10-Q 1 d623642d10q.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 September 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 November 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

     32   

Item 3.

 

Quantitative and Qualitative Disclosures About Market Risk

     50   

Item 4.

 

Controls and Procedures

     50   

PART II – OTHER INFORMATION

     50   

Item 1.

 

Legal Proceedings

     50   

Item 1A.

 

Risk Factors

     50   

Item 2.

 

Unregistered Sales of Equity Securities and Use of Proceeds

     50   

Item 3.

 

Defaults Upon Senior Securities

     50   

Item 4.

 

Mine Safety Disclosures

     50   

Item 5.

 

Other Information

     50   

Item 6.

 

Exhibits

     51   

SIGNATURES

     52   


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)

 

     9/30/2013     12/31/2012  

Assets

    

Cash and due from banks

   $ 19,410      $ 16,827   

Federal funds sold

     7,375        24,171   
  

 

 

   

 

 

 

Total cash and cash equivalents

     26,785        40,998   
  

 

 

   

 

 

 

Securities held-to-maturity (fair value of $3,777 in 2013 and $3,417 in 2012)

     3,543        3,075   

Securities available-for-sale, at fair value

     46,811        50,294   

Restricted stock, at cost

     1,428        1,538   

Loans, net of allowance for loan losses of $4,983 in 2013 and $5,535 in 2012

     330,472        319,922   

Loans held for sale

     799        904   

Premises and equipment, net

     8,461        8,340   

Software, net

     226        252   

Interest receivable

     1,309        1,557   

Cash value – bank owned life insurance

     9,157        8,931   

Other real estate owned, net of valuation allowance

     1,701        2,112   

Income taxes receivable

     622        624   

Deferred tax asset

     2,795        1,367   

Other assets

     1,263        1,467   
  

 

 

   

 

 

 

Total assets

   $ 435,372      $ 441,381   
  

 

 

   

 

 

 

Liabilities and Stockholders’ Equity

    

Deposits

    

Noninterest bearing demand

   $ 70,535      $ 64,853   

NOW, money market and savings

     225,345        241,876   

Time

     97,248        92,286   
  

 

 

   

 

 

 

Total deposits

     393,128        399,015   

FHLB borrowings

     2,000        2,000   

Capital notes

     10,000        10,000   

Interest payable

     67        70   

Other liabilities

     939        683   
  

 

 

   

 

 

 

Total liabilities

   $ 406,134      $ 411,768   
  

 

 

   

 

 

 

Stockholders’ equity

    

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

   $ 7,175      $ 7,175   

Additional paid-in-capital

     22,806        22,806   

Accumulated other comprehensive income (loss)

     (2,205     568   

Retained earnings (deficit)

     1,462        (936
  

 

 

   

 

 

 

Total stockholders’ equity

   $ 29,238      $ 29,613   
  

 

 

   

 

 

 

Total liabilities and stockholders’ equity

   $ 435,372      $ 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 Nine Months  
     Ended September 30,      Ended September 30,  
     2013      2012      2013      2012  

Interest Income

           

Loans

   $ 4,213       $ 4,332       $ 12,575       $ 12,734   

Securities

           

US Government and agency obligations

     182         219         544         740   

Mortgage backed securities

     25         2         39         22   

Municipals

     124         182         417         507   

Dividends

     4         4         34         33   

Other (Corporates)

     16         17         44         40   

Federal Funds sold

     9         7         24         18   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total interest income

     4,573         4,763         13,677         14,094   
  

 

 

    

 

 

    

 

 

    

 

 

 

Interest Expense

           

Deposits

           

NOW, money market savings

     121         164         369         578   

Time Deposits

     316         373         956         1,186   

FHLB borrowings

     19         50         57         199   

Reverse repurchase agreements

     —           —           —           15   

Capital notes

     150         149         450         387   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total interest expense

     606         736         1,832         2,365   
  

 

 

    

 

 

    

 

 

    

 

 

 

Net interest income

     3,967         4,027         11,845         11,729   

Provision for loan losses

     —           601         290         1,776   
  

 

 

    

 

 

    

 

 

    

 

 

 

Net interest income after provision for loan losses

     3,967         3,426         11,555         9,953   
  

 

 

    

 

 

    

 

 

    

 

 

 

Other operating income

           

Mortgage fee income

     295         402         954         917   

Service charges, fees and commissions

     351         317         979         911   

Increase in cash value of life insurance

     75         81         226         244   

Other

     37         11         74         83   

Gain on sale of available-for-sale securities

     11         241         405         411   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total other operating income

     769         1,052         2,638         2,566   
  

 

 

    

 

 

    

 

 

    

 

 

 

Other operating expenses

           

Salaries and employee benefits

     1,755         1,608         5,257         4,657   

Occupancy

     302         280         892         857   

Equipment

     259         250         760         748   

Supplies

     84         78         267         294   

Professional, data processing, and other outside expense

     582         508         1,712         1,524   

Marketing

     93         99         274         348   

Credit expense

     55         62         174         174   

Other real estate expenses

     60         586         400         908   

FDIC insurance expense

     143         145         430         433   

Other

     235         167         604         683   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total other operating expenses

     3,568         3,783         10,770         10,626   
  

 

 

    

 

 

    

 

 

    

 

 

 

Income before income taxes

     1,168         695         3,423         1,893   

Income tax expense

     355         156         1,025         508   
  

 

 

    

 

 

    

 

 

    

 

 

 

Net Income

   $ 813       $ 539       $ 2,398       $ 1,385   
  

 

 

    

 

 

    

 

 

    

 

 

 

Weighted average shares outstanding – basic

     3,352,725         3,342,418         3,352,725         3,342,416   
  

 

 

    

 

 

    

 

 

    

 

 

 

Weighted average shares outstanding – diluted

     3,356,874         3,342,771         3,354,290         3,342,812   
  

 

 

    

 

 

    

 

 

    

 

 

 

Income per common share – basic

   $ 0.24       $ 0.16       $ 0.72       $ 0.41   
  

 

 

    

 

 

    

 

 

    

 

 

 

Income per common share – diluted

   $ 0.24       $ 0.16       $ 0.71       $ 0.41   
  

 

 

    

 

 

    

 

 

    

 

 

 

 

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 Nine months ended September 30, 2013 and 2012

(dollar amounts in thousands) (unaudited)

 

     Three Months Ended
September 30,
    Nine Months Ended
September 30,
 
     2013     2012     2013     2012  

Net Income

   $ 813     $ 539     $ 2,398     $ 1,385  
  

 

 

   

 

 

   

 

 

   

 

 

 

Other comprehensive income (loss):

        

Unrealized (losses) gains on securities available-for-sale net of deferred taxes of $319 and $(170) for the three month periods and $1,290 and $(561) for the nine month periods ended September 30, 2013 and 2012

     (621     330       (2,506     1,090  

Reclassification adjustment for gains included in net income, net of taxes of $4 and $82 for the three month periods and $138 and $140 for the nine month periods ended September 30, 2013 and 2012

