10-Q 1 d579414d10q.htm FORM 10-Q Form 10-Q
Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

Form 10-Q

 

 

Quarterly Report Pursuant to Section 13 or 15(d)

of the Securities Exchange Act of 1934

For the Quarterly Period Ended June 30, 2013

 

 

BANK OF THE JAMES FINANCIAL

GROUP, INC.

(Exact Name of Registrant as Specified in Its Charter)

 

 

 

Virginia   001-35402   20-0500300

(State or other jurisdiction of

incorporation or organization)

 

(Commission

file number)

 

(I.R.S. Employer

Identification No.)

 

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

(434) 846-2000

(Registrant’s telephone number, including area code)

 

 

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

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

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

 

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

APPLICABLE ONLY TO CORPORATE ISSUERS

State the number of shares outstanding of each of the issuer’s classes of common equity, as of the latest practicable date: 3,352,725 shares of Common Stock, par value $2.14 per share, were outstanding at August 8, 2013.

 

 

 


Table of Contents

Table of Contents

 

PART I – FINANCIAL INFORMATION

     1   

Item 1.

 

Consolidated Financial Statements

     1   

Item 2.

 

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

     30   

Item 3.

 

Quantitative and Qualitative Disclosures About Market Risk

     46   

Item 4.

 

Controls and Procedures

     46   

PART II – OTHER INFORMATION

     46   

Item 1.

 

Legal Proceedings

     46   

Item 1A.

 

Risk Factors

     46   

Item 2.

 

Unregistered Sales of Equity Securities and Use of Proceeds

     47   

Item 3.

 

Defaults Upon Senior Securities

     47   

Item 4.

 

Mine Safety Disclosures

     47   

Item 5.

 

Other Information

     47   

Item 6.

 

Exhibits

     48   

SIGNATURES

     49   


Table of Contents

PART I – FINANCIAL INFORMATION

Item 1. Consolidated Financial Statements

Bank of the James Financial Group, Inc. and Subsidiaries

Consolidated Balance Sheets

(dollar amounts in thousands, except per share amounts) (2013 unaudited)

 

      6/30/2013     12/31/2012  

Assets

    

Cash and due from banks

   $ 16,165      $ 16,827   

Federal funds sold

     9,302        24,171   
  

 

 

   

 

 

 

Total cash and cash equivalents

     25,467        40,998   
  

 

 

   

 

 

 

Securities held-to-maturity (fair value of $3,322 in 2013 and $3,417 in 2012)

     3,063        3,075   

Securities available-for-sale, at fair value

     43,022        50,294   

Restricted stock, at cost

     1,428        1,538   

Loans, net of allowance for loan losses of $5,475 in 2013 and $5,535 in 2012

     331,703        319,922   

Loans held for sale

     861        904   

Premises and equipment, net

     8,240        8,340   

Software, net

     260        252   

Interest receivable

     1,443        1,557   

Cash value - bank owned life insurance

     9,082        8,931   

Other real estate owned, net of valuation allowance

     1,817        2,112   

Income taxes receivable

     678        624   

Deferred tax asset

     2,472        1,367   

Other assets

     1,335        1,467   
  

 

 

   

 

 

 

Total assets

   $ 430,871      $ 441,381   
  

 

 

   

 

 

 

Liabilities and Stockholders’ Equity

    

Deposits

    

Noninterest bearing demand

   $ 50,745      $ 66,917   

NOW, money market and savings

     243,044        239,812   

Time

     94,999        92,286   
  

 

 

   

 

 

 

Total deposits

     388,788        399,015   

FHLB borrowings

     2,000        2,000   

Capital notes

     10,000        10,000   

Interest payable

     68        70   

Other liabilities

     962        683   
  

 

 

   

 

 

 

Total liabilities

   $ 401,818      $ 411,768   
  

 

 

   

 

 

 

Stockholders’ equity

    

Common stock $2.14 par value; authorized 10,000,000 shares; issued and outstanding 3,352,725 as of June 30, 2013 and December 31, 2012

   $ 7,175      $ 7,175   

Additional paid-in capital

     22,806        22,806   

Accumulated other comprehensive income (loss)

     (1,577     568   

Retained earnings (deficit)

     649        (936
  

 

 

   

 

 

 

Total stockholders’ equity

   $ 29,053      $ 29,613   
  

 

 

   

 

 

 

Total liabilities and stockholders’ equity

   $ 430,871      $ 441,381   
  

 

 

   

 

 

 

See accompanying notes to these consolidated financial statements

 

1


Table of Contents

Bank of the James Financial Group, Inc. and Subsidiaries

Consolidated Statements of Income

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

 

     For the Three Months      For the Six Months  
     Ended June 30,      Ended June 30,  
     2013      2012      2013      2012  

Interest Income

           

Loans

   $ 4,199       $ 4,178       $ 8,362       $ 8,402   

Securities

           

US Government and agency obligations

     172         241         362         521   

Mortgage backed securities

     10         7         14         20   

Municipals

     141         171         293         325   

Dividends

     25         25         30         29   

Other (Corporates)

     12         17         28         23   

Federal Funds sold

     8         6         15         11   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total interest income

     4,567         4,645         9,104         9,331   
  

 

 

    

 

 

    

 

 

    

 

 

 

Interest Expense

           

Deposits

           

NOW, money market savings

     124         209         248         414   

Time Deposits

     317         392         640         813   

FHLB borrowings

     19         75         38         149   

Reverse repurchase agreements

     —           —           —           15   

Capital notes

     150         133         300         238   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total interest expense

     610         809         1,226         1,629   
  

 

 

    

 

 

    

 

 

    

 

 

 

Net interest income

     3,957         3,836         7,878         7,702   

Provision for loan losses

     55         425         290         1,175   
  

 

 

    

 

 

    

 

 

    

 

 

 

Net interest income after provision for loan losses

     3,902         3,411         7,588         6,527   
  

 

 

    

 

 

    

 

 

    

 

 

 

Other operating income

           

Mortgage fee income

     340         289         659         515   

Service charges, fees and commissions

     325         311         628         594   

Increase in cash value of life insurance

     76         82         151         164   

Other

     29         32         37         71   

Gain on sale of available-for-sale securities

     135         129         394         170   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total other operating income

     905         843         1,869         1,514   
  

 

 

    

 

 

    

 

 

    

 

 

 

Other operating expenses

           

Salaries and employee benefits

     1,726         1,546         3,502         3,049   

Occupancy

     285         291         590         577   

Equipment

     240         245         501         498   

Supplies

     93         103         183         216   

Professional, data processing, and other outside expense

     569         518         1,130         1,016   

Marketing

     95         145         181         249   

Credit expense

     64         56         119         112   

Other real estate expenses

     261         274         340         322   

FDIC insurance expense

     143         144         287         288   

Other

     195         237         369         516   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total other operating expenses

     3,671         3,559         7,202         6,843   
  

 

 

    

 

 

    

 

 

    

 

 

 

Income before income taxes

     1,136         695         2,255         1,198   

Income tax expense

     339         209         670         352   
  

 

 

    

 

 

    

 

 

    

 

 

 

Net Income

   $ 797       $ 486       $ 1,585       $ 846   
  

 

 

    

 

 

    

 

 

    

 

 

 

Weighted average shares outstanding - basic

     3,352,725         3,342,415         3,352,725         3,342,415   
  

 

 

    

 

 

    

 

 

    

 

 

 

Weighted average shares outstanding - diluted

     3,353,141         3,343,250         3,353,002         3,342,833   
  

 

 

    

 

 

    

 

 

    

 

 

 

Income per common share - basic

   $ 0.24       $ 0.15       $ 0.47       $ 0.25   
  

 

 

    

 

 

    

 

 

    

 

 

 

Income per common share - diluted

   $ 0.24       $ 0.15       $ 0.47       $ 0.25   
  

 

 

    

 

 

    

 

 

    

 

 

 

See accompanying notes to these consolidated financial statements

 

2


Table of Contents

Bank of the James Financial Group, Inc. and Subsidiaries

Consolidated Statements of Comprehensive Income (Loss)

Three and Six months ended June 30, 2013 and 2012

(dollar amounts in thousands) (unaudited)

 

     Three Months Ended
June 30,
    Six Months Ended
June 30,
 
     2013     2012     2013     2012  

Net Income

   $ 797     $ 486     $ 1,585     $ 846  
  

 

 

   

 

 

   

 

 

   

 

 

 

Other comprehensive income (loss):

        

Unrealized (losses) gains on securities available-for-sale net of deferred taxes of $838 and $(444) for the three month periods and $971 and $(389) for the six month periods ended June 30, 2013 and 2012

     (1,627     862       (1,885     760  

Reclassification adjustment for gains included in net income, net of taxes of $46 and $44 for the three month periods and $134 and $58 for the six month periods ended June 30, 2013 and 2012

     (89     (85     (260     (112
  

 

 

   

 

 

   

 

 

   

 

 

 

Other comprehensive income (loss), net of tax

     (1,716     777       (2,145     648  
  

 

