10-K 1 fmbm_10k.htm ANNUAL REPORT Blueprint
 

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D. C. 20549
 
FORM 10-K
 
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
 
For fiscal year ended December 31, 2018
Commission file number: 0-13273
 
F & M BANK CORP.
  (Exact name of registrant as specified in its charter)
 
Virginia
(State or other jurisdiction of
incorporation or organization)
 
54-1280811
(I.R.S. Employer
Identification No.)

P. O. Box 1111, Timberville, Virginia 22853
(Address of principal executive offices) (Zip Code)
 
(540) 896-8941
(Registrant’s telephone number including area code)
 
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock - $5 Par value per share
 
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Sarbanes Act. Yes [ ] No [x]
 
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes [ ] No [x]
 
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 [x] No [ ]
 
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes [X]  No [ ] 
 
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [x]
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the 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
Smaller reporting company
Emerging growth company
 
  
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes [ ] No [x]
 
The registrant’s Common Stock is quoted on the OTC Market’s OTCQX tier under the symbol FMBM. The aggregate market value of the 2,893,997 shares of Common Stock of the registrant issued and outstanding held by non-affiliates on June 30, 2018 was approximately $111,274,169 based on the closing sales price of $38.45 per share on that date. For purposes of this calculation, the term “affiliate” refers to all directors and executive officers of the registrant.
 
As of the close of business on March 11, 2019, there were 3,210,562 shares of the registrant's Common Stock outstanding.
 
DOCUMENTS INCORPORATED BY REFERENCE:
 
Part III: Portions of the Proxy Statement for the Annual Meeting of Shareholders to be held on May 11, 2019 (the “Proxy Statement”).

 
 
Table of Contents
 
 
 
 
Page
 
PART I
 
 
 
 
 
 
Item 1.
Business
 
2
Item 1A
Risk Factors 
 
9
Item 1B
Unresolved Staff Comments
 
16
Item 2
Properties
 
16
Item 3
Legal Proceedings
 
16
Item 4
Mine Safety Disclosures
 
17
 
 
 
 
 
PART II
 
 
 
 
 
 
Item 5
Market for Registrant's Common Equity and Related Stockholder Matters and Issuer Purchases of Equity Securities
 
17
Item 6
Selected Financial Data
 
19
Item 7
Management's Discussion and Analysis of Financial Condition and Results of Operations
 
20
Item 7A
Quantitative and Qualitative Disclosures About Market Risk
 
42
Item 8
Financial Statements and Supplementary Data
 
43
Item 9
Changes in and Disagreements with Accountants on Accounting and Financial Disclosures
 
98
Item 9A 
Controls and Procedures 
 
98
Item 9B 
Other Information 
 
99
 
 
 
 
 
PART III
 
 
 
 
 
 
Item 10
Directors, Executive Officers and Corporate Governance
 
99
Item 11
Executive Compensation
 
99
Item 12
Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
 
99
Item 13
Certain Relationships and Related Transactions, and Director Independence
 
99
Item 14
Principal Accounting Fees and Services
 
99
 
   
 
 
 
PART IV
 
 
 
   
 
 
Item 15
Exhibits, Financial Statement Schedules
 
100
Item 16 
Form 10-K Summary 
 
101
 
 
 
 
SIGNATURES
 
102
 
 
 
 
PART I
 
Item 1. Business
 
General
 
F & M Bank Corp. (the “Company” or “we”), incorporated in Virginia in 1983, is a one bank holding company under the Bank Holding Company Act of 1956 that has elected to become a financial holding company. The Company owns 100% of the outstanding stock of its banking subsidiary, Farmers & Merchants Bank (“Bank”) and a majority interest in VSTitle, LLC (“VST”). TEB Life Insurance Company (“TEB”) and Farmers & Merchants Financial Services, Inc. (“FMFS”) are wholly owned subsidiaries of the Bank. The Bank also holds a majority ownership in VBS Mortgage, LLC (DBA F&M Mortgage “F&M Mortgage”).
 
The Bank was chartered on April 15, 1908, as a state chartered bank under the laws of the Commonwealth of Virginia. TEB was incorporated on January 27, 1988, as a captive life insurance company under the laws of the State of Arizona. FMFS is a Virginia chartered corporation and was incorporated on February 25, 1993. F&M Mortgage was incorporated on May 11, 1999. The Bank purchased a majority interest in F&M Mortgage on November 3, 2008 and the Company purchased a majority interest in VST on January 1, 2017. F&M Mortgage owns the remaining minority interest in VST.
 
As a commercial bank, the Bank offers a wide range of banking services including commercial and individual demand and time deposit accounts, commercial and individual loans, internet and mobile banking, drive-in banking services, ATMs at all branch locations and several off-site locations, as well as a courier service for its commercial banking customers. TEB was organized to re-insure credit life and accident and health insurance currently being sold by the Bank in connection with its lending activities. FMFS was organized to write title insurance but now provides brokerage services, commercial and personal lines of insurance to customers of the Bank. F&M Mortgage originates conventional and government sponsored mortgages through their offices in Harrisonburg, Woodstock and Fishersville. VST provides title insurance and real estate settlement services through their offices in Harrisonburg, Fishersville and Charlottesville, VA.
 
The Bank makes various types of commercial and consumer loans and has a large portfolio of residential mortgages and indirect auto lending. The local economy is relatively diverse with strong employment in the agricultural, manufacturing, service and governmental sectors.
 
The Company’s and the Bank’s principal executive office is located at 205 South Main Street, Timberville, VA 22853, and its phone number is (540) 896-8941.
 
Filings with the SEC
 
The Company files annual, quarterly and other reports under the Securities Exchange Act of 1934 with the Securities and Exchange Commission (“SEC”). These reports are posted and are available at no cost on the Company’s website, www.FMBankVA.com, as soon as reasonably practicable after the Company files such documents with the SEC. The Company’s filings are also available through the SEC’s website at www.sec.gov.
 
Employees
 
On December 31, 2018, the Bank had 172 full-time and part-time employees; including executive officers, loan and other banking officers, branch personnel, operations personnel and other support personnel. None of the Company’s employees is represented by a union or covered under a collective bargaining agreement. Management of the Company considers their employee relations to be excellent. No one employee devotes full-time services to F & M Bank Corp.
 
Competition
 
The Bank's offices face strong competition from numerous other financial institutions. These other institutions include large national and regional banks, other community banks, nationally chartered savings banks, credit unions, consumer finance companies, mortgage companies, loan production offices, marketplace lenders and other financial technology firms, mutual funds and life insurance companies. Competition for loans and deposits is affected by a variety of factors including interest rates, types of products offered, the number and location of branch offices, marketing strategies and the reputation of the Bank within the communities served.
 
 
2
 
 
PART I, continued
 
Item 1. Business, continued
 
Regulation and Supervision
 
General. The operations of the Company and the Bank are subject to federal and state statutes, which apply to bank holding companies, financial holding companies and state member banks of the Federal Reserve System. The common stock of the Company is registered pursuant to and subject to the periodic reporting requirements of the Securities Exchange Act of 1934 (the “Exchange Act”). These include, but are not limited to, the filing of annual, quarterly, and other current reports with the Securities and Exchange Commission (the “SEC”). As an Exchange Act reporting company, the Company is directly affected by the Sarbanes-Oxley Act of 2002 (“Sarbanes-Oxley”).  The Company believes it is in compliance with SEC and other rules and regulations implemented pursuant to Sarbanes-Oxley and intends to comply with any applicable rules and regulations implemented in the future.
 