     (7     (159     (267     (271
  

 

 

   

 

 

   

 

 

   

 

 

 

Other comprehensive income (loss), net of tax

     (628     171       (2,773     819  
  

 

 

   

 

 

   

 

 

   

 

 

 

Comprehensive income (loss)

   $ 185     $ 710     $ (375   $ 2,204  
  

 

 

   

 

 

   

 

 

   

 

 

 

 

See accompanying notes to these consolidated financial statements

 

3


Table of Contents

Bank of the James Financial Group, Inc. and Subsidiaries

Consolidated Statements of Cash Flows

Nine Months ended September 30, 2013 and 2012

(dollar amounts in thousands) (unaudited)

 

     Nine Months Ended September 30,  
     2013     2012  

Cash flows from operating activities

    

Net Income

   $ 2,398     $ 1,385  

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

    

Depreciation

     521       504  

Net amortization and accretion of premiums and discounts on securities

     260       426  

(Gain) on sale of available for sale securities

     (405     (411

Provision for loan losses

     290       1,776  

Loss on sale of other real estate owned

     40       74  

Impairment of other real estate owned

     304       710  

Decrease (increase) in loans held-for-sale

     105       (3,729

(Increase) in cash value of life insurance

     (226     (244

Decrease in interest receivable

     248       117  

Decrease in other assets

     204       246  

(Increase) decrease in income taxes receivable

     2       (194

(Decrease) in interest payable

     (3     (34

Increase (decrease) in other liabilities

     256       (265
  

 

 

   

 

 

 

Net cash provided by operating activities

   $ 3,994     $ 361  
  

 

 

   

 

 

 

Cash flows from investing activities

    

Purchases of securities held to maturity

   $ (485   $  —    

Proceeds from maturities and calls of securities held to maturity

     —          5,000  

Purchases of securities available for sale

     (25,162     (34,930

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

     2,188       16,696  

Proceeds from sale of securities available for sale

     22,418       15,585  

Redemption of Federal Home Loan Bank stock

     110       78  

Proceeds from sale of other real estate owned

     777       2,307  

Improvements to other real estate owned

     —          (5

Origination of loans, net of principal collected

     (11,550     (3,834

Purchases of premises and equipment

     (616     (316
  

 

 

   

 

 

 

Net cash (used in) provided by investing activities

   $ (12,320   $ 581  
  

 

 

   

 

 

 

Cash flows from financing activities

    

Net (decrease) increase in deposits

   $ (5,887   $ 10,115  

Net (decrease) in repurchase agreements

     —          (8,379

Net (decrease) in Federal Home Loan Bank advances

     —          (8,000

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

     —          (7,000

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

     —          10,000  
  

 

 

   

 

 

 

Net cash (used in) financing activities

   $ (5,887   $ (3,264
  

 

 

   

 

 

 

(Decrease) in cash and cash equivalents

     (14,213     (2,322

Cash and cash equivalents at beginning of period

   $ 40,998     $ 23,340  
  

 

 

   

 

 

 

Cash and cash equivalents at end of period

   $ 26,785     $ 21,018  
  

 

 

   

 

 

 

Non cash transactions

    

Transfer of loans to foreclosed assets

   $ 710     $ 2,100  

Fair value adjustment for securities

     (4,201     1,236  
  

 

 

   

 

 

 

Cash transactions

    

Cash paid for interest

   $ 1,835     $ 2,399  

Cash paid for taxes

     1,023       702  
  

 

 

   

 

 

 

 

See accompanying notes to these consolidated financial statements

 

4


Table of Contents

Bank of the James Financial Group, Inc. and Subsidiaries

Consolidated Statements of Changes in Stockholders’ Equity

(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

     3,342,418       $ 7,152       $ 22,775       $ (3,068   $ (54   $ 26,805   
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

   

 

 

 

Net Income

     —           —           —           1,385        —          1,385   

Other Comprehensive Income

     —           —           —           —          819        819   
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

   

 

 

 

Balance at September 30, 2012

     3,342,418       $ 7,152       $ 22,775       $ (1,683   $ 765      $ 29,009   
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

   

 

 

 

Balance at December 31, 2012

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

 

 

    

 

 

    

 

 

    

 

 

   

 

 

   

 

 

 

Net Income

     —           —           —           2,398        —          2,398   

Other Comprehensive Loss

     —           —           —           —          (2,773     (2,773
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

   

 

 

 

Balance at September 30, 2013

     3,352,725       $ 7,175       $ 22,806       $ 1,462      $ (2,205   $ 29,238   
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

   

 

 

 

 

See accompanying notes to these consolidated financial statements

 

5


Table of Contents

Notes to Consolidated Financial Statements

Note 1 – Basis of Presentation

The unaudited consolidated financial statements have been prepared by Bank of the James Financial Group, Inc. (“Financial” or the “Company”) pursuant to the rules and regulations of the Securities and Exchange Commission. In management’s opinion the accompanying financial statements, which unless otherwise noted are unaudited, reflect all adjustments, consisting solely of normal recurring accruals, necessary for a fair presentation of the financial information as of and for the three and nine months ended September 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 nine month periods ended September 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 nine months ended September 30, 2013 and 2012.

 

6


Table of Contents

Note 3 – Earnings Per Share (continued)

 

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

Net income

   $ 813,000       $ 539,000       $ 2,398,000       $ 1,385,000   

Weight average number of shares

     3,352,725         3,342,418         3,352,725         3,342,416   

Options affect of incremental shares

     4,149         353         1,565         396   
  

 

 

    

 

 

    

 

 

    

 

 

 

Weighted average diluted shares

     3,356,874         3,342,771         3,354,290         3,342,812   
  

 

 

    

 

 

    

 

 

    

 

 

 

Basic EPS (weighted avg shares)

   $ 0.24       $ 0.16       $ 0.72       $ 0.41   
  

 

 

    

 

 

    

 

 

    

 

 

 

Diluted EPS (Including Option Shares)

   $ 0.24       $ 0.16       $ 0.71       $ 0.41   
  

 

 

    

 

 

    

 

 

    

 

 

 

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      Nine months ended  
     September 30,      September 30,  
     2013      2012      2013      2012  

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

     113,294         175,847         168,069         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.

 

7


Table of Contents

Note 4 – Stock Based Compensation (continued)

 

Stock option plan activity for the nine months ended September 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

     (1,531     10.96        
  

 

 

         

Options outstanding, September 30, 2013

     173,835       9.65        1.3      $ 31,309  
  

 

 

   

 

 

    

 

 

    

 

 

 

Options exercisable, September 30, 2013

     173,835     $ 9.65        1.3      $ 31,309  
  

 

 

   

 

 

    

 

 

    

 

 

 

Intrinsic value is calculated by subtracting exercise price of option shares from the market price of underlying shares as of September 30, 2013 and multiplying that amount by the number of options outstanding. No intrinsic value exists where the exercise price is greater than the market price on a given date.

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

Note 5 – Fair Value Measurements

Determination of Fair Value

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

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

 

8


Table of Contents

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.

