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 March 31, 2018

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.    Yes  ☒    No  ☐

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

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

Large accelerated filer	☐	Accelerated filer	☐
Non-accelerated filer	☐  (do not check if a smaller reporting company)	Smaller reporting company	☒
Emerging growth company	☐

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.  ☐

Indicate by check mark whether the registrant is a shell company (as defined by Rule 12b-2 of the Exchange Act).    Yes  ☐    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: 4,378,436 shares of Common Stock, par value $2.14 per share, were outstanding at May 8, 2018.

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	48
Item 4.	Controls and Procedures	48
PART II – OTHER INFORMATION		49
Item 1.	Legal Proceedings	49
Item 1A.	Risk Factors	49
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	49
Item 3.	Defaults Upon Senior Securities	49
Item 4.	Mine Safety Disclosures	49
Item 5.	Other Information	50
Item 6.	Exhibits	50
SIGNATURES		51

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) (2018 unaudited)

	March 31,			December 31,
	2018			2017
Assets
Cash and due from banks	$	21,769		$	20,267
Federal funds sold		33,519			16,751
Total cash and cash equivalents		55,288			37,018
Securities held-to-maturity (fair value of $3,478 in 2018 and $5,619 in 2017)		3,708			5,713
Securities available-for-sale, at fair value		54,633			55,312
Restricted stock, at cost		1,887			1,505
Loans, net of allowance for loan losses of $4,671 in 2018 and 4,752 in 2017		501,877			491,022
Loans held for sale		3,448			2,626
Premises and equipment, net		12,109			12,055
Interest receivable		1,827			1,713
Cash value - bank owned life insurance		13,103			13,018
Other real estate owned		2,096			2,650
Income taxes receivable		1,012			1,366
Deferred tax asset, net		1,644			1,418
Other assets		1,003			925
Total assets	$	653,635		$	626,341
Liabilities and Stockholders’ Equity
Deposits
Noninterest bearing demand	$	83,964		$	74,102
NOW, money market and savings		318,523			307,987
Time		182,029			185,404
Total deposits		584,516			567,493
FHLB borrowings		10,000			—
Capital notes		5,000			5,000
Interest payable		108			111
Other liabilities		2,336			2,072
Total liabilities	$	601,960		$	574,676
Commitments and Contingencies
Stockholders’ equity
Preferred stock; authorized 1,000,000 shares; none issued and outstanding	$	—		$	—
Common stock $2.14 par value; authorized 10,000,000 shares; issued and outstanding 4,378,436 as of March 31, 2018 and December 31, 2017		9,370			9,370
Additional paid-in-capital		31,495			31,495
Retained earnings		13,129			12,269
Accumulated other comprehensive (loss)		(2,319	)		(1,469	)
Total stockholders’ equity	$	51,675		$	51,665
Total liabilities and stockholders’ equity	$	653,635		$	626,341

See accompanying notes to these consolidated financial statements

1

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 Ended
	March 31,
	2018		2017
Interest Income
Loans	$	5,674	$	5,188
Securities
US Government and agency obligations		198		113
Mortgage backed securities		68		66
Municipals - taxable		79		69
Municipals - tax exempt		3		11
Dividends		8		7
Other (Corporates)		23		27
Interest bearing deposits		35		15
Federal Funds sold		67		13
Total interest income		6,155		5,509
Interest Expense
Deposits
NOW, money market savings		192		169
Time Deposits		581		465
FHLB borrowings		1		—
Capital notes 4% due 1/24/2022		50		37
Total interest expense		824		671
Net interest income		5,331		4,838
Provision for loan losses		22		100
Net interest income after provision for loan losses		5,309		4,738
Noninterest income
Gain on sales of loans held for sale		620		371
Service charges, fees and commissions		464		385
Increase in cash value of life insurance		85		86
Other		17		9
Gain on sales and calls of securities, net		—		10
Total noninterest income		1,186		861
Noninterest expenses
Salaries and employee benefits		2,713		2,380
Occupancy		395		372
Equipment		379		348
Supplies		149		134
Professional, data processing, and other outside expense		815		680
Marketing		140		148
Credit expense		125		94
Other real estate expenses		40		12
FDIC insurance expense		101		103
Other		240		226
Total noninterest expenses		5,097		4,497
Income before income taxes		1,398		1,102
Income tax expense		275		342
Net Income	$	1,123	$	760
Weighted average shares outstanding - basic		4,378,436		4,378,436
Weighted average shares outstanding - diluted		4,378,526		4,378,535
Earnings per common share - basic	$	0.26	$	0.17
Earnings per common share - diluted	$	0.26	$	0.17

See accompanying notes to these consolidated financial statements

2

Bank of the James Financial Group, Inc. and Subsidiaries

Consolidated Statements of Comprehensive Income

For the Three Months Ended March 31, 2018 and 2017

(dollar amounts in thousands) (unaudited)

	For the Three Months Ended March 31,
	2018			2017
Net Income	$	1,123		$	760
Other comprehensive (loss) income:
Unrealized (losses) gains on securities available-for-sale		(1,076	)		423
Tax effect		226			(144	)
Reclassification adjustment for gains included in net income (1)		—			(10	)
Tax effect (2)		—			4
Other comprehensive (loss) income, net of tax		(850	)		273
Comprehensive income	$	273		$	1,033

(1) Gains are included in “gain on sales and calls of securities, net” on the consolidated statements of income.

(2) The tax effect on these reclassifications is reflected in “income tax expense” on the consolidated statements of income.

See accompanying notes to these consolidated financial statements

3

Bank of the James Financial Group, Inc. and Subsidiaries

Consolidated Statements of Cash Flows

Three Months Ended March 31, 2018 and 2017

(dollar amounts in thousands) (unaudited)

	For the Three Months Ended March 31,
	2018			2017
Cash flows from operating activities
Net Income	$	1,123		$	760
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization		213			188
Net amortization and accretion of premiums and discounts on securities		104			93
(Gain) on sales of available-for-sale securities		—			(10	)
(Gain) on sales of loans held for sale		(620	)		(371	)
Proceeds from sales of loans held for sale		24,947			15,543
Origination of loans held for sale		(25,149	)		(12,972	)
Provision for loan losses		22			100
(Gain) loss on sale of other real estate owned		(5	)		8
Impairment of other real estate owned		34			—
(Increase) in cash value of life insurance		(85	)		(86	)
(Increase) decrease in interest receivable		(114	)		13
(Increase) in other assets		(78	)		(224	)
Decrease in income taxes receivable		354			342
(Decrease) in interest payable		(3	)		(11	)
Increase in other liabilities		264			392
Net cash provided by operating activities	$	1,007		$	3,765
Cash flows from investing activities
Proceeds from calls of securities held-to-maturity	$	2,000		$	—
Purchases of securities available-for-sale		(998	)		(9,568	)
Proceeds from maturities, calls and paydowns of securities available-for-sale		502			1,490
Proceeds from sale of securities available-for-sale		—			970
Purchase of Federal Home Loan Bank stock		(382	)		(42	)
Proceeds from sale of other real estate owned		525			147
Origination of loans, net of principal collected		(10,877	)		(2,526	)
Purchases of premises and equipment		(267	)		(484	)
Net cash (used in) investing activities	$	(9,497	)	$	(10,013	)
Cash flows from financing activities
Net increase (decrease) in deposits	$	17,023		$	(1,913	)
Proceeds from Federal Home Loan Bank advances		10,000			—
Dividends paid to common stockholders		(263	)		(263	)
Proceeds fom sale of 4% capital notes due 1/24/2022		—			5,000
Net cash provided by financing activities	$	26,760		$	2,824
Increase (decrease) in cash and cash equivalents		18,270			(3,424	)
Cash and cash equivalents at beginning of period	$	37,018		$	28,683
Cash and cash equivalents at end of period	$	55,288		$	25,259
Non cash transactions
Transfer of loans to other real estate owned	$	—		$	535
Fair value adjustment for securities available-for-sale		(1,076	)		413
Cash transactions
Cash paid for interest	$	827		$	682
Cash paid for income taxes		—			—

See accompanying notes to these consolidated financial statements

4

Bank of the James Financial Group, Inc. and Subsidiaries

Consolidated Statements of Changes in Stockholders’ Equity

For the Three Months Ended March 31, 2018 and 2017

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

										Accumulated
					Additional					Other
	Shares		Common		Paid-in		Retained			Comprehensive
	Outstanding		Stock		Capital		Earnings			(Loss)			Total
Balance at December 31, 2016		4,378,436	$	9,370	$	31,495	$	10,156		$	(1,600	)	$	49,421
Net Income		—		—		—		760			—			760
Dividends paid on common stock ($0.06 per share)		—		—		—		(263	)		—			(263	)
Other comprehensive income		—		—		—		—			273			273
Balance at March 31, 2017		4,378,436	$	9,370	$	31,495	$	10,653		$	(1,327	)	$	50,191
Balance at December 31, 2017		4,378,436	$	9,370	$	31,495	$	12,269		$	(1,469	)	$	51,665
Net Income		—		—		—		1,123			—			1,123
Dividends paid on common stock ($0.06 per share)		—		—		—		(263	)		—			(263	)
Other comprehensive loss		—		—		—		—			(850	)		(850	)
Balance at March 31, 2018		4,378,436	$	9,370	$	31,495	$	13,129		$	(2,319	)	$	51,675

See accompanying notes to these consolidated financial statements

5

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 March 31, 2018 and for the three months ended March 31, 2018 and 2017 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, 2017. These financial statements should be read in conjunction with the audited consolidated financial statements and footnotes for the year ended December 31, 2017 included in Financial’s Annual Report on Form 10-K. Results for the three month period ended March 31, 2018 are not necessarily indicative of the results that may be expected for the year ending December 31, 2018.