 

   

 

 

   

 

 

   

 

 

 

Comprehensive income (loss)

   $ (919   $ 1,263     $ (560   $ 1,494  
  

 

 

   

 

 

   

 

 

   

 

 

 

See accompanying notes to these consolidated financial statements

 

3


Table of Contents

Bank of the James Financial Group, Inc. and Subsidiaries

Consolidated Statements of Cash Flows

Six Months ended June 30, 2013 and 2012

(dollar amounts in thousands) (unaudited)

 

     Six Months Ended June 30,  
     2013     2012  

Cash flows from operating activities

    

Net Income

   $ 1,585     $ 846  

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

    

Depreciation

     354       334  

Net amortization and accretion of premiums and discounts on securities

     183       299  

(Gain) on sale of available for sale securities

     (394     (170

Provision for loan losses

     290       1,175  

Loss on sale of other real estate owned

     9       81  

Impairment of other real estate owned

     284       200  

Decrease (increase) in loans held-for-sale

     43       (730

(Increase) in cash value of life insurance

     (151     (164

Decrease in interest receivable

     114       81  

Decrease in other assets

     132        309  

(Increase) in income taxes payable

     (54     (22

(Decrease) in interest payable

     (2     (4

Increase (decrease) in other liabilities

     279       (325
  

 

 

   

 

 

 

Net cash provided by operating activities

   $ 2,672      $ 1,910  
  

 

 

   

 

 

 

Cash flows from investing activities

    

Proceeds from maturities and calls of securities held to maturity

   $  —       $ 5,000  

Purchases of securities available for sale

     (17,314     (25,400

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

     2,113       10,488  

Proceeds from sale of securities available for sale

     19,446       8,472  

Redemption of Federal Home Loan Bank stock

     110        61  

Proceeds from sale of other real estate owned

     493       2,088  

Improvements to other real estate owned

     —          (5

Origination of loans, net of principal collected

     (12,562     (3,011

Purchases of premises and equipment

     (262     (260
  

 

 

   

 

 

 

Net cash (used in) investing activities

   $ (7,976   $ (2,567
  

 

 

   

 

 

 

Cash flows from financing activities

    

Net (decrease) increase in deposits

   $ (10,227   $ 10,355  

Net (decrease) in repurchase agreements

     —          (8,379

Payoff of 6% senior capital notes due 4/1/2012

     —          (7,000

Proceeds from issuance of 6% senior capital notes due 4/1/2017

     —          9,627  
  

 

 

   

 

 

 

Net cash (used in) provided by financing activities

   $ (10,227   $ 4,603  
  

 

 

   

 

 

 

(Decrease) increase in cash and cash equivalents

     (15,531     3,946  

Cash and cash equivalents at beginning of period

   $ 40,998     $ 23,340  
  

 

 

   

 

 

 

Cash and cash equivalents at end of period

   $ 25,467     $ 27,286  
  

 

 

   

 

 

 

Non cash transactions

    

Transfer of loans to foreclosed assets

   $ 491     $ 1,434  

Fair value adjustment for securities

     (3,250     979  
  

 

 

   

 

 

 

Cash transactions

    

Cash paid for interest

   $ 1,228     $ 1,633  

Cash paid for taxes

     724        370  
  

 

 

   

 

 

 

See accompanying notes to these consolidated financial statements

 

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Table of Contents

Bank of the James Financial Group, Inc. and Subsidiaries

Consolidated Statements of Changes in Stockholders’ Equity

(dollars in thousands) (unaudited)

 

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

Balance at December 31, 2011

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

 

 

    

 

 

    

 

 

    

 

 

   

 

 

   

 

 

 

Net Income

     —           —           —           846        —          846   

Other Comprehensive Income

     —           —           —           —          648        648   
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

   

 

 

 

Balance at June 30, 2012

     3,342,415       $ 7,152       $ 22,775       $ (2,222   $ 594      $ 28,299   
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

   

 

 

 

Balance at December 31, 2012

     3,352,725       $ 7,175       $ 22,806       $ (936   $ 568        29,613   
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

   

 

 

 

Net Income

     —           —           —           1,585        —          1,585   

Other Comprehensive Loss

     —           —           —           —          (2,145     (2,145
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

   

 

 

 

Balance at June 30, 2013

     3,352,725       $ 7,175       $ 22,806       $ 649      $ (1,577   $ 29,053   
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

   

 

 

 

See accompanying notes to these consolidated financial statements

 

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Notes to Consolidated Financial Statements

Note 1 – Basis of Presentation

The unaudited consolidated financial statements have been prepared by Bank of the James Financial Group, Inc. (“Financial” or the “Company”) pursuant to the rules and regulations of the Securities and Exchange Commission. In management’s opinion the accompanying financial statements, which unless otherwise noted are unaudited, reflect all adjustments, consisting solely of normal recurring accruals, necessary for a fair presentation of the financial information as of and for the three and six months ended June 30, 2013 and 2012 in conformity with accounting principles generally accepted in the United States of America. Additional information concerning the organization and business of Financial, accounting policies followed, and other related information is contained in Financial’s Annual Report on Form 10-K for the year ended December 31, 2012. These financial statements should be read in conjunction with the audited consolidated financial statements and footnotes for the year ended December 31, 2012 included in Financial’s Annual Report on Form 10-K. Results for the three and six month periods ended June 30, 2013 are not necessarily indicative of the results that may be expected for the year ending December 31, 2013.

The Company’s primary market area consists of the area commonly referred to as Region 2000 which encompasses the seven jurisdictions of the Town of Altavista, Amherst County, Appomattox County, the Town of Bedford, Bedford County, Campbell County, and the City of Lynchburg.

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

Note 2 – Use of Estimates

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

Note 3 – Earnings Per Share

Currently, only the option shares granted to certain officers and other employees of Financial pursuant to the Amended and Restated Stock Option Plan of 1999 Financial (the “1999 Plan”) are considered dilutive. The following is a summary of the earnings per share calculation for the three and six months ended June 30, 2013 and 2012.

 

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Note 3 – Earnings Per Share (continued)

 

     Three months ended      Year to date  
     June 30,      June 30,  
     2013      2012      2013      2012  

Net income

   $ 797,000       $ 486,000       $ 1,585,000       $ 846,000   

Weight average number of shares

     3,352,725         3,342,415         3,352,725         3,342,415   

Options affect of incremental shares

     416         835         277         418   
  

 

 

    

 

 

    

 

 

    

 

 

 

Weighted average diluted shares

     3,353,141         3,343,250         3,353,002         3,342,833   
  

 

 

    

 

 

    

 

 

    

 

 

 

Basic EPS (weighted avg shares)

   $ 0.24       $ 0.15       $ 0.47       $ 0.25   
  

 

 

    

 

 

    

 

 

    

 

 

 

Diluted EPS (Including Option Shares)

   $ 0.24       $ 0.15       $ 0.47       $ 0.25   
  

 

 

    

 

 

    

 

 

    

 

 

 

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

 

     Three months ended      Six months ended  
     June 30,      June 30,  
     2013      2012      2013      2012  

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

     169,600         175,847         169,600         216,492   

Note 4 – Stock Based Compensation

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

 

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Note 4 – Stock Based Compensation (continued)

 

Stock option plan activity for the six months ended June 30, 2013 is summarized below:

 

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

Options outstanding, January 1, 2013

     175,366      $ 9.66        

Granted

     —           —           

Exercised

     —           —           

Forfeited

     —         $  —          
  

 

 

          

Options outstanding, June 30, 2013

     175,366        9.66        1.5      $ 7,092  
  

 

 

    

 

 

    

 

 

    

 

 

 

Options exercisable, June 30, 2013

     175,366      $ 9.66        1.5      $ 7,902  
  

 

 

    

 

 

    

 

 

    

 

 

 

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

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

Note 5 – Fair Value Measurements

Determination of Fair Value

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

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

 

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Note 5 – Fair Value Measurements (continued)

 

Fair Value Hierarchy

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

 

   

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

 

   

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

 

   

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

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

Securities

Where quoted prices are available in an active market, securities are classified within Level 1 of the valuation hierarchy. Level 1 securities would include highly liquid government bonds, mortgage products and exchange traded equities. If quoted market prices are not available, then fair values are estimated by using pricing models, quoted prices of securities with similar characteristics, or discounted cash flow.