 

9


Table of Contents

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 September 30, 2013  

Description

   Balance as of
September 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

   $ 3,699       $ —         $ 3,699       $ —     

US agency obligations

     18,220         —           18,220         —     

Mortgage-backed securities

     8,354         —           8,354         —     

Municipals

     14,649         —           14,649         —     

Other (corporates)

     1,889         —           1,889         —     
  

 

 

    

 

 

    

 

 

    

 

 

 

Total available-for-sale securities

   $ 46,811       $ —         $ 46,811       $ —     
  

 

 

    

 

 

    

 

 

    

 

 

 

 

                                                   
            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.

 

10


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 September 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 September 30, 2013  

Description

   Balance as of
September 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*

   $ 5,990       $ —         $ —         $ 5,990   

Loans held for sale

     799         —           799         —     

Other real estate owned

     1,701         —           —           1,701   

 

* 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.

 

11


Table of Contents

Note 5 – Fair Value Measurements (continued)

 

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

 

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

Valuation Technique(s)

  

Unobservable Input

   Range (Weighted
Average)

Assets

           

Impaired loans

 

   $

 

5,990

 

  

 

  

Discounted appraised value

 

  

Selling cost

 

   5% - 10% (6%)

 

        

Discount for lack of marketability and age of appraisal

   0% - 25% (15%)

OREO

 

    

 

1,701

 

  

 

  

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.

 

12


Table of Contents

Note 5 – Fair Value Measurements (continued)

 

Deposits

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

FHLB borrowings

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

Short-term borrowings

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

Capital notes

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

Accrued interest

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

Off-balance sheet credit-related instruments

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

 

13


Table of Contents

Note 5 – Fair Value Measurements (continued)

 

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

 

            Fair Value Measurements at September 30, 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

   $ 19,410       $ 19,410       $ —         $ —         $ 19,410   

Federal funds sold

     7,375         7,375         —           —           7,375   

Securities

              

Available-for-sale

     46,811         —           46,811         —           46,811   

Held-to-maturity

     3,543         —           3,777         —           3,777   

Loans, net

     330,472         —           —           338,436         338,436   

Loans held for sale

     799         —           799         —           799   

Interest receivable

     1,309         —           1,309         —           1,309   

BOLI

     9,157         —           9,157         —           9,157   

Liabilities

              

Deposits

   $ 393,128       $ —         $ 394,285       $ —         $ 394,285   

FHLB borrowings

     2,000         —           2,020         —           2,020   

Capital notes

     10,000         —           10,100         —           10,100   

Interest payable

     67         —           67         —           67   

 

14


Table of Contents

Note 5 – Fair Value Measurements (continued)

 

            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   

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.

 

15


Table of Contents

Note 5 – Fair Value Measurements (continued)

 

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.

 

16


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 September 30, 2013 and December 31, 2012 (amounts in thousands):

 

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

Held-to-Maturity

          

US agency obligations

   $ 3,543       $ 234       $ —        $ 3,777   
  

 

 

    

 

 

    

 

 

   

 

 

 

Available-for-Sale

          

US Treasuries

   $ 3,905       $ —         $ (206   $ 3,699   

US agency obligations

     20,312         3         (2,095     18,220   

Mortgage-backed securities

     8,470         37         (153     8,354   

Municipals

     15,451         33         (835     14,649   

Other

     2,012         —           (123     1,889   
  

 

 

    

 

 

    

 

 

   

 

 

 
   $ 50,150       $ 73       $ (3,412   $ 46,811   
  

 

 

    

 

 

    

 

 

   

 

 

 

 

                                                                   
            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   
  

 

 

    

 

 

    

 

 

   

 

 

 

 

17


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 September 30, 2013 and December 31, 2012 (amounts in thousands):

 

     Less than 12 months      More than 12 months      Total  

September 30, 2013

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

Description of securities

                 

US Treasuries

   $ 3,699       $ 206       $ —         $ —         $ 3,699       $ 206   

U.S. agency obligations

     16,274         2,095         —           —           16,274         2,095   

Mortgage-backed securities

     4,833         153         —           —           4,833         153   

Municipals

     11,206         718         946         117         12,152         835   

Other

     1,889         123         —           —           1,889         123   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 37,901       $ 3,295       $ 946       $ 117       $ 38,847       $ 3,412   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

     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 September 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 September 30, 2013, the Bank owned 42 securities that were being evaluated for other than temporary impairment. Eleven of these securities were S&P rated AAA, 30 were S&P rated AA, and one was S&P rated A. As of September 30, 2013, 17 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.

 

18


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 and other areas within Central Virginia. The mortgage segment provides a variety of mortgage loan products principally within Region 2000. Mortgage loans are originated and sold in the secondary market through purchase commitments from investors with servicing released. Because of the pre-arranged purchase commitments, there is minimal risk to the Company.

Both of the Company’s reportable segments are service based. The mortgage business is a 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.

 

19


Table of Contents

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

Business Segments

 

     Community
Banking
     Mortgage      Total  

Nine months ended September 30, 2013

        

Net interest income

   $ 11,845       $ —         $ 11,845   

Provision for loan losses

     290         —           290   
  

 

 

    

 

 

    

 

 

 

Net interest income after provision for loan losses

     11,555         —           11,555   

Noninterest income

     1,684         954         2,638   

Noninterest expenses

     10,006         764         10,770   
  

 

 

    

 

 

    

 

 

 

Income before income taxes

     3,233         190         3,423   

Income tax expense

     960         65         1,025   
  

 

 

    

 

 

    

 

 

 

Net income

   $ 2,273       $ 125       $ 2,398   
  

 

 

    

 

 

    

 

 

 

Total assets

   $ 434,493       $ 879       $ 435,372   
  

 

 

    

 

 

    

 

 

 

Nine months ended September 30, 2012

        

Net interest income

   $ 11,729       $ —         $ 11,729   

Provision for loan losses

     1,776         —           1,776   
  

 

 

    

 

 

    

 

 

 

Net interest income after provision for loan losses

     9,953         —           9,953   

Noninterest income

     1,649         917         2,566   

Noninterest expenses

     9,898         728         10,626   
  

 

 

    

 

 

    

 

 

 

Income before income taxes

     1,704         189         1,893   

Income tax expense

     444         64         508   
  

 

 

    

 

 

    

 

 

 

Net income

   $ 1,260       $ 125       $ 1,385   
  

 

 

    

 

 

    

 

 

 

Total assets

   $ 421,830       $ 4,247       $ 426,077   
  

 

 

    

 

 

    

 

 

 

 

     Community
Banking
     Mortgage      Total  

Three months ended September 30, 2013

        

Net interest income

   $ 3,967       $ —         $ 3,967   

Provision for loan losses

     —           —           —     
  

 

 

    

 

 

    

 

 

 

Net interest income after provision for loan losses

     3,967         —           3,967   

Noninterest income

     474         295         769   

Noninterest expenses

     3,323         245         3,568   
  

 

 

    

 

 

    

 

 

 