Certain immaterial reclassifications have been made to prior period balances to conform to the current period presentation. Reclassifications had no effect on prior year net income or stockholders’ equity.

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. Recently, the Company has expanded into Charlottesville, Roanoke, and Harrisonburg.

Financial’s critical accounting policies include the evaluation of the allowance for loan losses which is based on management’s estimate of an amount that is adequate to absorb probable losses inherent in the 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 losses based on available information including the composition of the loan portfolio, historical loan losses, 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 policy with respect to the methodology for determining the allowance for loan losses involves a higher degree of complexity and requires management to make subjective judgments that often require assumptions or estimates about uncertain matters. This critical policy and its assumptions are periodically reviewed with the Board of Directors.

Financial also considers valuation of other real estate owned (OREO) a critical accounting policy. OREO consists of properties acquired through foreclosure or deed in lieu of foreclosure. These properties are carried at fair value less estimated costs to sell at the date of foreclosure. Losses from the acquisition of property in full or partial satisfaction of loans are charged against the allowance for loan losses. Subsequent write-downs, if any, are charged against expense. Gains and losses on the sales of foreclosed properties are included in determining net income in the year of the sale. Operating costs after acquisition are expensed.

6

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 Common Share (EPS)

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 in calculating diluted earnings per share. The following is a summary of the earnings per share calculation for the three months ended March 31, 2018 and 2017.

	Three Months Ended
	March 31,
	2018		2017
Net income	$	1,123,000	$	760,000
Weighted average number of shares		4,378,436		4,378,436
Options effect of incremental shares		90		99
Weighted average diluted shares		4,378,526		4,378,535
Basic EPS (weighted avg shares)	$	0.26	$	0.17
Diluted EPS (Including Option Shares)	$	0.26	$	0.17

No option shares were excluded in calculating diluted earnings per share for either of the periods presented.

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

Note 4 – Stock Based Compensation (continued)

Stock option plan activity for the three months ended March 31, 2018 is summarized below:

					Weighted
			Weighted		Average
			Average		Remaining
			Exercise		Contractual		Intrinsic
	Shares		Price		Life (in years)		Value
Options outstanding, January 1, 2018		636	$	12.79
Granted		—		—
Exercised		—		—
Forfeited		—		—
Options outstanding, March 31, 2018		636	$	12.79		0.17	$	2
Options exercisable, March 31, 2018		636	$	12.79		0.17	$	2

Intrinsic value is calculated by subtracting the exercise price of option shares from the market price of underlying shares as of March 31, 2018 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

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:

Fair Value on a Recurring Basis

Securities Available-for-Sale

Fair values of securities, excluding restricted investments in Federal Reserve Bank stock, Federal Home Loan Bank stock, and Community Bankers’ Bank stock are based on quoted prices available in an active market. If quoted prices are available, these 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.

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

9

Note 5 – Fair Value Measurements (continued)

			Carrying Value at March 31, 2018 (in thousands)
Description	Balance as of March 31, 2018		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
US Treasuries	$	1,814	$	—	$	1,814	$	—
US agency obligations		23,218		—		23,218		—
Mortgage-backed securities		13,665		—		13,665		—
Municipals		12,139		—		12,139		—
Corporates		3,797		—		3,797		—
Total available-for-sale securities	$	54,633	$	—	$	54,633	$	—
			Carrying Value at December 31, 2017 (in thousands)
Description	Balance as of December 31, 2017		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
US Treasuries	$	1,858	$		$	1,858	$
US agency obligations		23,850		—		23,850		—
Mortgage-backed securities		13,388		—		13,388		—
Municipals		12,274		—		12,274		—
Corporates		3,942		—		3,942		—
Total available-for-sale securities	$	55,312	$	—	$	55,312	$	—

Fair Value on a Non-recurring Basis

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 when due. 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, in situations where the collateral is a house or building in the process of construction, the appraisal is more than 12 months old, management has determined the fair value of the collateral is further impaired below the appraised value, or the appraisal is not based solely on market comparables adjusted for observable inputs, the 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

Note 5 – Fair Value Measurements (continued)

Loans held for sale

Loans held for sale are carried at cost which approximates 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 March 31, 2018. Gains and losses on the sale of loans are recorded within gains on sales of loans held for sale, net 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 property 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).

Any fair value adjustments are recorded in the period incurred and expensed against current earnings. However, in situations where the collateral is a house or building in the process of construction, the appraisal is more than 12 months old, management has determined the fair value of the collateral is further impaired below the appraised value, or the appraisal is not based solely on market comparables adjusted for observable inputs, the value is considered 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 March 31, 2018
Description	Balance as of March 31, 2018		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Impaired loans*	$	2,266	$	—	$	—	$	2,266
Loans held for sale		3,448		—		3,448		—
Other real estate owned		2,096		—		—		2,096

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

			Carrying Value at December 31, 2017
Description	Balance as of December 31, 2017		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Impaired loans*	$	2,523	$	—	$	—	$	2,523
Loans held for sale		2,626		—		2,626		—
Other real estate owned		2,650		—		—		2,650

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

11

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 March 31, 2018 (dollars in thousands)
	Fair Value		Valuation Technique(s)		Unobservable Input	Range (Weighted Average)
Assets
Impaired loans	$	2,266		Discounted appraised value	Selling cost		0% - 10% (8%	)
					Discount for lack of marketability and age of appraisal		0% - 20% (6%	)
OREO		2,096		Discounted appraised value	Selling cost		0% - 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,  2017 (dollars in thousands)
	Fair Value		Valuation Technique(s)		Unobservable Input	Range (Weighted Average)
Assets
Impaired loans	$	2,523		Discounted appraised value	Selling cost		0% - 10% (8%	)
					Discount for lack of marketability and age of appraisal		0% - 20% (6%	)
OREO		2,650		Discounted appraised value	Selling cost		0% - 10% (6%	)
					Discount for lack of marketability and age of appraisal		0% - 25% (15%	)

12

Note 5 – Fair Value Measurements (continued)

The estimated fair values, and related carrying or notional amounts, of Financial’s financial instruments and their placement in the fair value hierarchy at March 31, 2018 and December 31, 2017 was as follows (in thousands):

			Fair Value Measurements at March 31, 2018 using
			Quoted Prices		Significant
			in Active		Other		Significant
			Markets for		Observable		Unobservable
	Carrying		Identical Assets		Inputs		Inputs
	Amounts		(Level 1)		(Level 2)		(Level 3)		Balance
Assets
Cash and due from banks	$	21,769	$	21,769	$	—	$	—	$	21,769
Fed funds sold		33,519		33,519		—		—		33,519
Securities
Available-for-sale		54,633		—		54,633		—		54,633
Held-to-maturity		3,708		—		3,478		—		3,478
Restricted stock		1,887				1,887		—		1,887
Loans, net (1)		501,877		—		—		493,747		493,747
Loans held for sale		3,448		—		3,448		—		3,448
Interest receivable		1,827		—		1,827		—		1,827
BOLI		13,103		—		13,103		—		13,103
Liabilities
Deposits	$	584,516	$	—	$	585,276	$	—	$	585,276
FHLB borrowings		10,000		—		10,000		—		10,000
Capital notes		5,000		—		4,885		—		4,885
Interest payable		108		—		108		—		108
			Fair Value Measurements at December 31, 2017 using
			Quoted Prices		Significant
			in Active		Other		Significant
			Markets for		Observable		Unobservable
	Carrying		Identical Assets		Inputs		Inputs
	Amounts		(Level 1)		(Level 2)		(Level 3)		Balance
Assets
Cash and due from banks	$	20,267	$	20,267	$	—	$	—	$	20,267
Fed funds sold		16,751		16,751						16,751
Securities
Available-for-sale		55,312		—		55,312		—		55,312
Held-to-maturity		5,713		—		5,619		—		5,619
Restricted stock		1,505		—		1,505				1,505
Loans, net (1)		491,022		—		—		492,397		492,397
Loans held for sale		2,626		—		2,626		—		2,626
Interest receivable		1,713		—		1,713		—		1,713
BOLI		13,018		—		13,018		—		13,018
Liabilities
Deposits	$	567,493	$	—	$	568,224	$	—	$	568,224
Capital notes		5,000		—		5,310				5,310
Interest payable		111		—		111		—		111

(1) Carrying amount is net of unearned income and the Allowance. In accordance with the prospective adoption of ASU No. 2016-01, the fair value of loans as of March 31, 2018 was measured using an exit price notion. The fair value of loans as of December 31, 2017 was measured using an entry price notion.

13

Note 5 – Fair Value Measurements (continued)

Fair value estimates are made at a specific point in time, based on relevant market information and information about the financial instrument. These estimates do not reflect any premium or discount that could result from offering for sale at one time Financial’s entire holdings of a particular financial instrument. Because no market exists for a significant portion of Financial’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 Financial. Management attempts to match maturities of assets and liabilities to the extent believed necessary to minimize interest rate risk. However, borrowers with fixed rate obligations are less likely to prepay in a rising rate environment and more likely to prepay in a falling rate environment. Conversely, depositors who are receiving fixed rates are more likely to withdraw funds before maturity in a rising rate environment and less likely to do so in a falling rate environment.

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

Note 6 – Capital Notes

On January 25, 2017, Financial closed a private placement of unregistered debt securities (the “2017 Offering”) pursuant to which Financial issued $5,000,000 in principal of notes (the “2017 Notes”). The 2017 Notes bear interest at the rate of 4% per year with interest payable quarterly in arrears. The 2017 Notes are to mature on January 24, 2022, but are subject to prepayment in whole or in part on or after January 24, 2018 at Financial’s sole discretion on 30 days written notice to the holders. Of the proceeds, $3,000,000 was injected into the Bank as equity capital in March 2017. It is anticipated the remaining $2,000,000 will remain at the holding company level for debt service on the 2017 Notes.

