adopted international standard, a minimum leverage ratio of 3%, calculated as the ratio of Tier 1 capital to balance sheet exposures plus certain off-balance sheet exposures (computed as the average for each quarter of the month-end ratios for the quarter).

Basel III also provides for a “countercyclical capital buffer,” generally to be imposed when national regulators determine that excess aggregate credit growth becomes associated with a buildup of systemic risk, that would be a CET1 add-on to the capital conservation buffer in the range of 0% to 2.5% when fully implemented (potentially resulting in total buffers of between 2.5% and 5%).

The aforementioned capital conservation buffer is designed to absorb losses during periods of economic stress. Banking institutions with a ratio of CET1 to risk-weighted assets above the minimum but below the conservation buffer (or below the combined capital conservation buffer and countercyclical capital buffer, when the latter is applied) will face constraints on dividends, equity repurchases and compensation based on the amount of the shortfall.

The implementation of the Basel III final framework will commence January 1, 2013. On that date, banking institutions will be required to meet the following minimum capital ratios:

 

   

3.5% CET1 to risk-weighted assets.

 

   

4.5% Tier 1 capital to risk-weighted assets.

 

   

8.0% Total capital to risk-weighted assets.

 

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The Basel III final framework provides for a number of new deductions from and adjustments to CET1. These include, for example, the requirement that mortgage servicing rights, deferred tax assets dependent upon future taxable income and significant investments in non-consolidated financial entities be deducted from CET1 to the extent that any one such category exceeds 10% of CET1 or all such categories in the aggregate exceed 15% of CET1.

Implementation of the deductions and other adjustments to CET1 will begin on January 1, 2014 and will be phased-in over a five-year period (20% per year). The implementation of the capital conservation buffer will begin on January 1, 2016 at 0.625% and be phased in over a four-year period (increasing by that amount on each subsequent January 1, until it reaches 2.5% on January 1, 2019).

The U.S. banking agencies have indicated informally that they expect to propose regulations implementing Basel III in mid-2012. In addition to Basel III, the Dodd-Frank Act requires or permits the federal banking agencies to adopt regulations affecting banking institutions’ capital requirements in a number of respects, including potentially more stringent capital requirements for systemically important financial institutions. Accordingly, the regulations ultimately applicable to Financial may be substantially different from the Basel III final framework as published in December 2010. Requirements to maintain higher levels of capital or to maintain higher levels of liquid assets could adversely impact Financial’s net income and return on equity.

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

Loans to Insiders. The Bank is subject to the restrictions contained in Section 22(h) of the Federal Reserve Act and the Federal Reserve Board’s Regulation O thereunder on loans to executive officers, directors and principal stockholders. Under Section 22(h), loans to a director, an executive officer or a greater-than-10% stockholder of a bank as well as certain affiliated interests of any of the foregoing may not exceed, together with all other outstanding loans to such person and affiliated interests, the loans-to-one-borrower limit applicable to national banks (generally 15% of the institution’s unimpaired capital and surplus), and all loans to all such persons in the aggregate may not exceed the institution’s unimpaired capital and unimpaired surplus. Regulation O also prohibits the making of loans in an amount greater than $25,000 or 5% of capital and surplus but in any event not over $500,000, to directors, executive officers and greater-than-10% stockholders of a bank, and their respective affiliates, unless such loans are approved in advance by a majority of the board of directors of the bank with any “interested” director not participating in the voting. Furthermore, Regulation O requires that loans to directors, executive officers and principal stockholders of a bank be made on terms substantially the same as those that are offered in comparable transactions to unrelated third parties unless the loans are made pursuant to a benefit or compensation program that is widely available to all employees of the bank and does not give preference to insiders over other employees. Regulation O also prohibits a depository institution from paying overdrafts over $1,000 of any of its executive officers or directors unless they are paid pursuant to written pre-authorized extension of credit or transfer of funds plans.

 

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

Community Reinvestment Act. The Community Reinvestment Act (“CRA”) requires that, in connection with examinations of financial institutions within their respective jurisdictions, the Federal Reserve Board, the Federal Deposit Insurance Corporation, the Office of the Comptroller of the Currency or the Office of Thrift Supervision shall evaluate the record of the financial institutions in meeting the credit needs of their local communities, including low and moderate income neighborhoods, consistent with the safe and sound operation of those institutions. The CRA does not establish specific lending requirements or programs for financial institutions nor does it limit an institution’s discretion to develop the types of products and services that it believes are best suited to its particular community, consistent with the CRA. An institution’s CRA activities are considered in, among other things, evaluating mergers, acquisitions and applications to open a branch or facility, as well as determining whether the institution will be permitted to exercise certain of the powers allowed by the GLB Act. The CRA also requires all institutions to make public disclosure of their CRA ratings. The Bank was last examined for CRA compliance in July 2008 and received a CRA rating of “satisfactory.”

Safety and Soundness. The federal banking agencies have broad powers under current federal law to take prompt corrective action to resolve problems of insured depository institutions. The extent of these powers depends upon whether the institutions in question are “well capitalized,” “adequately capitalized,” “undercapitalized,” “significantly undercapitalized,” or “critically undercapitalized,” all such terms are defined under uniform regulations defining such capital levels issued by each of the federal banking agencies. An insured depository institution which is less than adequately capitalized must adopt an acceptable capital restoration plan, is subject to increased regulatory oversight and is increasingly restricted in the scope of its permissible activities. As of December 31, 2011, the Bank was considered “well capitalized.”

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

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

USA Patriot Act. The USA Patriot Act became effective on October 26, 2001 and provides for the facilitation of information sharing among governmental entities and financial institutions for the purpose of combating terrorism and money laundering. Among other provisions, the USA Patriot Act permits financial institutions, upon providing notice to the United States Treasury, to share information with one another in order to better identify and report to the federal government concerning activities that may involve money laundering or terrorist activities. The USA Patriot Act is considered a significant banking law in terms of information disclosure regarding certain customer transactions. Although it does create a reporting obligation, the Bank does not expect the USA Patriot Act to materially affect its products, services or other business activities.

 

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Reporting Terrorist Activities. The Federal Bureau of Investigation (“FBI”) has sent, and will send, our banking regulatory agencies lists of the names of persons suspected of involvement in the September 11, 2001, terrorist attacks on New York City and Washington, DC. The Bank has been asked, and may be asked again, to search its records for any relationships or transactions with persons on those lists. If the Bank finds any relationships or transactions, it must file a suspicious activity report and contact the FBI. The Office of Foreign Assets Control (“OFAC”), which is a division of the Department of the Treasury is responsible for helping to ensure that United States entities do not engage in transactions with “enemies” of the United States, as defined by various Executive Orders and Acts of Congress. OFAC has sent, and will send, our banking regulatory agencies lists of names of persons and organizations suspected of aiding, harboring or engaging in terrorist acts. If the Bank finds a name on any transaction, account or wire transfer that is on an OFAC list, it must freeze such account, file a suspicious activity report and notify the FBI. The Bank has appointed an OFAC compliance officer to oversee the inspection of its accounts and the filing of any notifications. The Bank actively checks high-risk OFAC areas such as new accounts, wire transfers and customer files. The Bank performs these checks utilizing software, which is updated each time a modification is made to the lists provided by OFAC and other agencies of Specially Designated Nationals and Blocked Persons.

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

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

Effect of Governmental Monetary Policies

Our earnings are affected by domestic economic conditions and the monetary and fiscal policies of the United States government and its agencies. The Federal Reserve Bank’s monetary policies have had, and are likely to continue to have, an important impact on the operating results of commercial banks through its

 

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power to implement national monetary policy in order, among other things, to curb inflation or combat a recession. The monetary policies of the Federal Reserve Board have major effects upon the levels of bank loans, investments and deposits through its open market operations in United States government securities and through its regulation of the discount rate on borrowings of member banks and the reserve requirements against member bank deposits. It is not possible to predict the nature or impact of future changes in monetary and fiscal policies.

Future Regulatory Uncertainty

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

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

 

Item 1A. Risk Factors

In addition to other information set forth in this report, the following factors, among others, should be considered carefully in evaluating our business.

Risks Related to Our Business

The Company’s business may be adversely affected by conditions in the financial markets and economic conditions generally. From 2007 to 2010, financial markets experienced unprecedented pressure associated with the declining value of residential real estate, and deleveraging by investors in mortgage related securities. This has resulted in a sharp decline in the value of home mortgage loans and securities that derive their value from such loans. Many commercial banks have faced large write-downs of their loan and investment portfolios, resulting in large losses, repeated over a number of quarters, declining stock prices, significant capital issuances, bank failures, and loss of confidence in the safety of the banking system.

Market conditions have also led to the failure or merger of a number of prominent financial institutions. Financial institution failures or near-failures resulted in further losses as a consequence of defaults on securities issued by them and defaults under contracts entered into with such entities as counterparties. Furthermore, declining asset values, defaults on mortgages and consumer loans, and the lack of market and investor confidence, as well as other factors, have all combined to put pressure on rating agencies to lower credit ratings, and to increase the cost and decrease the availability of credit and liquidity, despite very significant declines in Federal Reserve borrowing rates and other government actions. Some banks and other lenders have suffered significant losses and have become reluctant to lend, even on a secured basis, due to the increased risk of default and the impact of declining asset values on the value of collateral. The foregoing has significantly weakened the strength and liquidity of some financial institutions worldwide. In 2008, the U.S. government, the Federal Reserve, the Treasury and other regulators took numerous steps to increase liquidity and to restore investor confidence, including investing approximately $350 billion in the equity of other banking organizations, but asset values in several key categories, notably real estate, have continued to decline.

 

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The Company’s financial performance generally, and in particular the ability of borrowers to pay interest on and repay principal of outstanding loans and the value of collateral securing those loans, is highly dependent upon the business environment in the markets where the Company operates (the Region 2000 area of Virginia) and in the United States as a whole. A favorable business environment is generally characterized by, among other factors, economic growth, efficient capital markets, low inflation, high business and investor confidence, and strong business earnings. Unfavorable or uncertain economic and market conditions can be caused by: declines in economic growth, business activity or investor or business confidence; limitations on the availability or increases in the cost of credit and capital; increases in inflation or interest rates; natural disasters; or a combination of these or other factors.

Overall, during the past several years, households and businesses in the United States have been adversely affected by the deteriorating business environment. Although the business environment in Virginia generally has declined, the impact has been less severe in Region 2000 than in many other areas in Virginia and in the United States. It is possible that the business growth in Region 2000 may be limited for the foreseeable future. There can be no assurance that these conditions will improve in the near term. Such conditions could adversely affect the credit quality of the Company’s loans, results of operations and financial condition.

Our FDIC Deposit Insurance premiums have risen significantly in the recent past and may continue to increase in the future as a result of increased assessment rates imposed by the FDIC. As a member institution of the FDIC, we are required to pay semi-annual deposit insurance premium assessments to the FDIC. During the year ended December 31, 2011, we expensed approximately $661,000 in deposit insurance assessments. Due to the recent failure of several unaffiliated FDIC insurance depository institutions, and the FDIC’s Temporary Liquidity Guaranty Program, the deposit insurance premium assessments paid by all banks has increased. Continued increases in this expense would have a material adverse effect on our financial condition.

The markets for our services are highly competitive and we face substantial competition. The banking business is highly competitive. We compete as a financial intermediary with other commercial banks, savings banks, credit unions, finance companies, mutual funds, insurance companies and brokerage and investment banking firms soliciting business from residents of and businesses located in Lynchburg, Virginia and surrounding areas and elsewhere. Many of these competing institutions have greater resources than we have. Specifically, many of our competitors enjoy competitive advantages, including greater financial resources, a wider geographic presence or more accessible branch office locations, the ability to offer additional services, greater marketing resources, more favorable pricing alternatives, and lower origination and operating costs. We are also subject to lower lending limits than our larger competitors. Increased competitive pressures have been one effect of the Gramm-Leach-Bliley Act. This competition could result in a decrease in loans we originate and could negatively affect our results of operations.

In attracting deposits, we compete with insured depository institutions such as banks, savings institutions, and credit unions, as well as institutions offering uninsured investment alternatives, including money market funds. Traditional banking institutions, as well as entities intending to transact business solely online, are increasingly using the Internet to attract deposits without geographic or physical limitations. In addition, many non-bank competitors are not subject to the same extensive regulations that govern us. These competitors may offer higher interest rates than we offer, which could result in either attracting fewer deposits or increasing our interest rates in order to attract deposits. Increased deposit competition could increase our cost of funds and could adversely affect our ability to generate the funds necessary for our lending operations, which would negatively affect our results of operations.

We have a limited operating history upon which to base any estimate of our future success. We and our subsidiaries have limited operating histories. As a consequence, there is limited historical

 

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financial information on which to base any estimate of our future performance. The financial statements presented in this report may not be as meaningful as those of a company which has a longer history of operations. Because of our limited operating history, you may not have access to the type and amount of information that would be available to a shareholder of a financial institution with a more extended operating history.