Income before income taxes

     1,118         50         1,168   

Income tax expense

     337         18         355   
  

 

 

    

 

 

    

 

 

 

Net income

   $ 781       $ 32       $ 813   
  

 

 

    

 

 

    

 

 

 

Total assets

   $ 434,493       $ 879       $ 435,372   
  

 

 

    

 

 

    

 

 

 

Three months ended September 30, 2012

        

Net interest income

   $ 4,027       $ —         $ 4,027   

Provision for loan losses

     601         —           601   
  

 

 

    

 

 

    

 

 

 

Net interest income after provision for loan losses

     3,426         —           3,426   

Noninterest income

     650         402         1,052   

Noninterest expenses

     3,491         292         3,783   
  

 

 

    

 

 

    

 

 

 

Income before income taxes

     585         110         695   

Income tax expense

     119         37         156   
  

 

 

    

 

 

    

 

 

 

Net income

   $ 466       $ 73       $ 539   
  

 

 

    

 

 

    

 

 

 

Total assets

   $ 421,830       $ 4,247       $ 426,077   
  

 

 

    

 

 

    

 

 

 

 

20


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:  
     September 30,
2013
     December 31,
2012
 

Commercial

   $ 54,943       $ 55,084   

Commercial real estate

     164,275         153,416   

Consumer

     69,277         70,639   

Residential

     46,960         46,318   
  

 

 

    

 

 

 

Total loans

     335,455         325,457   

Less allowance for loan losses

     4,983         5,535   
  

 

 

    

 

 

 

Net loans

   $ 330,472       $ 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.

 

21


Table of Contents

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

 

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

 

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

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

 

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

 

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

 

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

 

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

 

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

 

22


Table of Contents

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

 

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

 

Financing Receivables on Non-Accrual Status  
(dollars in thousands)  
    As of  
    September 30, 2013     December 31, 2012  

Commercial

  $ 1,810      $ 2,100   

Commercial Real Estate:

   

Commercial Mortgages-Owner Occupied

    1,190        1,431   

Commercial Mortgages-Non-Owner Occupied

    353        853   

Commercial Construction

    508        849   

Consumer

   

Consumer Unsecured

    —          —     

Consumer Secured

    49        —     

Residential:

   

Residential Mortgages

    112        1,113   

Residential Consumer Construction

    —          —     
 

 

 

   

 

 

 

Totals

  $ 4,022      $ 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 $1,701,000 on September 30, 2013 from $2,112,000 on December 31, 2012. The following table represents the changes in OREO balance during the nine months ended September 30, 2013.

 

OREO Changes  
(dollars in thousands)  
     Nine Months ended
September 30, 2013
 

Balance at the beginning of the year (net)

   $ 2,112   

Transfers from loans

     710   

Capitalized costs

     —     

Writedowns

     (304

Sales proceeds

     (777

(Loss) on disposition

     (40
  

 

 

 

Balance at the end of the period (net)

   $ 1,701   
  

 

 

 

 

23


Table of Contents

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

 

     Impaired Loans  
     (dollars in thousands)  
     For the Nine Months Ended September 30, 2013  
2013    Recorded
Investment
     Unpaid
Principal
Balance
     Related
Allowance
     Average
Recorded
Investment
     Interest
Income
Recognized
 

With No Related Allowance Recorded:

              

Commercial

   $ 3,371       $ 3,765       $ —         $ 2,951       $ 66   

Commercial Real Estate

              

Commercial Mortgages-Owner Occupied

     1,871         2,032         —           2,232         102   

Commercial Mortgage Non-Owner Occupied

     629         629         —           3,499         20   

Commercial Construction

     200         613         —           470         5   

Consumer

              

Consumer Unsecured

     —           —           —           —           —     

Consumer Secured

     57         57         —           263         2   

Residential

              

Residential Mortgages

     732         775         —           1,435         33   

Residential Consumer Construction

     —           —           —           —           —     

With An Allowance Recorded:

              

Commercial

   $ 1,790       $ 1,790       $ 512       $ 1,205       $ 81   

Commercial Real Estate

              

Commercial Mortgages-Owner Occupied

     1,338         1,367         70         2,505         26   

Commercial Mortgage Non-Owner Occupied

     735         737         67         788         30   

Commercial Construction

     424         516         48         624         —     

Consumer

              

Consumer Unsecured

     —           —           —           —           —     

Consumer Secured

     160         160         160         345         8   

Residential

              

Residential Mortgages

     2,156         2,503         226         1,586         112   

Residential Consumer Construction

     —           —           —           —           —     

Totals:

              

Commercial

   $ 5,161       $ 5,555       $ 512       $ 4,156       $ 147   

Commercial Real Estate

              

Commercial Mortgages-Owner Occupied

     3,209         3,399         70         4,737         128   

Commercial Mortgage Non-Owner Occupied

     1,364         1,366         67         4,287         50   

Commercial Construction

     624         1,129         48         1,094         5   

Consumer

              

Consumer Unsecured

     —           —           —           —           —     

Consumer Secured

     217         217         160         608         10   

Residential

              

Residential Mortgages

     2,888         3,278         226         3,021         145   

Residential Consumer Construction

     —           —           —           —           —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 
   $ 13,463       $ 14,944       $ 1,083       $ 17,903       $ 485   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

24


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   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

25


Table of Contents

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 Nine Months Ended September 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     (797     (126     (28     (970

Recoveries

     30        38        60        —          128   

Provision

     103        152        28        (7     290   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Ending Balance

     1,101        2,242        1,019        621        4,983   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Ending Balance: Individually evaluated for impairment

   $ 512      $ 185      $ 160      $ 226      $ 1,083   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Ending Balance: Collectively evaluated for impairment

     589        2,057        859        395        3,900   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Totals:

   $ 1,101      $ 2,242      $ 1,019      $ 621      $ 4,983   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Financing Receivables:

          

Ending Balance: Individually evaluated for impairment

     5,161        5,197        217        2,888        13,463   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Ending Balance: Collectively evaluated for impairment

     49,782        159,078        69,060        44,072        321,992   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Totals:

   $ 54,943      $ 164,275      $ 69,277      $ 46,960      $ 335,455   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

26


Table of Contents

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   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

27


Table of Contents

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

 

 

     Age Analysis of Past Due Financing Receivables as of  
     September 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

   $ 51       $ 62       $ 1,810       $ 1,923       $ 53,020       $ 54,943       $ —     

Commercial Real Estate:

                    

Commercial Mortgages-Owner Occupied

     —           652         409         1,061         63,897         64,958         —     

Commercial Mortgages-Non-Owner Occupied

     377         180         718         1,275         89,712         90,987         718   

Commercial Construction

     —           —           508         508         7,822         8,330         —     

Consumer:

                    

Consumer Unsecured

     —           —           —           —           4,224         4,224         —     

Consumer Secured

     64         —           49         113         64,940         65,053         —     

Residential:

                    