14

Note 7 - Securities

The following tables summarize the Bank’s holdings for both securities held-to-maturity and securities available-for-sale as of March 31, 2018 and December 31, 2017 (amounts in thousands):

	March 31, 2018
	Amortized Costs		Gross Unrealized
			Gains		(Losses)			Fair Value
Held-to-Maturity
US agency obligations	$	3,708	$	—	$	(230	)	$	3,478
Available-for-Sale
US Treasuries		1,958		—		(144	)		1,814
US agency obligations		24,835		5		(1,622	)		23,218
Mortgage-backed securities		14,142		3		(480	)		13,665
Municipals		12,521		24		(406	)		12,139
Corporates		4,113		—		(316	)		3,797
	$	57,569	$	32	$	(2,968	)	$	54,633
	December 31, 2017
	Amortized Costs		Gross Unrealized
			Gains		(Losses)			Fair Value
Held-to-Maturity
US agency obligations	$	5,713	$	8	$	(102	)	$	5,619
Available-for-Sale
US Treasuries		1,956		—		(98	)		1,858
US agency obligations		24,881		5		(1,036	)		23,850
Mortgage-backed securities		13,662		2		(276	)		13,388
Municipals		12,556		16		(298	)		12,274
Corporates		4,117		—		(175	)		3,942
	$	57,172	$	23	$	(1,883	)	$	55,312

15

Note 7 – Securities (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 March 31, 2018 and December 31, 2017 (amounts in thousands):

	Less than 12 months				More than 12 months				Total
	Fair		Unrealized		Fair		Unrealized		Fair		Unrealized
March 31, 2018	Value		Losses		Value		Losses		Value		Losses
Description of securities
Held-to-maturity
US agency obligations	$	2,286	$	150	$	1,192	$	80	$	3,478	$	230
Available-for-sale
US Treasuries		—		—		1,814		144		1,814		144
US agency obligations		9,213		425		14,001		1,197		23,214		1,622
Mortgage-backed securities		1,414		36		11,415		444		12,829		480
Municipals		2,053		42		9,048		364		11,101		406
Corporates		—		—		3,797		316		3,797		316
Total	$	12,680	$	503	$	40,075	$	2,465	$	52,755	$	2,968
	Less than 12 months				More than 12 months				Total
	Fair		Unrealized		Fair		Unrealized		Fair		Unrealized
December 31, 2017	Value		Losses		Value		Losses		Value		Losses
Description of securities
Held-to-maturity
US agency obligations	$	2,367	$	70	$	1,243	$	32	$	3,610	$	102
Available-for-sale
US Treasuries		—		—		1,858		98		1,858		98
US agency obligations		11,465		215		12,379		821		23,844		1,036
Mortgage-backed securities		2,802		26		9,712		250		12,514		276
Municipals		4,823		41		5,644		257		10,467		298
Corporates		—		—		3,942		175		3,942		175
Total	$	19,090	$	282	$	33,535	$	1,601	$	52,625	$	1,883

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).

16

Note 7 – Securities (continued)

At March 31, 2018, the Company did not consider the unrealized losses as other-than-temporary losses due to the nature of the securities involved. As of March 31, 2018, the Bank owned 57 securities in an unrealized loss position that were being evaluated for other than temporary impairment. Twelve of these securities were S&P rated AAA, 42 were rated AA and three were rated A. As of March 31, 2018, 33 of these securities were direct obligations of the U.S. government or government sponsored entities, 19 were municipal issues, and five were investments in domestic corporate issued securities.

Based on the analysis performed by management as mandated by the Bank’s investment policy, management believes the default risk to be minimal. Because management does not intend to sell and it is likely that management will not be required to sell the securities prior to their anticipated recovery, and the decline in fair value is largely due to change in interest rates and other market conditions, no declines currently are deemed to be other-than-temporary.

There were no gross gains on available-for-sale securities during the three month period ended March 31, 2018 compared to $10 for the same respective period in 2017. There were no losses on sales of available-for-sale securities and no sales of held-to-maturity securities during the three month periods ended March 31, 2018 and 2017.

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 gain on sale 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.

17

Note 8 – Business Segments (continued)

Information about reportable business segments and reconciliation of such information to the consolidated financial statements for the three months ended March 31, 2018 and 2017 was as follows (dollars in thousands):

Business Segments

	Community
	Banking		Mortgage		Total
Three months ended March 31, 2018
Net interest income	$	5,331	$	—	$	5,331
Provision for loan losses		22		—		22
Net interest income after provision for loan losses		5,309		—		5,309
Noninterest income		566		620		1,186
Noninterest expenses		4,604		493		5,097
Income before income taxes		1,271		127		1,398
Income tax expense		248		27		275
Net income (loss)	$	1,023	$	100	$	1,123
Total assets	$	650,068	$	3,567	$	653,635
Three months ended March 31, 2017
Net interest income	$	4,838	$	—	$	4,838
Provision for loan losses		100		—		100
Net interest income after provision for loan losses		4,738		—		4,738
Noninterest income		490		371		861
Noninterest expenses		4,128		369		4,497
Income before income taxes		1,100		2		1,102
Income tax expense		341		1		342
Net income	$	759	$	1	$	760
Total assets	$	576,675	$	1,758	$	578,433

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 into classes, based on the associated risks. 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

18

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

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

	As of:
	March 31,		December 31,
	2018		2017
Commercial	$	96,983	$	96,127
Commercial real estate		261,619		251,807
Consumer		85,076		83,746
Residential		62,870		64,094
Total loans (1)		506,548		495,774
Less allowance for loan losses		4,671		4,752
Net loans	$	501,877	$	491,022

(1) Includes net deferred costs and premiums of $764 and $940 as of March 31, 2018 and December 31, 2017, respectively.

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.

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.

19

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

• “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.

20

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

Loans on Non-Accrual Status
(dollars in thousands)
	As of
	March 31, 2018		December 31, 2017
Commercial	$	699	$	727
Commercial Real Estate:
Commercial Mortgages-Owner Occupied		1,308		1,465
Commercial Mortgages-Non-Owner Occupied		278		468
Commercial Construction		90		—
Consumer
Consumer Unsecured		—		—
Consumer Secured		491		566
Residential:
Residential Mortgages		623		1,025
Residential Consumer Construction		56		58
Totals	$	3,545	$	4,309

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 $2,096 on March 31, 2018 from $2,650 on December 31, 2017. The following table represents the changes in OREO balance during the three months ended March 31, 2018 and year ended December 31, 2017.

OREO Changes
(dollars in thousands)
	Three months ended			Year ended
	March 31, 2018			December 31, 2017
Balance at the beginning of the year (net)	$	2,650		$	2,370
Transfers from loans		—			815
Capitalized costs		—			40
Valuation adjustments		(34	)		(60	)
Sales proceeds		(525	)		(514	)
Gain (loss) on disposition		5			(1	)
Balance at the end of the period (net)	$	2,096		$	2,650

At March 31, 2018 and December 31, 2017, the Company had $0 of consumer mortgage loans secured by residential real estate for which foreclosure was in process. The Company held no residential real estate properties in other real estate owned as of March 31, 2018 and three residential real estate properties carried on the books at a value of $520 in other real estate owned as of December 31, 2017.

21

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

	Impaired Loans
	(dollars in thousands)
	As of and For the Three Months Ended March 31, 2018
			Unpaid				Average		Interest
	Recorded		Principal		Related		Recorded		Income
	Investment		Balance		Allowance		Investment		Recognized
2018
With No Related Allowance Recorded:
Commercial	$	768	$	788	$	—	$	847	$	8
Commercial Real Estate
Commercial Mortgages-Owner Occupied		2,340		2,434		—		2,384		30
Commercial Mortgage Non-Owner Occupied		427		439		—		551		8
Commercial Construction		—		—		—		—		—
Consumer
Consumer Unsecured		—		—		—		—		—
Consumer Secured		398		494		—		339		6
Residential
Residential Mortgages		1,459		1,538		—		1,520		19
Residential Consumer Construction		—		—		—		—		—
With An Allowance Recorded:
Commercial	$	438	$	846	$	134	$	378	$	4
Commercial Real Estate
Commercial Mortgages-Owner Occupied		517		517		81		591		8
Commercial Mortgage Non-Owner Occupied		72		72		18		73		1
Commercial Construction		90		703		1		130		—
Consumer
Consumer Unsecured		2		2		2		2		—
Consumer Secured		157		233		112		292		2
Residential
Residential Mortgages		197		204		35		174		—
Residential Consumer Construction		—		—		—		—		—
Totals:
Commercial	$	1,206	$	1,634	$	134	$	1,225	$	12
Commercial Real Estate
Commercial Mortgages-Owner Occupied		2,857		2,951		81		2,975		38
Commercial Mortgage Non-Owner Occupied		499		511		18		624		9
Commercial Construction		90		703		1		130		—
Consumer
Consumer Unsecured		2		2		2		2		—
Consumer Secured		555		727		112		631		8
Residential
Residential Mortgages		1,656		1,742		35		1,694		19
Residential Consumer Construction		—		—		—		—		—
	$	6,865	$	8,270	$	383	$	7,281	$	86