The Company, as a bank holding company and a financial holding company, is subject to the provisions of the Bank Holding Company Act of 1956, as amended (the "Act") and is supervised by the Board of Governors of the Federal Reserve System (the “Federal Reserve Board”). The Act requires the Company to secure the prior approval of the Federal Reserve Board before the Company acquires ownership or control of more than 5% of the voting shares or substantially all of the assets of any institution, including another bank.
 
As a financial holding company, the Company is required to file with the Federal Reserve Board an annual report and such additional information as it may require pursuant to the Act. The Federal Reserve Board may also conduct examinations of F & M Bank Corp. and any or all of its subsidiaries. Under the Act and the regulations of the Federal Reserve Board, a bank holding company and its subsidiaries are prohibited from engaging in certain tie-in arrangements in connection with an extension of credit, pro-vision of credit, sale or lease of property or furnishing of services.
 
The permitted activities of a bank holding company are limited to managing or controlling banks, furnishing services to or performing services for its subsidiaries, and engaging in other activities that the Federal Reserve Board determines by regulation or order to be so closely related to banking or managing or controlling banks as to be a proper incident thereto. In addition, bank holding companies that qualify and elect to be financial holding companies, such as the Company, may engage in any activity, or acquire and retain the shares of a company engaged in any activity, that is either (i) financial in nature or incidental to such financial activity (as determined by the Federal Reserve Board in consultation with the Secretary of the Treasury) or (ii) complementary to a financial activity and does not pose a substantial risk to the safety and soundness of depository institutions or the financial system generally (as solely determinedby the Federal Reserve Board), without prior approval of the Federal Reserve Board. Activities that are financial in nature include but are not limited to securities underwriting and dealing, insurance underwriting, and making merchant banking investments.Since 1994, the Company has entered into agreements with the Virginia Community Development Corporation to purchase equity positions in several Low-Income Housing Funds; these funds provide housing for low-income individuals throughout Virginia. Approval of the Federal Reserve Board is necessary to engage in any of the activities described above or to acquire interests engaging in these activities.
 
The Bank as a state member bank is supervised and regularly examined by the Virginia Bureau of Financial Institutions and the Federal Reserve Board; such supervision and examination by the Virginia Bureau of Financial Institutions and the Federal Reserve Board is intended primarily for the protection of depositors and not the stockholders of the Company.
 
Payment of Dividends. The Company is a legal entity, separate and distinct from its subsidiaries. A significant portion of the revenues of the Company result from dividends paid to it by the Bank. There are various legal limitations applicable to the payment of dividends by the Bank to the Company. Under the current regulatory guidelines, prior approval from the Federal Reserve Board is required if cash dividends declared in any given year exceed net income for that year, plus retained net profits of the two preceding years. A bank also may not declare a dividend out of or in excess of its net undivided profits without regulatory approval. The payment of dividends by the Bank or the Company may also be limited by other factors, such as requirements to maintain capital above regulatory guidelines.
 
Bank regulatory agencies have the authority to prohibit the Bank or the Company from engaging in an unsafe or unsound practice in conducting their businesses. The payment of dividends, depending on the financial condition of the Bank, or the Company, could be deemed to constitute such an unsafe or unsound practice. Based on the Bank’s current financial condition, the Company does not expect that any of these laws will have any impact on its ability to obtain dividends from the Bank.
 
 
3
 
 
PART I, continued
 
Item 1. Business, continued
 
Regulation and Supervision, continued
 
The Company also is subject to regulatory restrictions on payment of dividends to its shareholders. Regulators have indicated that bank holding companies should generally pay dividends only if the organization’s net income available to common shareholders over the past year has been sufficient to fully fund the dividends and the prospective rate of earnings retention appears consistent with the organization’s capital needs, asset quality, and overall financial condition. Further, a bank holding company should inform and consult with the Federal Reserve Board prior to declaring a dividend that exceeds earnings for the period (e.g., quarter) for which the dividend is being paid or that could result in a material adverse change to the organization’s capital structure.
 
Capital Requirements. Effective January 1, 2015, the Federal Reserve, the Federal Deposit Insurance Company (FDIC) and the Office of the Comptroller of the Currency (OCC) adopted a new rule that substantially amended the regulatory risk-based capital rules applicable to us. The final rule implemented the "Basel III" regulatory capital reforms and changes required by the Dodd-Frank Act (see definition below). The final rule includes new minimum risk-based capital and leverage ratios and refines the definition of what constitutes "capital" for purposes of calculating these ratios. The minimum capital requirements currently applicable to the Bank are: (i) a new common equity Tier 1 ("CET1") capital ratio of 4.5%; (ii) a Tier 1 to risk-based assets capital ratio of 6%; (iii) a total capital ratio of 8%; and (iv) a Tier 1 leverage ratio of 4%. The final rule also establishes a "capital conservation buffer" of 2.5% above the new regulatory minimum capital ratios, and when fully effective on January 1, 2019, will result in the following minimum ratios: (a) a common equity Tier 1 capital ratio of 7.0%; (b) a Tier 1 to risk-based assets capital ratio of 8.5%; and (c) a total capital ratio of 10.5%. An institution will be subject to limitations on paying dividends, engaging in share repurchases, and paying discretionary bonuses if its capital level falls below the buffer amount. These limitations will establish a maximum percentage of eligible retained income that can be utilized for such activities.
 
The CETI and Tier 1 leverage ratio of the Bank as of December 31, 2018, were 13.65% and 11.79%, respectively, which are significantly above the minimum requirements. The guidelines also provide that banking organizations experiencing internal growth or making acquisitions will be expected to maintain strong capital positions substantially above the minimum supervisory levels, without significant reliance on intangible assets.
 
In December 2017, the Basel Committee published standards that it described as the finalization of the Basel III post-crisis regulatory reforms (the standards are commonly referred to as “Basel IV”). Among other things, these standards revise the Basel Committee’s standardized approach for credit risk (including by recalibrating risk weights and introducing new capital requirements for certain “unconditionally cancellable commitments,” such as unused credit card lines of credit) and provide a new standardized approach for operational risk capital. Under the proposed framework, these standards will generally be effective on January 1, 2022, with an aggregate output floor phasing-in through January 1, 2027. Under the current capital rules, operational risk capital requirements and a capital floor apply only to advanced approaches institutions, and not to the Company. The impact of Basel IV on the Company and the Bank will depend on the manner in which it is implemented by the federal bank regulatory agencies.
 
As directed by the Economic Growth, Regulatory Relief and Consumer Protection Act (the “Economic Growth Act”), on November 21, 2018, the federal banking regulators jointly issued a proposed rule that would permit qualifying banks that have less than $10 billion in total consolidated assets to elect to be subject to a 9% “community bank leverage ratio.” A qualifying bank that has chosen the proposed framework would not be required to calculate the existing risk-based and leverage capital requirements and would be considered to have met the capital ratio requirements to be “well capitalized” under prompt corrective action rules, provided it has a community bank leverage ratio greater than 9%. This proposed rule has not been finalized and, as a result, the content and scope of any final rule, and its impact on the Bank (if any), cannot be determined at this time.
 