Residential Mortgages

     201         —           112         313         40,375         40,688         —     

Residential Consumer Construction

     —           —           —           —           6,272         6,272         —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 693       $ 894       $ 3,606       $ 5,193       $ 330,262       $ 335,455       $ 718   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

     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       $ —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

28


Table of Contents

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

 

 

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

Commercial

   $ 47,458       $ 2,038       $ 233       $ 5,214       $ —         $ 54,943   

Commercial Real Estate:

                 

Commercial Mortgages-Owner Occupied

     57,832         2,606         1,287         3,233         —           64,958   

Commercial Mortgages-Non Owner Occupied

     80,612         2,593         5,807         1,975         —           90,987   

Commercial Construction

     7,706         —           —           624         —           8,330   

Consumer

                 

Consumer Unsecured

     4,223         —           —           1         —           4,224   

Consumer Secured

     63,733         692         167         461         —           65,053   

Residential:

                 

Residential Mortgages

     37,039         83         371         3,195         —           40,688   

Residential Consumer Construction

     6,272         —           —           —           —           6,272   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Totals

   $ 304,875       $ 8,012       $ 7,865       $ 14,703       $ —         $ 335,455   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

     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   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

29


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 nine months ended September 30, 2013 and 2012.

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

There were no loan modifications classified as TDRs within the last twelve months that defaulted during the three months ended September 30, 2012.

The following table describes TDRs that defaulted within 12 months of the modification during the nine months ended September 30, 2012.

 

 

For the Nine Months Ended September 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 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

 

30


Table of Contents

Note 11 – Recent accounting pronouncements (continued)

 

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.

In July 2013, the FASB issued ASU 2013-10, “Derivatives and Hedging (Topic 815): Inclusion of the Fed Funds Effective Swap Rate (or Overnight Index Swap Rate) as a Benchmark Interest Rate for Hedge Accounting Purposes.” The amendments in this ASU permit the Fed Funds Effective Swap Rate (also referred to as the Overnight Index Swap Rate) to be used as a U.S. benchmark interest rate for hedge accounting purposes under Topic 815, in addition to interest rates on direct Treasury obligations of the U.S. government and the London Interbank Offered Rate. The amendments also remove the restriction on using different benchmark rates for similar hedges. The amendments apply to all entities that elect to apply hedge accounting of the benchmark interest rate under Topic 815. The amendments are effective prospectively for qualifying new or redesignated hedging relationships entered into on or after July 17, 2013. The adoption of the new guidance did not have a material impact on the Company’s consolidated financial statements.

In July 2013, the FASB issued ASU 2013-11, “Income Taxes (Topic 740): Presentation of an Unrecognized Tax Benefit When a Net Operating Loss Carryforward, a Similar Tax Loss, or a Tax Credit Carryforward Exists.” The amendments in this Update provide guidance on the financial statement presentation of an unrecognized tax benefit when a net operating loss carryforward, similar tax loss, or tax credit carryforward exists. An unrecognized tax benefit, or a portion of an unrecognized tax benefit, should be presented in the financial statements as a reduction to a deferred tax asset for a net operating loss carryforward, a similar tax loss, or a tax credit carryforward, except as follows. To the extent a net operating loss carryforward, a similar tax loss, or a tax credit carryforward is not available at the reporting date under the tax law of the applicable jurisdiction to settle any additional income taxes that would result from the disallowance of a tax position or the tax law of the applicable jurisdiction does not require the entity to use, and the entity does not intend to use, the deferred tax asset for such purpose, the unrecognized tax benefit should be presented in the financial statements as a liability and should not be combined with deferred tax assets. The amendments in this ASU are effective for fiscal years, and interim periods within those years, beginning after December 15, 2013. Early adoption is permitted. The amendments should be applied prospectively to all unrecognized tax benefits that exist at the effective date. Retrospective application is permitted. The adoption of the new guidance did not have a material impact on the Company’s consolidated financial statements.

 

31


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

CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS

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

GENERAL

Critical Accounting Policies

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

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.

 

32


Table of Contents

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 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”),

 

33


Table of Contents
    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”),

 

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

The Bank also has opened a limited-service branch located in the Westminster-Canterbury facilities located at 501 VES Road, Lynchburg, Virginia 24503 and a commercial loan production office located at Luxor Office Park LLC, 1430 Rolkin Court Suite 203, Charlottesville, VA 22911

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.

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. The Bank has installed an ATM in a local municipal building in order to establish a presence in this market until the branch has been established.

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.

 

34


Table of Contents

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:

 

     September 30,
2013
(in thousands)
 

Commitments to extend credit

   $ 67,257   

Letters of Credit

     1,219   
  

 

 

 

Total

   $ 68,476   
  

 

 

 

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 September 30, 2013 and December 31, 2012 and the results of operations of Financial for the three and nine month periods ended September 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.

 

35


Table of Contents

Financial Condition Summary

September 30, 2013 as Compared to December 31, 2012

Total assets were $435,372,000 on September 30, 2013 compared with $441,381,000 at December 31, 2012, a decrease of 1.36%. Total assets as of December 31, 2012 were temporarily elevated because of several deposits to professional settlement accounts related to end-of-the-year real estate and business closings. The decrease as of September 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 $393,128,000 on September 30, 2013, a decrease of 1.48%. Total deposits decreased for the reasons set forth in the prior paragraph.

Total loans, excluding loans held for sale, increased to $335,455,000 on September 30, 2013 from $325,457,000 on December 31, 2012. Loans, net of unearned income and allowance, increased to $330,472,000 on September 30, 2013 from $319,922,000 on December 31, 2012, an increase of 3.30%. The following summarizes the position of the Bank’s loan portfolio as of the dates indicated by dollar amount and percentages (dollar amounts in thousands):

 

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

Commercial

   $ 54,943         16.38   $ 55,084         16.93

Commercial Real Estate

     164,275         48.96     153,416         47.13

Consumer

     69,277         20.66     70,639         21.71

Residential

     46,960         14.00     46,318         14.23
  

 

 

    

 

 

   

 

 

    

 

 

 

Total loans

   $ 335,455         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 $5,723,000 on September 30, 2013 from $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 36.62% to $4,022,000 on September 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 $1,181,000 and $862,000 as of September 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 nine months ended September 30, 2013, the Bank acquired 18 additional OREO properties and disposed of 12 OREO properties, and as of September 30, 2013 the Bank is carrying 23 OREO properties at a value of $1,701,000. The OREO properties are available for sale and are being actively marketed on the Bank’s website and through other means.

 

36


Table of Contents

The Bank had loans in the amount of $567,000 at September 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 $26,785,000 on September 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 increased to $3,543,000 on September 30, 2013 from $3,075,000 on December 31, 2012. Securities available-for-sale decreased to $46,811,000 on September 30, 2013, from $50,294,000 December 31, 2012. During the nine months ended September 30, 2013 the Bank received $2,188,000 in proceeds from maturities and/or calls of securities available-for-sale and $22,607,000 in proceeds from the sale of securities available-for-sale. The Bank purchased $25,162,000 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 September 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 September 30, 2013, Financial, on a consolidated basis, had liquid assets of $73,596,000 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 September 30, 2013. Management 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.