Opening new branches may not result in increased assets or revenues for us. As set forth below, we are considering opening additional branches over the next 18 months (see “Management’s Discussion and Analysis – Expansion Plans”). The investment necessary for these branch expansions may negatively impact our earnings and efficiency ratio. There is a risk that we will be unable to manage our growth, as the process of opening new branches may divert our time and resources. There is a risk that, if we do open these branches, they may not be profitable, which would negatively impact our results of operations. There is also risk that we may fail to open any additional branches.

Our plans for future expansion depend, in some instances, on factors beyond our control, and an unsuccessful attempt to achieve growth could have a material adverse effect on our business, financial condition, results of operations and future prospects. We expect to continue to engage in new branch expansion in the future. We may also seek to acquire other financial institutions, or parts of those institutions, though we have no present plans in that regard. Expansion involves a number of risks, including:

 

   

the time and costs of evaluating new markets, hiring experienced local management and opening new offices;

 

   

the time lags between these activities and the generation of sufficient assets and deposits to support the costs of the expansion;

 

   

our entrance into new markets where we lack experience; and

 

   

the introduction of new products and services with which we have no prior experience into our business.

We could suffer loan losses from a decline in credit quality. We could sustain losses if borrowers, guarantors, and related parties fail to perform in accordance with the terms of their loans. We have adopted underwriting and credit monitoring procedures and policies, including the establishment and review of the allowance for loan losses that we believe are appropriate to minimize this risk by assessing the likelihood of nonperformance, tracking loan performance, and diversifying our credit portfolio. These policies and procedures, however, may not prevent unexpected losses that could materially adversely affect our results of operations.

We may continue to acquire and hold elevated amounts other real estate owned (“OREO”) properties, which could lead to increased operating expenses and vulnerability to additional declines in the market value of real estate in our areas of operations. From time-to-time, we foreclose on and take title to the real estate serving as collateral for our loans as part of our business. During 2011, we continued to acquire OREO and at December 31, 2011, the Bank had 17 OREO properties with an aggregate book value of $3,253,000. Large OREO balances may lead to increased expenses, as the Bank will incur costs to manage, maintain, improve in some cases, and dispose of the OREO properties. If our OREO balance continues to increase, management expects that our earnings will be negatively affected by various expenses associated with OREO, including personnel costs, insurance and taxes, completion and repair costs, valuation adjustments, and other expenses associated with property ownership. Also, at the time that we foreclose on a loan and take possession of a property we estimate the value of that property using third party appraisals and opinions and internal judgments. OREO property is valued on our books at the estimated market value of the property, less the estimated costs to sell (or “fair value”). Upon foreclosure, a charge-off to the allowance for credit losses is recorded for any excess between the value of the asset on our books over its fair value. Thereafter, we periodically reassess our judgment of fair value

 

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based on updated appraisals or other factors, including, at times, at the request of our regulators. Any further declines in our estimate of fair value for OREO will result in additional charges, with a corresponding expense in our statements of income that is recorded under the line item for “Other real estate expenses.” As a result, our results of operations are vulnerable to additional declines in the market for residential and commercial real estate in the areas in which we operate. The expenses associated with OREO and any further property write downs could have a material adverse effect on our results of operations and financial condition. As of December 31, 2011, we have $10,375,000 in nonaccrual loans, which may lead to further increases in our OREO balance in the future.

Additional growth and regulatory requirements may require us to raise additional capital in the future, and capital may not be available when it is needed, which could adversely affect our financial condition, and results of operations. We are required by federal and state regulatory authorities to maintain adequate levels of capital to support our operations. We anticipate our capital resources are sufficient to satisfy our capital requirements for the foreseeable future. We may at some point, however, need to raise additional capital to support our continued growth. Our ability to raise additional capital, if needed, will depend on conditions in the capital markets at that time, which are outside our control, and on our financial performance. Accordingly, we cannot assure you of our ability to raise additional capital, if needed, on terms acceptable to us. If we cannot raise additional capital when needed, our ability to further expand our operations could be materially impaired.

If the value of real estate in our core market were to decline materially, a significant portion of our loan portfolio could become under-collateralized, which could have a material adverse effect on our business, financial condition and results of operations. With most of our loans concentrated in the Region 2000 areas surrounding Lynchburg, Virginia, a decline in local economic conditions could adversely affect the values of our real estate collateral. Consequently, a decline in local economic conditions may have a greater effect on our earnings and capital than on the earnings and capital of larger financial institutions whose real estate loan portfolios are more geographically diverse.

In addition to considering the financial strength and cash flow characteristics of borrowers, we often secure loans with real estate collateral. At December 31, 2011, approximately 80% of our loans had real estate as a primary or secondary component of collateral. The real estate collateral in each case provides an alternate source of repayment in the event of default by the borrower and may deteriorate in value during the time the credit is extended. If we are required to liquidate the collateral securing a loan to satisfy the debt during a period of reduced real estate values, our earnings and capital could be adversely affected.

Our corporate culture has contributed to our success, and if we cannot maintain this culture as we grow, we could lose the teamwork and increased productivity fostered by our culture, which could harm our business. We believe that a critical contributor to our success has been our corporate culture, which we believe fosters teamwork and increased productivity. As our organization grows and we are required to implement more complex organizational management structures, we may find it increasingly difficult to maintain the beneficial aspects of our corporate culture. This could negatively impact our future success.

If we fail to retain our key employees, our growth and profitability could be adversely affected. Our success is, and is expected to remain, highly dependent on our executive management team, consisting of Robert R. Chapman III, J. Todd Scruggs, and Harry P. Umberger, Jr. This is particularly true because, as a community bank, we depend on our management team’s ties to the community to generate business for us. Our growth will continue to place significant demands on our management, and the loss of any such person’s services may have an adverse effect upon our growth and profitability.

As a community bank, the Bank has different lending risks than larger banks. We provide services to our local communities. Our ability to diversify our economic risks is limited by our own local markets and economies. We lend primarily to small to medium-sized businesses, professionals, and individuals which may expose us to greater lending risks than those of banks lending to larger, better-capitalized businesses with longer operating histories.

 

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We manage our credit exposure through careful monitoring of loan applicants and loan concentrations in particular industries, and through loan approval and review procedures. We have established an evaluation process designed to determine the adequacy of our allowance for loan losses. While this evaluation process uses historical and other objective information, the classification of loans and the establishment of loan losses is an estimate based on experience, judgment, and expectations regarding our borrowers, the economies in which we and our borrowers operate, as well as the judgment of our regulators. We cannot assure you that our loan loss reserves will be sufficient to absorb future loan losses or prevent a material adverse effect on our business, financial condition, or results of operations.

Risks Related to Our Industry

Our profitability is vulnerable to interest rate fluctuations. Our profitability depends substantially upon our net interest income. Net interest income is the difference between the interest earned on assets, such as loans and investment securities, and the interest paid on liabilities, such as NOW accounts, savings accounts, time deposits and other borrowings. Market interest rates for loans, investments and deposits are highly sensitive to many factors beyond our control. Recently, interest rate spreads have generally narrowed due to changing market conditions, policies of various government and regulatory authorities and competitive pricing pressures, and we cannot predict whether these rate spreads will narrow further. This narrowing of interest rate spreads could adversely affect our financial condition and results of operations. In addition, we cannot predict whether interest rates will continue to remain at present levels. Changes in interest rates may cause significant changes, up or down, in our net interest income. Depending on our portfolio of loans and investments, our results of operations may be adversely affected by changes in interest rates.

We are subject to extensive regulation that could limit or restrict our activities and impose financial requirements or limitations on the conduct of our business, which limitations or restrictions could adversely affect our profitability. As a bank holding company, we are primarily regulated by the Board of Governors of the Federal Reserve System (“Federal Reserve”). The Bank is primarily regulated by the Federal Reserve and the Virginia Bureau of Financial Institutions (“BFI”). Our compliance with Federal Reserve and the BFI regulations is costly and may limit our growth and restrict certain of our activities, including payment of dividends, mergers and acquisitions, investments, loans and interest rates charged, interest rates paid on deposits and locations of offices. We are also subject to capital requirements by our regulators.

The laws and regulations, including the Dodd-Frank Act, applicable to the banking industry could change at any time, and we cannot predict the effects of these changes on our business and profitability. As discussed under “Supervision and Regulation,” we are subject to extensive federal and state regulation. Because government regulation greatly affects the business and financial results of all commercial banks and bank holding companies, our cost of compliance could adversely affect our ability to operate profitably. The increased scope, complexity, and cost of corporate governance, reporting, and disclosure practices are proportionately higher for a company of our size and will affect our profitability more than that of some of our larger competitors. We expect to experience increasing compliance costs related to this supervision and regulation.

Changes in monetary policies may have an adverse effect on our business, financial condition and results of operations. Our financial condition and results of operations are affected by credit policies of monetary authorities, particularly the Federal Reserve Board. Actions by monetary and fiscal authorities, including the Federal Reserve Board, could have an adverse effect on our deposit levels, loan demand or business and earnings.

 

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Item 1B. Unresolved Staff Comments

Not applicable.

 

Item 2. Properties

Current Locations and Property

As of December 31, 2011, the Bank conducted its banking business from ten locations, its mortgage origination services business primarily from two locations, and its investment and insurance services business primarily from one location.

Depending on such factors as cost, availability, and location, we may either lease or purchase our facilities. The existing facilities that we have purchased typically have been former branches of other financial institutions. We own 6 of our locations and lease 5 of our locations. The following table describes the location and general character of our facilities:

 

Address

  

Type of Facility

  

Year
Opened

  

Owned/Leased

5204 Fort Avenue

Lynchburg, Virginia

  

Full service branch with drive thru and ATM

   2000    Owned

4698 South Amherst

Highway

Madison Heights, Virginia

  

Full service branch with drive thru and ATM

   2002    Owned

17000 Forest Road

Forest, Virginia

  

Full service branch with drive thru and ATM

Headquarters for Mortgage Division

   2005    Owned

164 South Main Street

Amherst, Virginia

  

Full service branch with drive thru and ATM

   2007    Owned

1405 Ole Dominion Blvd.

Bedford, Virginia

  

Full service branch with drive thru and ATM

   2008    Owned

1110 Main Street

Altavista, Virginia

  

Full service branch with drive thru and ATM

   2009    Owned

828 Main Street

Lynchburg, Virginia

  

Corporate Headquarters; Full service branch with ATM

   2004    Leased (1)

615 Church Street

Lynchburg, Virginia

  

Full service branch with drive thru and ATM

Headquarters for Investment and Insurance Divisions

   1999    Leased (2)

4935 Boonsboro Road,

Suites C and D

Lynchburg, Virginia

  

Full service branch with drive thru and ATM

   2006    Leased (3)

1152 Hendricks Store Rd.

Moneta, Virginia

  

Mortgage banking office

   2005    Leased (4)

501 VES Road

Lynchburg, Virginia

  

Limited service branch

   2010    Leased (5)

 

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Table of Contents
(1) Base lease expires July 31, 2014. We have one or more renewal options that we may exercise at our discretion subject to the terms and conditions outlined in the lease.
(2) Base lease expires July 31, 2019. We have one or more renewal options that we may exercise at our discretion subject to the terms and conditions outlined in the lease.
(3) The current term expires on December 31, 2015. The Bank has one renewal option to extend the lease for an additional five year period that we may exercise at our discretion subject to the terms and conditions outlined in the lease.”
(4) Base lease expires September 30, 2013. We have one or more renewal options that we may exercise at our discretion subject to the terms and conditions outlined in the lease.
(5) Base lease expires May 31, 2015.

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

In addition, the Bank may evaluate the feasibility of entering into sale/leaseback agreements for certain branches.

Interest in Additional Properties

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

 

   

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

 

   

real property located at 5 Village Highway (near the intersection of Routes 501 and 24) in Rustburg, Virginia. The structure on the property has been demolished and removed. The Bank does not anticipate opening a branch at this location prior to the first quarter of 2013.

The Bank is considering whether to open a retail branch in the Hendricks Store Road, Moneta, Virginia location.

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

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

 

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Table of Contents
Item 3. Legal Proceedings

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

 

Item 4. Mine Safety Disclosure

Not applicable.

PART II

 

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

Market Prices and Dividends

As of January 25, 2012, the Common Stock of Financial is traded on the NASDAQ Capital Market LLC (NASDAQ) under the symbol “BOTJ.” Prior to this time, the Common Stock of Financial was quoted on the Over the Counter Bulletin Board (OTCBB) under the symbol “BOJF (“BOJF.OB” on some systems) and transactions generally involved a small number of shares. The following table sets forth the quarterly high and low bid prices for each quarter in fiscal 2011 and 2010 for Financial and was obtained from Bloomberg. Management believes this source to be accurate.