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

 

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Note 5 – Fair Value Measurements (continued)

 

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

 

            Carrying Value at June 30, 2013  

Description

   Balance as of
June  30,
2013
     Quoted Prices
In Active
Markets for
Identical  Assets
(Level 1)
     Significant
Other
Observable
Inputs
(Level 2)
     Significant
Unobservable
Inputs
(Level 3)
 

US Treasuries

   $ 3,736       $ —         $ 3,736       $ —     

US agency obligations

     17,479         —           17,479      

Mortgage-backed securities

     3,745         —           3,745         —     

Municipals

     16,171         —           16,171         —     

Other (corporates)

     1,891         —           1,891         —     
  

 

 

    

 

 

    

 

 

    

 

 

 

Total available-for-sale securities

   $ 43,022       $ —         $ 43,022       $ —     
  

 

 

    

 

 

    

 

 

    

 

 

 
            Carrying Value at December 31, 2012  

Description

   Balance as of
December 31,
2012
     Quoted Prices
In Active
Markets for
Identical Assets
(Level 1)
     Significant
Other
Observable
Inputs
(Level 2)
     Significant
Unobservable
Inputs
(Level 3)
 

US agency obligations

   $ 23,069       $ —         $ 23,069       $ —     

Mortgage-backed securities

     1,812         —           1,812         —     

Municipals

     22,804            22,804      

Other (corporates)

     2,609         —           2,609         —     
  

 

 

    

 

 

    

 

 

    

 

 

 

Total available-for-sale securities

   $ 50,294       $ —         $ 50,294       $ —     
  

 

 

    

 

 

    

 

 

    

 

 

 

Impaired loans

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

 

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Table of Contents

Note 5 – Fair Value Measurements (continued)

 

Loans held for sale

Loans held for sale are carried at estimated fair value. These loans currently consist of one-to-four family residential loans originated for sale in the secondary market. Fair value is based on the price secondary markets are currently offering for similar loans using observable market data which is not materially different than cost due to the short duration between origination and sale (Level 2). As such, the Company records fair value adjustments on a nonrecurring basis. No nonrecurring fair value adjustments were recorded on loans held for sale during the period ended June 30, 2013. Gains and losses on the sale of loans are recorded within mortgage fee income on the Consolidated Statements of Income.

Other real estate owned

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

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

Any fair value adjustments are recorded in the period incurred and expensed against current earnings. The carrying values of all OREO properties are considered to be Level 3.

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

 

            Carrying Value at June 30, 2013  

Description

   Balance as of
June 30,
2013
     Quoted Prices in
Active Markets for

Identical Assets
(Level 1)
     Significant Other
Observable Inputs
(Level 2)
     Significant
Unobservable Inputs
(Level 3)
 

Impaired loans*

   $ 5,730       $ —         $ —         $ 5,730   

Loans held for sale

     861         —           861         —     

Other real estate owned

     1,817         —           —           1,817   

 

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

 

            Carrying Value at December 31, 2012  

Description

   Balance as of
December 31,
2012
     Quoted Prices in
Active Markets for
Identical Assets
(Level 1)
     Significant Other
Observable Inputs
(Level 2)
     Significant
Unobservable Inputs
(Level 3)
 

Impaired loans*

   $ 6,836       $ —         $ —         $ 6,836   

Loans held for sale

     904         —           904         —     

Other real estate owned

     2,112         —           —           2,112   

 

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

 

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Note 5 – Fair Value Measurements (continued)

 

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

 

     Quantitative information about Level 3 Fair Value Measurements for  June 30, 2013
(dollars in thousands)
     Fair
Value
    

Valuation Technique(s)

  

Unobservable Input

   Range (Weighted
Average)

Assets

           

Impaired loans

   $ 5,730       Discounted appraised value   

Selling cost

   5% - 10% (6%)
        

Discount for lack of marketability and age of appraisal

   0% - 25% (15%)

OREO

     1,817       Discounted appraised value   

Selling cost

   5% - 10% (6%)
        

Discount for lack of marketability and age of appraisal

   0% - 25% (15%)
     Quantitative information about Level 3 Fair Value Measurements for  December 31, 2012
(dollars in thousands)
     Fair
Value
    

Valuation Technique(s)

  

Unobservable Input

   Range (Weighted
Average)

Assets

           

Impaired loans

   $ 6,836       Discounted appraised value   

Selling cost

   5% - 10% (6%)
        

Discount for lack of marketability and age of appraisal

   0% - 25% (15%)

OREO

     2,112       Discounted appraised value   

Selling cost

   5% - 10% (6%)
        

Discount for lack of marketability and age of appraisal

   0% - 25% (15%)

Financial Instruments

Cash, cash equivalents and Federal Funds sold

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

Loans

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

Bank Owned Life Insurance (BOLI)

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

 

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Note 5 – Fair Value Measurements (continued)

 

Deposits

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

FHLB borrowings

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

Short-term borrowings

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

Capital notes

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

Accrued interest

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

Off-balance sheet credit-related instruments

Fair values for off-balance sheet, credit-related financial instruments are based on fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the counterparties’ credit standing. Fair value of off-balance sheet credit-related instruments were deemed to be immaterial at June 30, 2013 and December 31, 2012 and therefore are not included in the table below.

 

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Table of Contents

Note 5 – Fair Value Measurements (continued)

 

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

 

            Fair Value Measurements at June 30, 2013 using  
     Carrying
Amounts
     Quoted Prices
in Active
Markets for
Identical Assets
(Level 1)
     Significant
Other
Observable
Inputs
(Level 2)
     Significant
Unobservable
Inputs

(Level 3)
     Balance  

Assets

              

Cash and due from banks

   $ 16,165       $ 16,165       $ —         $ —         $ 16,165   

Federal funds sold

     9,302         9,302         —           —           9,302   

Securities

              

Available-for-sale

     43,022         —           43,022         —           43,022   

Held-to-maturity

     3,063         —           3,322         —           3,322   

Loans, net

     331,703         —           —           342,550         342,550   

Loans held for sale

     861         —           861         —           861   

Interest receivable

     1,443         —           1,443         —           1,443   

BOLI

     9,082         —           9,082         —           9,082   

Liabilities

              

Deposits

   $ 388,788       $ —         $ 386,572       $ —         $ 386,572   

FHLB borrowings

     2,000         —           2,024         —           2,024   

Capital notes

     10,000         —           10,122         —           10,122   

Interest payable

     68         —           68         —           68   
            Fair Value Measurements at December 31, 2012 using  
     Carrying
Amounts
     Quoted Prices
in Active
Markets for
Identical Assets
(Level 1)
     Significant
Other
Observable
Inputs
(Level 2)
     Significant
Unobservable
Inputs

(Level 3)
     Balance  

Assets

              

Cash and due from banks

   $ 16,827       $ 16,827       $ —         $ —         $ 16,827   

Federal funds sold

     24,171         24,171         —           —           24,171   

Securities

              

Available-for-sale

     50,294         —           50,294         —           50,294   

Held-to-maturity

     3,075         —           3,417         —           3,417   

Loans, net

     319,922         —           —           330,863         330,863   

Loans held for sale

     904         —           904         —           904   

Interest receivable

     1,557         —           1,557         —           1,557   

BOLI

     8,931         —           8,931         —           8,931   

Liabilities

              

Deposits

   $ 399,015       $ —         $ 400,212       $ —         $ 400,212   

FHLB borrowings

     2,000         —           2,160         —           2,160   

Capital notes

     10,000         —           10,006         —           10,006   

Interest payable

     70         —           70         —           70   

 

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Table of Contents

Note 5 – Fair Value Measurements (continued)

 

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

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

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

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

Note 6 – Capital Notes

During the third quarter of 2012, Financial closed the private placement of unregistered debt securities (the “2012 Offering”) pursuant to which Financial issued $10,000,000 in principal of notes (the “2012 Notes”). The 2012 Notes have not been and will not be 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 bear interest at the rate of 6% per year with interest payable quarterly in arrears. 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. Financial used $7,000,000 of the proceeds from the 2012 Offering in April 2012 to pay, on maturity, the principal due on notes issued in 2009.

 

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Table of Contents

Note 7 – Investments

The following tables summarize the Bank’s holdings for both securities held-to-maturity and securities available-for-sale as of June 30, 2013 and December 31, 2012 (amounts in thousands):

 

            June 30, 2013        
     Amortized      Gross Unrealized        
     Costs      Gains      (Losses)     Fair Value  

Held-to-Maturity

          

US agency obligations

   $ 3,063       $ 259       $ —        $ 3,322   
  

 

 

    

 

 

    

 

 

   

 

 

 

Available-for-Sale

          

US Treasuries

   $ 3,903       $ —         $ (167   $ 3,736   

US agency obligations

     18,897         —           (1,418     17,479   

Mortgage-backed securities

     3,734         11         —          3,745   

Municipals

     16,864         72         (765     16,171   

Other

     2,012         —           (121     1,891   
  

 

 

    

 

 

    

 

 

   

 

 

 
   $ 45,410       $ 83       $ (2,471   $ 43,022   
  

 

 

    

 

 

    

 

 

   

 

 

 
            December 31, 2012        
     Amortized      Gross Unrealized     Fair Value  
     Costs      Gains      (Losses)    

Held-to-Maturity

          

US agency obligations

   $ 3,075       $ 342       $ —        $ 3,417   
  

 

 

    

 

 

    

 

 

   

 

 

 

Available-for-Sale

          

US agency obligations

   $ 22,980       $ 184       $ (95   $ 23,069   

Mortgage-backed securities

     1,805         7         —          1,812   

Municipals

     22,099         780         (75     22,804   

Other

     2,548         61         —          2,609   
  

 