 

37


Table of Contents

At September 30, 2013, the Bank had a leverage ratio of 9.01%, a Tier 1 risk-based capital ratio of 11.90% and a total risk-based capital ratio of 13.15%. As of September 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 September 30, 2013 and December 31, 2012:

Bank Level Only Capital Ratios

 

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

Tier 1 capital

     

Common Stock

   $ 3,743       $ 3,742   

Surplus

     19,325         19,325   

Retained earnings

     15,787         13,006   
  

 

 

    

 

 

 

Total Tier 1 capital

   $ 38,855       $ 36,073   
  

 

 

    

 

 

 

Tier 2 capital

     

Allowance for loan losses

   $ 4,093       $ 4,064   

Total Tier 2 capital:

   $ 4,093       $ 4,064   
  

 

 

    

 

 

 

Total risk-based capital

   $ 42,948       $ 40,137   
  

 

 

    

 

 

 

Risk weighted assets

   $ 326,590       $ 323,655   

Average total assets

   $ 431,075       $ 428,851   

 

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

Capital Ratios:

        

Tier 1 capital to average total assets

     9.01     8.41     4.00     5.00

Tier 1 risk-based capital ratio

     11.90     11.15     4.00     6.00

Total risk-based capital ratio

     13.15     12.40     8.00     10.00

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 Nine months Ended September 30, 2013 and 2012

Earnings Summary

Financial had net income including all operating segments of $813,000 and $2,398,000 for the three and nine months ended September 30, 2013 compared to $539,000 and $1,385,000 for the comparable periods in 2012. The basic and diluted earnings per common share for the three months ended September 30, 2013 was $0.24 and the basic and diluted earnings per common share for the nine months ended September 30, 2013 was $0.72 and $0.71 respectively, compared to basic and diluted earnings per share of $0.16 and $0.41 for the three and nine months ended September 30, 2012.

 

38


Table of Contents

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 $400,000.

These operating results represent an annualized return on stockholders’ equity of 10.55% and 10.76% for the three and nine months ended September 30, 2013, compared with 7.73% and 6.78% for the same periods in 2012. The Company had an annualized return on average assets for the three and nine months ended September 30, 2013 of 0.74% and 0.74% compared with 0.49% and 0.43% for the three and nine months ended September 30, 2012.

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

Interest Income, Interest Expense, and Net Interest Income

Interest income decreased to $4,573,000 and $13,677,000 for the three and nine months ended September 30, 2013 from $4,763,000 and $14,094,000 for the same periods in 2012, decreases of 3.99% and 2.96%, respectively. Interest income decreased primarily because the average rate received on earning assets decreased to 4.66% and 4.69% for the three and nine months ended September 30, 2013 as compared with 4.83% and 4.82% 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 $606,000 and $1,832,000 for the three and nine months ended September 30, 2013 from $736,000 and $2,365,000 for the same periods in 2012, decreases of 17.66% and 22.54%, 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 0.53% and 0.55% during the three and nine month periods ended September 30, 2013 as compared to 0.65% and 0.73% 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.

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 nine months ended September 30, 2013 was $3,967,000 and $11,845,000 compared with $4,027,000 and $11,729,000 for the same periods in 2012. The change in net interest income for the three and nine months ended September 30, 2013 as compared with the comparable periods in 2012 was immaterial because the net interest margin remained relatively stable. The net interest margin was 4.06% for the both three and nine months ended September 30, 2013, as compared to 4.09% and 4.01% for the same periods a year ago.

Financial’s net interest margin analysis and average balance sheets are shown in Schedule I on page 46.

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

 

39


Table of Contents

$758,000 and $2,233,000 for the three and nine months ended September 30, 2013 from $811,000 and $2,155,000 for the three and nine months ended September 30, 2013. This decrease for the three months ended September 30, 2013 as compared to the same period last year was due primarily to a decrease in mortgage originations resulting from an increase in interest rates and the resulting decrease in refinancing activity. The increase for the nine months ended September 30, 2013 as compared to the same period last year was due to increases in mortgage origination fees and service charges, fees, and commissions. The increase in mortgage loan rates occurred in the third quarter of 2013 and therefore did not impact the year to date mortgage revenue. Management expects that although purchase money loans will offset a portion of the decline in refinance activity, revenue from the mortgage segment will be under pressure during the rising interest rate environment. Gain on sales of securities decreased to $11,000 and $405,000 for the three and nine months ended September 30, 2013 from $241,000 and $411,000 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 decreased in the three month period and increased in the nine month period ended September 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.

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 months ended September 30, 2013 decreased to $3,568,000 from $3,783,000, or a decrease of 5.68%, for the comparable period in 2013. This decrease resulted from a decrease in expenses related to other real estate expenses. Non-interest expense for the nine months ended September 30, 2013 increased to $10,770,000 from $10,626,000, or 1.36%, for the comparable period in 2013. This increase in non-interest expense from the comparable period in 2012 can be

 

40


Table of Contents

attributed in large part to an increase in compensation expense, discussed in more detail in the following paragraph, and professional, data and other outside expense resulting from increased data processing charges related to a larger customer based and the startup costs related to the introduction of new products. Other real estate expenses consist primarily of insurance, maintenance, real estate taxes, and other expenses related to property ownership.

Total personnel expense was $1,755,000 and $5,257,000 for the three and nine month periods ended September 30, 2013 as compared to $1,608,000 and $4,657,000 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, no provision was required for the three month period ended September 30, 2013 and the Bank provided $290,000 to the allowance for loan loss for the nine months ended September 30, 2013. This compares to provisions of $601,000 and $1,776,000 for the comparable periods in 2012, representing decreases of 100.00% and 83.67%, respectively.

The decrease in the loan loss provision for the three and nine months ended September 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 and nine months ended September 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 September 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 $619,000 and $1,850,000 for the three and nine month periods ended September 30, 2012 to $513,000 and $970,000 for the comparable periods in 2013.

Management believes that the current allowance for loan loss of $4,983,000 (or 1.49% of total loans) at September 30, 2013, as compared to $5,535,000 (or 1.70% of total loans) as of December 31, 2012, is adequate.