25

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

	Impaired Loans
	(dollars in thousands)
	As of and For the Year Ended December 31, 2017
			Unpaid				Average		Interest
	Recorded		Principal		Related		Recorded		Income
	Investment		Balance		Allowance		Investment		Recognized
2017
With No Related Allowance Recorded:
Commercial	$	925	$	1,505	$	—	$	812	$	54
Commercial Real Estate
Commercial Mortgages-Owner Occupied		2,427		2,539		—		2,723		179
Commercial Mortgage Non-Owner Occupied		675		690		—		512		30
Commercial Construction		—		—		—		—		—
Consumer
Consumer Unsecured		—		—		—		—		—
Consumer Secured		279		283		—		149		11
Residential
Residential Mortgages		1,580		1,673		—		1,568		63
Residential Consumer Construction		—		—		—		—		—
With An Allowance Recorded:
Commercial	$	317	$	323	$	112	$	919	$	16
Commercial Real Estate
Commercial Mortgages-Owner Occupied		665		665		93		1,126		39
Commercial Mortgage Non-Owner Occupied		73		73		18		74		5
Commercial Construction		169		695		79		169		—
Consumer
Consumer Unsecured		2		2		2		1		—
Consumer Secured		427		445		255		269		11
Residential
Residential Mortgages		151		178		4		425		3
Residential Consumer Construction		—		—		—		—		—
Totals:
Commercial	$	1,242	$	1,828	$	112	$	1,731	$	70
Commercial Real Estate
Commercial Mortgages-Owner Occupied		3,092		3,204		93		3,849		218
Commercial Mortgage Non-Owner Occupied		748		763		18		586		35
Commercial Construction		169		695		79		169		—
Consumer
Consumer Unsecured		2		2		2		1		—
Consumer Secured		706		728		255		418		22
Residential
Residential Mortgages		1,731		1,851		4		1,993		66
Residential Consumer Construction		—		—		—		—		—
	$	7,690	$	9,071	$	563	$	8,747	$	411

23

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

	Allowance for Loan Losses and Recorded Investment in Loans (dollars in  thousands) As of and For the Three Months Ended March 31, 2018
				Commercial
	Commercial			Real Estate			Consumer			Residential		Total
2018
Allowance for Loan Losses:
Beginning Balance	$	1,264		$	1,738		$	1,172		$	578	$	4,752
Charge-offs		(13	)		(82	)		(145	)		—		(240	)
Recoveries		98			—			39			—		137
Provision		56			(72	)		(3	)		41		22
Ending Balance	$	1,405		$	1,584		$	1,063		$	619	$	4,671
Ending Balance: Individually evaluated for impairment	$	134		$	100		$	114		$	35	$	383
Ending Balance: Collectively evaluated for impairment		1,271			1,484			949			584		4,288
Totals:	$	1,405		$	1,584		$	1,063		$	619	$	4,671
Loans:
Ending Balance: Individually evaluated for impairment	$	1,206		$	3,446		$	557		$	1,656	$	6,865
Ending Balance: Collectively evaluated for impairment		95,777			258,173			84,519			61,214		499,683
Totals:	$	96,983		$	261,619		$	85,076		$	62,870	$	506,548

24

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

	Allowance for Loan Losses and Recorded Investment in Loans (dollars in  thousands) As of and For the Year Ended December 31, 2017
				Commercial
	Commercial			Real Estate			Consumer			Residential			Total
2017
Allowance for Loan Losses:
Beginning Balance	$	2,192		$	2,109		$	954		$	461		$	5,716
Charge-offs		(1,652	)		(91	)		(246	)		(105	)		(2,094	)
Recoveries		6			41			51			39			137
Provision		718			(321	)		413			183			993
Ending Balance	$	1,264		$	1,738		$	1,172		$	578		$	4,752
Ending Balance: Individually evaluated for impairment	$	112		$	190		$	257		$	4		$	563
Ending Balance: Collectively evaluated for impairment		1,152			1,548			915			574			4,189
Totals:	$	1,264		$	1,738		$	1,172		$	578		$	4,752
Loans:
Ending Balance: Individually evaluated for impairment	$	1,242		$	4,009		$	708		$	1,731		$	7,690
Ending Balance: Collectively evaluated for impairment		94,885			247,798			83,038			62,363			488,084
Totals:	$	96,127		$	251,807		$	83,746		$	64,094		$	495,774

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

	Age Analysis of Past Due Loans as of
	March 31, 2018
	(dollars in thousands)
					Greater								Recorded Investment
	30-59 Days		60-89 Days		than		Total Past				Total		> 90 Days &
	Past Due		Past Due		90 Days		Due		Current		Loans		Accruing
2018
Commercial	$	294	$	250	$	457	$	1,001	$	95,982	$	96,983	$	—
Commercial Real Estate:
Commercial Mortgages- Owner Occupied		705		—		226		931		102,001		102,932		—
Commercial Mortgages-Non-Owner Occupied		205		174		60		439		147,674		148,113		—
Commercial Construction		—		—		90		90		10,484		10,574		—
Consumer:
Consumer Unsecured		6		—		—		6		7,323		7,329		—
Consumer Secured		376		229		174		779		76,968		77,747		—
Residential:
Residential Mortgages		1,951		233		435		2,619		50,837		53,456		—
Residential Consumer Construction		—		—		56		56		9,358		9,414		—
Total	$	3,537	$	886	$	1,498	$	5,921	$	500,627	$	506,548	$	—

	Age Analysis of Past Due Loans as of
	December 31, 2017
	(dollars in thousands)
					Greater								Recorded Investment
	30-59 Days		60-89 Days		than		Total Past				Total		> 90 Days &
	Past Due		Past Due		90 Days		Due		Current		Loans		Accruing
2017
Commercial	$	320	$	—	$	250	$	570	$	95,557	$	96,127	$	—
Commercial Real Estate:
Commercial Mortgages-Owner Occupied		904		64		177		1,145		92,504		93,649		—
Commercial Mortgages-Non-Owner Occupied		—		361		299		660		138,101		138,761		—
Commercial Construction		—		—		169		169		19,228		19,397		—
Consumer:
Consumer Unsecured		3		—		—		3		6,977		6,980		—
Consumer Secured		245		139		462		846		75,920		76,766		—
Residential:
Residential Mortgages		706		414		532		1,652		51,545		53,197		—
Residential Consumer Construction		—		—		58		58		10,839		10,897		—
Total	$	2,178	$	978	$	1,947	$	5,103	$	490,671	$	495,774	$	—

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

	Credit Quality Information - by Class
	March 31, 2018
	(dollars in thousands)
	Pass		Monitor		Special Mention		Substandard		Doubtful		Totals
2018
Commercial	$	94,358	$	845	$	483	$	1,297	$	—	$	96,983
Commercial Real Estate:
Commercial Mortgages-Owner Occupied		93,507		2,846		3,667		2,912		—		102,932
Commercial Mortgages-Non Owner Occupied		145,009		1,589		911		604		—		148,113
Commercial Construction		10,294		—		190		90		—		10,574
Consumer
Consumer Unsecured		7,317		—		10		2		—		7,329
Consumer Secured		77,005		—		—		742		—		77,747
Residential:
Residential Mortgages		51,158		—		240		2,058		—		53,456
Residential Consumer Construction		9,358		—		—		56		—		9,414
Totals	$	488,006	$	5,280	$	5,501	$	7,761	$	—	$	506,548
	Credit Quality Information - by Class
	December 31, 2017
	(dollars in thousands)
	Pass		Monitor		Special Mention		Substandard		Doubtful		Totals
2017
Commercial	$	93,571	$	1,217	$	4	$	1,335	$	—		96,127
Commercial Real Estate:
Commercial Mortgages-Owner Occupied		83,834		2,926		3,734		3,155		—		93,649
Commercial Mortgages-Non Owner Occupied		135,855		1,898		152		856		—		138,761
Commercial Construction		18,423		—		805		169		—		19,397
Consumer
Consumer Unsecured		6,978		—		—		2		—		6,980
Consumer Secured		75,774		90		—		902		—		76,766
Residential:
Residential Mortgages		50,816		—		241		2,140		—		53,197
Residential Consumer Construction		10,839		—		—		58		—		10,897
Totals	$	476,090	$	6,131	$	4,936	$	8,617	$	—	$	495,774

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

Troubled Debt Restructurings (TDR)

There were no loan modifications that would have been classified as TDRs during the three months ended March 31, 2018 and 2017.

There were no loan modifications classified as TDRs within the last twelve months that defaulted during the three months ended March 31, 2018 and 2017.

At March 31, 2018 and December 31, 2017, the Bank had no outstanding commitments to disburse additional funds on loans classified as TDRs.

Note 10 – Revenue Recognition

On January 1, 2018, the Company adopted ASU No. 2014-09 “Revenue from Contracts with Customers” (Topic 606) and all subsequent ASUs that modified Topic 606. The implementation of the new standard did not have a material impact on the measurement or recognition of revenue; as such, a cumulative effect adjustment to opening retained earnings was not deemed necessary. Results for reporting periods beginning after January 1, 2018 are presented under Topic 606, while prior period amounts were not adjusted and continue to be reported in accordance with our historic accounting under Topic 605.

Topic 606 does not apply to revenue associated with financial instruments, including revenue from loans and securities. Topic 606 is applicable to noninterest revenue streams such as deposit related fees, interchange fees, merchant income, and annuity and insurance commissions. However, the recognition of these revenue streams did not change significantly upon adoption of Topic 606. Substantially all of the Company’s revenue is generated from contracts with customers. Noninterest revenue streams in-scope of Topic 606 are discussed below.

Service Charges on Deposit Accounts

Service charges on deposit accounts consist of account analysis fees (i.e., net fees earned on analyzed business checking accounts), monthly service fees, check orders, and other deposit account related fees. The Company’s performance obligation for account analysis fees and monthly service fees is generally satisfied, and the related revenue recognized, over the period in which the service is provided. Check orders and other deposit account related fees are largely transactional based, and therefore, the Company’s performance obligation is satisfied, and related revenue recognized, at a point in time. Payment for service charges on deposit accounts is primarily received immediately or at the end of the month through a direct charge to customers’ accounts.