 

    

 

 

    

 

 

   

 

 

 
   $ 49,432       $ 1,032       $ (170   $ 50,294   
  

 

 

    

 

 

    

 

 

   

 

 

 

 

16


Table of Contents

Note 7 – Investments (continued)

 

The following tables show the gross unrealized losses and fair value of the Bank’s investments with unrealized losses that are not deemed to be other-than-temporarily impaired, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position, at June 30, 2013 and December 31, 2012 (amounts in thousands):

 

     Less than 12 months      More than 12 months      Total  

June 30, 2013

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

Description of securities

                 

US Treasuries

   $ 3,736       $ 167       $ —         $ —         $ 3,736       $ 167   

U.S. agency obligations

     15,480         1,418         —           —           15,480         1,418   

Municipals

     12,211         765         —           —           12,211         765   

Other

     1,891         121         —           —           1,891         121   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 33,318       $ 2,471       $ —         $ —         $ 33,318       $ 2,471   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 
     Less than 12 months      More than 12 months      Total  

December 31, 2012

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

Description of securities

                 

U.S. agency obligations

   $ 9,116       $ 95       $ —         $ —         $ 9,116       $ 95   

Municipals

     1,879         75         —           —           1,879         75   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 10,995       $ 170       $ —         $ —         $ 10,995       $ 170   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

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

At June 30, 2013, the Company did not consider the unrealized losses as other-than-temporary losses due to the nature of the securities involved. As of June 30, 2013, the Bank owned 37 securities that were being evaluated for other than temporary impairment. Ten of these securities were S&P rated AAA, 26 were S&P rated AA, and one was S&P rated A. As of June 30, 2013, 12 of these securities were direct obligations of the U.S. government or government sponsored entities, 22 were municipal issues, and three were publicly traded U.S. corporations.

Based on the analysis performed by management as mandated by the Bank’s investment policy, management believes the default risk to be minimal. Because the Bank expects to recover the entire amortized cost basis, no declines currently are deemed to be other-than-temporary.

 

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Table of Contents

Note 8 – Business Segments

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

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

 

18


Table of Contents

Information about reportable business segments and reconciliation of such information to the consolidated financial statements for the three and six months ended June 30, 2013 and 2012 was as follows (dollars in thousands):

Business Segments

 

     Community
Banking
     Mortgage      Total  

Six months ended June 30, 2013

        

Net interest income

   $ 7,878       $  —         $ 7,878   

Provision for loan losses

     290         —           290   
  

 

 

    

 

 

    

 

 

 

Net interest income after provision for loan losses

     7,588         —           7,588   

Noninterest income

     1,210         659         1,869   

Noninterest expenses

     6,683         519         7,202   
  

 

 

    

 

 

    

 

 

 

Income before income taxes

     2,115         140         2,255   

Income tax expense

     623         47         670   
  

 

 

    

 

 

    

 

 

 

Net income

   $ 1,492       $ 93       $ 1,585   
  

 

 

    

 

 

    

 

 

 

Total assets

   $ 429,937       $ 934       $ 430,871   
  

 

 

    

 

 

    

 

 

 

Six months ended June 30, 2012

        

Net interest income

   $ 7,702       $  —         $ 7,702   

Provision for loan losses

     1,175         —           1,175   
  

 

 

    

 

 

    

 

 

 

Net interest income after provision for loan losses

     6,527         —           6,527   

Noninterest income

     999         515         1,514   

Noninterest expenses

     6,407         436         6,843   
  

 

 

    

 

 

    

 

 

 

Income before income taxes

     1,119         79         1,198   

Income tax expense

     325         27         352   
  

 

 

    

 

 

    

 

 

 

Net income

   $ 794       $ 52       $ 846   
  

 

 

    

 

 

    

 

 

 

Total assets

   $ 431,967       $ 1,237       $ 433,204   
  

 

 

    

 

 

    

 

 

 
     Community
Banking
     Mortgage      Total  

Three months ended June 30, 2013

        

Net interest income

   $ 3,957       $  —         $ 3,957   

Provision for loan losses

     55         —           55   
  

 

 

    

 

 

    

 

 

 

Net interest income after provision for loan losses

     3,902         —           3,902   

Noninterest income

     565         340         905   

Noninterest expenses

     3,405         266         3,671   
  

 

 

    

 

 

    

 

 

 

Income before income taxes

     1,062         74         1,136   

Income tax expense

     314         25         339   
  

 

 

    

 

 

    

 

 

 

Net income

   $ 748       $ 49       $ 797   
  

 

 

    

 

 

    

 

 

 

Total assets

   $ 429,937       $ 934       $ 430,871   
  

 

 

    

 

 

    

 

 

 

Three months ended June 30, 2012

        

Net interest income

   $ 3,836       $  —         $ 3,836   

Provision for loan losses

     425         —           425   
  

 

 

    

 

 

    

 

 

 

Net interest income after provision for loan losses

     3,411         —           3,411   

Noninterest income

     554         289         843   

Noninterest expenses

     3,318         241         3,559   
  

 

 

    

 

 

    

 

 

 

Income before income taxes

     647         48         695   

Income tax expense

     193         16         209   
  

 

 

    

 

 

    

 

 

 

Net income

   $ 454       $ 32       $ 486   
  

 

 

    

 

 

    

 

 

 

Total assets

   $ 431,967       $ 1,237       $ 433,204   
  

 

 

    

 

 

    

 

 

 

 

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Table of Contents

Note 9 – Loans, allowance for loan losses and OREO

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

 

Loan Segments:       Loan Classes:   
   Commercial       Commercial and industrial loans
   Commercial real estate       Commercial mortgages – owner occupied
         Commercial mortgages – non-owner occupied
         Commercial construction
   Consumer       Consumer unsecured
         Consumer secured
   Residential       Residential mortgages
         Residential consumer construction

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

 

     As of:  
     June 30,
2013
     December 31,
2012
 

Commercial

   $ 59,623       $ 55,084   

Commercial real estate

     161,495         153,416   

Consumer

     70,567         70,639   

Residential

     45,493         46,318   
  

 

 

    

 

 

 

Total loans

     337,178         325,457   

Less allowance for loan losses

     5,475         5,535   
  

 

 

    

 

 

 

Net loans

   $ 331,703       $ 319,922   
  

 

 

    

 

 

 

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

 

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

 

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

 

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

We segregate loans into the above categories based on the following criteria and we review the characteristics of each rating at least annually, generally during the first quarter. The characteristics of these ratings are as follows:

 

 

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

 

 

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

 

 

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

 

 

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

 

 

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

 

 

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

 

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

 

Financing Receivables on Non-Accrual Status

(dollars in thousands)

 
     As of  
     June 30, 2013      December 31, 2012  

Commercial

   $ 1,876       $ 2,100   

Commercial Real Estate:

     

Commercial Mortgages-Owner Occupied

     1,431         1,431   

Commercial Mortgages-Non-Owner Occupied

     866         853   

Commercial Construction

     726         849   

Consumer

     

Consumer Unsecured

     —           —     

Consumer Secured

     —           —     

Residential:

     

Residential Mortgages

     115         1,113   

Residential Consumer Construction

     —           —     
  

 

 

    

 

 

 

Totals

   $ 5,014       $ 6,346   
  

 

 

    

 

 

 

We also classify other real estate owned (OREO) as a nonperforming asset. OREO represents real property owned by the Bank either through purchase at foreclosure or received from the borrower through a deed in lieu of foreclosure. OREO decreased to $1,817,000 on June 30, 2013 from $2,112,000 on December 31, 2012. The following table represents the changes in OREO balance during the six months ended June 30, 2013.