 

41


Table of Contents

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 Nine months Ended September 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     (797     (126     (28     (970

Recoveries

     30        38        60        —          128   

Provision

     103        (152     28        7        290   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Ending Balance

     1,101        2,242        1,019        621        4,983   

Ending Balance: Individually evaluated for impairment

   $ 512      $ 185      $ 160      $ 226      $ 1,083   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Ending Balance: Collectively evaluated for impairment

     589        2,057        859        395        3,900   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Totals:

   $ 1,101      $ 2,242      $ 1,019      $ 621      $ 4,983   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Financing Receivables:

          

Ending Balance: Individually evaluated for impairment

     5,161        5,197        217        2,888        13,463   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Ending Balance: Collectively evaluated for impairment

     49,782        159,078        69,060        44,072        321,992   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Totals:

   $ 54,943      $ 164,275      $ 69,277      $ 46,960      $ 335,455   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

42


Table of Contents
     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   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

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

 

     Three months ended
September 30,
(in thousands)
   

Nine months ended
September 30,

(in thousands)

 
     2013     2012     2013     2012  

Balance, beginning of period

   $ 5,475      $ 5,693      $ 5,535      $ 5,612   

Provision for loan losses

     —          601        290        1,776   

Loans charged off

     (513     (619     (970     (1,850

Recoveries of loans charged off

     21        18        128        155   
  

 

 

   

 

 

   

 

 

   

 

 

 

Net charge offs

     (492     (601     (842     (1,695
  

 

 

   

 

 

   

 

 

   

 

 

 

Balance, end of period

   $ 4,983      $ 5,693      $ 4,983      $ 5,693   
  

 

 

   

 

 

   

 

 

   

 

 

 

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.

 

43


Table of Contents

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.

 

44


Table of Contents

The decrease in the balance in the allowance for loan loss reserve as of September 30, 2013 as compared to December 31, 2012 resulted from provisions being lower than the net charge-offs during the first nine months of 2013. Charge-offs realized during the first nine months of 2013 had been provided for in the reserve in previous fiscal years. The loan loss reserve is determined as discussed above.

Net charge offs decreased to $492,000 and $842,000 for the three and nine months ended September 30, 2013 from $601,000 and $1,695,000 for the same periods in 2012. Charged off loans, which are loans that management deems uncollectible, are written against the loan loss reserve and constitute a realized loss. While a charged off loan may subsequently be collected, such recoveries generally are realized over an extended period of time.

Income Taxes

For the three and nine months ended September 30, 2013, Financial had an income tax expense of $355,000 and $1,025,000, respectively, as compared to $156,000 and $508,000 for the three and nine months ended September 30, 2013. This represents an effective tax rate of 30.39% and 29.94% for the for the three and nine month periods ended September 30, 2013 and 22.45% and 26.84% for the three and nine month periods ended September 30, 2012.

Legislation

Expiration of the FDIC’s Transaction Account Guarantee Program (“TAG”). Temporary unlimited deposit insurance coverage for noninterest-bearing transaction accounts under the Dodd-Frank Act expired on December 31, 2012. TAG, which was originally part of the Temporary Liquidity Guarantee Program of 2008, added unlimited insurance coverage to noninterest bearing accounts, regardless of balance. This temporary unlimited coverage was in addition to, and separate from, the general FDIC deposit insurance coverage of up to $250,000 available to depositors. Depending on the perceptions by depositors of the safety and soundness of banking institutions, the termination of the TAG program could result in deposit disintermediation in individual banks and in the banking industry as a whole. As of the date hereof, we have not experienced any material disintermediation.

 

45


Table of Contents

Schedule I

Net Interest Margin Analysis

Average Balance Sheets

For the Quarter Ended September 30, 2013 and 2012

 

     2013     2012  
    

Average

Balance

Sheet

   

Interest

Income/

Expense

    

Average

Rates
Earned/

Paid

   

Average

Balance

Sheet

   

Interest

Income/

Expense

    

Average

Rates

Earned/

Paid

 

ASSETS

              

Loans, including fees (1) (2)

   $ 334,296      $ 4,205         4.99   $ 323,871      $ 4,318         5.29

Loans held for sale

     891        8         3.56     1,663        14         1.69

Federal funds sold

     10,121        9         0.35     8,804        7         0.32

Securities (3)

     50,404        440         3.47     57,489        451         3.11

Federal agency equities

     1,312        4         1.21     1,792        4         0.89

CBB equity

     116        —           —          116        —           —     
  

 

 

   

 

 

    

 

 

   

 

 

   

 

 

    

 

 

 

Total earning assets

     397,140        4,666         4.66     393,735        4,794         4.83
    

 

 

    

 

 

     

 

 

    

 

 

 

Allowance for loan losses

     (5,349          (5,766     

Non-earning assets

     42,885             44,363        
  

 

 

        

 

 

      

Total assets

   $ 434,676           $ 432,332        
  

 

 

        

 

 

      

LIABILITIES AND STOCKHOLDERS’ EQUITY

              

Deposits

              

Demand interest bearing

   $ 95,997      $ 50         0.21   $ 85,186      $ 56         0.26

Savings

     133,461        71         0.21     147,880        108         0.29

Time deposits

     95,939        316         1.31     93,766        373         1.58
  

 

 

   

 

 

    

 

 

   

 

 

   

 

 

    

 

 

 

Total interest bearing deposits

     325,397        437         0.53     326,832        537         0.65

Other borrowed funds

              

Other borrowings

     2,000        19         3.77     6,207        50         3.20

Capital Notes

     10,000        150         6.00     9,848        149         6.00
  

 

 

   

 

 

    

 

 

   

 

 

   

 

 

    

 

 

 

Total interest-bearing liabilities

     337,397        606         0.71     342,887        736         0.85
    

 

 

    

 

 

     

 

 

    

 

 

 

Non-interest bearing deposits

     66,267             61,703        

Other liabilities

     442             86        
  

 

 

        

 

 

      

Total liabilities

     404,106             404,676        

Stockholders’ equity

     30,570             27,656        
  

 

 

        

 

 

      

Total liabilities and Stockholders’ equity

   $ 434,676           $ 432,332        
  

 

 

        

 

 

      

Net interest income

     $ 4,060           $ 4,058      
    

 

 

        

 

 

    

Net interest margin

          4.06          4.09
       

 

 

        

 

 

 

Interest spread

          3.95          3.98
       

 

 

        

 

 

 

 

46


Table of Contents
(1) Net deferred loan fees and costs are included in interest income.
(2) Nonperforming loans are included in the average balances. However, interest income and yields calculated do not reflect any accrued interest associated with non-accrual loans.
(3) The interest income and yields calculated on securities have been tax affected to reflect any tax exempt interest on municipal securities.

 

47


Table of Contents

Net Interest Margin Analysis

Average Balance Sheets

For the Nine months Ended September 30, 2013 and 2012

 

     2013     2012  
    

Average

Balance

Sheet

   

Interest

Income/

Expense

    

Average

Rates
Earned/

Paid

   

Average

Balance

Sheet

   

Interest

Income/

Expense

    

Average

Rates

Earned/

Paid

 

ASSETS

              

Loans, including fees (1) (2)

   $ 331,198      $ 12,550         5.07   $ 322,160      $ 12,706         5.27

Loans held for sale

     921        25         3.63     1,109        28         3.38

Federal funds sold

     8,607        24         0.37     8,908        18         0.27

Securities (3)

     50,601        1,137         3.00     59,409        1,388         3.12

Federal agency equities

     1,344        34         3.38     1,827        33         2.41

CBB equity

     116        —           —          116        —           —     
  

 

 

   

 

 

    

 

 

   

 

 

   

 

 

    

 

 

 

Total earning assets

     392,787        13,770         4.69     393,529        14,173         4.82
    

 

 

    

 

 

     

 

 