Fees, Exchange, and Other Service Charges

Fees, exchange, and other service charges are primarily comprised of debit and credit card income, ATM fees, merchant services income, treasury services income and other service charges. Debit and credit card income is primarily comprised of interchange fees earned whenever the Company’s debit and credit cards are processed through card payment networks such as Visa. ATM fees are primarily generated when a Company cardholder uses a non-Company ATM or a non-Company cardholder uses a Company ATM. Merchant services income mainly represents fees charged to merchants to process their debit and credit card transactions, in addition to account management fees. Treasury services income primarily represents fees charged to customers for sweep, positive pay and lockbox services. Other service charges include revenue from processing wire transfers, bill pay service, cashier’s checks, and other services. The Company’s

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Note 10 – Revenue Recognition (continued)

performance obligation for fees, exchange, and other service charges are largely satisfied, and related revenue recognized, when the services are rendered or upon completion. Payment is typically received immediately or at the end of the month.

Other

Other noninterest income consists of other recurring revenue streams such as commissions from sales of mutual funds and other investments, safety deposit box rental fees, and other miscellaneous revenue streams. Commissions from the sale of mutual funds and other investments are recognized on trade date, which is when the Company has satisfied its performance obligation. The Company also receives periodic service fees (i.e., trailers) from mutual fund companies typically based on a percentage of net asset value. Trailer revenue is recorded over time, usually monthly or quarterly, as net asset value is determined. Safe deposit box rental fees are charged to the customer on an annual basis and recognized upon receipt of payment. The Company determined that since rentals and renewals occur fairly consistently over time, revenue is recognized on a basis consistent with the duration of the performance obligation.

Note 11 – Recent accounting pronouncements

In January 2016, the FASB issued ASU No. 2016-01, “Recognition and Measurement of Financial Assets and Financial Liabilities.” This ASU addresses certain aspects of recognition, measurement, presentation, and disclosure of financial instruments by making targeted improvements to GAAP. The provisions of the ASU that apply to the Company are as follows: (1) require equity investments (except those accounted for under the equity method of accounting or those that result in consolidation of the investee) to be measured at fair value with changes in fair value recognized in net income. However, an entity may choose to measure equity investments that do not have readily determinable fair values at cost minus impairment, if any, plus or minus changes resulting from observable price changes in orderly transactions for the identical or a similar investment of the same issuer; (2) simplify the impairment assessment of equity investments without readily determinable fair values by requiring a qualitative assessment to identify impairment. When a qualitative assessment indicates that impairment exists, an entity is required to measure the investment at fair value; (3) eliminate the requirement to disclose the method(s) and significant assumptions used to estimate the fair value that is required to be disclosed for financial instruments measured at amortized cost on the balance sheet; (4) require use of the exit price notion when measuring the fair value of financial instruments for disclosure purposes; (5) require separate presentation of financial assets and financial liabilities by measurement category and form of financial asset (that is, securities or loans and receivables) on the balance sheet or the accompanying notes to the financial statements; and (6) clarify that an entity should evaluate the need for a valuation allowance on a deferred tax asset related to available-for-sale securities in combination with the entity’s other deferred tax assets. The adoption of ASU No. 2016-01 on January 1, 2018 did not have a material impact on the Company’s Consolidated Financial Statements. In accordance with (4) above, the Company utilized an exit price notion as of March 31, 2018 (see Note 5 Fair Value Measurements).

In February 2016, the FASB issued ASU No. 2016-02, “Leases (Topic 842).” Among other things, in the amendments in ASU 2016-02, lessees will be required to recognize the following for all leases (with the exception of short-term leases) at the commencement date: (1) A lease liability, which is a lessee‘s obligation to make lease payments arising from a lease, measured on a discounted basis; and (2) A right-of-use asset, which is an asset that represents the lessee’s right to use, or control the use of, a specified asset for the lease term. Under the new guidance, lessor accounting is largely unchanged. Certain targeted improvements were made to align, where necessary, lessor accounting with the lessee accounting model and Topic 606, Revenue from Contracts with Customers. The amendments in this ASU are effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. Early application is permitted upon issuance. Lessees (for capital and operating leases) and lessors (for sales-

29

Note 11 – Recent accounting pronouncements (continued)

type, direct financing, and operating leases) must apply a modified retrospective transition approach for leases existing at, or entered into after, the beginning of the earliest comparative period presented in the financial statements. The modified retrospective approach would not require any transition accounting for leases that expired before the earliest comparative period presented. Lessees and lessors may not apply a full retrospective transition approach. The Company is currently assessing the impact that ASU 2016-02 will have on its consolidated financial statements. The Company has gathered and is in the process of analyzing lease data to determine the impact that ASU 2016-02 will have on its consolidated financial statements.

In June 2016, the FASB issued ASU No. 2016-13, “Financial Instruments – Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments.” The amendments in this ASU, among other things, require the measurement of all expected credit losses for financial assets held at the reporting date based on historical experience, current conditions, and reasonable and supportable forecasts. Financial institutions and other organizations will now use forward-looking information to better inform their credit loss estimates. Many of the loss estimation techniques applied today will still be permitted, although the inputs to those techniques will change to reflect the full amount of expected credit losses. In addition, the ASU amends the accounting for credit losses on available-for-sale debt securities and purchased financial assets with credit deterioration. The amendments in this ASU are effective for SEC filers for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2019. The Company is currently assessing the impact that ASU 2016-13 will have on its consolidated financial statements. The Company has been in discussions with its core processor to coordinate its plans for implementation.

In January 2017, the FASB issued ASU No. 2017-04, “Intangibles – Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment”. The amendments in this ASU simplify how an entity is required to test goodwill for impairment by eliminating Step 2 from the goodwill impairment test. Step 2 measures a goodwill impairment loss by comparing the implied fair value of a reporting unit’s goodwill with the carrying amount of that goodwill. Instead, under the amendments in this ASU, an entity should perform its annual, or interim, goodwill impairment test by comparing the fair value of a reporting unit with its carrying amount. An entity still has the option to perform the qualitative assessment for a reporting unit to determine if the quantitative impairment test is necessary. Public business entities that are U.S. Securities and Exchange Commission (SEC) filers should adopt the amendments in this ASU for annual or interim goodwill impairment tests in fiscal years beginning after December 15, 2019. Early adoption is permitted for interim or annual goodwill impairment tests performed on testing dates after January 1, 2017. The Company does not expect the adoption of ASU 2017-04 to have a material impact on its consolidated financial statements.

In March 2017, the FASB issued ASU 2017-08, “Receivables—Nonrefundable Fees and Other Costs (Subtopic 310-20), Premium Amortization on Purchased Callable Debt Securities.” The amendments in this ASU shorten the amortization period for certain callable debt securities purchased at a premium. Upon adoption of the standard, premiums on these qualifying callable debt securities will be amortized to the earliest call date. Discounts on purchased debt securities will continue to be accreted to maturity. The amendments are effective for fiscal years beginning after December 15, 2018, and interim periods within those fiscal years. Early adoption is permitted, including adoption in an interim period. Upon transition, entities should apply the guidance on a modified retrospective basis, with a cumulative-effect adjustment to retained earnings as of the beginning of the period of adoption and provide the disclosures required for a change in accounting principle. The Company is currently assessing the impact that ASU 2017-08 will have on its consolidated financial statements.

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Note 11 – Recent accounting pronouncements (continued)

In August 2017, the FASB issued ASU 2017-12, “Derivatives and Hedging (Topic 815): Targeted Improvements to Accounting for Hedging Activities.” The amendments in this ASU modify the designation and measurement guidance for hedge accounting as well as provide for increased transparency regarding the presentation of economic results on both the financial statements and related footnotes. Certain aspects of hedge effectiveness assessments will also be simplified upon implementation of this update.    The amendments are effective for annual periods, including interim periods within those annual periods, beginning after December 15, 2018. Early adoption is permitted, including adoption in any interim period. The Company does not expect the adoption of ASU 2017-12 to have a material impact on its consolidated financial statements.

In February 2018, the FASB issued ASU 2018-03, “Technical Corrections and Improvements to Financial Instruments-Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities.” The amendments provide targeted improvements to address certain aspects of recognition, measurement, presentation, and disclosure of financial instruments. Specifically, the amendments include clarifications related to: measurement elections, transition requirements, and adjustments associated with equity securities without readily determinable fair values; fair value measurement requirements for forward contracts and purchased options on equity securities; presentation requirements for hybrid financial liabilities for which the fair value option has been elected; and measurement requirements for liabilities denominated in a foreign currency for which the fair value option has been elected. The amendments are effective for fiscal years beginning after December 15, 2017, and interim periods within those fiscal years beginning after June 15, 2018. Early adoption is permitted. The Company does not expect the adoption of ASU 2018-03 to have a material impact on its consolidated financial statements.

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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.

Financial’s critical accounting policies include the evaluation of the allowance for loan losses which is based on management’s estimate of an amount that is adequate to absorb probable losses inherent in the loan portfolio of the Bank. 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, 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 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

32

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”).

The Bank’s policy with respect to the methodology for determining the allowance for loan losses involves a higher degree of complexity and requires management to make subjective judgments that often require assumptions or estimates about uncertain matters. This critical policy and its assumptions are periodically reviewed with the Board of Directors.

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.

Financial also considers valuation of other real estate owned (OREO) a critical accounting policy. OREO consists of properties acquired through foreclosure or deed in lieu of foreclosure. These properties are carried at fair value less estimated costs to sell at the date of foreclosure. Losses from the acquisition of property in full or partial satisfaction of loans are charged against the allowance for loan losses. Subsequent write-downs, if any, are charged against expense. Gains and losses on the sales of foreclosed properties are included in determining net income in the year of the sale. Operating costs after acquisition are expensed.