 

OREO Changes

(dollars in thousands)

 
     Six Months ended
June 30,  2013
 

Balance at the beginning of the year (net)

   $ 2,112   

Transfers from loans

     491   

Capitalized costs

     —     

Writedowns

     (284

Sales proceeds

     (493

(Loss) on disposition

     (9
  

 

 

 

Balance at the end of the period (net)

   $ 1,817   
  

 

 

 

 

22


Table of Contents

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

 

    

Impaired Loans

(dollars in thousands)

 
     For the Six Months Ended June 30, 2013  
2013   

Recorded

Investment

     Unpaid
Principal
Balance
    

Related

Allowance

     Average
Recorded
Investment
    

Interest

Income

Recognized

 

With No Related Allowance Recorded:

              

Commercial

   $ 1,528       $ 1,677       $ —         $ 2,029       $ 21   

Commercial Real Estate

              

Commercial Mortgages-Owner Occupied

     2,781         2,832         —           2,687         57   

Commercial Mortgage Non-Owner Occupied

     3,290         3,291         —           4,830         81   

Commercial Construction

     627         627         —           684         18   

Consumer

              

Consumer Unsecured

     —           —           —           —           —     

Consumer Secured

     741         740         —           605         3   

Residential

              

Residential Mortgages

     738         776         —           1,438         22   

Residential Consumer Construction

     —           —           —           —           —     

With An Allowance Recorded:

              

Commercial

   $ 2,520       $ 2,723       $ 628       $ 1,570       $ 38   

Commercial Real Estate

              

Commercial Mortgages-Owner Occupied

     1,032         1,353         196         2,352         27   

Commercial Mortgage Non-Owner Occupied

     768         768         139         804         21   

Commercial Construction

     726         994         265         775         —     

Consumer

              

Consumer Unsecured

     1         1         1         1         —     

Consumer Secured

     166         166         162         348         6   

Residential

              

Residential Mortgages

     1,282         1,282         166         1,149         44   

Residential Consumer Construction

     —           —           —           —           —     

Totals:

              

Commercial

   $ 4,048       $ 4,400       $ 628       $ 3,599       $ 59   

Commercial Real Estate

              

Commercial Mortgages-Owner Occupied

     3,813         4,185         196         5,039         84   

Commercial Mortgage Non-Owner Occupied

     4,058         4,059         139         5,634         102   

Commercial Construction

     1,353         1,621         265         1,459         18   

Consumer

              

Consumer Unsecured

     1         1         1         1         —     

Consumer Secured

     907         906         162         953         9   

Residential

              

Residential Mortgages

     2,020         2,058         166         2,587         66   

Residential Consumer Construction

     —           —           —           —           —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 
   $ 16,200       $ 17,230       $ 1,557       $ 19,272       $ 338   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

23


Table of Contents

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

 

    

Impaired Loans

(dollars in thousands)

 
     For the Year Ended December 31, 2012  
2012   

Recorded

Investment

     Unpaid
Principal
Balance
    

Related

Allowance

     Average
Recorded
Investment
    

Interest

Income

Recognized

 

With No Related Allowance Recorded:

              

Commercial

   $ 2,530       $ 2,683       $ —         $ 2,944       $ 30   

Commercial Real Estate

              

Commercial Mortgages-Owner Occupied

     2,592         2,754         —           2,402         167   

Commercial Mortgage Non-Owner Occupied

     6,369         6,528         —           5,625         330   

Commercial Construction

     740         742         —           922         52   

Consumer

              

Consumer Unsecured

     —           —           —           —           —     

Consumer Secured

     469         554         —           381         34   

Residential

              

Residential Mortgages

     2,138         2,263         —           1,500         112   

Residential Consumer Construction

     —           —           —           —           —     

With An Allowance Recorded:

              

Commercial

   $ 620       $ 780       $ 373       $ 1,794       $ 42   

Commercial Real Estate

              

Commercial Mortgages-Owner Occupied

     3,671         3,869         525         3,094         226   

Commercial Mortgage Non-Owner Occupied

     840         842         189         1,715         42   

Commercial Construction

     823         1,048         94         1,262         2   

Consumer

              

Consumer Unsecured

     1         1         1         1         —     

Consumer Secured

     530         530         195         736         35   

Residential

              

Residential Mortgages

     1,015         1,303         160         1,469         42   

Residential Consumer Construction

     —           —           —           —           —     

Totals:

              

Commercial

   $ 3,150       $ 3,463       $ 373       $ 4,738       $ 72   

Commercial Real Estate

              

Commercial Mortgages-Owner Occupied

     6,263         6,623         525         5,496         393   

Commercial Mortgage Non-Owner Occupied

     7,209         7,370         189         7,340         372   

Commercial Construction

     1,563         1,790         94         2,184         54   

Consumer

              

Consumer Unsecured

     1         1         1         1         —     

Consumer Secured

     999         1,084         195         1,117         69   

Residential

              

Residential Mortgages

     3,153         3,566         160         2,969         154   

Residential Consumer Construction

     —           —           —           —           —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 
   $ 22,338       $ 23,897       $ 1,537       $ 23,845       $ 1,114   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

24


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

 

    

Allowance for Credit Losses and Recorded Investment in Financing

Receivables

 
     (dollars in thousands)  
     For the Six Months Ended June 30, 2013  
2013    Commercial     Commercial
Real Estate
    Consumer     Residential     Total  

Allowance for Credit Losses:

          

Beginning Balance

   $ 987      $ 2,849      $ 1,057      $ 642      $ 5,535   

Charge-offs

     (19     (321     (89     (28     (457

Recoveries

     18        39        50        —          107   

Provision

     303        10        42        (65     290   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Ending Balance

     1,289        2,577        1,060        549        5,475   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Ending Balance: Individually evaluated for impairment

   $ 628      $ 600      $ 163      $ 166      $ 1,557   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Ending Balance: Collectively evaluated for impairment

     661        1,977        897        383        3,918   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Totals:

   $ 1,289      $ 2,577      $ 1,060      $ 549      $ 5,475   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Financing Receivables:

          

Ending Balance: Individually evaluated for impairment

     4,048        9,224        908        2,020        16,200   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Ending Balance: Collectively evaluated for impairment

     55,575        152,271        69,659        43,473        320,978   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Totals:

   $ 59,623      $ 161,495      $ 70,567      $ 45,493      $ 337,178   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

25


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

 

     Allowance for Credit Losses and Recorded Investment in
Financing Receivables
(dollars in thousands)
For the Year Ended December 31, 2012
 
2012    Commercial     Commercial
Real Estate
    Consumer     Residential     Total  

Allowance for Credit Losses:

          

Beginning Balance

   $ 892      $ 2,677      $ 1,486      $ 557      $ 5,612   

Charge-offs

     (739     (1,061     (697     (102     (2,599

Recoveries

     18        129        77        9        233   

Provision

     816        1,104        191        178        2,289   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Ending Balance

   $ 987      $ 2,849      $ 1,057      $ 642      $ 5,535   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Ending Balance: Individually evaluated for impairment

   $ 373      $ 808      $ 196      $ 160      $ 1,537   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Ending Balance: Collectively evaluated for impairment

     614        2,041        861        482        3,998   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Totals:

   $ 987      $ 2,849      $ 1,057      $ 642      $ 5,535   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Financing Receivables:

          

Ending Balance: Individually evaluated for impairment

   $ 3,150      $ 15,035      $ 1,000      $ 3,153      $ 22,338   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Ending Balance: Collectively evaluated for impairment

     51,934        138,381        69,639        43,165        303,119   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Totals:

   $ 55,084      $ 153,416      $ 70,639      $ 46,318      $ 325,457   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

26


Table of Contents

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

 

     Age Analysis of Past Due Financing Receivables as of
June 30, 2013
(dollars in thousands)
 
2013    30-59
Days

Past
Due
     60-89
Days

Past
Due
     Greater
than
90 Days
     Total
Past

Due
     Current      Total
Financing
Receivables
     Recorded
Investment

> 90 Days  &
Accruing
 

Commercial

   $ 1,808       $ —         $ 1,877       $ 3,685       $ 55,938       $ 59,623       $ —     

Commercial Real Estate:

                    

Commercial Mortgages-Owner Occupied

     780         —           1,431         2,211         59,870         62,081         —     

Commercial Mortgages-Non-Owner Occupied

     957         402         —           1,359         87,785         89,144         —     

Commercial Construction

     —           —           726         726         9,544         10,270         —     

Consumer:

                    

Consumer Unsecured

     2         —           —           2         3,814         3,816         —     

Consumer Secured

     101         87         —           188         66,563         66,751         —     

Residential:

                    

Residential Mortgages

     299         115         —           414         39,483         39,897         —     

Residential Consumer Construction

     —           —           —           —           5,596         5,596         —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 3,947       $ 604       $ 4,034       $ 8,585       $ 328,593       $ 337,178       $ —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

     Age Analysis of Past Due Financing Receivables as of
December 31, 2012
(dollars in thousands)
 
2012    30-59
Days

Past
Due
     60-89
Days

Past
Due
     Greater
than
90 Days
     Total
Past

Due
     Current      Total
Financing
Receivables
     Recorded
Investment

> 90 Days  &
Accruing
 

Commercial

   $ 223       $ 14       $ 2,100       $ 2,337       $ 52,747       $ 55,084       $ —     

Commercial Real Estate:

                    

Commercial Mortgages-Owner Occupied

     351         —           168         519         59,412         59,931         —     

Commercial Mortgages-Non-Owner Occupied

     559         50         853         1,462         82,654         84,116         —     

Commercial Construction

     547         —           849         1,396         7,973         9,369         —     

Consumer:

                    

Consumer Unsecured

     2         8         —           10         3,494         3,504         —     

Consumer Secured

     193         —           —           193         66,942         67,135         —     

Residential:

                    

Residential Mortgages

     590         68         472         1,130         40,290         41,420         —     

Residential Consumer Construction

     —           —           —           —           4,898         4,898         —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 2,465       $ 140       $ 4,442       $ 7,047       $ 318,410       $ 325,457       $ —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

27


Table of Contents

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

 

     Credit Loss Disclosures
Credit Quality Information - by Class
June 30, 2013
(dollars in thousands)
 