 

     Market Prices and Dividends (1)  
     Bid Price ($)         
     High      Low      Dividends ($)  

Fiscal 2011

        

Fourth Quarter

     5.00         3.75         0.00   

Third Quarter

     5.50         3.75         0.00   

Second Quarter

     6.25         4.80         0.00   

First Quarter

     6.65         5.20         0.00   

Fiscal 2010

        

Fourth Quarter

     6.36         5.95         0.00   

Third Quarter

     8.00         5.95         0.00   

Second Quarter

     7.70         6.30         0.00   

First Quarter

     7.00         4.15         0.00   

 

(1) All figures have been adjusted to reflect the 10% stock dividend declared on May 18, 2010 and paid on July 23, 2010 as well as all prior stock dividends declared by Financial.

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

As of March 15, 2012 (the most recent date available), the Common Stock traded for $5.85 per share. As of March 15, 2012, there were approximately 3,342,415 shares of Common Stock outstanding, which shares are held by approximately 3,050 shareholders of record. Neither Financial nor the Bank prior to the formation of Financial has declared or paid a cash dividend on its Common Stock.

 

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Table of Contents

Dividend Policy

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

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

The Company is a legal entity separate and distinct from its subsidiaries. Its ability to distribute cash dividends will depend primarily on the ability of the Bank to pay dividends to it, and the Bank is subject to laws and regulations that limit the amount of dividends that it can pay. As a state member bank, the Bank is subject to certain restrictions imposed by the reserve and capital requirements of federal and Virginia banking statutes and regulations. For a discussion of these restrictions, see “Supervision and Regulation of Financial – Limits on the Payment of Dividends.”

Cash dividends are not planned at this time. Financial intends to follow a policy of keeping retained earnings, if any, for the purpose of increasing net worth and reserves of the Bank during its initial years of operation in order to promote the Bank’s growth and ability to compete in its market area. As a result, Financial does not anticipate paying a cash dividend on its Common Stock in 2012.

Securities Authorized for Issuance under Equity Compensation Plans

The following table summarizes information concerning Financial’s equity compensation plans at December 31, 2011. All figures have been adjusted to reflect the 10% stock dividend declared on May 18, 2010 and paid on July 23, 2010 as well as all prior stock dividends declared by Financial. All outstanding stock options have been issued under plans approved by shareholders.

 

Plan Category

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

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

     216,886       $ 8.83         0   

Equity compensation plans not approved by shareholders

     N/A         N/A         N/A   

Total

     216,886       $ 8.83      

 

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Table of Contents

Recent Sales of Unregistered Equity Securities

None.

 

Item 6. Selected Financial Data

Not applicable.

 

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

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

The following discussion is intended to assist readers in understanding and evaluating our financial condition and results of operations. You should read this discussion in conjunction with our financial statements and accompanying notes included elsewhere in this report. Because Bank of the James Financial Group, Inc. (“Financial”) has no material operations and conducts no business other than the ownership of its operating subsidiary, Bank of the James (and its divisions and subsidiary), the discussion primarily concerns the business of the Bank. However, for ease of reading and because our financial statements are presented on a consolidated basis, references to “we,” “us,” or “our” refer to Financial, Bank of the James, and their divisions and subsidiaries as appropriate. The comparison of operating results for Financial between the years ended December 31, 2011 and 2010 should be read in the context of both the size and the relatively short operating history of the Bank.

Cautionary Statement Regarding Forward-Looking Statements

This report contains statements that constitute “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended, and the Private Securities Litigation Reform Act of 1995. The words “believe,” “estimate,” “expect,” “intend,” “anticipate,” “plan” and similar expressions and variations thereof identify certain of such forward-looking statements which speak only as of the dates on which they were made. We undertake no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events, or otherwise. Readers are cautioned that any such forward-looking statements are not guarantees of future performance and involve risks and uncertainties, and that actual results may differ materially from those indicated in the forward-looking statements as a result of various factors. Factors that could cause actual results to differ from the results discussed in the forward-looking statements include, but are not limited to: economic conditions (both generally and more specifically in the markets in which we operate); competition for our customers from other providers of financial services; government legislation and regulation relating to the banking industry (which changes from time to time and over which we have no control) including but not limited to the Dodd-Frank Wall Street Reform and Consumer Protection Act; changes in the value of real estate securing loans made by the Bank; changes in interest rates; and material unforeseen changes in the liquidity, results of operations, or financial condition of our customers. Other risks, uncertainties and factors could cause our actual results to differ materially from those projected in any forward-looking statements we make.

Overview

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

 

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Table of Contents

The Bank is a Virginia banking corporation headquartered in Lynchburg, Virginia. The Bank was incorporated under the laws of the Commonwealth of Virginia as a state chartered bank in 1998 and began banking operations in July 1999. We began providing securities brokerage services to the public in April 2006 through Financial’s BOTJ Investment Group, Inc. subsidiary. Following a restructuring, we now provide the securities brokerage services through Investment. Investment conducts its business primarily from one office located in the City of Lynchburg. We began offering insurance and annuity products in September 2008. Insurance currently operates out of the same location as Investment.

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

As discussed in more detail below,

 

   

For the year ended December 31, 2011, Financial had net income of $600,000, a decrease of $1,220,000 from net income of $1,820,000, from the year ended December 31, 2010;

 

   

For the year ended December 31, 2011, the income per basic and diluted share was $0.18, as compared income of $0.55 per basic and diluted share for the year ended December 31, 2010;

 

   

Net interest income increased to $15,327,000 for the current year from $15,201,000 for the year ended December 31, 2010;

 

   

Noninterest income (exclusive of gains and losses on sales of securities) decreased to $2,498,000 for the year ended December 31, 2011 from $3,160,000 for the year ended December 31, 2010;

 

   

Total assets as of December 31, 2011 were $427,436,000 compared to $418,928,000 at the end of 2010, an increase of $8,508,000 or 2.03%;

 

   

Loans, net of unearned income and loan loss provision, decreased to $319,188,000 as of December 31, 2011 from $320,715,000 as of the end of December 31, 2010, a decrease of 0.48%; and

 

   

The net interest margin decreased 5 basis points to 3.89% for 2012, compared to 3.94% for 2009.

The following table sets forth selected financial ratios:

 

     For the Year Ended
December 31,
 
     2011     2010     2009  

Return on average equity

     2.25     7.27     -0.16

Return on average assets

     0.14     0.44     -2.60

Dividend payout %

     0.00     0.00     0.00

Average equity to total average assets

     6.24     6.01     6.17

 

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Table of Contents

Effect of Economic Trends

The twelve months ended December 31, 2011 continue to reflect the turbulent economic conditions and continued weakness in the financial markets which have negatively impacted the liquidity and credit quality of financial institutions in the United States. Concerns regarding increased credit losses from the weakening economy have negatively affected capital and earnings of most financial institutions. Nationally, financial institutions have experienced significant declines in the value of collateral for real estate loans and heightened credit losses, which have resulted in record levels of nonperforming assets, charge-offs and foreclosures.

Although management cannot be certain, it expects weak economic conditions to persist in 2012. Financial institutions likely will continue to experience heightened credit losses and higher levels of nonperforming assets, charge-offs and foreclosures. In light of these conditions, financial institutions also face heightened levels of scrutiny from federal and state regulators. Financial institutions experienced, and are expected to continue to experience, pressure on credit costs, loan yields, deposit and other borrowing costs, liquidity, and capital.

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

The downward trend in short term interest rates beginning in the last quarter of 2007 was due to the actions of the Federal Open Market Committee (“FOMC”) resulting from a weakening economy. The federal funds target rate set by the Federal Reserve has remained at 0.00% to 0.25% since December 2008, following a decline from 4.25% in December 2007 through a series of rate reductions. As liquidity increased as a result of open market operations and other government actions, longer-term interest rates decreased and the yield curve remains positively sloped. Although it cannot be certain, management believes that short term interest rates will remain stable for at least the first two quarters of 2012. An increase in long-term interest rates likely would have an adverse impact on the Mortgage Division, primarily due to reduced refinancing opportunities.

The Treasury Department, the FDIC and other governmental agencies continue to enact rules and regulations to implement the EESA, TARP, the Financial Stability Plan, the Recovery Act and related economic recovery programs, many of which contain limitations on the ability of financial institutions to take certain actions or to engage in certain activities if the financial institution is a participant in the TARP capital purchase program or related programs. Future regulations, or enforcement of the terms of programs already in place, may require financial institutions to raise additional capital and result in the conversion of preferred equity issued under TARP or other programs to common equity. Although the Company did not participate in TARP and therefore should not be directly impacted by the foregoing, there can be no assurance as to the actual impact of these programs or any other governmental program on the financial markets.

Stock Dividends

On May 19, 2010, Financial declared a 10% stock dividend, which was paid on July 23, 2010 to shareholders of record on June 21, 2010. Except as otherwise described in this report, all share amounts and dollar amounts per share in this report with regard to the common stock have been adjusted to reflect these and all prior stock dividends.

 

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Table of Contents

Critical Accounting Policies

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

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

Because Financial has a relatively short operating history, historical trends alone do not provide sufficient information to judge the adequacy of the allowance for loan losses. Therefore, management considers industry trends, peer comparisons, as well as individual classified impaired loans, in addition to historical experience to evaluate the allowance for loan losses. Our method for determining the allowance for loan losses is discussed more fully under “Provision and Allowance for Loan Losses for the Bank” below.

RESULTS OF OPERATIONS

December 31, 2011 compared to year ended December 31, 2010

Net Income

The net income for Financial for the year ended December 31, 2011 was $600,000 or $0.18 per basic and diluted share compared with net income of $1,820,000 or $0.55 per basic and diluted share for the year ended December 31, 2010. Note 12 of the Audited Financial Statements provides additional information with respect to the calculation of Financial’s earnings per share.

The decrease of $1,220,000 in 2011 net income compared to 2010 was due in large part the following: i) a significant increase in provisions for loan losses in 2011 as compared to 2010; ii) a slight increase in net interest income; iii) an increase in the loss on sale of other real estate owned; and iv) a slight decrease (exclusive of OREO losses and expenses) in noninterest expense that was generally offset by a slight increase in noninterest income. As discussed in more detail below, we charged off $4,716,000 in nonperforming loans during the year ended December 31, 2011 as compared with $1,899,000 in 2010. The amount of the provision to the loan loss reserve was $4,807,000 in the year ended December 31, 2011 as compared to $2,783,000 in 2010.

 

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These operating results represent a return on average shareholders’ equity of 2.25% for the year ended December 31, 2011 compared to 7.27% for the year ended December 31, 2010. The return on average assets for the year ended December 31, 2011 was 0.14% compared to 0.44% in 2010.

Net Interest Income

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

Interest income decreased to $19,519,000 for the year ended December 31, 2011 from $21,589,000 for the year ended December 31, 2010. This decrease was due to a decrease in the yields on average earning assets which primarily consist of loans and investment securities.

Interest expense decreased to $4,192,000 for the year ended December 31, 2011 from $6,388,000 primarily as a result of the decrease in rates paid on deposit accounts, as discussed more fully below.

Net interest income for 2011 increased $126,000 to $15,327,000 or 0.83% from net interest income of $15,201,000 in 2010. The growth in net interest income was due in large part to a decrease in our interest expense of $2,196,000 from $6,388,000 for the year ended December 31, 2010 to $4,192,000 for the year ended December 31, 2011. This decrease in interest expense was primarily due to reductions in the interest rate paid on time deposits and savings accounts, specifically savings accounts. On December 31, 2011, 51.7% of the interest bearing deposits were held in a product known as the “Peaks Savings Account.” During 2011, the Bank reduced the rate paid on this account from 1.00% APY to 0.25% to APY. The average interest rate paid on time deposits decreased by 60 basis points during 2011 as compared to 2010.

The net interest margin decreased to 3.89% in 2011 from 3.94% in 2010. The average rate on earning assets decreased 65 basis points from 5.60% in 2010 to 4.95% in 2011 and the average rate on interest-bearing liabilities decreased from 1.85% in 2010 to 1.20% in 2011. Although management cannot predict with certainty future interest rate decisions by the FOMC, statements from the Federal Reserve Board indicate that interest rates will remain low through the end of 2014. A continued low interest rate environment could make it difficult to maintain an acceptable spread between the average rate the Bank receives on assets and the average rate that the Bank pays on liabilities.