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 division”), investment services through the Bank’s Investment division (which we refer to as “Investment division”), and insurance activities through BOTJ Insurance, Inc., a subsidiary of the Bank, (which we refer to as “Insurance business”). Of these three other business activities, only the Mortgage division is material to the Bank’s results and operations.

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. Historically, our primary market area has been 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. Within the past three years, the Bank has begun to expand to other areas in Virginia, specifically Roanoke, Charlottesville, and Harrisonburg. 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 areas.

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.bank.

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.

33

The Bank intends to enhance its profitability by increasing its market share in our service areas, providing additional services to its customers, and controlling costs.

The Bank services its banking customers through the following locations in Virginia:

Full Service Branches

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

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

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

• A branch located at 4698 South Amherst Highway in Amherst County (the “Madison Heights Branch”),

• A branch located at 17000 Forest Road in Forest (the “Forest Branch”),

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

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

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

• A branch located at 1110 Main Street, Altavista, Virginia (the “Altavista Branch”),

• A branch located at 1391 South High Street, Harrisonburg, VA (the “Harrisonburg Branch”),

• A branch located at 1745 Confederate Blvd, Appomattox, VA (the “Appomattox Branch”),

• A branch located at 225 Merchant Walk Avenue, Charlottesville, VA (the “5^th Street Station Branch”), and

• A branch located at 3562 Electric Road, Roanoke, VA (the “Roanoke Branch”).

Limited Service Branches

• Westminster-Canterbury facilities located at 501 VES Road, Lynchburg, Virginia,

• Westminster-Canterbury facilities located at 250 Pantops Mountain Road, Charlottesville, Virginia,

• Luxor Office Park LLC, 1430 Rolkin Court Suite 203, Charlottesville, Virginia (the “Charlottesville Branch”).

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Loan Production Offices

• Residential mortgage loan production office located at the Forest Branch,

• Commercial, consumer and mortgage loan production office located at the Charlottesville Branch.

The Investment division and the Insurance business operate primarily out of offices located at the Church Street Branch.

The Bank continuously evaluates areas located within our service areas 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, including the following properties that we own and are holding for expansion:

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

• Real property located at 5 Village Highway (near the intersection of Routes 501 and 24) in Rustburg, Virginia. The structure on the property has been demolished and removed. The Bank does not anticipate opening a branch at this location prior to 2018.

• Real property located at 45 South Main Street, Lexington, Virginia. The bank does not anticipate opening a branch at this location prior to 2018.

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

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

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

OFF-BALANCE SHEET ARRANGEMENTS

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

The Bank’s exposure to credit loss in the event of nonperformance by the other party to the financial instrument for commitments to extend credit and standby letters of credit is represented by the contractual amount of those instruments. The Bank uses the same credit policies in making commitments

35

and conditional obligations as it does for on-balance sheet instruments. A summary of the Bank’s commitments is as follows:

	March 31, 2018 (in thousands)
Commitments to extend credit	$	97,955
Letters of Credit		3,376
Total	$	101,331

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. 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.

The Bank has rate lock commitments to originate mortgage loans through its Mortgage Division. The Bank has entered into corresponding commitments with third party investors to sell each of these loans that close. No other obligation exists. As a result of these contractual relationships with these investors, the Bank is not exposed to losses nor will it realize gains related to its rate lock commitments due to changes in interest rates.

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 March 31, 2018 and December 31, 2017 and the results of operations of Financial for the three month periods ended March 31, 2018 and 2017. This discussion should be read in conjunction with the financial statements included elsewhere herein.

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

Financial Condition Summary

March 31, 2018 as Compared to December 31, 2017

Total assets were $653,635,000 on March 31, 2018 compared with $626,341,000 at December 31, 2017, an increase of 4.36%. The increase in total assets was primarily due to growth in the loan portfolio and cash and cash equivalents funded by an increase in deposits and a Federal Home Loan Bank advance in the amount of $10,000,000.

Total deposits increased from $567,493,000 as of December 31, 2017 to $584,516,000 on March 31, 2018, an increase of 3.00%. The increase resulted in large part from increases in non-interest bearing demand deposits and a slight increase in NOW, money market, and savings accounts. NOW, money market, and savings deposits increased from $307,987,000 on December 31, 2017 to $318,523,000 on March 31, 2018. Noninterest bearing demand deposits increased from $74,102,000 on December 31, 2017 to $83,964,000 on March 31, 2018. Time deposits decreased from $185,404,000 on December 31, 2017 to $182,029,000 on March 31, 2018.

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Total loans, excluding loans held for sale, increased to $506,548,000 on March 31, 2018 from $495,774,000 on December 31, 2017. Loans, excluding loans held for sale and net of deferred fees and costs and the allowance for loan losses, increased to $501,877,000 on March 31, 2018 from $491,022,000 on December 31, 2017, an increase of 2.21%. 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):

	March 31, 2018					December 31, 2017
	Amount		Percentage			Amount		Percentage
Commercial	$	96,983		19.15	%	$	96,127		19.39	%
Commercial Real Estate		261,619		51.64	%		251,807		50.79	%
Consumer		85,076		16.80	%		83,746		16.89	%
Residential		62,870		12.41	%		64,094		12.93	%
Total loans	$	506,548		100.00	%	$	495,774		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 $5,641,000 on March 31, 2018 from $6,958,000 on December 31, 2017. OREO decreased to $2,096,000 on March 31, 2018 from $2,650,000 on December 31, 2017. This decrease was due to the Bank’s ability to liquidate properties in OREO during the three months ended March 31, 2018. Non-performing loans decreased from $4,309,000 at December 31, 2017 to $3,545,000 at March 31, 2018. 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 allowance for loan losses. 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 loan losses charged against earnings.

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, 2017, the Bank was carrying seven OREO properties on its books at a value of $2,650,000. During the three months ended March 31, 2018, the Bank acquired no additional OREO properties and disposed of three OREO properties, and as of March 31, 2018 the Bank is carrying four OREO properties at a value of $2,096,000. The OREO properties are available for sale and are being actively marketed on the Bank’s website and through other means.

The Bank had loans in the amount of $435,000 at March 31, 2018 classified as performing Troubled Debt Restructurings (“TDRs”) as compared to $440,000 at December 31, 2017. 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 increased to $55,288,000 on March 31, 2018 from $37,018,000 on December 31, 2017. Cash and cash equivalents consist of cash due from correspondents, cash in vault, and overnight investments (including federal funds sold). The increase in cash and cash equivalents was due primarily to an increase in federal funds sold, the proceeds of which were used to fund loans. In addition, cash and cash equivalents are subject to routine fluctuations in deposits, including fluctuations in transactional accounts and professional settlement accounts.

Securities held-to-maturity decreased to $3,708,000 on March 31, 2018 from $5,713,000 on December 31, 2017. This decrease resulted from the call of a security with a par value of $2,000,000 during the quarter. Securities available-for-sale decreased to $54,633,000 on March 31, 2018, from

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$55,312,000 on December 31, 2017. The decrease resulted from the normal amortization of and principal payments on mortgage-backed securities in the available-for-sale portfolio. During the three months ended March 31, 2018 the Bank received $502,000 in proceeds from calls, maturities, and paydowns of securities available-for-sale and $0 in proceeds from the sale of securities available-for-sale. The Bank purchased $998,000 in securities available-for sale during the same period.

Financial’s investment in Federal Home Loan Bank of Atlanta (FHLBA) stock totaled $989,000 at March 31, 2018 and $607,000 at December 31, 2017, an increase of $382,000. This increase is attributable to the FHLBA’s increase in minimum ownership requirements and the stock purchase requirement associated with the $10,000,000 advance noted above. 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 March 31, 2018, Financial, on a consolidated basis, had liquid assets of $109,921,000 in the form of cash, interest-bearing and noninterest-bearing deposits with banks, and available-for-sale investments. Of this amount, approximately $20,373,000 (representing current book value) of the available-for-sale securities are pledged as collateral with $9,498,000 pledged as security for public deposits, and $10,875,000 pledged as security on a line of credit the Bank may draw on from time to time to meet liquidity needs. This line of credit currently has a zero balance. Management believes that liquid assets were adequate at March 31, 2018. Management anticipates that additional liquidity will be provided by the growth in deposit accounts and loan repayments at the Bank. In addition, if additional liquidity is needed, the Bank has the ability to purchase federal funds on the open market, borrow from the FHLBA using loans or investments within the Bank’s portfolio as collateral, and to borrow from the Federal Reserve Bank’s discount window.

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. Based in part on recent loan growth, the Bank is monitoring liquidity to ensure it is able to fund future loans.

On January 25, 2017, Financial closed a private placement of unregistered debt securities (the “2017 Offering”) pursuant to which Financial issued $5,000,000 in principal of notes (the “2017 Notes”). The 2017 Notes bear interest at the rate of 4% per year with interest payable quarterly in arrears. The 2017 Notes are to mature on January 24, 2022, but are subject to prepayment in whole or in part on or after January 24, 2018 at Financial’s sole discretion on 30 days written notice to the holders. Of the proceeds, $3,000,000 was injected into the Bank as equity capital in March 2017. The Company left the remaining $2,000,000 at the holding company level for debt service on the 2017 Notes and other general corporate purposes.

At March 31, 2018, the Bank had a leverage ratio of approximately 9.29%, a Tier 1 risk-based capital ratio and a CET1 ratio of approximately 11.09% and a total risk-based capital ratio of approximately 11.98%. As of March 31, 2018 and December 31, 2017 the Bank’s regulatory capital levels exceeded those established for well-capitalized institutions.