2013    Pass      Monitor      Special
Mention
     Substandard      Doubtful      Totals  

Commercial

   $ 52,761       $ 2,514       $ 240       $ 4,108       $ —         $ 59,623   

Commercial Real Estate:

                 

Commercial Mortgages-Owner Occupied

     54,184         3,959         100         3,662         176         62,081   

Commercial Mortgages-Non Owner Occupied

     80,814         2,667         1,256         4,369         38         89,144   

Commercial Construction

     8,375         542         —           1,353         —           10,270   

Consumer

                 

Consumer Unsecured

     3,815         —           —           1         —           3,816   

Consumer Secured

     64,186         1,145         227         1,193         —           66,751   

Residential:

                 

Residential Mortgages

     36,530         603         373         2,391         —           39,897   

Residential Consumer Construction

     5,596         —           —           —           —           5,596   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Totals

   $ 306,261       $ 11,430       $ 2,196       $ 17,077       $ 214       $ 337,178   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

     Credit Loss Disclosures
Credit Quality Information - by Class
December 31, 2012
(dollars in thousands)
 
2012    Pass      Monitor      Special
Mention
     Substandard      Doubtful      Totals  

Commercial

   $ 49,162       $ 1,422       $ 1,350       $ 3,150       $ —         $ 55,084   

Commercial Real Estate:

                 

Commercial Mortgages-Owner Occupied

     49,717         2,952         1,000         6,262         —           59,931   

Commercial Mortgages-Non Owner Occupied

     72,120         2,212         2,576         7,208         —           84,116   

Commercial Construction

     7,806         —           —           1,563         —           9,369   

Consumer

                 

Consumer Unsecured

     3,503         —           —           1         —           3,504   

Consumer Secured

     63,948         1,343         867         977         —           67,135   

Residential:

                 

Residential Mortgages

     37,784         —           483         3,153         —           41,420   

Residential Consumer Construction

     4,898         —           —           —           —           4,898   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Totals

   $ 288,938       $ 7,929       $ 6,276       $ 22,314       $ —         $ 325,457   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

28


Table of Contents

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

 

There were no loan modifications that would have been classified as Troubled Debt Restructurings (TDR) during the three and six months ended June 30, 2013 and 2012.

There were no loan modifications classified as TDRs within the last twelve months that defaulted during the three and six months ended June 30, 2013.

The following table describes TDRs that defaulted within 12 months of the modification during the three and six months ended June 30, 2012.

 

For the Three Months Ended June 30, 2012  
(dollars in thousands)  

Troubled Debt Restructurings That Subsequently Defaulted

   Number of
Contracts
   Recorded
Investment
 

Commercial

   2    $  208   

 

For the Six Months Ended June 30, 2012  
(dollars in thousands)  

Troubled Debt Restructurings That Subsequently Defaulted

   Number of
Contracts
   Recorded
Investment
 

Commercial

   4    $  798   

Note 10 – Subsequent Events

In preparing these financial statements, Financial has evaluated events and transactions for potential recognition or disclosure through the date the financial statements were issued.

Note 11 – Recent accounting pronouncements

In December 2011, the FASB issued ASU 2011-11, “Balance Sheet (Topic 210) – Disclosures about Offsetting Assets and Liabilities.” This ASU requires entities to disclose both gross information and net information about both instruments and transactions eligible for offset in the balance sheet and instruments and transactions subject to an agreement similar to a master netting arrangement. An entity is required to apply the amendments for annual reporting periods beginning on or after January 1, 2013, and interim periods within those annual periods. An entity should provide the disclosures required by those amendments retrospectively for all comparative periods presented. The adoption of the new guidance did not have a material impact on the Company’s consolidated financial statements.

In July 2012, the FASB issued ASU 2012-02, “Intangibles – Goodwill and Other (Topic 350): Testing Indefinite-Lived Intangible Assets for Impairment.” The amendments in this ASU apply to all entities that have indefinite-lived intangible assets, other than goodwill, reported in their financial statements. The amendments in this ASU provide an entity with the option to make a qualitative assessment about the likelihood that an indefinite-lived intangible asset is impaired to determine whether it should perform a quantitative impairment test. The amendments also enhance the consistency of impairment testing guidance among long-lived asset categories by permitting an entity to assess qualitative factors to determine whether it is necessary to calculate the asset’s fair value when testing an indefinite-lived

 

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Note 11 – Recent accounting pronouncements (continued)

 

intangible asset for impairment. The amendments are effective for annual and interim impairment tests performed for fiscal years beginning after September 15, 2012. Early adoption is permitted. The adoption of the new guidance did not have a material impact on the Company’s consolidated financial statements.

In January 2013, the FASB issued ASU 2013-01, “Balance Sheet (Topic 210): Clarifying the Scope of Disclosures about Offsetting Assets and Liabilities.” The amendments in this ASU clarify the scope for derivatives accounted for in accordance with Topic 815, Derivatives and Hedging, including bifurcated embedded derivatives, repurchase agreements and reverse repurchase agreements and securities borrowing and securities lending transactions that are either offset or subject to netting arrangements. An entity is required to apply the amendments for fiscal years, and interim periods within those years, beginning on or after January 1, 2013. The adoption of the new guidance did not have a material impact on the Company’s consolidated financial statements.

In February 2013, the FASB issued ASU 2013-02, “Comprehensive Income (Topic 220): Reporting of Amounts Reclassified Out of Accumulated Other Comprehensive Income.” The amendments in this ASU require an entity to present (either on the face of the statement where net income is presented or in the notes) the effects on the line items of net income of significant amounts reclassified out of accumulated other comprehensive income. In addition, the amendments require a cross-reference to other disclosures currently required for other reclassification items to be reclassified directly to net income in their entirety in the same reporting period. Companies should apply these amendments for fiscal years, and interim periods within those years, beginning on or after December 15, 2012. The Company has included the required disclosures from ASU 2013-02 in the consolidated financial statements.

 

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

CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS

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

 

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GENERAL

Critical Accounting Policies

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

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.

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”).

The Bank is a Virginia banking corporation headquartered in Lynchburg, Virginia. The Bank was incorporated under the laws of the Commonwealth of Virginia as a state chartered bank in 1998 and began banking operations in July 1999. The Bank was organized to engage in general retail and commercial banking business. The Bank is a community-oriented financial institution that provides varied banking services to individuals, small and medium-sized businesses, and professional concerns in the Central Virginia, Region 2000 area, which encompasses the seven jurisdictions of the Town of Altavista, Amherst County, Appomattox County, the Town of Bedford, Bedford County, Campbell County, and the City of Lynchburg. The Bank strives to provide its customers with products comparable to statewide regional banks located in its market area, while maintaining the prompt response time and level of service of a community bank. Management believes this operating strategy has particular appeal in the Bank’s market area.

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.

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

 

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loans, investment securities and other investments, and (ii) interest expense on interest-bearing liabilities, which consist principally of deposits and other borrowings. The Bank’s net income also is affected by its provision for loan losses, as well as the level of its non-interest income, including loan fees and service charges, and its non-interest expenses, including salaries and employee benefits, occupancy expense, data processing expenses, Federal Deposit Insurance Corporation premiums, expense in complying with the Sarbanes-Oxley Act of 2002, miscellaneous other expenses, franchise taxes, and income taxes.

The Bank intends to enhance its profitability by increasing its market share in the Region 2000 area, providing additional services to its customers, and controlling costs.

The Bank now services its banking customers through the following nine full service branch locations in the Region 2000 area.

 

   

The main office located at 828 Main Street in Lynchburg (opened October 2004) (the “Main Street Office”),

 

   

A branch located at 615 Church Street in Lynchburg (opened July 1999) (the “Church Street Branch”),

 

   

A branch located at 5204 Fort Avenue in Lynchburg (opened November 2000) (the “Fort Avenue Branch”),

 

   

A branch located on South Amherst Highway in Amherst County (opened June 2002) (the “Madison Heights Branch”),

 

   

A branch located at 17000 Forest Road in Forest (opened February 2005) (the “Forest Branch”),

 

   

A branch located at 4935 Boonsboro Road, Suites C and D in Lynchburg (opened April 2006) (the “Boonsboro Branch”),

 

   

A branch located at 164 South Main Street, Amherst, Virginia (opened January 2007) (the “Amherst Branch”),

 

   

A branch located at 1405 Ole Dominion Boulevard in the Town of Bedford, Virginia, located off of Independence Boulevard (opened October 2008) (the “Bedford Branch”), and

 

   

A branch located at 1110 Main Street, Altavista, Virginia (relocated from temporary branch in June 2009) (the “Altavista Branch”).

The Bank also has opened a limited-service branch located in the Westminster-Canterbury facilities located at 501 VES Road, Lynchburg, Virginia 24503.

In addition, the Bank, through its Mortgage division, originates residential mortgage loans through two offices—one located at the Forest Branch and the other located at 1152 Hendricks Store Road, Moneta, Virginia.

The Investment division operates primarily out of its office located at the Church Street Branch.