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

 

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Table of Contents

Net Interest Margin Analysis

Average Balance Sheets

For the Twelve Months Ended December 31, 2011 and 2010

(dollars in thousands)

 

     2011     2010  
     Average
Balance
Sheet
    Interest
Income/
Expense
     Average
Rates
Earned/
Paid
    Average
Balance
Sheet
    Interest
Income/
Expense
     Average
Rates
Earned/
Paid
 

ASSETS

              

Loans, including fees (1) (2)

   $ 324,456      $ 17,572         5.42   $ 326,442      $ 19,710         6.04

Federal funds sold

     9,310        23         0.25     9,707        24         0.25

Securities (3)

     58,516        1,872         3.20     47,091        1,808         3.84

Federal agency equities

     1,976        52         2.63     2,174        47         2.16

CBB equity

     116        —           0.00     116        —           0.00
  

 

 

   

 

 

      

 

 

   

 

 

    

Total earning assets

     394,374        19,519         4.95     385,530        21,589         5.60
    

 

 

        

 

 

    

Allowance for loan losses

     (5,169          (4,683     

Non-earning assets

     38,308             35,482        
  

 

 

        

 

 

      

Total assets

   $ 427,513           $ 416,329        
  

 

 

        

 

 

      

LIABILITIES AND STOCKHOLDERS’ EQUITY

              

Deposits

              

Demand interest bearing

   $ 63,666      $ 346         0.54   $ 54,517      $ 554         1.01

Savings

     175,866        1,329         0.76     179,998        2,751         1.53

Time deposits

     84,822        1,725         2.03     84,319        2,221         2.63
  

 

 

   

 

 

      

 

 

   

 

 

    

Total interest bearing deposits

     324,354        3,400         1.05     318,834        5,526         1.73

Other borrowed funds

              

Fed funds purchased

     10        —           0.00     236        2         0.85

Repurchase agreements

     8,383        75         0.89     8,756        116         1.32

Other borrowings

     10,000        297         2.97     10,959        324         2.96

Capital notes

     7,000        420         6.00     7,000        420         6.00
  

 

 

   

 

 

      

 

 

   

 

 

    

Total interest-bearing liabilities

     349,747        4,192         1.20     345,785        6,388         1.85
    

 

 

        

 

 

    

Noninterest bearing deposits

     50,784             45,293        

Other liabilities

     325             214        
  

 

 

        

 

 

      

Total liabilities

     400,856             391,292        

Stockholders’ equity

     26,657             25,037        
  

 

 

        

 

 

      

Total liabilities and Stockholders’ equity

   $ 427,513           $ 416,329        
  

 

 

        

 

 

      

Net interest earnings

     $ 15,327           $ 15,201      
    

 

 

        

 

 

    

Net interest margin

          3.89          3.94
       

 

 

        

 

 

 

Interest spread

          3.75          3.75
       

 

 

        

 

 

 

 

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

 

(2) Nonperforming loans are included in the average balances. However, interest income and yields calculated do not reflect any accrued interest associated with nonaccrual loans.

 

(3) The interest income and yields calculated on securities have been tax affected to reflect any tax exempt interest on municipal securities.

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

 

     Volume and Rate  
   (dollars in thousands)  
   Years Ending December 31,  
     2011     2010  
     Volume
Effect
    Rate
Effect
    Change in
Income/
Expense
    Volume
Effect
    Rate
Effect
    Change in
Income/
Expense
 

Loans

   $ (1,180   $ (958   $ (2,138   $ 1,366      $ (90   $ 1,276   

Federal funds sold

     —          (1     (1     (16     8        (8

Securities

     91        (27     64        (119     (146     (265

Restricted stock

     (13     18        5        1        4        5   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total earning assets

     (1,101     (969     (2,070     1,232        (224     1,008   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Liabilities:

            

Demand interest bearing

     (566     358        (208     86        (45     41   

Savings

     (67     (1,355     (1,422     1,027        (2,609     (1,582

Time deposits

     13        (509     (496     (393     (706     (1,099

Fed funds purchased

     1        (3     (2     2        —          2   

Capital notes

     —          —          —          107        —          107   

FHLB borrowings

     (48     21        (27     (277     23        (254

Repurchase agreements

     (9     (32     (41     (54     (25     (79
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total interest-bearing liabilities

   $ (678   $ (1,518   $ (2,196   $ 498      $ (3,362   $ (2,864
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Change in net interest income

   $ (424   $ 550      $ 126      $ 734      $ 3,138      $ 3,872   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

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Table of Contents

Noninterest Income of Financial

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

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

Because the overall mortgage loan market was suppressed, during 2011 as a result of continued declines in real estate values and a difficult credit market, mortgage loan origination decreased. The Mortgage Division originated 290 mortgage loans, totaling $49,481,000 in 2011 as compared with 374 mortgage loans, totaling $75,582,000 during the year ended December 31, 2010. In 2011, the Mortgage Division faced a declining real estate market and loans for new home purchase comprised 37% of the total volume. Refinancing increased significantly in response to continued historical low interest rates. For the year ended December 31, 2011, the Mortgage Division accounted for 4.49% of Financial’s total revenue as compared with 6.03% of Financial’s total revenue for the year ended December 31, 2010. Mortgage contributed $158,653 and $263,000 to Financial’s pre-tax net income in 2011 and 2010, respectively. Management anticipates that residential mortgage rates will remain low by historical standards throughout 2012. Despite this decrease, the Mortgage Division continues to improve its market share in Region 2000. Management expects that low rates coupled with the Mortgage Division’s reputation in Region 2000 will allow us to continue to grow revenue at the Mortgage Division.

Service charges and fees and commissions decreased to $1,149,000 for the year ended December 31, 2011 from $1,344,000 for the year ended December 31, 2010. This decrease was due in large part to a decrease in commissions earned on the sale of securities to $69,000 for the year ended December 31, 2011 from $276,000 for the year ended December 31, 2010. The decrease was offset in part an increase in debit card fees which increased to $505,000 for the year ended December 31, 2011 from $403,000 for the year ended December 31, 2010.

Our Investment division provides brokerage services through an agreement with a third-party broker-dealer. Pursuant to this arrangement, the third party broker-dealer operates a service center adjacent to one of the branches of the Bank. The center is staffed by dual employees of the Bank and the broker-dealer. Investment receives commissions on transactions generated and in some cases ongoing management fees such as mutual fund 12b-1 fees. The Investment division’s financial impact on our consolidated revenue has been immaterial. Although management cannot predict the financial impact of Investment with certainty, management anticipates it will continue to be an immaterial component of revenue in 2012.

In the third quarter of 2008, we began providing insurance and annuity products to Bank customers and others, through the Bank’s Insurance subsidiary. The Bank has one full-time and one part-time employee that are dedicated to selling insurance products through Insurance. Insurance generates minimal revenue and its financial impact on our consolidated revenue has been immaterial. Management anticipates that Insurance’s impact on noninterest income will remain immaterial in 2011.

 

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Table of Contents

Noninterest income, exclusive of gains and losses on sale of securities, decreased to $2,498,000 in 2011 from $3,160,000 in 2010. Inclusive of gains and losses on sale of securities, noninterest income increased to $3,680,000 in 2011 from $3,518,000 in 2010. The following table summarizes our noninterest income for the periods indicated.

 

     Noninterest Income
(dollars in thousands)
December 31,
 
     2011      2010  

Mortgage fee income

   $ 1,042       $ 1,515   

Service charges, fees and commissions

     1,149         1,344   

Increase in cash value of life insurance

     249         234   

Other

     58         67   

Gain on sale of available-for-sale securities

     1,182         358   
  

 

 

    

 

 

 

Total noninterest income

   $ 3,680       $ 3,518   
  

 

 

    

 

 

 

The increase in noninterest income for 2011 as compared to 2010 was due to an increase in gains on sales of available-for-sale securities. These gains were largely offset by decreases in the other categories of non-interest income, particularly mortgage fee income. Mortgage fee income decreased due to the factors discussed previously.

Noninterest Expense of Financial

Noninterest expenses increased from $13,502,000 for the year ended December 31, 2010 to $13,693,000 for the year ended December 31, 2011. The following table summarizes our noninterest expense for the periods indicated.

 

     Noninterest Expense  
     (dollars in thousands)  
     December 31,  
     2011      2010  

Salaries and employee benefits

   $ 5,668       $ 6,686   

Occupancy

     1,091         1,022   

Equipment

     1,038         1,100   

Supplies

     365         373   

Professional, data processing and other outside expenses

     2,139         1,690   

Marketing

     333         274   

Credit expense

     257         323   

Loss on sale and/or writedown of other real estate owned

     1,021         185   

Amortization of tax credit investment

     247         196   

FDIC insurance expense

     661         902   

Other

     873         751   
  

 

 

    

 

 

 

Total noninterest expense

   $ 13,693       $ 13,502   
  

 

 

    

 

 

 

The slight increase in noninterest expense was due in large part to an increase in professional, data processing, and other outside expenses and the loss on the sale or writedown of OREO. The increase in these costs was largely offset by a decrease in personnel expenses. Our total personnel expense, net of fees collected from borrowers to cover direct salary costs incurred in originating certain loans (in accordance with current accounting rules), decreased to $5,668,000 for the year ended December 31, 2011, from

 

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$6,686,000 for the twelve months ended December 31, 2010. Compensation for some employees of the Mortgage Division and Investment is commission-based and therefore subject to fluctuation. Because of decreased volume of business at Mortgage, commission compensation and the corresponding employee benefits decreased significantly, in 2011. The Bank’s occupancy expense also increased in large part due to an increase in rent at two of our locations. Our data processing expense also increased because of an increase in the number of customers and accounts.

The efficiency ratio, that is the cost of producing each dollar of revenue, is determined by dividing noninterest expense by the sum of net interest income plus noninterest income. Because of a slight increase in net interest income, Financial’s efficiency ratio improved from 71.08% in 2010 to 70.74% in 2011. Management intends that additional interest earning assets will help further lower the efficiency ratio.

Income Tax Expense

For the year ended December 31, 2011, Financial had a federal income tax benefit of $93,000, as compared to a Federal income tax expense of $614,000 in 2010. Although we had net income, we realized a federal income tax benefit principally as a result of earnings on bank owned life insurance as well as the impact of tax credits. Note 11 of the Audited Financial Statements provides additional information with respect to our 2011 federal income tax expense and the deferred tax accounts.

Analysis of Financial Condition

As of December 31, 2011 and December 31, 2010

General

Our total assets were $427,436,000 at December 31, 2011, an increase of $8,508,000 or 2.03% from $418,928,000 at December 31, 2010, primarily due to an increase in cash and cash equivalents, securities available-for-sale (which was offset in part by a decrease in securities held-to-maturity), and the cash value of bank-owned life insurance. Deposits increased from $368,390,000 on December 31, 2010 to $374,234,000 on December 31, 2011. Loans, net of unearned income and allowance, decreased slightly to $319,188,000 on December 31, 2011 from $320,715,000 on December 31, 2010.

Loans

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

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

Loans, net of unearned income and allowance, decreased slightly to $319,188,000 on December 31, 2011 from $320,715,000 on December 31, 2010. Total loans decreased to $324,800,000 on December 31, 2011 from $326,182,000 on December 31, 2010. The minimal decrease in both loans, net of unearned income and allowance and total loans was due in large part to a smaller number of qualified borrowers. Management expects that the number of qualified borrowers will remain limited until the economy further improves.

 

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Table of Contents

As of December 31, 2011, the Bank had $10,375,000, or 3.19% of its total loans, in non-accrual status compared with $8,366,000, or 2.56% of its total loans, at December 31, 2010. This increase is due primarily to continued difficulties in the commercial real estate market which has resulted in the inability of certain borrowers to make payments in accordance with the terms of the loan. The Bank attempts to work with borrowers on a case-by-case basis to attempt to protect the Bank’s interests. However, despite our commitment, resolution across the portfolio is dependent on improvements in employment, housing, and overall economic conditions at the local, regional and national levels. See “Asset Quality” below.

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

 

     Loan Portfolio  
   (dollars in thousands)  
   December 31,  
     2011      2010      2009      2008      2007  

Commercial

   $ 59,623       $ 62,786       $ 60,045       $ 51,675       $ 42,078   

Commercial real estate

     150,622         143,428         141,530         121,800         99,181   

Consumer

     72,488         68,289         67,744         58,300         47,473   

Residential

     42,067         51,679         53,421         45,974         37,436   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total loans

     324,800         326,182         322,740         277,749         226,168   

Less allowance for loan losses

     5,612         5,467         4,288         2,859         2,146   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Net loans

   $ 319,188       $ 320,715       $ 318,452       $ 274,890       $ 224,022   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

The following table sets forth the maturities of the loan portfolio at December 31, 2011.