    

 

 

 

Allowance for loan losses

     (5,488          (5,805     

Non-earning assets

     43,774             41,932        
  

 

 

        

 

 

      

Total assets

   $ 431,073           $ 429,656        
  

 

 

        

 

 

      

LIABILITIES AND STOCKHOLDERS’ EQUITY

              

Deposits

              

Demand interest bearing

   $ 92,670      $ 155         0.22   $ 79,113      $ 181         0.31

Savings

     135,289        214         0.21     153,485        397         0.35

Time deposits

     94,551        956         1.35     92,293        1,186         1.72
  

 

 

   

 

 

    

 

 

   

 

 

   

 

 

    

 

 

 

Total interest bearing deposits

     322,510        1,325         0.55     324,891        1,764         0.73

Other borrowed funds

              

Fed funds purchased

     16        —           —          —          —           —     

Repurchase agreements

     —          —           —          2,188        15         0.92

Other borrowings

     2,000        57         3.81     8,726        199         3.05

Capital Notes

     10,000        450         6.00     8,002        387         6.00
  

 

 

   

 

 

    

 

 

   

 

 

   

 

 

    

 

 

 

Total interest-bearing liabilities

     334,526        1,832         0.73     343,807        2,365         0.92
    

 

 

    

 

 

     

 

 

    

 

 

 

Non-interest bearing deposits

     66,317             58,051        

Other liabilities

     436             575        
  

 

 

        

 

 

      

Total liabilities

     401,279             402,433        

Stockholders’ equity

     29,794             27,223        
  

 

 

        

 

 

      

Total liabilities and Stockholders’ equity

   $ 431,073           $ 429,656        
  

 

 

        

 

 

      

Net interest income

     $ 11,938           $ 11,808      
    

 

 

        

 

 

    

Net interest margin

          4.06          4.01
       

 

 

        

 

 

 

Interest spread

          3.96          3.90
       

 

 

        

 

 

 

 

48


Table of Contents
(1) Net deferred loan fees and costs are included in interest income.
(2) Nonperforming loans are included in the average balances. However, interest income and yields calculated do not reflect any accrued interest associated with non-accrual loans.
(3) The interest income and yields calculated on securities have been tax affected to reflect any tax exempt interest on municipal securities.

 

49


Table of Contents

Item 3. Quantitative and Qualitative Disclosures About Market Risk

Not applicable

Item 4. Controls and Procedures

EVALUATION OF DISCLOSURE CONTROLS AND PROCEDURES

Financial’s management, including Financial’s principal executive officer and principal financial officer, have evaluated the effectiveness of the Company’s “disclosure controls and procedures,” as such term is defined in Rule 13a-15(e) promulgated under the Securities Exchange Act of 1934, as amended, (the “Exchange Act”). Based upon their evaluation, the principal executive officer and principal financial officer concluded that, as of the end of the period covered by this report, Financial’s disclosure controls and procedures were effective for the purpose of ensuring that the information required to be disclosed in the reports that Financial files or submits under the Exchange Act with the Securities and Exchange Commission (the “SEC”) (1) is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and (2) is accumulated and communicated to the Company’s management, including its principal executive and principal financial officers, as appropriate to allow timely decisions regarding required disclosure.

There have been no significant changes during the quarter ended September 30, 2013, in the Company’s internal controls over financial reporting (as defined in Rules 13a-15(e) and 15d-15(e) of the Securities Exchange Act of 1934) or in other factors that could have significantly affected those controls subsequent to the date of our most recent evaluation of internal controls over financial reporting, including any corrective actions with regard to significant deficiencies and material weaknesses.

PART II – OTHER INFORMATION

Item 1. Legal Proceedings

The Company is not involved in any pending legal proceedings at this time, other than routine litigation incidental to its business.

 

Item 1A. Risk Factors

Not applicable

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

Not applicable

Item 3. Defaults Upon Senior Securities

Not applicable

Item 4. Mine Safety Disclosures

Not applicable

Item 5. Other Information

Not applicable

 

50


Table of Contents

Item 6. Exhibits

 

Exhibit
No.

  

Description of Exhibit

  31.1    Certification of Robert R. Chapman III Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002, dated November 8, 2013
  31.2    Certification of J. Todd Scruggs Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002, dated November 8, 2013
  32.1    Certification Pursuant To 18 U.S.C. Section 1350, As Adopted Pursuant To Section 906 Of The Sarbanes-Oxley Act Of 2002, dated November 8, 2013
101    The following materials from Bank of the James Financial Group, Inc.’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2013, formatted in eXtensible Business Reporting Language (XBRL): (i) Consolidated Balance Sheets (unaudited) as of September 30, 2013 and December 31, 2012; (ii) Consolidated Statements of Income (unaudited) for the Three and Nine months ended September 30, 2013 and 2012; (iii) Consolidated Statements of Comprehensive Income (unaudited) for the Three and Nine months ended September 30, 2013 and 2012 (iv) Consolidated Statements of Cash Flows (unaudited) for the Nine months ended September 30, 2013 and 2012 (v) Unaudited Consolidated Statements of Changes in Stockholders’ Equity for the Nine months ended September 30, 2012 and the Nine months Ended September 30, 2013; (vi) Notes to Unaudited Consolidated Financial Statements.

 

51


Table of Contents

SIGNATURES

In accordance with the requirements of the Exchange Act, the registrant caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

 

    BANK OF THE JAMES FINANCIAL GROUP, INC.
Date: November 8, 2013     By  

/S/ Robert R. Chapman III

      Robert R. Chapman III, President
      (Principal Executive Officer)
Date: November 8, 2013     By  

/S/ J. Todd Scruggs

      J. Todd Scruggs, Secretary and Treasurer
      (Principal Financial Officer and Principal Accounting Officer)

 

52


Table of Contents

Index of Exhibits

 

Exhibit
No.

  

Description of Exhibit

  31.1    Certification of Robert R. Chapman III Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002, dated November 8, 2013
  31.2    Certification of J. Todd Scruggs Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002, dated November 8, 2013
  32.1    Certification Pursuant To 18 U.S.C. Section 1350, As Adopted Pursuant To Section 906 Of The Sarbanes-Oxley Act Of 2002, dated November 8, 2013
101    The following materials from Bank of the James Financial Group, Inc.’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2013, formatted in eXtensible Business Reporting Language (XBRL): (i) Consolidated Balance Sheets (unaudited) as of September 30, 2013 and December 31, 2012; (ii) Consolidated Statements of Income (unaudited) for the Three and Nine months ended September 30, 2013 and 2012; (iii) Consolidated Statements of Comprehensive Income (unaudited) for the Three and Nine months ended September 30, 2013 and 2012 (iv) Consolidated Statements of Cash Flows (unaudited) for the Nine months ended September 30, 2013 and 2012 (v) Unaudited Consolidated Statements of Changes in Stockholders’ Equity for the Nine months ended September 30, 2012 and the Nine months Ended September 30, 2013; (vi) Notes to Unaudited Consolidated Financial Statements.

 

53