Pursuant to the Federal Reserve’s Small Bank Holding Company and Savings and Loan Holding Company Policy Statement, qualifying bank holding companies with total consolidated assets of less than $3 billion, such as the Company, are not subject to consolidated regulatory capital requirements.
 
 
4
 
 
PART I, continued
 
Item 1. Business, continued
 
Regulation and Supervision, continued
 
Source of Strength. Federal Reserve policy has historically required bank holding companies to act as a source of financial and managerial strength to their subsidiary banks. The Dodd-Frank Act codified this policy as a statutory requirement. Under this requirement, the Company is expected to commit resources to support the Bank, including at times when the Company may not be in a financial position to provide such resources. Any capital loans by a bank holding company to any of its subsidiary banks are subordinate in right of payment to depositors and to certain other indebtedness of such subsidiary banks. In the event of a bank holding company's bankruptcy, any commitment by the bank holding company to a federal bank regulatory agency to maintain the capital of a subsidiary bank will be assumed by the bankruptcy trustee and entitled to priority of payment.
 
Safety and Soundness. There are a number of obligations and restrictions imposed on bank holding companies and their subsidiary banks by law and regulatory policy that are designed to minimize potential loss to the depositors of such depository institutions and the FDIC insurance fund in the event of a depository institution default. For example, under the Federal Deposit Insurance Corporation Improvement Act of 1991, to avoid receivership of an insured depository institution subsidiary, a bank holding company is required to guarantee the compliance of any subsidiary bank that may become "undercapitalized" with the terms of any capital restoration plan filed by such subsidiary with its appropriate federal bank regulatory agency up to the lesser of (i) an amount equal to 5% of the institution's total assets at the time the institution became undercapitalized or (ii) the amount that is necessary (or would have been necessary) to bring the institution into compliance with all applicable capital standards as of the time the institution fails to comply with such capital restoration plan. Under the Federal Deposit Insurance Act, the federal bank regulatory agencies have adopted guidelines prescribing safety and soundness standards. These guidelines establish general standards relating to internal controls and information systems, internal audit systems, loan documentation, credit underwriting, interest rate exposure, asset growth and compensation, fees and benefits. In general, the guidelines require, among other things, appropriate systems and practices to identify and manage the risk and exposures specified in the guidelines.
 
The Gramm-Leach-Bliley Act. The Gramm-Leach-Bliley Act (the “GLB Act”) allows a bank holding company or other company to certify status as a financial holding company, which will allow such company to engage in activities that are financial in nature, that are incidental to such activities, or are complementary to such activities. The GLB Act enumerates certain activities that are deemed financial in nature, such as underwriting insurance or acting as an insurance principal, agent or broker;dealing in or making markets in securities; and engaging in merchant banking under certain restrictions. It also authorizes the Federal Reserve to determine by regulation what other activities are financial in nature, or incidental or complementary thereto.
 
USA Patriot Act of 2001. In October 2001, the USA Patriot Act of 2001 was enacted in response to the terrorist attacks in New York, Pennsylvania and Northern Virginia which occurred on September 11, 2001. The Patriot Act is intended to strengthen U.S. law enforcements’ and the intelligence communities’ abilities to work cohesively to combat terrorism on a variety of fronts. The continuing and potential impact of the Patriot Act and related regulations and policies on financial institutions of all kinds is significant and wide ranging. The Patriot Act contains sweeping anti-money laundering and financial transparency laws, and imposes various regulations, including standards for verifying client identification at account opening, and rules to promote cooperation among financial institutions, regulators and law enforcement entities in identifying parties that may be involved in terrorism or money laundering.
 
Community Reinvestment Act.   The requirements of the Community Reinvestment Act are also applicable to the Bank. The act imposes on financial institutions an affirmative and ongoing obligation to meet the credit needs of their local communities, including low and moderate income neighborhoods, consistent with the safe and sound operation of those institutions. A financial institution’s efforts in meeting community needs currently are evaluated as part of the examination process pursuant to twelve assessment factors. These factors are also considered in evaluating mergers, acquisitions and applications to open a branch or facility.
 
 
5
 
 
PART I, continued
 
Item 1. Business, continued
 
Regulation and Supervision, continued
 
Dodd-Frank Wall Street Reform and Consumer Protection Act. The Dodd-Frank Act was signed into law on July 21, 2010. Its wide-ranging provisions affect all federal financial regulatory agencies and nearly every aspect of the American financial services industry. Among the provisions of the Dodd-Frank Act that directly impact the Company is the creation of an independent Consumer Financial Protection Bureau (CFPB), which has the ability to implement, examine and enforce complaints with federal consumer protection laws, which govern all financial institutions. For smaller financial institutions, such as the Company and the Bank, their primary regulators will continue to conduct its examination activities.
 
The Dodd-Frank Act contains provisions designed to reform mortgage lending, which includes the requirement of additional disclosures for consumer mortgages. In addition, the Federal Reserve has issued new rules that have the effect of limiting the fees charged to merchants for debit card transactions. The result of these rules will be to limit the amount of interchange fee income available explicitly to larger banks and indirectly to us. The Dodd-Frank Act also contains provisions that affect corporate governance and executive compensation.
 
Although the Dodd-Frank Act provisions themselves are extensive, the ultimate impact on the Company of this massive legislation is unknown. The Act provides that several federal agencies, including the Federal Reserve and the Securities and Exchange Commission, shall issue regulations implementing major portions of the legislation, and this process is ongoing.
 
In May 2018, the Economic Growth Act was enacted to modify or remove certain regulatory financial reform rules and regulations, including some of those implemented under the Dodd-Frank Act. While the Economic Growth Act maintains most of the regulatory structure established by the Dodd-Frank Act, it amends certain aspects of the regulatory framework for small depository institutions with assets of less than $10 billion, such as the Bank, and for large banks with assets of more than $50 billion.
 
Among other matters, the Economic Growth Act expands the definition of qualified mortgages which may be held by a financial institution with total consolidated assets of less than $10 billion, exempts community banks from the Volcker Rule, and includes additional regulatory relief regarding regulatory examination cycles, call reports, mortgage disclosures and risk weights for certain high-risk commercial real estate loans.
 
It is difficult at this time to predict when or how any new standards under the Economic Growth Act will ultimately be applied to us or what specific impact the Economic Growth Act and implementing rules and regulations will have on community banks.
  
 
6
 
 
PART I, continued
 
Item 1. Business, continued
 
Forward-Looking Statements
 
Certain information contained in this report may include “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Exchange Act. These forward-looking statements are generally identified by phrases such as “we expect,” “we believe” or words of similar import. Such forward-looking statements involve known and unknown risks including, but not limited to:
 
● 
Changes in the quality or composition of our loan or investment portfolios, including adverse developments in borrower industries, declines in real estate values in our markets, or in the repayment ability of individual borrowers or issuers;
● 
The strength of the economy in our target market area, as well as general economic, market, or business conditions;
●            
An insufficient allowance for loan losses as a result of inaccurate assumptions;
●            
Our ability to maintain our “well-capitalized” regulatory status;
●            
Changes in the interest rates affecting our deposits and our loans;
● 
Changes in our competitive position, competitive actions by other financial institutions and the competitive nature of the financial services industry and our ability to compete effectively against other financial institutions in our banking markets;
●            
Our ability to manage growth;
● 
Our potential growth, including our entrance or expansion into new markets, the opportunities that may be presented to and pursued by us and the need for sufficient capital to support that growth;
●            
Our exposure to operational risk;
●            
Our ability to raise capital as needed by our business;
●            
Changes in laws, regulations and the policies of federal or state regulators and agencies;
●            
Other circumstances, many of which are beyond our control; and
● 
Other factors identified in “Risk Factors” below and in other reports the Company files with the SEC from time to time.