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The following table sets forth the minimum capital requirements and the Bank’s capital position as of March 31, 2018 and December 31, 2017:

Bank Level Only Capital Ratios

	March 31,		December 31,
Analysis of Capital (in 000’s)	2018		2017
Tier 1 capital
Common Stock	$	3,742	$	3,742
Surplus		22,325		22,325
Retained earnings		32,284		31,069
Total Tier 1 capital	$	58,351	$	57,136
Common Equity Tier 1 Capital (CET1)	$	58,351	$	57,136
Tier 2 capital
Allowance for loan losses	$	4,671	$	4,752
Total Tier 2 capital:	$	4,671	$	4,752
Total risk-based capital	$	63,022	$	61,888
Risk weighted assets	$	526,011	$	513,419
Average total assets	$	628,414	$	626,422

	Actual						Regulatory Benchmarks
	March 31, 2018			December 31, 2017			For Capital Adequacy Purposes (1)			For Well Capitalized Purposes
Capital Ratios:
Tier 1 capital to average total assets		9.29	%		9.12	%		4.00	%		5.00	%
Common Equity Tier 1 Ratio		11.09	%		11.13	%		7.00	%		6.50	%
Tier 1 risk-based capital ratio		11.09	%		11.13	%		8.50	%		8.00	%
Total risk-based capital ratio		11.98	%		12.05	%		10.50	%		10.00	%

(1) Includes the capital conservation buffer after full phase-in.

The above tables set forth the capital position and analysis for the Bank only. Because total assets on a consolidated basis are less than $1,000,000,000, 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 at March 31, 2018 would be slightly lower than those of the Bank.

In July 2013, the Federal Reserve Board approved a final rule establishing a regulatory capital framework for smaller, less complex financial institutions. The rule implements in the United States the Basel III regulatory capital reforms from the Basel Committee on Banking Supervision and certain changes required by the Dodd-Frank Wall Street Reform and Consumer Protection Act. The phase-in period for this rule began in January 2015. Under the final rule, minimum requirements were increased for both the quantity and quality of capital held by banking organizations. The rule included a new minimum ratio of common equity Tier 1 capital to risk-weighted assets of 4.5% and a common equity Tier 1 capital conservation buffer of 2.5% of risk-weighted assets that applies to all supervised financial institutions. The capital conservation buffer began its phase-in on January 1, 2016 at 0.625% and increases by an additional 0.625% annually until it reaches 2.5% on January 1, 2019. This will result in an effective Tier 1 capital ratio of 8.5% upon full implementation. The capital conservation buffer will limit capital distributions, stock redemptions, and certain discretionary bonuses. Beginning January 1, 2016, failure to maintain the capital conservation buffer will limit the ability of the Bank and Financial to pay dividends, repurchase shares or pay discretionary bonuses. The rule also raised the minimum ratio of Tier 1 capital to risk-weighted assets from 4% to 6% and includes a minimum leverage ratio of 4% for all banking organizations.

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Results of Operations

Comparison of the Three Months Ended March 31, 2018 and 2017

Earnings Summary

Financial had net income including all operating segments of $1,123,000 for the three months ended March 31, 2018, compared to $760,000 for the comparable period in 2017. Basic and diluted earnings per common share for the three months ended March 31, 2018 were $0.26, compared to basic and diluted earnings per share of $0.17 for the three months ended March 31, 2017.

The increase in net income for the three months ended March 31, 2018 as compared to the prior year was due primarily to an increase in net interest income and non-interest income and was partially offset by an increase in non-interest expense. Non-interest expense increased in large part because of the Bank’s recent expansion into Charlottesville, Harrisonburg, and Roanoke. These expansions resulted in increases in personnel, professional, data processing, and other outside expenses.

Also as discussed below under Income Taxes, the reduction in both income tax expense and the effective rate due to the passage of the Tax and Jobs Act of 2017 contributed significantly to the increase in net income for the three months ended March 31, 2018 as compared to the same period in 2017.

These operating results represent an annualized return on average stockholders’ equity of 8.62% for the three months ended March 31, 2018, compared with 6.05% for the three months ended March 31, 2017. This increase for the three months was a direct result of the increase in net income. The Company had an annualized return on average assets of 0.72% for the three months ended March 31, 2018 compared with 0.53% for the same period in 2017. The increase for the three months ended March 31, 2018 largely resulted from an increase in net income.

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

Interest Income, Interest Expense, and Net Interest Income

Interest income increased to $6,155,000 for the three months ended March 31, 2018 from $5,509,000 for the same period in 2017, an increase of 11.73%. Interest income increased primarily because of increased balances in the loan portfolio and increases in interest rates tied to floating rate loans. The average rate received on earning assets increased from 4.16% to 4.22% for the three months ended March 31, 2018 from the comparable period in 2017. The rate on total average earning assets increased for the three months ended March 31, 2018 as compared to the three months ended March 31, 2017 primarily because of the increase in short term rates by the FOMC, which, as noted above, resulted in an increase in the rates paid by borrowers on floating rate loans.

Interest expense increased to $824,000 for the three months ended March 31, 2018 from $671,000 for the same period in 2017, an increase of 22.80%. The increase in interest expense resulted primarily from an increase on the rates paid on and balances of deposits. The Bank’s average rate paid on interest bearing deposits was 0.64% during the three month period ended March 31, 2018 as compared to 0.57% for the same period in 2017.

The fundamental source of the Bank’s net 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 months ended March 31, 2018 was $5,331,000 as compared to $4,838,000 for the same period in 2017, an

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increase of 10.19%. The increase in net interest income for the three months ended March 31, 2018 as compared with the comparable period in 2017 primarily is attributable to the increase in interest income resulting from increased loan balances and the previously discussed increase in short term rates by the FOMC. The net interest margin was 3.65% for both the three months ended March 31, 2018 and 2017.

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

Non-Interest Income

Non-interest income is comprised primarily of fees and charges on transactional deposit accounts, gains on sales of mortgage loans held for sale, commissions on sales of investments and the Bank’s ownership interest in a title insurance agency. Non-interest income increased to $1,186,000 for the three months ended March 31, 2018 from $861,000 for the three months ended March 31, 2017.

This increase for the three months ended March 31, 2018 as compared to the same period last year was due primarily due to an increase in gains on sales of loans held for sale from $371,000 for the three months ended March 31, 2017 to $620,000 for the period ended March 31, 2018 as well increases in service charges, fees, and commissions from the comparable period ended March 31, 2017.

The Bank, through its Mortgage division, originates both conforming and non-conforming consumer residential mortgage loans in the markets we serve. 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, except in limited circumstances such as first payment default, no credit or interest rate risk on these mortgages.

Purchase mortgage originations totaled $16,085,000, or 63.96% of the total mortgage loans originated in the three months ended March 31, 2018 as compared to $6,022,000, or 46.42% of the total mortgage loans originated in the same period in 2017. The increase in amount of purchase mortgage originations for the first three months of 2018 resulted from the Bank’s increased presence in the Charlottesville, Harrisonburg and Roanoke markets as well as favorable longer-term interest rates. However, despite the increase in longer-term rates, refinancing activity continued primarily due to the relatively low interest rate environment as compared to long-term historical interest rate levels. Management anticipates that purchase mortgage originations going forward will represent a majority of mortgage originations as they have in the recent past.

Management anticipates that residential mortgage rates will remain stable or trend upward during the remainder of 2018. Management expects that the Mortgage division’s reputation in Region 2000, steady residential real estate inventory and the recent hiring of additional mortgage loan originators in Roanoke, Harrisonburg and Charlottesville, and most recently Blacksburg, will result in strong mortgage originations through the remainder of 2018. In addition, 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. Management also believes that in the event that interest rates rise, revenue from the mortgage segment could be under pressure.

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 2018.

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The Bank provides insurance and annuity products to Bank customers and others, through the Bank’s Insurance subsidiary. The Bank has three full-time employees 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 2018.

Non-Interest Expense

Non-interest expense for the three months ended March 31, 2018 increased to $5,097,000 from $4,497,000, an increase of 13.34% from the comparable period in 2017. This increase resulted from increases for personnel expense primarily related to the expansion into Charlottesville, Harrisonburg, and Roanoke, as well as increases in professional fees, data processing expense and outside expense. Total personnel expense was $2,713,000 for the three month period ended March 31, 2018 as compared to $2,380,000 for the same period in 2017.

Allowance and Provision for Loan Losses

The allowance for loan losses represents an amount that, in our judgment, will be adequate to absorb probable losses inherent in the loan portfolio. 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 two components – specific impairment and general reserves. As discussed below, loans having a risk rating of 7 or below that are significantly past due, and the borrower’s performance and financial condition provide evidence that it is probable that the Bank will be unable to collect all amounts when due as well as all TDRs, are evaluated for specific impairment. The general reserve component is based on an evaluation of general economic conditions, actual and expected credit losses, and loan performance measures. Based on the application of the loan loss calculation, the Bank provided $22,000 to the allowance for loan losses for the three month period ended March 31, 2018. This compares to the provision of $100,000 for the comparable period in 2017, representing a decrease of 78.00%.

Charged-off loans, which are loans that management deems uncollectible, are charged against the allowance for loan losses and constitute a realized loss. Charged-off loans were $240,000 for the three months ended March 31, 2018 as compared to $130,000 for the comparable period in 2017. While a charged off loan may subsequently be collected, such recoveries generally are realized over an extended period of time. In the three months ended March 31, 2018, the Bank had recoveries of charged off loans of $137,000 as compared with $30,000 for the comparable period in 2017.