The Bank continuously evaluates areas located within Region 2000 to identify additional viable branch locations. Based on this ongoing evaluation, the Bank may acquire one or more additional suitable sites.

 

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

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 2014. 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 2014.

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

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

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

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

OFF-BALANCE SHEET ARRANGEMENTS

The Bank is a party to various financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of our customers. These financial instruments include commitments to extend credit and standby letters of credit. Such commitments involve, to varying degrees, elements of credit risk and interest rate risk in excess of the amount recognized in the balance sheets and could impact the overall liquidity and capital resources to the extent customers accept and/or use these commitments.

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:

 

     June 30, 2013
(in thousands)
 

Commitments to extend credit

   $ 62,229   

Letters of Credit

     2,230   
  

 

 

 

Total

   $ 64,459   
  

 

 

 

 

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

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

SUMMARY OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following discussion represents management’s discussion and analysis of the financial condition of Financial as of June 30, 2013 and December 31, 2012 and the results of operations of Financial for the three and six month periods ended June 30, 2013 and 2012. This discussion should be read in conjunction with the financial statements included elsewhere herein.

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

Financial Condition Summary

June 30, 2013 as Compared to December 31, 2012

Total assets were $430,871,000 on June 30, 2013 compared with $441,381,000 at December 31, 2012, a decrease of 2.38%. Total assets as of December 31, 2012 temporarily increased because of several deposits to professional settlement accounts related to end-of-the-year real estate and business closings. The decrease as of June 30, 2013 reflects the expected disbursements from these accounts, which reflects the primary reason for the decrease. This led to a decrease in deposits and a corresponding decrease in Federal Funds sold. The Bank also had a slight decrease in its securities portfolio.

Total deposits decreased from $399,015,000 as of December 31, 2012 to $388,788,000 on June 30, 2013, a decrease of 2.56%. Total deposits decreased for the reasons set forth in the prior paragraph.

Total loans, excluding loans held for sale, increased to $337,178,000 on June 30, 2013 from $325,457,000 on December 31, 2012. Loans, net of unearned income and allowance, increased to $331,703,000 on June 30, 2013 from $319,922,000 on December 31, 2012, an increase of 3.68%. The following summarizes the position of the Bank’s loan portfolio as of the dates indicated by dollar amount and percentages (dollar amounts in thousands):

 

     June 30, 2013     December 31, 2012  
     Amount      Percentage     Amount      Percentage  

Commercial

   $ 59,623         17.69   $ 55,084         16.93

Commercial Real Estate

     161,495         47.89     153,416         47.13

Consumer

     70,567         20.92     70,639         21.71

Residential

     45,493         13.50     46,318         14.23
  

 

 

    

 

 

   

 

 

    

 

 

 

Total loans

   $ 337,178         100.00   $ 325,457         100.00
  

 

 

    

 

 

   

 

 

    

 

 

 

Total nonperforming assets, which consist of non-accrual loans, loans past due 90 days or more and still accruing, and other real estate owned (“OREO”) decreased to $6,831,000 on June 30, 2013 from

 

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$8,458,000 on December 31, 2012. This decrease was due to a decrease in both non-accrual (or nonperforming) loans and a slight decrease in OREO. Non-accrual loans decreased 20.99% to $5,014,000 on June 30, 2013 from $6,346,000 on December 31, 2012. As discussed in more detail below under “Results of Operations—Allowance for Loan Losses”, management has provided for the anticipated losses on these loans in the loan loss reserve. If interest on non-accrual loans had been accrued, such interest on a cumulative basis would have approximated $1,067,000 and $862,000 as of June 30, 2013 and December 31, 2012, respectively. Loan payments received on non-accrual loans are first applied to principal. When a loan is placed on non-accrual status there are several negative implications. First, all interest accrued but unpaid at the time of the classification is reversed and deducted from the interest income totals for the Bank. Second, accruals of interest are discontinued until it becomes certain that both principal and interest can be repaid. Third, there may be actual losses that necessitate additional provisions for credit losses charged against earnings. These loans were included in the non-performing loan totals listed above.

OREO represents real property acquired by the Bank for debts previously contracted, including through foreclosure, deeds in lieu of foreclosure or repossession. On December 31, 2012, the Bank was carrying 17 OREO properties on its books at a value of $2,112,000. During the six months ended June 30, 2013, the Bank acquired 9 additional OREO properties and disposed of 5 OREO properties, and as of June 30, 2013 the Bank is carrying 21 OREO properties at a value of $1,817,000. The OREO properties are available for sale and are being actively marketed on the Bank’s website and through other means.

The Bank had loans in the amount of $567,000 at June 30, 2013 classified as performing Troubled Debt Restructurings (“TDRs”) as compared to $572,000 at December 31, 2012. None of these TDRs were included in non-accrual loans. These loans have had their original terms modified to facilitate payment by the borrower. The loans have been classified as TDRs primarily due to a change to interest only payments and the maturity of these modified loans is primarily less than one year.

Cash and cash equivalents decreased to $25,467,000 on June 30, 2013 from $40,998,000 on December 31, 2012. Cash and cash equivalents consist of cash due from correspondents, cash in vault, and overnight investments (including federal funds sold). This decrease is in large part due to the decrease in Federal funds sold resulting from the decrease in deposits as explained above. Cash and cash equivalents can vary due to routine fluctuations in deposits, including fluctuations in transactional accounts and professional settlement accounts, both of which are subject to fluctuations.

Securities held-to-maturity decreased to $3,063,000 on June 30, 2013 from $3,075,000 on December 31, 2012. Securities available-for-sale decreased to $43,022,000 on June 30, 2013, from $50,294,000 December 31, 2012. During the six months ended June 30, 2013 the Bank received $2,113,000 in proceeds from maturities and/or calls of securities available-for-sale and $19,446,000 in proceeds from the sale of securities available-for-sale. The Bank purchased $17,314,000 in securities available-for sale during the same period. The decrease from December 31, 2012 in securities available-for-sale was primarily due to the liquidation of securities in anticipation of funding loan growth.

Financial’s investment in Federal Home Loan Bank of Atlanta (FHLBA) stock totaled $620,000 at June 30, 2013 and $730,000 at December 31, 2012, a decrease of $110,000. FHLBA stock is generally viewed as a long-term investment and because there is no market for the stock other than other Federal Home Loan Banks or member institutions, FHLBA stock is viewed as a restricted security. Therefore, when evaluating FHLBA stock for impairment, its value is based on the ultimate recoverability of the par value rather than by recognizing temporary declines in value.

Liquidity and Capital

At June 30, 2013, Financial, on a consolidated basis, had liquid assets of $68,489,000 in the form of cash, interest-bearing and noninterest-bearing deposits with banks, federal funds sold and available-for-sale investments. Management believes that liquid assets were adequate at June 30, 2013. Management

 

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anticipates that additional liquidity will be provided by the growth in deposit accounts and loan repayments at the Bank. In addition, the Bank has the ability to purchase federal funds on the open market and borrow from the Federal Reserve Bank’s discount window, if necessary.

Financial has $12,000,000 categorized as “Other borrowings” which consists of the following: i) $2,000,000, on which the Bank pays a fixed rate of 3.785%, from a Federal Home Loan Bank Advance that matures in April 2015; and ii) $10,000,000 from the private placement of unregistered debt securities as previously disclosed (the “2012 Notes”). The 2012 Notes bear interest at the rate of 6% per year with interest payable quarterly in arrears. 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.

Management is not aware of any trends, events or uncertainties that are reasonably likely to have a material negative impact on Financial’s short-term or long-term liquidity.

At June 30, 2013, the Bank had a leverage ratio of 8.88%, a Tier 1 risk-based capital ratio of 11.58% and a total risk-based capital ratio of 12.83%. As of June 30, 2013 and December 31, 2012 the Bank’s regulatory capital levels exceeded those established for well-capitalized institutions. The following table sets forth the minimum capital requirements and the Bank’s capital position as of June 30, 2013 and December 31, 2012:

Bank Level Only Capital Ratios

 

Analysis of Capital (in 000’s)    June 30,
2013
     December 31,
2012
 

Tier 1 capital

     

Common Stock

   $ 3,742       $ 3,742   

Surplus

     19,325         19,325   

Retained earnings

     14,855         13,006   
  

 

 

    

 

 

 

Total Tier 1 capital

   $ 37,922       $ 36,073   
  

 

 

    

 

 

 

Tier 2 capital

     

Allowance for loan losses

   $ 4,111       $ 4,064   

Total Tier 2 capital:

   $ 4,111       $ 4,064   
  

 

 

    

 

 

 

Total risk-based capital

   $ 42,033       $ 40,137   
  

 

 

    

 

 

 

Risk weighted assets

   $ 327,524       $ 323,655   

Average total assets

   $ 427,039       $ 428,851   

 

     Actual     Regulatory Benchmarks  
     June 30,
2013
    December 31,
2012
    For Capital
Adequacy
Purposes
    For Well
Capitalized
Purposes
 

Capital Ratios:

        

Tier 1 capital to average total assets

     8.88     8.41     4.00     5.00

Tier 1 risk-based capital ratio

     11.58     11.15     4.00     6.00

Total risk-based capital ratio

     12.83     12.40     8.00     10.00

 

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The above tables set forth 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, while remaining “well capitalized,” would be lower than the comparable capital ratios of the Bank because the proceeds from the private placement of the 6% capital notes due on April 1, 2017 do not qualify as equity capital on a consolidated basis.