Although we believe that our expectations with respect to the forward-looking statements are based upon reliable assumptions within the bounds of our knowledge of our business and operations, there can be no assurance that our actual results, performance or achievements will not differ materially from any future results, performance or achievements expressed or implied by such forward-looking statements.
 
Operating Revenue
 
The following table displays components that contributed 15% or more of the Company’s total operating revenue for the years ended December 31, 2018, 2017, and 2016:
 
Period
Class of Service
 
Percentage of Total Revenues
 
 
 
 
 
 
December 31, 2018
Interest and fees on loans held for investment
  78.42%
December 31, 2017
Interest and fees on loans held for investment
  77.35%
December 31, 2016
Interest and fees on loans held for investment
  79.02%
 
 
7
 
 
PART I, continued
 
Item 1. Business, continued
 
Executive Officers of the Company
 
Mark C. Hanna, 50, has served as President/CEO of the Bank since July 1, 2018. Prior to that he served as President since December 2017. Prior to joining the Company, he served as Executive Vice President and Tidewater Regional President of EVB and its successor, Sonabank from November 2014 through October 2017. Previously, he served as President and Chief Executive Officer of Virginia Company Bank from November 2006 through November 2014.
 
Neil W. Hayslett, 57, has served as Executive Vice President and Chief Operating Officer of the Bank and the Company since March 1, 2018, prior to that he served as Executive Vice President/Chief Administrative Officer of the Bank and the Company from June 2013 until March 2018 and Executive Vice President/Chief Financial Officer from November 2007 until June 2013. Prior to that time, he served as Senior Vice President/Chief Financial Officer of the Bank and the Company from January 2003 until November 2007 and served as Vice President/Chief Financial Officer from October 1996 to January 2003.
 
Carrie A. Comer, 49, has served as Executive Vice President and Chief Financial Officer of the Bank and the Company since March 1, 2018, prior to that she served as Senior Vice President/Chief Financial Officer of the Company and Bank since June 2013. Ms. Comer served as Vice President/Controller of the Bank from March 2009 to June 2013. From December 2005 to March 2009, Ms. Comer served as Assistant Vice President/Controller of F&M Bank.
 
Stephanie E. Shillingburg, 57, has served as Executive Vice President/Chief Banking Officer of the Bank and the Company since July 2016, Executive Vice President/Chief Retail Officer from June 2013 until July 2016, Senior Vice President/Branch Administrator from February 2005 until June 2013. She also served as Vice President/Branch Administrator from March 2003 until February 2005 and as Branch Manager of the Edinburg Branch from February 2001 until March 2003.
 
Edward Strunk, 62, has served as Executive Vice President and Chief Credit Officer of the Bank and the Company since March 1, 2018. Prior to that he serviced as Senior Vice President/Senior Lending Officer since July 2006, Senior Vice President/Commercial Loan Administrator from May 2011 until July 2016, Vice President/Commercial Loan Administrator from February 2011 until May 2011 and Vice Present/Business Development Officer III from May 2007 until February 2011.
 
Josh Hale, 42, has served as Executive Vice President and Chief Lending Officer of the Bank and the Company since March 1, 2018. Prior to that he served as Senior Vice President/Business Development Leader since June 2013, Vice President/Commercial Relationship Manager III from December 2010 until June 2013, Vice President/Business Development Officer II from March 2009 until December 2010 and Assistant Vice President/Business Development Officer II from December 2004 until March 2009.
 
Barton E. Black, 48, has served as Executive Vice President and Chief Strategy & Risk Officer of the Bank and the Company since March 1, 2019. Prior to joining the company, he served as Managing Director at Strategic Risk Associates, a financial services consulting company based in Virginia from August 2012 through February 2019.

 
8
 
 
PART I, continued
 
Item 1A. Risk Factors
 
General economic conditions in our market area could adversely affect us.
 
We are affected by the general economic conditions in the local markets in which we operate. Conditions such as economic recession, falling home prices, rising foreclosures and other factors beyond our control could lead to, among other things, an increased level of commercial and consumer delinquencies. If economic conditions in our market deteriorate, we could experience further adverse consequences, including a decline in demand for our products and services and an increase in problem assets, foreclosures and loan losses. Future economic conditions in our market will depend on factors outside of our control such as political and market conditions, broad trends in industry and finance, legislative and regulatory changes, changes in government, military and fiscal policies and inflation, any of which could negatively affect our performance and financial condition.
  
Our allowance for loan losses may prove to be insufficient to absorb losses in the loan portfolio.
 
Like all financial institutions, we maintain an allowance for loan losses to provide for loans that our borrowers may not repay in their entirety. We believe that we maintain an allowance for loan losses at a level adequate to absorb probable losses inherent in the loan portfolio. Through a periodic review and consideration of the loan portfolio, management determines the amount of the allowance for loan losses by considering general market conditions, credit quality of the loan portfolio, the collateral supporting the loans and performance of customers relative to their financial obligations with us.
 
The amount of future losses is susceptible to changes in economic, operating and other conditions, including changes in interest rates, which may be beyond our control, and these losses may exceed current estimates. Although we believe the allowance for loan losses is a reasonable estimate of known and inherent losses in the loan portfolio, it cannot fully predict such losses or that the loss allowance will be adequate in the future. While the risk of nonpayment is inherent in banking, we could experience greater nonpayment levels than we anticipate. In addition, we have loan participation arrangements with several other banks within the region and may not be able to exercise control of negotiations with borrowers in the event these loans do not perform. Additional problems with asset quality could cause our interest income and net interest margin to decrease and our provisions for loan losses to increase, which could adversely affect our results of operations and financial condition.
 
Federal and state regulators periodically review our allowance for loan losses and may require us to increase our provision for loan losses or recognize further loan charge-offs, based on judgments different than those of management. Any increase in the amount of the provision or loans charged-off as required by these regulatory agencies could have a negative effect on our operating results.
 
Our loan concentrations could, as a result of adverse market conditions, increase credit losses which could adversely impact earnings.
 
We offer a variety of secured loans, including commercial lines of credit, commercial term loans, real estate, construction, home equity, consumer and other loans. Many of our loans are secured by real estate (both residential and commercial) in our market area, which could result in adverse consequences to us in the event of a prolonged economic downturn in our market. As of December 31, 2018, approximately 77% of our loans had real estate as a primary or secondary component of collateral.  A significant decline in real estate values in our market would mean that the collateral for many of our loans would provide less security. As a result, we would be more likely to suffer losses on defaulted loans because our ability to fully recover on defaulted loans by selling the real estate collateral would be diminished. In addition, our consumer and dealer loans (such as automobile loans) are collateralized, if at all, with assets that may not provide an adequate source of repayment of the loan due to depreciation, damage or loss.
 