 

    

Remaining Maturities of Selected Loans

(dollars in thousands)

 
     At December 31, 2011  
     Less than
One Year
     One to
Five
Years
    Greater
than Five
Years
     Total  

Commercial

   $ 12,080       $ 7,253      $ 40,290       $ 59,623   

Commercial real estate

     30,517         18,322        101,783         150,622   

Consumer

     14,686         8,818        48,984         72,488   

Residential

     8,523         5,117        28,427         42,067   
  

 

 

    

 

 

   

 

 

    

 

 

 

Total

   $ 65,806       $ 39,510      $ 219,484       $ 324,800   

For maturities over one year:

          

Fixed Rates

   $ 116,573         45.01     

Variable Rates

     142,421         54.99     
  

 

 

         

Total

   $ 258,994           

 

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Table of Contents

Deposits

We experienced an increase in deposits from $368,390,000 at December 31, 2010 to $374,234,000 at December 31, 2011, for an increase of 1.59%. Noninterest-bearing deposits increased $11,297,000 or 25.52% from $44,272,000 at December 31, 2010 to $55,569,000 at December 31, 2011. Interest-bearing deposits decreased $5,453,000 from $324,118,000 at December 31, 2010 to $318,665,000 at December 31, 2011. This 1.68% decrease in interest bearing deposits was anticipated by management and largely resulted from the Bank’s decision to lower its interest rates paid on deposit accounts to more closely track the local market. Additionally, the balance in non-FDIC insured sweep accounts (repurchase agreements) increased slightly from $7,330,000 on December 31, 2010 to $8,379,000 on December 31, 2011.

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

 

     Average Deposits and Rates Paid  
     (dollars in thousands)  
     Year Ended December 31,  
     2011     2010     2009  
     Amount      Rate     Amount      Rate     Amount      Rate  

Noninterest- bearing deposits

   $ 50,784         —        $ 45,293         —        $ 40,319         —     
  

 

 

      

 

 

      

 

 

    

Interest -bearing deposits

               

Interest checking

   $ 23,766         0.44   $ 21,324         0.75   $ 17,877         0.72

Money market

     39,900         0.61     33,193         1.20     27,321         1.40

Savings

     175,866         0.76     179,998         1.52     152,606         2.84

Time deposits

               

Less than $100,000

     51,926         2.00     51,930         2.61     64,424         3.37

Greater than $100,000

     32,896         2.08     32,389         2.67     32,504         3.54
  

 

 

      

 

 

      

 

 

    

Total interest-bearing deposits

   $ 324,354         1.05   $ 318,834         1.73   $ 294,732         2.77
  

 

 

      

 

 

      

 

 

    

Total deposits

   $ 375,138         $ 364,127         $ 335,051      
  

 

 

      

 

 

      

 

 

    

The following table includes a summary of average deposits and average rates paid and maturities of CDs greater than $100,000.

 

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

At December 31, 2011

   $ 2,785       $ 6,152       $ 8,885       $ 16,398       $ 34,220   

Cash and Cash Equivalents

Cash and cash equivalents increased from $18,759,000 on December 31, 2010 to $23,340,000 on December 31, 2011. This increase was due primarily to routine fluctuations in deposits, including fluctuations in transactional accounts and professional settlement accounts. Federal funds sold decreased from $7,094,000 on December 31, 2010 to $5,662,000 on December 31, 2011.

 

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Table of Contents

Investment Securities

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

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

 

     Securities Portfolio
(dollars in thousands)
December 31,
 
     2011      2010      2009  

Held-to-maturity

        

U.S. agency obligations

   $ 8,533       $ 14,601       $ 15,277   
  

 

 

    

 

 

    

 

 

 

Available-for-sale

        

U.S. agency obligations

     25,485         14,341         38,442   

Mortgage – backed securities

     3,939         17,762         213   

Municipals

     18,914         5,465         3,622   

Corporates

     —           1,018         2,962   
  

 

 

    

 

 

    

 

 

 

Total available-for-sale

   $ 48,338       $ 38,586       $ 45,239   
  

 

 

    

 

 

    

 

 

 

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

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

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

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

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

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

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

Securities held-to-maturity decreased from $14,297,000 as of December 31, 2010 to $8,133,000 as of December 31, 2011. This decrease resulted in large part by certain issuers exercising their contractual right to redeem (call) certain of the securities. The decision to invest in securities held-to-maturity is based on the same factors as the decision to invest in securities available-for-sale except that management invests surplus funds in securities held-to-maturity only after concluding that such funds will not be necessary for liquidity purposes during the term of such security. However, the held-to-maturity securities may be pledged for such purposes as short term borrowings and as collateral for public deposits.

 

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Table of Contents

The portfolio of securities available-for-sale increased to $48,338,000 as of December 31, 2011 from $38,586,000 as of December 31, 2010. During 2011, the Bank purchased available-for-sale securities in order to maintain the ability to fund loans if demand and quality of credits increased.

The following table shows the maturities of held-to-maturity and available-for-sale securities at amortized cost and market value at December 31, 2011 and December 31, 2010 and approximate weighted average yields of such securities. Yields on state and political subdivision securities are not shown on a tax equivalent basis. Financial attempts to maintain diversity in its portfolio and maintain credit quality and repricing terms that are consistent with its asset/liability management and investment practices and policies. For further information on Financial’s securities, see Note 4 to the consolidated financial statements included in Item 8 of this Form 10-K.

 

     Securities Portfolio Maturity Distribution / Yield Analysis  
     (dollars in thousands)  
     At December 31, 2011  
     Less
than
One
Year
     One to
Five
Years
     Five to
Ten
Years
    Greater
than Ten
Years and
Other
Securities
    Total  

Held-to-maturity

            

U.S. agency

            

Amortized cost

   $ —         $ —         $ 2,072      $ 6,061      $ 8,133   

Market value

   $ —         $ —         $ 2,362      $ 6,171      $ 8,533   

Weighted average yield

           4.00     3.63  

Available-for-sale securities

            

U.S. agency

            

Amortized cost

   $ —         $ —         $ 6,146      $ 19,270      $ 25,416   

Market value

   $ —         $ —         $ 6,157      $ 19,328      $ 25,485   

Weighted average yield

           2.63     2.85  

Mortgage Backed Securities

            

Amortized cost

   $ —         $ —         $ —        $ 3,938      $ 3,938   

Market value

   $ —         $ —         $ —        $ 3,939      $ 3,939   

Weighted average yield

             2.18  

Municipals

            

Amortized cost

   $ —         $ —         $ 1,138      $ 17,924      $ 19,062   

Market value

   $ —         $ —         $ 1,204      $ 17,710      $ 18,914   

Weighted average yield

           4.39     3.52  

Total portfolio

            

Amortized cost

   $ —         $ —         $ 9,356      $ 47,193      $ 56,549   

Market value

   $ —         $ —         $ 9,723      $ 47,148      $ 56,871   

Weighted average yield

           3.15     3.15  

 

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Table of Contents
     Securities Portfolio Maturity Distribution / Yield Analysis  
     (dollars in thousands)  
     At December 31, 2010  
     Less
than
One
Year
     One to
Five
Years
    Five to
Ten
Years
    Greater
than Ten
Years and
Other
Securities
    Total  

Held-to-maturity

           

U.S. agency

           

Amortized cost

   $ —         $ —        $ 2,083      $ 12,214      $ 14,297   

Market value

   $ —         $ —        $ 2,191      $ 12,410      $ 14,601   

Weighted average yield

          4.00     3.41  

Available-for-sale securities

           

U.S. agency

           

Amortized cost

   $ —         $ 1,993      $ 3,000      $ 9,765      $ 14,758   

Market value

   $ —         $ 1,929      $ 2,910      $ 9,502      $ 14,341   

Weighted average yield

        1.58     2.20     3.61  

Mortgage Backed Securities

           

Amortized cost

   $ —         $ —        $ 1,010      $ 17,047      $ 18,057   

Market value

   $ —         $ —        $ 1,011      $ 16,751      $ 17,762   

Weighted average yield

          2.76     3.17  

Municipals

           

Amortized cost

   $ —         $ —        $ 919      $ 4,868      $ 5,787   

Market value

   $ —         $ —        $ 921      $ 4,545      $ 5,466   

Weighted average yield

          4.81     5.45  

Corporate

           

Amortized cost

   $ —         $ —        $ —        $ 1,033      $ 1,033   

Market value

   $ —         $ —        $ —        $ 1,017      $ 1,017   

Weighted average yield

            7.38  

Total portfolio

           

Amortized cost

   $ —         $ 1,993      $ 7,012      $ 44,927      $ 53,932   

Market value

   $ —         $ 1,929      $ 7,033      $ 44,225      $ 53,187   

Weighted average yield

        1.58     3.16     3.68  

 

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Cash surrender value of bank owned life insurance

On July 1, 2009, the Company funded bank owned life insurance (BOLI) for a chosen group of its officers, where the Company is the owner and sole beneficiary of the policies. As of December 31, 2011, the BOLI had a cash surrender value of $8,609,000, an increase of $3,249,000 from the cash surrender value of $5,360,000 as of December 31, 2010. Of the increased amount, $3,000,000 resulted from the purchase of additional policies insuring an additional group of employees and $249,000 is attributed to an increase in the cash surrender value relating to the aggregate earnings on all of the BOLI policies. The value of BOLI increases from the cash surrender values of the pool of insurance. The increase in cash surrender value is recorded as a component of noninterest income; however, the Company does not pay tax on increase in cash value. This profitability is used to offset a portion of current and future employee benefit costs. BOLI can be liquidated if necessary with associated tax costs. However, the Company intends to hold this pool of insurance, because it provides income that enhances the Company’s capital position. Therefore, the Company has not provided for deferred income taxes on the earnings from the increase in cash surrender value.

Liquidity

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

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

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

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

At December 31, 2011, liquid assets, which include cash, interest-bearing and noninterest-bearing deposits with banks, federal funds sold, and securities available-for-sale totaled $71,678,000 on December 31, 2011 as compared to $57,345,000 at December 31, 2010. Investment securities traditionally provide a secondary source of liquidity since they can be converted into cash in a timely manner. However, approximately $19,300,000 of these securities are pledged against outstanding debt or lines of credit. Therefore, the related debt would need to be repaid prior to the securities being sold in order for these securities to be converted to cash.

 

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

 

Funding Sources

(dollars in thousands)

 
     December 31, 2011  

Source

   Capacity      Outstanding      Available  

Fed funds purchased lines (unsecured)

   $ 18,000       $ —         $ 18,000   

Reverse repurchase agreements

     3,000         —           3,000   

Borrowings from FHLB Atlanta

     85,850         10,000         75,850   
  

 

 

    

 

 

    

 

 

 

Total

   $ 106,850       $ 10,000       $ 96,850   
  

 

 

    

 

 

    

 

 

 

At the end of 2011, approximately 64.11%, or $208,227 of the loan portfolio would mature or could reprice within a one-year period. At December 31, 2011 non-deposit sources of available funds totaled $96,850, which included $75,400 available from the FHLBA.

Capital Resources

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

Regulatory agencies measure capital adequacy utilizing a formula that takes into account the individual risk profiles of financial institutions. The guidelines define capital as Tier 1 (primarily common stockholders’ equity, defined to include certain debt obligations) and Tier 2 (remaining capital generally consisting of a limited amount of subordinated debt, certain hybrid capital instruments and other debt securities, preferred stock and a limited amount of the general valuation allowance for loan losses). The Bank’s regulatory capital levels exceed those established for well-capitalized institutions. The following table (along with Note 16 of the Audited Financial Statements) shows the minimum capital requirements and the Bank’s capital position as of December 31, 2011 and 2010.

 

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

(dollars in thousands)

 
     December 31,  
     2011      2010  

Tier 1 Capital:

     

Common stock

   $ 3,742       $ 3,742   

Additional paid in capital

     19,325         19,325   

Retained earnings

     10,394         9,049   
  

 

 

    

 

 

 

Total Tier 1 Capital

   $ 33,461       $ 32,116   
  

 

 

    

 

 

 

Tier 2 Capital:

     

Allowable portion of allowance for loan losses

     3,991         3,989   
  

 

 

    

 

 

 

Total Tier 2 Capital

   $ 3,991       $ 3,989   
  

 

 

    

 

 

 

Total risk-based capital

   $ 37,452       $ 36,105   
  

 

 

    

 

 

 

Risk weighted assets

   $ 317,684       $ 317,606   

Average total assets

   $ 427,680       $ 423,349   

 

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Table of Contents
                 Regulatory Minimums  
     December 31,     Capital
Adequacy
    Well
Capitalized
 
     2011     2010      

Capital Ratios

        

Tier 1 capital to average total assets

     7.82     7.59     4.00     5.00

Tier 1 risk-based capital ratio

     10.53     10.11     4.00     6.00

Total risk-based capital ratio

     11.79     11.37     8.00     10.00

The Bank, as predecessor to Financial, was initially capitalized through a public offering of its common stock, $4.00 (split adjusted to $2.14) par value per share (“Common Stock”), at $10.00 per share, which concluded in February, 1999 and resulted in a capitalization of the Bank of $9,356,300. On December 22, 2006, Financial completed a follow-on offering pursuant to which it raised $5,147,000 (net of costs and expenses of $106,000).