In light of the current economic environment, management continues its ongoing assessment of specific impairment in the Bank’s loan portfolio. As set forth in the tables below, the Bank’s allowance arising from the specific impairment evaluation as of March 31, 2018 decreased slightly as compared to December 31, 2017.

For the three months ended March 31, 2018, the Bank had a minimal change in asset quality from December 31, 2017. As shown in the table below, the total balance in the allowance decreased, from $4,752,000 as of December 31, 2017 to $4,671,000 on March 31, 2018. The allowance for loan losses as a percent of loans decreased slightly to 0.92% as of March 31, 2018 from 0.96% as of December 31, 2017 due to an increase the Bank’s loan balances and the slight decrease in the reserve. Increased loan balances during the quarter lead to an increase in the general reserve. Management believes that the current allowance for loan losses is adequate.

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

	Allowance for Loan Losses and Recorded Investment in Loans (dollars in thousands)
	As of and For the Three Months Ended March 31, 2018
	Commercial			Commercial Real Estate			Consumer			Residential		Total
2018
Allowance for Loan Losses:
Beginning Balance	$	1,264		$	1,738		$	1,172		$	578	$	4,752
Charge-offs		(13	)		(82	)		(145	)		—		(240	)
Recoveries		98			—			39			—		137
Provision		56			(72	)		(3	)		41		22
Ending Balance	$	1,405		$	1,584		$	1,063		$	619	$	4,671
Ending Balance: Individually evaluated for impairment	$	134		$	100		$	114		$	35	$	383
Ending Balance: Collectively evaluated for impairment		1,271			1,484			949			584		4,288
Totals:	$	1,405		$	1,584		$	1,063		$	619	$	4,671
Loans:
Ending Balance: Individually evaluated for impairment	$	1,206		$	3,446		$	557		$	1,656	$	6,865
Ending Balance: Collectively evaluated for impairment		95,777			258,173			84,519			61,214		499,683
Totals:	$	96,983		$	261,619		$	85,076		$	62,870	$	506,548

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	Allowance for Loan Losses and Recorded Investment in Loans (dollars in thousands)
	As of and For the Year Ended December 31, 2017
	Commercial			Commercial Real Estate			Consumer			Residential			Total
2017
Allowance for Loan Losses:
Beginning Balance	$	2,192		$	2,109		$	954		$	461		$	5,716
Charge-offs		(1,652	)		(91	)		(246	)		(105	)		(2,094	)
Recoveries		6			41			51			39			137
Provision		718			(321	)(1)		413			183			993
Ending Balance	$	1,264		$	1,738		$	1,172		$	578		$	4,752
Ending Balance: Individually evaluated for impairment	$	112		$	190		$	257		$	4		$	563
Ending Balance: Collectively evaluated for impairment		1,152			1,548			915			574			4,189
Totals:	$	1,264		$	1,738		$	1,172		$	578		$	4,752
Loans:
Ending Balance: Individually evaluated for impairment	$	1,242		$	4,009		$	708		$	1,731		$	7,690
Ending Balance: Collectively evaluated for impairment		94,885			247,798			83,038			62,363			488,084
Totals:	$	96,127		$	251,807		$	83,746		$	64,094		$	495,774

(1) The experience within the historical charge-off period used to calculate the allowance has improved which reduced the need for a provision relating to this segment.

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

	Three months ended March 31, (in thousands)
	2018			2017
Balance, beginning of period	$	4,752		$	5,716
Provision for loan losses		22			100
Loans charged off		(240	)		(130	)
Recoveries of loans charged off		137			30
Net (charge offs)		(103	)		(100	)
Balance, end of period	$	4,671		$	5,716

No nonaccrual loans were excluded from the impaired loan disclosures at March 31, 2018 and December 31, 2017. If interest on these loans had been accrued, such income cumulatively would have approximated $504,000 and $472,000 on March 31, 2018 and December 31, 2017, respectively. Loan payments received on nonaccrual loans are applied to principal. When a loan is placed on nonaccrual status there are several negative implications. First, all interest accrued but unpaid at the time of the

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classification is deducted from the interest income totals for the Bank. Second, accruals of interest are discontinued until it becomes certain that both principal and interest can be repaid. Third, there may be actual losses that necessitate additional provisions for credit losses charged against earnings.

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.

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.

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• “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.

Income Taxes

For the three months ended March 31, 2018, Financial had an income tax expense of $275,000 as compared to $342,000 for the three months ended March 31, 2017. This represents an effective tax rate of 19.67% for the three months ended March 31, 2018 as compared with 31.03% for the three months ended March 31, 2017. Our effective rate was lower than the statutory corporate tax rate in both quarters because of federal income tax benefits resulting from the tax treatment of earnings on bank owned life insurance and certain tax free municipal securities. The decrease in both the expense and the effective rate from March 31, 2017 is due to the decrease in our applicable corporate income tax rate following the passage of the Tax and Jobs Act of 2017 from 34% in the 2017 period to 21% in the 2018 period.

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Schedule I

Net Interest Margin Analysis

Average Balance Sheets

For the Quarter Ended March 31, 2018 and 2017

(dollars in thousands)

	2018								2017
	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)	$	497,177		$	5,649		4.61	%	$	470,005		$	5,173		4.46	%
Loans held for sale		2,439			25		4.16	%		1,390			15		4.38	%
Fed funds sold		18,506			67		1.49	%		7,072			13		0.75	%
Interest bearing bank balances		10,000			35		1.42	%		7,000			15		0.87	%
Securities (3)		62,673			372		2.40	%		50,916			291		2.32	%
Federal agency equities		1,401			8		2.32	%		1,259			7		2.25	%
CBB equity		116			—		—			116			—		—
Total earning assets		592,312			6,156		4.22	%		537,758			5,514		4.16	%
Allowance for loan losses		(4,708	)							(5,712	)
Non-earning assets		42,344								44,521
Total assets	$	629,948							$	576,567
LIABILITIES AND STOCKHOLDERS’ EQUITY
Deposits
Demand interest bearing	$	202,198		$	139		0.28	%	$	181,961		$	112		0.25	%
Savings		103,485			55		0.22	%		108,414			58		0.22	%
Time deposits		182,770			581		1.29	%		163,990			464		1.15	%
Total interest bearing deposits		488,453			773		0.64	%		454,365			634		0.57	%
Other borrowed funds
FHLB borrowings		222			1		1.83	%		—			—		—
Capital Notes		5,000			50		4.06	%		3,667			37		4.00	%
Total interest-bearing liabilities		493,675			824		0.68	%		458,032			671		0.59	%
Non-interest bearing deposits		82,227								66,516
Other liabilities		1,199								1,049
Total liabilities		577,101								525,597
Stockholders’ equity		52,847								50,970
Total liabilities and Stockholders’ equity	$	629,948							$	576,567
Net interest income				$	5,332							$	4,843
Net interest margin							3.65	%							3.65	%
Interest spread							3.54	%							3.56	%

(1) Net accretion or amortization of deferred loan fees and costs are included in interest income.

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(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. Assumed income tax rates of 21% and 34% were used for the first quarter of 2018 and 2017, respectively.

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 three months ended March 31, 2018, 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.

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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

For information regarding the Company’s risk factors, see Part I, Item 1A “Risk Factors” in the Company’s Annual Report on Form 10-K for the year ended December 31, 2017, filed with the Securities and Exchange Commission on March 21, 2018. There have been no material changes from risk factors as previously disclosed in Part 1 Item 1A of the Company’s Form 10-K for the year ended December 31, 2017.

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

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Item 5. Other Information

Not applicable

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 May 10, 2018
31.2	Certification of J. Todd Scruggs Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002, dated May 10, 2018
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 May 10, 2018
101	The following materials from Bank of the James Financial Group, Inc.’s Quarterly Report on Form 10-Q for the quarter ended March 31, 2018, formatted in eXtensible Business Reporting Language (XBRL): (i) Consolidated Balance Sheets (unaudited) as of March 31, 2018 and December 31, 2017; (ii) Consolidated Statements of Income (unaudited) for the three months ended March 31, 2018 and 2017; (iii) Consolidated Statements of Comprehensive Income (unaudited) for the three months ended March 31, 2018 and 2017 (iv) Consolidated Statements of Cash Flows (unaudited) for the three months ended March 31, 2018 and 2017 (v) Consolidated Statements of Changes in Stockholders’ Equity (unaudited) for the three months ended March 31, 2018 and 2017; (vi) Notes to Unaudited Consolidated Financial Statements.

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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 May 10, 2018
31.2	Certification of J. Todd Scruggs Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002, dated May 10, 2018
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 May 10, 2018
101	The following materials from Bank of the James Financial Group, Inc.’s Quarterly Report on Form 10-Q for the quarter ended March 31, 2018, formatted in eXtensible Business Reporting Language (XBRL): (i) Consolidated Balance Sheets (unaudited) as of March 31, 2018 and December 31, 2017; (ii) Consolidated Statements of Income (unaudited) for the three months ended March 31, 2018 and 2017; (iii) Consolidated Statements of Comprehensive Income (unaudited) for the three months ended March 31, 2018 and 2017 (iv) Consolidated Statements of Cash Flows (unaudited) for the three months ended March 31, 2018 and 2017 (v) Consolidated Statements of Changes in Stockholders’ Equity (unaudited) for the three months ended March 31, 2018 and 2017; (vi) Notes to Unaudited Consolidated Financial Statements.

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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: May 10, 2018	By	/S/ Robert R. Chapman III
		Robert R. Chapman III, President
		(Principal Executive Officer)
Date: May 10, 2018	By	/S/ J. Todd Scruggs
		J. Todd Scruggs, Secretary and Treasurer
		(Principal Financial Officer and Principal Accounting Officer)

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