In addition, we have a large portfolio of residential mortgages which could be adversely affected by a decline in the real estate markets. Construction and development lending entails significant additional risks, because these loans, which often involve larger loan balances concentrated with single borrowers or groups of related borrowers, are dependent on the successful completion of real estate projects. Loan funds for construction and development loans often are advanced upon the security of the land or home under construction, which value is estimated prior to the completion of construction.  The deterioration of one or a few of these loans could cause a significant increase in the percentage of non-performing loans. An increase in non-performing loans could result in a loss of earnings from these loans, an increase in the provision for loan losses and an increase in charge-offs, all of which could have a material adverse effect on our financial condition.
 
 
9
 
 
PART I, continued
 
Item 1A. Risk Factors, continued
 
Our dealer finance division exposes us to increased credit risks.
 
In 2012, the Bank began a loan production office which specializes in providing consumer installment loans to finance automobile purchases through a network of automobile dealers. As of December 31, 2018, we had approximately $98 million in loans outstanding in this portfolio. We serve customers over a broad range of creditworthiness, and the required terms and rates are reflective of those risk profiles. While these loans have higher yields than many of our other loans, such loans involve significant risks in addition to normal credit risk. Potential risk elements associated with indirect lending include the limited personal contact with the borrower as a result of indirect lending through our network of dealers, the absence of assured continued employment of the borrower, the varying general creditworthiness of the borrower, changes in the local economy and difficulty in monitoring collateral. While indirect automobile loans are secured, such loans are secured by depreciating assets and characterized by loan to value ratios that could result in us not recovering the full value of an outstanding loan upon default by the borrower. Delinquencies, charge-offs and repossessions of vehicles in this portfolio are always concerns. If general economic conditions worsen, we may experience higher levels of delinquencies, repossessions and charge-offs.
 
Our small-to-medium sized business target market may have fewer financial resources to weather continued downturn in the economy.
 
We target our commercial development and marketing strategy primarily to serve the banking and financial services needs of small and medium sized businesses. These businesses generally have less capital or borrowing capacity than larger entities. If general economic conditions negatively impact this major economic sector in the markets in which we operate, our results of operations and financial condition may be adversely affected.
 
Our inability to maintain adequate sources of funding and liquidity may negatively impact our current financial condition or our ability to grow.
 
Our access to funding and liquidity sources in amounts adequate to finance our activities on terms which are acceptable to us could be impaired by factors that affect us specifically or the financial services industry or economy in general.  In managing our balance sheet, a primary source of funding asset growth and liquidity historically has been deposits, including both local customer deposits and brokered deposits.  If the level of deposits were to materially decrease, we would have to raise additional funds by increasing the interest that we pay on certificates of deposit or other depository accounts, seek other debt or equity financing, or draw upon our available lines of credit.  Our access to these funding and liquidity sources could be detrimentally impacted by a number of factors, including operating losses, rising levels of non-performing assets, a decrease in the level of our business activity as a result of a downturn in the markets in which our loans or deposits are concentrated or regulatory restrictions.  In addition, our ability to continue to attract deposits and other funding or liquidity sources is subject to variability based upon additional factors including volume and volatility in the securities markets and the relative interest rates that we are prepared to pay for these liabilities.  We do not maintain significant additional sources of liquidity through potential sales in our investment portfolio or liquid assets at the holding company level.  Our potential inability to maintain adequate sources of funding or liquidity may, among other things, inhibit our ability to fund asset growth or negatively impact our financial condition, including our ability to pay dividends or satisfy our obligations.
 
If we do not maintain our capital requirements and our status as a “well-capitalized” bank, there could an adverse effect on our liquidity and our ability to fund our loan portfolio.
 
We are subject to regulatory capital adequacy guidelines. If we fail to meet the capital adequacy guidelines for a “well-capitalized” bank, it could increase the regulatory scrutiny for the Bank and the Company.  In addition, if we failed to be “well capitalized” for regulatory capital purposes, we would not be able to renew or accept brokered deposits without prior regulatory approval and we would not be able to offer interest rates on our deposit accounts that are significantly higher than the average rates in our market area. As a result, it would be more difficult for us to attract new deposits as our existing brokered deposits mature and do not roll over and to retain or increase existing, non-brokered deposits.  If we are prohibited from renewing or accepting brokered deposits and are unable to attract new deposits, our liquidity and our ability to fund our loan portfolio may be adversely affected.  In addition, we could be required to pay higher insurance premiums to the FDIC, which would reduce our earnings.
 
 
10
 
 
PART I, continued
 
Item 1A. Risk Factors, continued
 
We are subject to more stringent capital requirements as a result of the Basel III regulatory capital reforms and the Dodd-Frank Act which could adversely affect our results of operations and future growth.
 
In 2013, the Federal Reserve, the FDIC and the OCC approved a new rule that substantially amended the regulatory risk-based capital rules applicable to us. The final rule implements the “Basel III” regulatory capital reforms and changes required by the Dodd-Frank Act. The final rule includes new minimum risk-based capital and leverage ratios which were effective for us on January 1, 2015 and refines the definition of what constitutes “capital” for purposes of calculating these ratios. The new minimum capital requirements are: (i) a new common equity Tier 1 (“CET1”) capital ratio of 4.5%; (ii) a Tier 1 to risk-based assets capital ratio of 6%; (iii) a total capital ratio of 8%; and (iv) a Tier 1 leverage ratio of 4%. The final rule also established a “capital conservation buffer” of 2.5% above the new regulatory minimum capital ratios, which is phased in as of January 1, 2019 Including this buffer, we effectively are subject to the following minimum ratios beginning January 1, 2019: (a) a common equity Tier 1 capital ratio of 7.0%; (b) a Tier 1 to risk-based assets capital ratio of 8.5%; and (c) a total capital ratio of 10.5%. An institution will be subject to limitations on paying dividends, engaging in share repurchases, and paying discretionary bonuses if its capital level falls below the buffer amount. These limitations will establish a maximum percentage of eligible retained income that can be utilized for such activities. In addition, the final rule provides for a number of new deductions from and adjustments to capital and prescribes a revised approach for risk weightings that could result in higher risk weights for a variety of asset categories.
 
While the recently passed Economic Growth Act requires that federal banking regulators establish a simplified leverage capital framework for smaller banks, these more stringent capital requirements for us could, among other things, result in lower returns on equity, require the raising of additional capital, adversely affect our future growth opportunities, and result in regulatory actions such as a prohibition on the payment of dividends or on the repurchase shares if we are unable to comply with such requirements.
 
Our future success is dependent on our ability to effectively compete in the face of substantial competition from other financial institutions in our primary markets and other non-bank competitors.
 
We encounter significant competition for deposits, loans and other financial services from banks and other financial institutions, including savings and loan associations, savings banks, finance companies, and credit unions in our market area. A number of these banks and other financial institutions are significantly larger than us and have substantially greater access to capital and other resources, larger lending limits, more extensive branch systems, and may offer a wider array of banking services. In addition, credit unions have been able to increasingly expand their membership definitions and, because they enjoy a favorable tax status, may be able to offer more attractive loan and deposit pricing. To a limited extent, we compete with other providers of financial services, such as money market mutual funds, brokerage firms, consumer finance companies, marketplace lenders and other financial technology firms, insurance companies and governmental organizations any of which may offer more favorable financing rates and terms than us. Many of these non-bank competitors are not subject to the same extensive regulations that govern us. As a result, these non-bank competitors may have advantages in providing certain services. This competition may reduce or limit our margins and our market share and may adversely affect our results of operations and financial condition.
 