In 2009, Financial completed a private placement of unregistered debt securities pursuant to which it issued notes to accredited investors in an amount of $7,000,000 (the “2009 Notes”). The debt issued pursuant to this offering bears interest at the rate of 6% per year with interest payable quarterly in arrears. The first interest payment was due and paid on July 1, 2009. No principal payments are due until the debt matures on April 1, 2012 (the “Maturity Date”). Financial used $6,000,000 of the proceeds to provide additional capital to the Bank. Financial retained $1,000,000 which it has used to service interest payments on the debt. On the Maturity Date the principal and all accrued but unpaid interest on the debt will be due and payable.

Financial currently is conducting a private placement of unregistered debt securities (the “2012 Offering”). Financial will sell a maximum of $12,000,000 in principal of notes in the 2012 Offering (the “2012 Notes”). The 2012 Notes will not be and have not been registered under the Securities Act of 1933 and may not be offered or sold in the United States absent registration or an applicable exemption from registration requirements. The 2012 Notes will bear interest at the rate of 6% per year with interest payable quarterly in arrears. The first interest payment will be due on July 1, 2012. The notes mature on April 1, 2017, but are subject to prepayment in whole or in part on or after April 1, 2013 at Financial’s sole discretion on 30 days written notice to the holders. Unless prepaid, no principal payments are due until the debt matures on April 1, 2017 (the “Maturity Date”). Financial intends to use up to the first $7,000,000 in proceeds from the 2012 Offering to pay the 2009 Notes on maturity. As of March 20, 2012, Financial has accepted subscription agreements for the purchase of $7,820,000. Financial anticipates that it will close on these purchases on or before March 30, 2012. Financial anticipates that it will continue to sell the 2012 Notes until it has sold $12,000,000 in principal of 2012 Notes, Financial terminates the offering, or April 30, 2012, whichever occurs first.

Based on these accepted subscription agreements, and funds generated from operations, Financial will have sufficient liquidity and capital with which to operate.

The capital ratios set forth in above tables state the capital position and analysis for the Bank only. Because total assets on a consolidated basis are less than $500,000,000, Financial is not subject to the consolidated capital requirements imposed by the Bank Holding Company Act. Consequently, Financial does not calculate its financial ratios on a consolidated basis. If calculated, the capital ratios for the Company on a consolidated basis would no longer be comparable to the capital ratios of the Bank because the proceeds from these private placements do not qualify as equity capital on a consolidated basis.

In December 2010, the Basel Committee on Banking Supervision (the Basel Committee) released its final framework for strengthening international capital and liquidity regulation, now officially identified by the Basel Committee as “Basel III.” Basel III, when implemented by the U.S. banking agencies and fully phased-in, will require bank holding companies and their bank subsidiaries to maintain substantially more capital, with a greater emphasis on common equity. Implementation is presently scheduled to be phased in between 2014 and 2019, although it is possible that implementation may be delayed as a result of multiple factors including the current condition of the banking industry within the U.S. and abroad.

 

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In addition to Basel III, Dodd-Frank requires or permits the U.S. banking agencies to adopt regulations affecting banking institutions’ capital requirements in a number of respects, including potentially more stringent capital requirements for systemically important financial institutions. Accordingly, the regulations ultimately applicable to the Company may be substantially different from the Basel III final framework as published in December 2010. Requirements to maintain higher levels of capital or to maintain higher levels of liquid assets could adversely impact the Company’s net income and return on equity.

Stockholder’s Equity

Stockholders’ equity increased by $1,310,000 from $25,495,000 on December 31, 2010 to $26,805,000 on December 31, 2011 because of the net income of $600,000, plus the adjustment for other comprehensive income, in the year ended December 31, 2011.

ASSET QUALITY

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

During 2011, the quality of certain classes of our assets declined. Specifically, as a result of the economic downturn, commercial development loans and residential speculative housing construction loans were impacted by a decline in the value of the collateral supporting those loans. Although asset quality declined in 2011, management believes that it has been proactive in quantifying and mitigating the risk. Non-accrual loans increased to $10,375,000 on December 31, 2011 from $8,366,000 on December 31, 2010. Management has provided for the anticipated losses on these loans in the loan loss reserve.

We also classify other real estate owned (OREO) as a nonperforming asset. OREO is the value of real property acquired by the Bank either at a foreclosure sale of collateral on which the Bank has a lien or by deed in lieu of foreclosure. OREO decreased slightly to $3,253,000 on December 31, 2011 from $3,440,000 on December 31, 2010. The following table represents the changes in OREO balance in 2011 and 2010.

 

OREO Changes

(Dollars in Thousands)

 
     Year Ended December 31,  
     2011     2010  

Balance at the beginning of the year (gross)

   $ 3,440      $ 666   

Transfers from Loans

     4,619        2,509   

Transfer from premises and equipment

     —          1,031   

Capitalized Costs

     20        31   

Charge-Offs

     (220     (132

Sales Proceeds

     (3,944     (612

Gain (loss) on disposition

     (487     (53
  

 

 

   

 

 

 

Balance at the end of the year (gross)

   $ 3,428      $ 3,440   
  

 

 

   

 

 

 

Less valuation allowance

     (175     —     

Balance at the end of the year (net)

   $ 3,253      $ 3,440   
  

 

 

   

 

 

 

 

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Table of Contents

We also classify troubled debt restructurings (TDRs) as both performing and nonperforming assets. As discussed above, we measure impaired loans based on the present value of expected future cash flows discounted at the effective interest rate of the loan or, as a practical expedient, at the loan’s observable market price or the fair value of the collateral if the loan is collateral dependent. We maintain a valuation allowance to the extent that the measure of the impaired loan is less than the recorded investment. TDRs occur when we agree to significantly modify the original terms of a loan by granting a concession due to the deterioration in the financial condition of the borrower. TDRs are considered impaired loans. These concessions typically are made for loss mitigation purposes and could include reductions in the interest rate, payment extensions, forgiveness of principal, forbearance or other actions. Performing TDRs decreased to $783,000 on December 31, 2011 from $4,987,000 on December 31, 2010.

The following table sets forth the number of outstanding TDR contracts and the total amount of the Bank’s TDRs as of December 31, 2011 and 2010.

 

Troubled Debt Restructurings

(Dollars in Thousands)

 
     December 31,  
     2011      2010  

Number of performing TDR contracts

     3         6   

Number of nonperforming TDR contracts

     2         —     
  

 

 

    

 

 

 

Total number of TDR contracts

     5         6   
  

 

 

    

 

 

 

Amount of performing TDR contracts

   $ 783       $ 4,987   

Amount of nonperforming TDR contracts

     1,935         —     
  

 

 

    

 

 

 

Total amount of TDRs contracts

   $ 2,718       $ 4,987   
  

 

 

    

 

 

 

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

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

The Bank’s allowance for loan losses increased 2.65% from $5,467,000 on December 31, 2010 to $5,612,000 on December 31, 2011. This increase resulted primarily from the current economic conditions and recent historic charge-off trends and reflects a slight decrease in the balances in the Bank’s loan portfolio. While impairment resulting from the individual impairment analysis (ASC 310) decreased, the overall reserve increased because of the application of the Bank’s loan rating system and the increase in reserve related to the unallocated portion of the reserve (ASC 450). As of December 31, 2011 the allowance for loan losses was equal to 1.73% of the total loan portfolio as compared with 1.68% at December 31, 2010.

No nonaccrual loans were excluded from impaired loan disclosure under current accounting rules at December 31, 2011 and 2010. If interest on these loans had been accrued, such income would have approximated $1,259,000 and $1,059,000 for 2011 and 2010, respectively. Loan payments received on nonaccrual loans are applied to principal. When a loan is placed on non-accrual status there are several negative implications. First, all interest accrued but unpaid at the time of the classification is deducted from the interest income totals for the Bank. Second, accruals of interest are discontinued until it becomes certain that both principal and interest can be repaid. Third, there may be actual losses that necessitate additional provisions for credit losses charged against earnings. These loans were included in the nonperforming loan totals listed below.

 

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The following table sets forth the detail of loans charged-off, recovered, and the changes in the allowance for loan losses as of the dates indicated:

 

     Allowance for Loan Losses  
     (dollars in thousands)  
     At December 31,  
     2011      2010      2009      2008      2007  

Balance, beginning of period

   $ 5,467       $ 4,288       $ 2,859       $ 2,146       $ 2,091   

Loans charged-off:

              

Commercial, financial and agricultural

     723         845         733         379         165   

Real estate-construction

     454         300         917         31         25   

Real estate-mortgage

     2,912         369         918         82         125   

Installment and other

     627         385         229         197         127   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total loans charged off

   $ 4,716       $ 1,899       $ 2,797       $ 689       $ 442   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Recoveries:

              

Commercial, financial and agricultural

   $ 15       $ 132       $ 35       $ 17       $ 22   

Real estate-construction

     1         —           —           —           —     

Real estate-mortgage

     3         119         —           —           —     

Installment and other

     35         44         40         30         24   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total recoveries

   $ 54       $ 295       $ 75       $ 47       $ 46   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Net charge-offs

   $ 4,662       $ 1,604       $ 2,722       $ 642       $ 396   

Provision for loan losses

     4,807         2,783         4,151         1,355         451   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Balance, end of period

   $ 5,612       $ 5,467       $ 4,288       $ 2,859       $ 2,146   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

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

Percent of Loans to Total Loans

 

     Allocation of Allowance for Loan Losses  
     (dollars in thousands)  
     At December 31,  
     2011     2010     2009     2008     2007  
   Amount      Percent
of Loans
to Total
Loans
    Amount      Percent
of Loans
to Total
Loans
    Amount      Percent
of Loans
to  Total

Loans
    Amount      Percent
of Loans
to Total
Loans
    Amount      Percent
of Loans
to Total
Loans
 

Commercial

   $ 892         18.36   $ 473         19.25   $ 777         18.60   $ 536         19.03   $ 523         19.40

Commercial – real estate

     2,677         46.37     2,897         43.97     697         52.44     1,864         49.27     1,226         50.53

Consumer

     1,486         22.3     1,207         20.94     619         19.00     305         16.04     292         14.02

Residential

     557         12.96     890         15.84     2,195         9.96     154         15.66     105         16.05
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 
   $ 5,612         100.00   $ 5,467         100.00   $ 4,288         100.00   $ 2,859         100.00   $ 2,146         100.00
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

 

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

 

     Nonperforming Assets  
     (dollars in thousands)  
     At December 31,  
     2011     2010     2009     2008     2007  

Nonaccrual loans

   $ 10,376      $ 8,366      $ 5,687      $ 3,859      $ 1,246   

Foreclosed property (OREO)

     3,253        3,440        666        81        —     

Loans past due 90 days accruing interest

     —          —          —          —          —     
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total nonperforming assets

   $ 13,629      $ 11,806      $ 6,353      $ 3,940      $ 1,246   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Restructured loans – performing portion (TDR)

   $ 783      $ 4,987      $ 916      $ —        $ —     

Allowance for loan losses to period end loans

     1.73     1.68     1.33     1.03     0.95

Nonperforming assets to period end loans

     4.20     3.62     2.25     1.39     0.55

Net charge-offs (recoveries) to average loans

     1.44     0.49     0.90     0.26     0.19

Interest Rate Sensitivity

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

Management also is attempting to mitigate interest rate risk by limiting the dollar amount of loans carried on its balance sheet that have fixed rates in excess of five years. To reduce our exposure to interest rate risks inherent with longer term fixed rate loans, we generally do not hold such mortgages on our books. The Bank established the Mortgage Division to serve potential customers that desired fixed rate loans in excess of five years.

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

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

 

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Table of Contents

Other Borrowings

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

Short-term borrowings consist of securities sold under agreements to repurchase, which are secured transactions with customers and generally mature the day following the date sold. The short-term borrowings totaled $8,379,000 and $7,330,000 as of December 31, 2011 and 2010, respectively. The highest average daily balance for any month for repurchase agreements was approximately $9,573,000 and $9,980,000 in the years ended December 31, 2011 and December 31, 2010, respectively. Short-term borrowings may also include federal funds purchased, which are unsecured overnight borrowings from other financial institutions. Unsecured federal funds lines and their respective limits are maintained with the following institutions: Community Bankers’ Bank, $11,000,000, Suntrust Bank, $3,000,000, and Zions Bank, $4,000,000. In addition, the Bank maintains a $3,000,000 reverse repurchase agreement with Suntrust whereby securities may be pledged as collateral in exchange for funds for a minimum of 30 days with a maximum of 90 days. The Bank also maintains a secured federal funds line with Community Bankers’ Bank whereby it may pledge securities as collateral with no specified minimum or maximum amount or term. No amounts were outstanding on the facilities at either December 31, 2011 or December 31, 2010. The highest average daily balance for any month for federal funds lines was approximately $0 and $2,053,000 in the years ended December 31, 2011 and December 31, 2010, respectively.