Results of Operations

Comparison of the Three and Six Months Ended June 30, 2013 and 2012

Earnings Summary

Financial had net income including all operating segments of $797,000 and $1,585,000 for the three and six months ended June 30, 2013 compared to $486,000 and $846,000 for the comparable periods in 2012. The basic and diluted earnings per common share for the three and six months ended June 30, 2013 were $0.24 and $0.47, compared to basic and diluted earnings per share of $0.15 and $0.25 for the three and six months ended June 30, 2012.

The increase in net income was due in large part to a decreased provision to the allowance for loan loss reserve as discussed in more detail below (See “Allowance for Loan Losses”) and a decrease in interest expense. The increase was partially offset by an increase in non-interest expense, which included a write-down in OREO properties in the amount of $284,000.

These operating results represent an annualized return on stockholders’ equity of 10.74% and 10.88% for the three and six months ended June 30, 2013, compared with 7.18% and 6.28% for the same periods in 2012. The Company had an annualized return on average assets for the three and six months ended June 30, 2013 of 0.75% and 0.74% compared with 0.45% and 0.40% for the three and six months ended June 30, 2012.

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

Interest Income, Interest Expense, and Net Interest Income

Interest income decreased to $4,567,000 and $9,104,000 for the three and six months ended June 30, 2013 from $4,645,000 and $9,331,000 for the same periods in 2012, decreases of 1.68% and 2.43%, respectively. Interest income decreased primarily because the average rate received on earning assets decreased to 4.66% and 4.67% for the three and six months ended June 30, 2013 as compared with 4.73% and 4.76% for the comparable periods in 2012. The rate on total average earning assets decreased largely because of a decrease in market rates of interest. Although market interest rates recently have increased slightly, management expects that interest rates will remain near historic lows for the remainder of 2013 and may continue to negatively impact our interest income.

Interest expense decreased to $610,000 and $1,226,000 for the three and six months ended June 30, 2013 from $809,000 and $1,629,000 for the same periods in 2012, decreases of 24.60% and 24.74%, respectively. This significant decrease in interest expense resulted in large part from a decrease in the rate paid on balances on deposits. The Bank’s average rate paid on deposits was 0.55% and 0.55% during the three and six month periods ended June 30, 2013 as compared to 0.74% and 0.76% for the same periods in 2012. This resulted from management’s efforts to minimize the Bank’s interest expense and maximize its net interest margin.

 

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The fundamental source of the Bank’s revenue is net interest income, which is determined by the difference between (i) interest and dividend income on interest earning assets, which consist primarily of loans, investment securities and other investments, and (ii) interest expense on interest-bearing liabilities, which consist principally of deposits and other borrowings. Net interest income for the three and six months ended June 30, 2013 was $3,957,000 and $7,878,000 compared with $3,836,000 and $7,702,000 for the same periods in 2012. The increase in net interest income for the three and six months ended June 30, 2013 as compared with the comparable periods in 2012 was due to a decrease in the rate paid on average interest-bearing liabilities as compared to 2012. The net interest margin was 4.10% for the both three and six months ended June 30, 2013, up from 3.91% and 3.95% for the same periods a year ago.

Financial’s net interest margin analysis and average balance sheets are shown in Schedule I on page 44.

Non-Interest Income

Non-interest income is comprised primarily of fees and charges on transactional deposit accounts, mortgage loan origination fees, commissions on sales of investments and the Bank’s ownership interest in a title insurance agency. Non-interest income exclusive of gains on sales of securities increased to $770,000 and $1,475,000 for the three and six months ended June 30, 2013 from $714,000 and $1,344,000 for the three and six months ended June 30, 2013. This increase for the three and six months ended June 30, 2013 as compared to the same periods last year was due primarily to increases in mortgage origination fees and service charges, fees, and commissions. Gain on sales of securities increased to $135,000 and $394,000 for the three and six months ended June 30, 2013 from $129,000 and $170,000 for the comparable periods in 2012.

The Bank, through the Mortgage division, originates both conforming and non-conforming consumer residential mortgage loans 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 major national mortgage banking or financial institutions. The Mortgage division assumes no credit or interest rate risk on these mortgages.

Despite the recent increase in rates, management anticipates that residential mortgage rates will remain near the current historic lows for the remainder of 2013. Management expects that low rates and government-assisted programs such as Home Affordable Refinance Program (HARP) coupled with the Mortgage division’s reputation in Region 2000 will allow us to maintain revenue at the Mortgage division. Because many people able to refinance mortgages have already done so, management expects refinancing activity to decrease. As a result of the rising interest rates, management expects that loans for home purchases (as opposed to refinances) will constitute the majority of mortgage originations.

Revenue from mortgage origination fees increased in the three and six month periods ended June 30, 2013 as compared to the same periods for 2012. Management believes that regulatory pressure may result in a decreased number of competitors to the Mortgage division and this could result in an increase in market share.

Our Investment division provides brokerage services through an agreement with a third-party broker-dealer. Pursuant to this arrangement, the third party broker-dealer operates a service center adjacent to one of the branches of the Bank. The center is staffed by dual employees of the Bank and the broker-dealer. Investment receives commissions on transactions generated and in some cases ongoing management fees such as mutual fund 12b-1 fees. The Investment division’s financial impact on our consolidated revenue has been immaterial. Although management cannot predict the financial impact of Investment with certainty, management anticipates the Investment division’s impact on noninterest income will remain immaterial in 2013.

 

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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 2013.

Non-Interest Expense

Non-interest expense for the three and six months ended June 30, 2013 increased to $3,671,000 and $7,202,000, or 3.15% and 5.25%, from $3,559,000 and $6,843,000 for the comparable periods in 2012. This increase in non-interest expense from the comparable period in 2012 can be attributed in large part to an increase in compensation expense, discussed in more detail in the following paragraph, and professional data and outside expenses. Other real estate expenses consist primarily of insurance, maintenance, real estate taxes, and other expenses related to property ownership.

Total personnel expense was $1,726,000 and $3,502,000 for the three and six month periods ended June 30, 2013 as compared to $1,546,000 and $3,049,000 for the same periods in 2012. Compensation for some employees of the Mortgage division and the Investment division is commission-based and therefore subject to fluctuation.

Allowance for Loan Losses

The allowance for loan losses represents an amount that, in our judgment, will be adequate to absorb any losses on existing loans that may become uncollectible. The provision for loan losses increases the allowance, and loans charged off, net of recoveries, reduce the allowance. The provision to the allowance for loan losses is charged to earnings to bring the total allowance to a level deemed appropriate by management and is based upon many factors, including calculations of specific impairment of certain loans, general economic conditions, actual and expected credit losses, loan performance measures, historical trends and specific conditions of the individual borrower. Based on the application of the loan loss calculation, the Bank provided $55,000 and $290,000 to the allowance for loan loss for the three and six months ended June 30, 2013 compared to provisions of $425,000 and $1,175,000 for the comparable period in 2012, representing decreases of 87.06% and 75.32%, respectively.

The decrease in the loan loss provision for the three months ended June 30, 2013 as compared to the same periods in 2012 was due to the following factors:

 

   

The Bank’s asset quality has improved as problem assets, including certain commercial loans and residential speculative housing construction loans have decreased as the collateral for those loans has been liquidated or the loans have been paid off. Management’s evaluation of these asset classes resulted in the decreased provision in the quarter ended June 30, 2013.

 

   

In light of the current economic environment, management continues its ongoing assessment of specific impairment in the Bank’s loan portfolio. The analysis resulted in a decrease in the provision for the quarter ended June 30, 2013 as compared to the same quarter in 2012.

 

   

General reserves related to consumer loans collectively evaluated for impairment have also increased, but this increase has been offset by a dramatic decline in charge-offs from $847,000 and $1,231,000 for the three and six month periods ended June 30, 2012 to $271,000 and $457,000 for the comparable periods in 2013.

 

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Management believes that the current allowance for loan loss of $5,475,000 (or 1.62% of total loans) at June 30, 2013, as compared to $5,535,000 (or 1.70% of total loans) as of December 31, 2012, is adequate.

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

 

     Allowance for Credit Losses and Recorded Investment in Financing
Receivables
 
     (dollars in thousands)  
     For the Six Months Ended June 30, 2013  
2013    Commercial     Commercial
Real Estate
    Consumer     Residential     Total  

Allowance for Credit Losses:

          

Beginning Balance

   $ 987      $ 2,849      $ 1,057      $ 642      $ 5,535   

Charge-offs

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