Our inability to successfully manage growth or implement our growth strategy may adversely affect our results of operations and financial condition.
 
We may not be able to successfully implement our growth strategy if we are unable to identify attractive markets, locations or opportunities to expand in the future.  Our ability to manage growth successfully also depends on whether we can maintain capital levels adequate to support our growth, maintain cost controls, asset quality and successfully integrate any businesses acquired into the organization.
 
As we continue to implement our growth strategy, we may incur increased personnel, occupancy and other operating expenses. We must absorb those higher expenses while we begin to generate new deposits, and there is a further time lag involved in redeploying new deposits into attractively priced loans and other higher yielding earning assets. Thus, our plans to branch could depress earnings in the short run, even if we efficiently execute a branching strategy leading to long-term financial benefits.
 
 
11
 
 
PART I, continued
 
Item 1A. Risk Factors, continued
 
Our exposure to operational risk may adversely affect us.
 
Similar to other financial institutions, we are exposed to many types of operational risk, including reputational risk, legal and compliance risk, the risk of fraud or theft by employees or outsiders, unauthorized transactions by employees or operational errors, including clerical or record-keeping errors or those resulting from faulty or disabled computer or telecommunications systems.
 
Reputational risk, or the risk to our earnings and capital from negative public opinion, could result from our actual alleged conduct in any number of activities, including lending practices, corporate governance, regulatory compliance or the occurrence of any of the events or instances mentioned below, or from actions taken by government regulators or community organizations in response to that conduct. Negative public opinion could also result from adverse news or publicity that impairs the reputation of the financial services industry generally.
 
Further, if any of our financial, accounting, or other data processing systems fail or have other significant shortcomings, we could be adversely affected. We depend on internal systems and outsourced technology to support these data storage and processing operations. Our inability to use or access these information systems at critical points in time could unfavorably impact the timeliness and efficiency of our business operations. We could be adversely affected if one of our employees causes a significant operational break-down or failure, either as a result of human error or where an individual purposefully sabotages or fraudulently manipulates our operations or systems. We are also at risk of the impact of natural disasters, terrorism and international hostilities on our systems or for the effects of outages or other failures involving power or communications systems operated by others.
 
Misconduct by employees could include fraudulent, improper or unauthorized activities on behalf of clients or improper use of confidential information. We may not be able to prevent employee errors or misconduct, and the precautions we take to detect this type of activity might not be effective in all cases. Employee errors or misconduct could subject us to civil claims for negligence or regulatory enforcement actions, including fines and restrictions on our business.
 
In addition, there have been instances where financial institutions have been victims of fraudulent activity in which criminals pose as customers to initiate wire and automated clearinghouse transactions out of customer accounts. Although we have policies and procedures in place to verify the authenticity of our customers, we cannot assure that such policies and procedures will prevent all fraudulent transfers. Such activity can result in financial liability and harm to our reputation.
 
If any of the foregoing risks materialize, it could have a material adverse effect on our business, financial condition and results of operations.
 
Our operations rely on certain external vendors.
 
We are reliant upon certain external vendors to provide products and services necessary to maintain our day-to-day operations. Accordingly, our operations are exposed to risk that these vendors will not perform in accordance with the contracted arrangements under service agreements. Although we maintain a system of comprehensive policies and a control framework designed to monitor vendor risks, the failure of an external vendor to perform in accordance with the contracted arrangements under service agreements could be disruptive to our operations, which could have a material adverse impact on our business and, in turn, our financial condition and results of operations.
 
 
12
 
 
PART I, continued
 
Item 1A. Risk Factors, continued
 
Changes in market interest rates could affect our cash flows and our ability to successfully manage our interest rate risk.
 
Our profitability and financial condition depend to a great extent on our ability to manage the net interest margin, which is the difference between the interest income earned on loans and investments and the interest expense paid for deposits and borrowings. The amounts of interest income and interest expense are principally driven by two factors; the market levels of interest rates, and the volumes of earning assets or interest bearing liabilities. The management of the net interest margin is accomplished by our Asset Liability Committee. Short term interest rates are highly sensitive to factors beyond our control and are effectively set and managed by the Federal Reserve, while longer term rates are generally determined by the market based on investors’ inflationary expectations. Thus, changes in monetary and or fiscal policy will affect both short term and long term interest rates which in turn will influence the origination of loans, the prepayment speed of loans, the purchase of investments, the generation of deposits and the rates received on loans and investment securities and paid on deposits or other sources of funding. The impact of these changes may be magnified if we do not effectively manage the relative sensitivity of our earning assets and interest bearing liabilities to changes in market interest rates. We generally attempt to maintain a neutral position in terms of the volume of earning assets and interest bearing liabilities that mature or can re-price within a one year period in order that we may maintain the maximum net interest margin; however, interest rate fluctuations, loan prepayments, loan production and deposit flows are constantly changing and greatly influence this ability to maintain a neutral position.
 
Generally, our earnings will be more sensitive to fluctuations in interest rates the greater the difference between the volume of earning assets and interest bearing liabilities that mature or are subject to re-pricing in any period. The extent and duration of this sensitivity will depend on the cumulative difference over time, the velocity and direction of interest rate changes, and whether we are more asset sensitive or liability sensitive. Additionally, the Asset Liability Committee may desire to move our position to more asset sensitive or more liability sensitive depending upon their expectation of the direction and velocity of future changes in interest rates in an effort to maximize the net interest margin. Should we not be successful in maintaining the desired position, or should interest rates not move as anticipated, our net interest margin may be negatively impacted.   
 
Our operations may be adversely affected by cyber security risks.
 
In the ordinary course of business, we collect and store sensitive data, including proprietary business information and personally identifiable information of its customers and employees in systems and on networks. The secure processing, maintenance and use of this information is critical to operations and our business strategy. We have invested in accepted technologies and review processes and practices that are designed to protect our networks, computers and data from damage or unauthorized access. Despite these security measures, our computer systems and infrastructure may be vulnerable to attacks by hackers or breached due to employee error, malfeasance or other disruptions. A breach of any kind could compromise systems and the information stored there could be accessed, damaged or disclosed. A breach in security could result in legal claims, regulatory penalties, disruption in operations, and damage to our reputation, any of which could adversely affect our business.
 
Legislative or regulatory changes or actions, or significant litigation, could adversely impact us or the businesses in which we are engaged.
 
We are subject to extensive state and federal regulation, supervision and legislation that govern almost all aspects of our operations. Laws and regulations may change from time to time and are primarily intended for the protection of consumers, depositors and the deposit insurance funds. The impact of any changes to laws and regulations or other actions by regulatory agencies may negatively impact us or our ability to increase the value of our business. Additionally, actions by regulatory agencies or significant litigation against us could cause us to devote significant time and resources to defending ourselves and may lead to penalties that materially affect us. Future changes in the laws or regulations or their interpretations or enforcement could be materially adverse us and our shareholders.
 
 
13
 
 
PART I, continued
 
Item 1A. Risk Factors, continued
 
Changes in accounting standards could impact reported earnings.
 