Long-term borrowing are obtained through the Federal Home Loan Bank of Atlanta (“FHLBA”). The Bank’s available credit through the FHLBA is $85,400,000 as of September 30, 2011, the most recent calculation.

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

 

(dollars in thousands)    As of December 31,  
     2011     2010  

Short Term:

    

Securities sold under agreements to repurchase

    

Maximum month-end outstanding balance

   $ 9,204      $ 9,590   

Average outstanding balance during the year

     8,383        8,756   

Average interest rate during the year

     0.89     1.32

Average interest rate at end of year

     0.91     1.03

Long Term:

    

Federal Home Loan Bank advances

    

Maximum month-end outstanding balance

   $ 10,000      $ 10,000   

Average outstanding balance during the year

     10,000        10,959   

Average interest rate during the year

     2.97     2.96

Average interest rate at end of year

     2.97     2.96

 

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Table of Contents

Maturities of FHLBA advances:

 

     Amount
(dollars in
thousands)
    

Type

   Rate     Ultimate Maturity
Date
 
   $ 3,000      

Fixed rate credit

     3.410     4/15/2013   
     5,000      

Fixed rate credit

     2.360     4/15/2013   
     2,000      

Fixed rate credit

     3.785     4/15/2015   
  

 

 

       

 

 

   

Total

   $ 10,000      

Weighted average rate

     2.960  
  

 

 

       

 

 

   

The maximum balance on the FHLBA credit was approximately $10,000,000 and $20,000,000 for the years ended December 31, 2011 and December 31, 2010, respectively.

Off-Balance Sheet Arrangements

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

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

 

    

Contract Amounts

(dollars in thousands) at

 
     December 31,  
     2011      2010  

Commitments to extend credit

   $ 51,153       $ 52,963   

Standby letters of credit

     2,574         3,111   
  

 

 

    

 

 

 

Total

   $ 53,727       $ 56,074   
  

 

 

    

 

 

 

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

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

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

 

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

 

Year Ending

   Amount
(in  thousands)
 

2012

   $ 537   

2013

     546   

2014

     417   

2015

     240   

2016

     196   

Thereafter

     534   
  

 

 

 
   $ 2,470   
  

 

 

 

Expansion Plans

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

Timberlake Road Area, Campbell County (Lynchburg), Virginia. As previously disclosed, the Bank has purchased certain real property located at the intersection of Turnpike and Timberlake Roads, Campbell County, Virginia. The Bank does not anticipate opening a branch at this location prior to 2013 or beyond. The Bank has determined that the existing structure is not suitable for use as a bank branch.

Rustburg, Virginia. In March, 2011 the Bank purchased certain real property near the intersection of Routes 501 and 24 in Rustburg, Virginia. The structure on the property is being demolished and removed. The Bank does not anticipate opening a branch at this location prior to the first quarter of 2014 or beyond.

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

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

 

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Recent Accounting Pronouncements

For information regarding recent accounting pronouncements and their effect on us, see “Recent Accounting Pronouncements” in Note 21 to the consolidated financial statements included in Item 8 of this Form 10-K.

 

Item 7A. Quantitative and Qualitative Disclosure About Market Risk

Not applicable

 

Item 8. Financial Statements and Supplementary Data

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

Management’s Annual Report on Internal Control Over Financial Reporting

Report of Independent Registered Public Accounting Firm

Consolidated Financial Statements

Balance Sheets, December 31, 2011 and December 31, 2010

Statements of Income, Years Ended December 31, 2011 and December 31, 2010

Statements of Changes in Stockholders’ Equity, Years Ended December 31, 2011 and December 31, 2010

Statements of Cash Flows, Years Ended December 31, 2011 and December 31, 2010

Notes to Consolidated Financial Statements

 

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LOGO

MANAGEMENT’S ANNUAL REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING

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

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

In order to ensure that Financial’s internal control over financial reporting is effective, management regularly assesses such controls and did so most recently for its financial reporting as of December 31, 2011. This assessment was based on criteria for effective internal control over financial reporting described in Internal Control Integrated Framework issued by the Committee of Sponsoring Organizations (COSO) of the Treadway Commission. Based on this assessment, management has concluded that the internal control over financial reporting was effective as of December 31, 2011.

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

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

 

Robert R. Chapman III

Chief Executive Officer & President

March 20, 2012

 

J. Todd Scruggs

Secretary-Treasurer (Principal Financial Officer)

March 20, 2012

 

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LOGO

To the Shareholders and Board of Directors

Bank of the James Financial Group, Inc.

Lynchburg, Virginia

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

We have audited the accompanying consolidated balance sheets of Bank of the James Financial Group, Inc. and subsidiaries as of December 31, 2011 and 2010, and the related consolidated statements of income, changes in stockholders’ equity, and cash flows for the years then ended. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.

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

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Bank of the James Financial Group, Inc. and subsidiaries as of December 31, 2011 and 2010, and the results of their operations and their cash flows for the years then ended, in conformity with U.S. generally accepted accounting principles.

 

LOGO

Winchester, Virginia

March 20, 2012

 

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BANK OF THE JAMES FINANCIAL GROUP, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(dollars in thousands, except share and per share data)

 

 

 

     December 31,  
     2011     2010  

Assets

    

Cash and due from banks

   $ 17,678      $ 11,665   

Federal funds sold

     5,662        7,094   
  

 

 

   

 

 

 

Total cash and cash equivalents

     23,340        18,759   
  

 

 

   

 

 

 

Securities held-to-maturity (fair value of $8,533 in 2011 and $14,601 in 2010)

     8,133        14,297   

Securities available-for-sale, at fair value

     48,338        38,586   

Restricted stock, at cost

     1,977        2,180   

Loans, net of allowance for loan losses of $5,612 in 2011 and $5,467 in 2010

     319,188        320,715   

Premises and equipment, net

     8,859        8,880   

Interest receivable

     1,583        1,469   

Cash value – bank owned life insurance

     8,609        5,360   

Other real estate owned net of valuation allowance

     3,253        3,440   

Other assets

     4,156        5,242   
  

 

 

   

 

 

 

Total assets

   $ 427,436      $ 418,928   
  

 

 

   

 

 

 

Liabilities and stockholders’ equity

    

Deposits

    

Noninterest bearing demand

   $ 55,569      $ 44,272   

NOW, money market and savings

     230,386        241,176   

Time

     88,279        82,942   
  

 

 

   

 

 

 

Total deposits

     374,234        368,390   
  

 

 

   

 

 

 

Repurchase agreements

     8,379        7,330   

Federal Home Loan Bank borrowings

     10,000        10,000   

Capital notes

     7,000        7,000   

Interest payable

     111        121   

Other liabilities

     907        592   
  

 

 

   

 

 

 

Total liabilities

   $ 400,631      $ 393,433   
  

 

 

   

 

 

 

Commitments and contingencies

    

Stockholders’ equity

    

Common stock $2.14 par value; authorized 10,000,000 shares, issued and outstanding 3,342,415 shares in 2011 and 3,323,743 shares in 2010

   $ 7,152      $ 7,113   

Additional paid-in-capital

     22,775        22,742   

Retained earnings (deficit)

     (3,068     (3,668

Accumulated other comprehensive (loss)

     (54     (692
  

 

 

   

 

 

 

Total stockholders’ equity

   $ 26,805      $ 25,495   
  

 

 

   

 

 

 

Total liabilities and stockholders’ equity

   $ 427,436      $ 418,928   
  

 

 

   

 

 

 

See notes to the consolidated financial statements

 

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BANK OF THE JAMES FINANCIAL GROUP, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS

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

 

 

 

     Years Ended December 31,  
     2011     2010  

Interest and Dividend Income

    

Loans

   $ 17,572      $ 19,710   

Securities

    

US agency obligations

     939        1,312   

Mortgage backed

     384        133   

Municipals

     524        259   

Dividends

     52        47   

Corporates

     25        104   

Federal funds sold

     23        24   
  

 

 

   

 

 

 

Total interest and dividend income

   $ 19,519      $ 21,589   
  

 

 

   

 

 

 

Interest Expense

    

Deposits

    

NOW, money market and savings

   $ 1,675      $ 3,305   

Time Deposits

     1,725        2,221   

Federal funds purchased

     —          2   

Federal Home Loan Bank borrowings

     297        324   

Repurchase agreements

     75        116   

Capital notes

     420        420   
  

 

 

   

 

 

 

Total interest expense

   $ 4,192      $ 6,388   
  

 

 

   

 

 

 

Net interest income

   $ 15,327      $ 15,201   

Provision for loan losses

     4,807        2,783   
  

 

 

   

 

 

 

Net interest income after provision for loan losses

   $ 10,520      $ 12,418   
  

 

 

   

 

 

 

Other operating income

    

Mortgage fee income

   $ 1,042      $ 1,515   

Service charges, fees and commissions

     1,149        1,344   

Increase in cash value of life insurance

     249        234   

Other

     58        67   

Gain on sale of available-for-sale securities

     1,182        358   
  

 

 

   

 

 

 

Total other operating income

   $ 3,680      $ 3,518   
  

 

 

   

 

 

 

Other operating expenses

    

Salaries and employee benefits

   $ 5,668      $ 6,686   

Occupancy

     1,091        1,022   

Equipment

     1,038        1,100   

Supplies

     365        373   

Professional, data processing and other outside expenses

     2,139        1,690   

Marketing

     333        274   

Credit expense

     257        323   

Other real estate expenses

     1,021        244   

Amortization of tax credit investment

     247        196   

FDIC insurance expense

     661        902   

Other

     873        692   
  

 

 

   

 

 

 

Total other operating expenses

   $ 13,693      $ 13,502   
  

 

 

   

 

 

 

Income before income taxes

   $ 507      $ 2,434   

Income tax expense (benefit)

     (93     614   
  

 

 

   

 

 

 

Net Income

   $ 600      $ 1,820   
  

 

 

   

 

 

 

Income per common share – basic and diluted

   $ 0.18      $ 0.55   
  

 

 

   

 

 

 

See notes to the consolidated financial statements

 

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BANK OF THE JAMES FINANCIAL GROUP, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY

(dollars in thousands)

 

 

 

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

Balance at December 31, 2009

     2,990,788       $ 6,400       $ 20,765       $ (2,938   $ (502   $ 23,725   

Net Income

     —           —           —           1,820        —          1,820   

Unrealized gains on securities available-for-sale net of deferred taxes of $24

     —           —           —           —          47        47   

Reclassification adjustment for gains included in net income, net of income tax expense of $121

     —           —           —             (237     (237
               

 

 

 

Comprehensive Income

                  1,630   
               

 

 

 

10% Stock dividend

     298,942         640         1,910         (2,550     —          —     

Exercise of stock options

     34,013         73         65         —          —          138   

Stock compensation expense

     —           —           2         —          —          2   
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

   

 

 

 

Balance at December 31, 2010

     3,323,743       $ 7,113       $ 22,742       $ (3,668   $ (692   $ 25,495   
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

   

 

 

 

Net Income

     —           —           —           600        —          600   

Unrealized gains on securities available-for-sale net of deferred taxes of $731

     —           —           —           —          1,418        1,418   

Reclassification adjustment for gains included in net income, net of income tax expense of $402

     —           —           —           —          (780     (780
               

 

 

 

Comprehensive Income

                  1,238   
               

 

 

 

Exercise of stock options

     18,672         39         33         —          —          72   
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

   

 

 

 

Balance at December 31, 2011

     3,342,415       $ 7,152       $ 22,775       $ (3,068   $ (54   $ 26,805   
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

   

 

 

 

See notes to the consolidated financial statements

 

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BANK OF THE JAMES FINANCIAL GROUP, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(dollars in thousands)

 

 

 

     Years Ended December 31,  
     2011     2010  

Cash flows from operating activities

    

Net Income

   $ 600      $ 1,820   

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

    

Depreciation

     715        813   

Net amortization and accretion of premiums and discounts on securities

     604        514   

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

     (1,182     (358

Provision for loan losses

     4,807        2,783   

Loss on sale of other real estate owned

     487        53   

Impairment of other real estate owned

     395        132   

Stock compensation expense

     —          2   

Benefit for deferred income taxes

     195        (79

Amortization of tax credit investment

     247        196   

(Increase) decrease in interest receivable

     (114     710   

(Increase) decrease in other assets

     439        573   

Decrease in income taxes receivable

     (374     323   

(Decrease) in interest payable

     (10     (79

Increase in other liabilities

     315        318   
  

 

 

   

 

 

 

Net cash provided by operating activities

   $ 7,124      $ 7,721   
  

 