The accounting standard setters, including the Financial Accounting Standards Board (FASB), SEC and other regulatory bodies, periodically change the financial accounting and reporting standards that govern the preparation of our consolidated financial statements. These changes can be difficult to predict and can materially impact how we record and report our financial condition and results of operations. In some cases, we could be required to apply a new or revised standard retroactively, resulting in the restatement of prior period financial statements. For example, a new accounting standard referred to as current expected credit loss, or CECL, will be effective for our fiscal year beginning January 1, 2020, and will substantially change how we calculate our allowance for loan losses. To implement the new standard, the Company will incur costs related to data collection and documentation, technology and training. Although the Company is currently unable to reasonably estimate the impact of the new standard on its financial statements, adoption of the new standard could necessitate, among other things, higher loan loss reserve levels, and the Company expects to recognize a one-time cumulative effect adjustment to the allowance for loan losses during the quarter in which the standard becomes effective. If the Company is required to materially increase the level of the allowance for loan losses or incurs additional expenses to determine the appropriate level of the allowance for loan losses, such changes could adversely affect the Company’s capital levels, financial condition and results of operations.
 
Consumers may decide not to use banks to complete their financial transactions.
 
Technology and other changes are allowing parties to complete financial transactions through alternative methods that historically have involved banks. The activity and prominence of so-called marketplace lenders and other technological financial service companies have grown significantly over recent years and is expected to continue growing. In addition, consumers can now maintain funds that would have historically been held as bank deposits in brokerage accounts, mutual funds or general-purpose reloadable prepaid cards. Consumers can also complete transactions, such as paying bills and/or transferring funds directly without the assistance of banks. If we are unable to address the competitive pressures that we face, we could lose market share, which could result in reduced net revenue and profitability and lower returns, as well as the loss of customer deposits. The loss of these revenue streams and the lower cost of deposits as a source of funds could have a material adverse effect on our financial condition and results of operations.
 
Failure to keep pace with technological change could adversely affect our business.
 
The financial services industry is continually undergoing rapid technological change with frequent introductions of new technology-driven products and services. The effective use of technology increases efficiency and enables financial institutions and other firms to better serve customers and to reduce costs. The pace of technological changes has increase in the “Fintech” environment, in which industry changing products and services are often introduced and adopted including innovative ways that customers can make payments, access products, and manage accounts. Our future success depends, in part, upon our ability to address the needs of our customers by using technology to provide products and services that will satisfy customer demands, as well as to create additional efficiencies in our operations. Many of our competitors have substantially greater resources to invest in technological improvements. We may not be able to effectively implement new technology-driven products and services, which could entail significant time, resources and additional risk to develop or adopt, or be successful in marketing these products and services to our customers. Failure to successfully keep pace with technological change affecting the financial services industry could have a material adverse impact on our business and, in turn, our financial condition and results of operations.
 
 
14
 
 
PART I, continued
 
Item 1A. Risk Factors, continued
 
The full impact of changes to federal tax laws is uncertain and may negatively impact our financial performance.
 
We are subject to changes in tax law that could increase our effective tax rates. These law changes may be retroactive to previous periods and, as a result, could negatively affect our current and future financial performance.
 
The Tax Cuts and Jobs Act, the full impact of which is subject to further evaluation and analysis, is likely to have both positive and negative effects on our financial performance. For example, the new legislation resulted in a reduction in our federal corporate tax rate from 35% to 21% beginning in 2018, which has had and is expected to continue to have a favorable impact on our earnings and capital generation abilities. However, the new legislation also enacted limitations on certain deductions, such as the deduction of FDIC deposit insurance premiums, which will partially offset the anticipated increase in net earnings from the lower tax rate. Further, the full impact of the Tax Act may differ from the foregoing and from our expectations, possibly materially, due to changes in interpretations or in assumptions that we have made or that we make in 2019, guidance or regulations that may be promulgated, and other actions that we may take as a result of the Tax Act.
 
Similarly, the Bank’s customers are likely to experience varying effects from both the individual and business tax provisions of the Tax Act. For example, changes to tax deductibility of business interest expense could impact business customer borrowing. Such effects, whether positive or negative, may have a corresponding impact on our business and the economy as a whole.
 
The Bank may be required to transition from the use of the London Interbank Offered Rate (“LIBOR”) index in the future.
 
The Bank has certain variable-rate loans indexed to LIBOR to calculate the loan interest rate. The United Kingdom Financial Conduct Authority, which regulates LIBOR, has announced that the continued availability of the LIBOR on the current basis is not guaranteed after 2021. It is impossible to predict whether and to what extent banks will continue to provide LIBOR submissions to the administrator of LIBOR or whether any additional reforms to LIBOR may be enacted in the United Kingdom or elsewhere. At this time, no consensus exists as to what rate or rates may become acceptable alternatives to LIBOR, and it is impossible to predict the effect of any such alternatives on the value of LIBOR-based variable-rate loans, as well as LIBOR-based securities, subordinated notes, or other securities or financial arrangements. The implementation of a substitute index or indices for the calculation of interest rates under the Bank’s loan agreements with borrowers or other financial arrangements may cause the Bank to incur significant expenses in effecting the transition, may result in reduced loan balances if borrowers do not accept the substitute index or indices, and may result in disputes or litigation with customers or other counter-parties over the appropriateness or comparability to LIBOR of the substitute index or indices, any of which could have a material adverse effect on the Bank’s results of operations.
 
 
15
 
 
PART I, continued
 
Item 1B. Unresolved Staff Comments
The Company does not have any unresolved staff comments to report for the year ended December 31, 2018.
 
Item 2. Properties
 
The locations of F & M Bank Corp. and its subsidiaries are shown below.
 
Corporate Offices
205 South Main Street
Timberville, VA 22853
Timberville Branch
165 New Market Road
Timberville, VA 22853
Elkton Branch
127 West Rockingham Street
Elkton, VA 22827
Broadway Branch
126 Timberway
Broadway, VA 22815
Bridgewater Branch
100 Plaza Drive
Bridgewater, VA 22812
Edinburg Branch
120 South Main Street
Edinburg, VA 22824
Woodstock Branch
161 South Main Street
Woodstock, VA 22664
Crossroads Branch
80 Cross Keys Road
Harrisonburg, VA 22801
Coffman’s Corner Branch
2030 Legacy Lane
Harrisonburg, VA 22801
Luray Branch
700 East Main Street
Luray, VA 22835
Myers Corner Branch
30 Gosnell Crossing
Staunton, VA 24401
North Augusta Branch
2813 North Augusta Street
Staunton, VA 22401
Craigsville Branch
125 W. Craig Street
Craigsville, VA 24430
Grottoes Branch
200 Augusta Avenue
Grottoes, VA 24441
Dealer Finance Division
4759 Spotswood Trail
Penn Laird, VA 22846
 
 
 
F&M Mortgage offices are located at:
 
 
Harrisonburg Office
2040 Deyerle Avenue, Suite 107
Harrisonburg, VA 22801
Fishersville Office
19 Myers Corner Drive, Suite 105
Staunton, VA 24401
Woodstock Office
161 South Main Street
Woodstock, VA 22664
 
 
 
VSTitle offices are located at:
 
 
Harrisonburg Office
410 Neff Avenue
Harrisonburg, VA 22801
Fishersville Office
1707 Jefferson Highway
Fishersville, VA 22939
Charlottesville Office
154 Hansen Rd., Suite 202-C
Charlottesville, VA 22911
 
With the exception of the Edinburg Branch, Luray Branch, Dealer Finance Division, and the North Augusta Branch, the remaining facilities are owned by Farmers & Merchants Bank. ATMs are available at all branch locations. The Woodstock office of F&M Mortgage is leased from F&M Bank. All office of VST are leased.
 