 

   

 

 

 

Cash flows from investing activities

    

Purchases of securities held-to-maturity

   $ (1,000   $ —     

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

     7,000        1,000   

Purchases of securities available-for-sale

     (72,827     (45,659

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

     20,114        8,464   

Purchases of bank owned life insurance

     (3,000     —     

Proceeds from sale of securities available-for-sale

     44,671        43,657   

Proceeds from sale of restricted stock

     203        135   

Origination of loans, net of principal collected

     (6,618     (7,555

Improvements to other real estate owned

     (20     (31

Purchases of premises and equipment

     (694     (266

Proceeds from the sale of other real estate owned

     2,663        612   
  

 

 

   

 

 

 

Net cash provided by (used in) investing activities

   $ (9,508   $ 357   
  

 

 

   

 

 

 

Cash flows from financing activities

    

Net increase (decrease) in deposits

   $ 5,844      $ (7,382

Net increase (decrease) in repurchase agreements

     1,049        (3,380

Net (decrease) in Federal Home Loan Bank advances

     —          (10,000

Proceeds from exercise of stock options

     72        138   
  

 

 

   

 

 

 

Net cash provided by (used in) financing activities

   $ 6,965      $ (20,624
  

 

 

   

 

 

 

(Decrease) increase in cash and cash equivalents

     4,581        (12,546

Cash and cash equivalents at beginning of period

   $ 18,759      $ 31,305   
  

 

 

   

 

 

 

Cash and cash equivalents at end of period

   $ 23,340      $ 18,759   
  

 

 

   

 

 

 

Non cash transactions

    

Transfer of loans to foreclosed assets

   $ 4,619      $ 2,509   

Portion of foreclosed asset sales financed

     1,281        —     

Transfer of premises and equipment to foreclosed assets

     —          1,031   

Fair value adjustment for securities

   $ 968      $ (288
  

 

 

   

 

 

 

Cash transactions

    

Cash paid for interest

   $ 4,202      $ 6,467   

Cash paid for taxes

     712        1,045   
  

 

 

   

 

 

 

See notes to the consolidated financial statements

 

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BANK OF THE JAMES FINANCIAL GROUP, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements

December 31, 2011 and 2010

(dollars in thousands, except share and per share data)

 

 

Note 1 - Organization

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

Bank of the James was incorporated on October 23, 1998, and began banking operations on July 22, 1999. The Bank is a Virginia chartered bank and is engaged in lending and deposit gathering activities in Region 2000. It operates under the laws of Virginia and the Rules and Regulations of the Federal Reserve System and the Federal Deposit Insurance Corporation. The Bank’s nine locations consist of four branches in Lynchburg, Virginia, one in Forest, Virginia which includes the Mortgage Division, one in Madison Heights, Virginia, one in the Town of Amherst, Virginia, one in the City of Bedford, Virginia, and one in the Town of Altavista, Virginia.

Note 2 - Summary of significant accounting policies

Consolidation

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

Basis of presentation and use of estimates

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

Cash and cash equivalents

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

Securities

Certain debt securities that management has the positive intent and ability to hold to maturity are classified as “held-to-maturity” and recorded at amortized cost. Trading securities are recorded at fair value with changes in fair value included in earnings. Securities not classified as held-to-maturity or trading, including

 

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BANK OF THE JAMES FINANCIAL GROUP, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements

December 31, 2011 and 2010

(dollars in thousands, except share and per share data)

 

 

 

Note 2 - Summary of significant accounting policies (continued)

 

equity securities with readily determinable fair values, are classified as “available-for-sale” and recorded at fair value, with unrealized gains and losses excluded from earnings and reported in other comprehensive income. Purchase premiums and discounts are recognized in interest income using the interest method over the terms of the securities. Gains and losses on the sale of securities are recorded on the trade date and are determined using the specific identification method.

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

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

Restricted investments

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

Loans

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

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

 

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BANK OF THE JAMES FINANCIAL GROUP, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements

December 31, 2011 and 2010

(dollars in thousands, except share and per share data)

 

 

 

Note 2 - Summary of significant accounting policies (continued)

 

Past due status

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

Non-accrual status

Financial stops accruing interest on a loan at the time the loan is 90 days past due unless the credit is well-secured and in process of collection. At the time the loan is placed on non-accrual status, all previously accrued but not collected interest is reversed against interest income. While the loan is classified as non-accrual, any payments collected are accounted for on the cash-basis or cost-recovery method which requires the entire amount of the payment to be applied directly to principal, until qualifying for return to performing status. Loans may be returned to performing status when all the principal and interest amounts contractually due are brought current (within 90 days past due), future payments are reasonably assured, and contractually required payments have been made on a timely basis for at least 6 consecutive months.

Charge-off

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

Allowance for loan losses

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

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

 

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BANK OF THE JAMES FINANCIAL GROUP, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements

December 31, 2011 and 2010

(dollars in thousands, except share and per share data)

 

 

 

Note 2 - Summary of significant accounting policies (continued)

 

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

 

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

 

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

 

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

 

  4. Local economic and industrial conditions;

 

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

 

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

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

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

 

   

In accordance with current accounting rules (ASC 310), the Bank performs an individual impairment analysis on all loans with a risk rating of substandard, doubtful, and loss (our internal risk ratings of 7 through 9). The Bank also performs individual loan analysis and assesses potential future losses associated with those relationships risk rated as special mention (our internal risk rating of 6).

 

   

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

 

   

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

 

   

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

Troubled debt restructurings

In situations where, for economic or legal reasons related to a borrower’s financial condition, management may grant a concession to the borrower that it would not otherwise consider, the related loan is classified as a troubled debt restructuring (“TDR”). Management strives to identify borrowers in financial difficulty early and work with them to modify their loan to more affordable terms before their loans reach nonaccrual status. These modified terms may include rate reductions, principal forgiveness, payment forbearance and

 

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BANK OF THE JAMES FINANCIAL GROUP, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements

December 31, 2011 and 2010

(dollars in thousands, except share and per share data)

 

 

 

Note 2 - Summary of significant accounting policies (continued)

 

other actions intended to minimize the economic loss and to avoid foreclosure or repossession of collateral. In cases where borrowers are granted new terms that provide for a reduction of either interest or principal, management measures any impairment on the restructuring as noted above for impaired loans. The Bank had $4,987 and $2,718 classified as TDRs as of December 31, 2011 and 2010, respectively.

Premises, equipment and depreciation

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

Other real estate owned

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

Transfers of financial assets

Transfers of financial assets are accounted for as sales, when control over the assets has been surrendered. Control over transferred assets is deemed to be surrendered when (1) the assets have been isolated from the Bank – put presumptively beyond reach of the transferor and its creditors, even in bankruptcy or other receivership, (2) the transferee obtains the right (free of conditions that constrain it from taking advantage of that right) to pledge or exchange the transferred assets, and (3) the Bank does not maintain effective control over the transferred assets through an agreement to repurchase them before their maturity or the ability to unilaterally cause the holder to return specific assets.

Income taxes

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

When tax returns are filed, it is highly certain that some positions taken would be sustained upon examination by the taxing authorities, while others are subject to uncertainty about the merits of the position taken or the amount of the position that would be ultimately sustained. The benefit of a tax position is recognized in the financial statements in the period during which, based on all available evidence, management believes it is more likely than not that the position will be sustained upon examination,

 

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BANK OF THE JAMES FINANCIAL GROUP, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements

December 31, 2011 and 2010

(dollars in thousands, except share and per share data)

 

 

 

Note 2 - Summary of significant accounting policies (continued)

 

including the resolution of appeals or litigation processes, if any. Tax positions taken are not offset or aggregated with other positions. Tax positions that meet the more-likely-than-not recognition threshold are measured as the largest amount of tax benefit that is more than 50 percent likely of being realized upon settlement with the applicable taxing authority. The portion of the benefits associated with tax positions taken that exceeds the amount measured as described above is reflected as a liability for unrecognized tax benefits in the accompanying consolidated balance sheets along with any associated interest and penalties that would be payable to the taxing authorities upon examination.

Interest and penalties associated with unrecognized tax benefits are classified as additional income taxes in the consolidated statements of income.

Stock options

Current accounting guidance requires the costs resulting from all share-based payments to employees be recognized in the financial statements. Stock-based compensation is estimated at the date of grant, using the Black-Scholes option valuation model for determining fair value. The model employs the following assumptions:

 

  1. Dividend yield – calculated as the ratio of historical dividends paid per share of common stock to the stock price on the date of grant;

 

  2. Expected life (term of the option) – based on the average of the contractual life and vesting schedule for the respective option;

 

  3. Expected volatility – based on the monthly historical volatility of Financial’s stock price over the expected life of the options;

 

  4. Risk-free interest rate – based on the U.S. Treasury yield with a maturity similar to the expected life of the option on the day of grant.

There were no options granted in 2011 or 2010.

ASC 718 Compensation – Stock Compensation requires Financial to estimate forfeitures when recognizing compensation expense and that this estimate of forfeitures be adjusted over the requisite service period or vesting schedule based on the extent to which actual forfeitures differ from such estimates. Changes in estimated forfeitures are recognized through a cumulative catch-up adjustment, which is recognized in the period of change, and also will impact the amount of estimated unamortized compensation expense to be recognized in future periods

For the years ended December 31, 2011 and 2010, Financial recognized stock-based compensation expense related to the Amended and Restated Stock Option Plan of 1999 Financial (the “1999 Plan”) of $0 and $2 respectively, in accordance with ASC 718.

As of December 31, 2010, all compensation expense related to the foregoing stock option plan had been recognized. The Company’s ability to grant additional option shares under the 1999 Plan has expired.

 

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BANK OF THE JAMES FINANCIAL GROUP, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements

December 31, 2011 and 2010

(dollars in thousands, except share and per share data)

 

 

 

Note 2 - Summary of significant accounting policies (continued)

 

Earnings per share

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

Reclassification

Certain 2010 amounts have been reclassified to conform to the 2011 presentation.

Comprehensive income

Comprehensive income consists of net income and other comprehensive income. Other comprehensive income includes unrealized gains (losses) on securities available-for-sale, and unrealized losses related to factors other than credit on debt securities.

Marketing

The Company expenses advertising costs as incurred. Advertising expenses were $261 and $193 for 2011 and 2010, respectively.

Note 3 - Restrictions on cash

To comply with Federal Reserve regulations, the Bank is required to maintain certain average cash reserve balances. The daily average cash reserve requirements were approximately $1,732 and $1,857 for the weeks including December 31, 2011 and 2010, respectively.

 

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BANK OF THE JAMES FINANCIAL GROUP, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements

December 31, 2011 and 2010

(dollars in thousands, except share and per share data)

 

 

 

Note 4 - Securities

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

 

     December 31, 2011  
     Amortized      Gross Unrealized     Fair  
     Cost      Gains      Losses     Value  

Held-to-maturity

          

U.S. agency obligations

   $ 8,133       $ 400       $ —        $ 8,533   
  

 

 

    

 

 

    

 

 

   

 

 

 

Available-for-sale

          

U.S. agency obligations

   $ 25,416       $ 117       $ (48   $ 25,485   

Mortgage-backed securities

     3,938         5         (4     3,939   

Municipals

     19,062         241         (389     18,914   
  

 

 

    

 

 

    

 

 

   

 

 

 
   $ 48,416       $ 363       $ (441   $ 48,338   
  

 

 

    

 

 

    

 

 

   

 

 

 
     December 31, 2010  
     Amortized      Gross Unrealized     Fair  
     Cost      Gains      Losses     Value  

Held-to-maturity

          

U.S. agency obligations

   $ 14,297       $ 304       $ —        $ 14,601   
  

 

 

    

 

 

    

 

 

   

 

 

 

Available-for-sale

          

U.S. agency obligations

   $ 14,758       $ 24       $ (441   $ 14,341   

Mortgage-backed securities

     18,057         1         (296     17,762   

Municipals

     5,787         15         (337     5,465   

Corporates

     1,033         —           (15     1,018   
  

 

 

    

 

 

    

 

 

   

 

 

 
   $ 39,635       $ 40       $ (1,089   $ 38,586   
  

 

 

    

 

 

    

 

 

   

 

 

 

 

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BANK OF THE JAMES FINANCIAL GROUP, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements

December 31, 2011 and 2010

(dollars in thousands, except share and per share data)

 

 

 

Note 4 - Securities (continued)

 

Temporarily Impaired Securities

The following tables show the gross unrealized losses and fair value of the Bank’s investments with unrealized losses that are not deemed to be other-than-temporarily impaired, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position, at December 31, 2011 and 2010:

 

December 31, 2011    Less than 12 months      More than 12 months      Total  
     Fair      Unrealized      Fair      Unrealized      Fair      Unrealized  
     Value      Losses      Value      Losses      Value