Through an agreement with FCTI, Inc., the Bank also operates cash only ATMs at five Food Lion grocery stores, one in Mt. Jackson, VA and four in Harrisonburg, VA. The Bank has an agreement with CardTronics ATM to operate twelve cash only ATMs in various Rite Aid Pharmacies, CVS Pharmacies and Target Stores in Rockingham and Augusta Counties of VA. The Bank also has an agreement with ATM USA to operate ATMs in various locations in our market area.
 
Item 3. Legal Proceedings
 
In the normal course of business, the Company may become involved in litigation arising from banking, financial, or other activities of the Company. Management after consultation with legal counsel, does not anticipate that the ultimate liability, if any, arising out of these matters will have a material effect on the Company’s financial condition, operating results or liquidity.
 
 
16
 
 
Item 4. Mine Safety Disclosures
 
None.
 
PART II
 
Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities (dollars in thousands)
 
Stock Listing
The Company’s Common Stock is quoted under the symbol “FMBM” on the OTCQX Market. The bid and ask price is quoted at www.OTCMARKETS.com/Stock/FMBM/quote. Any over-the-counter market quotations reflect iner-dealer prices, without retail mark-up, mark-down or commission and may not necessarily represent actual transactions. With its inclusion on the OTCQX Markets, there are now several active market makers for FMBM stock.
 
Transfer Agent and Registrar
Broadridge Corporate Issuer Solutions
PO Box 1342
Brentwood, NY 11717
 
Stock Performance
The following graph compares the cumulative total return to the shareholders of the Company for the last five fiscal years with the total return of the Russell 2000 Index and the SNL Bank Index, as reported by SNL Financial, LC, assuming an investment of $100 in the Company’s common stock on December 31, 2013, and the reinvestment of dividends.
 
 
 
 
Period Ending
 
Index
 
12/31/13
 
 
12/31/14
 
 
12/31/15
 
 
12/31/16
 
 
12/31/17
 
 
12/31/18
 
F & M Bank Corp.
  100.00 
  109.35 
  131.74 
  156.15 
  204.67 
  191.92 
Russell 2000 Index
  100.00 
  104.89 
  100.26 
  121.63 
  139.44 
  124.09 
SNL Bank Index
  100.00 
  111.79 
  113.69 
  143.65 
  169.64 
  140.98 
 
 
17
 
 
PART II, continued
 
Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities (dollars in thousands), continued
 
Recent Stock Prices and Dividends
 
Dividends to common shareholders totaled $3,890 and $2,972 in 2018 and 2017, respectively. In addition to regular dividends totaling $1.00 per share, a special dividend of $.20 per share was paid in 2018 to mark the Bank’s 110th anniversary. Preferred stock dividends were $413 and $415 in 2018 and 2017, respectively. Regular quarterly dividends have been declared for at least 26 years. The payment of dividends depends on the earnings of the Company and its subsidiaries, the financial condition of the Company and other factors including capital adequacy, regulatory requirements, general economic conditions and shareholder returns. The ratio of dividends per common share to net income per common share was 44.78% (including special dividend) in 2018, compared to 35.74% in 2017.
 
Refer to Payment of Dividends in Item 1. Business, Regulation and Supervision section above for a summary of applicable restrictions on the Company’s ability to pay dividends.
 
Stock Repurchases
 
On October 20, 2016, the Company’s Board of Directors approved a plan to repurchase up to 150,000 shares of common stock. Shares repurchased through the end of 2018 totaled 71,422 shares; of this amount, 49,448 were repurchased in 2018 at an average price of $36.04 per share.
 
The number of common shareholders was approximately 2,083 as of March 4, 2019. This amount includes all shareholders, whether titled individually or held by a brokerage firm or custodian in street name.
 
Quarterly Stock Information
 
These quotes include the terms of trades transacted through a broker. The terms of exchanges occurring between individual parties may not be known to the Company.
 
 
 
2018
 
 
2017
 
 
 
Stock Price Range
 
 
Per Share
 
 
Stock Price Range
 
 
Per Share
 
Quarter
 
Low
 
 
High
 
 
Dividends Declared
 
 
Low
 
 
High
 
 
Dividends Declared
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
1st
 $33.00 
 $35.50 
 $.45 
 $26.50 
 $28.45 
 $.22 
2nd
  34.50 
  40.00 
  .25 
  27.50 
  29.35 
  .23 
3rd
  36.00 
  38.50 
  .25 
  29.20 
  32.00 
  .24 
4th
  30.00 
  36.00 
  .25 
  30.02 
  34.50 
  .25 
Total
    
    
 $1.20 
    
    
 $.94 
 
 
 
18
 
PART II, continued
 
Item 6. Selected Financial Data
 
Five Year Summary of Selected Financial Data
 
(Dollars and shares in thousands, except per share data)
 
2018
 
 
2017
 
 
2016
 
 
20156
 
 
20146
 
Income Statement Data:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Interest and Dividend Income
 $36,708 
 $34,095 
 $32,150 
 $29,404 
 $26,772 
Interest Expense
  4,832 
  3,897 
  3,599 
  2,876 
  3,648 
Net Interest Income
  31,876 
  30,198 
  28,551 
  26,528 
  23,124 
Provision for Loan Losses
  2,930 
  - 
  - 
  300 
  2,250 
Net Interest Income After Provision for Loan Losses
  28,946 
  30,198 
  28,551 
  26,228 
  20,874 
Noninterest Income6
  8,770 
  8,517 
  6,313 
  5,412 
  3,530 
Low income housing partnership losses
  (767)
  (625)
  (731)
  (619)
  (608)
Noninterest Expenses6
  26,744 
  24,719 
  21,272 
  19,554 
  15,656 
Income before income taxes
  10,205 
  13,371 
  12,861 
  11,467 
  8,140 
Income Tax Expense
  1,110 
  4,330 
  3,099 
  2,886 
  2,293 
Net income attributable to noncontrolling interest
  (10)
  (31)
  (194)
  (164)
  (45)
Net Income attributable to F & M Bank Corp.
 $9,085 
 $9,010 
 $9,568 
 $8,417 
 $5,802 
Per Common Share Data:
    
    
    
    
    
Net Income – basic
 $2.68 
 $2.63 
 $2.77 
 $2.40 
 $1.82 
Net Income - diluted
 $2.53 
 $2.48 
 $2.57 
 $2.25 
 $1.80 
Dividends Declared
  1.20 
  .94 
  .80 
  .73 
  .68 
Book Value per Common Share
  26.84 
  25.73 
  24.18 
  22.38 
  20.77 
Balance Sheet Data:
    
    
    
    
    
Assets
 $780,253 
 $753,270 
 $744,889 
 $665,357 
 $605,308 
Loans Held for Investment
  638,799 
  616,974 
  591,636 
  544,053 
  518,202 
Loans Held for Sale
  55,910 
  39,775 
  62,735 
  57,806 
  13,382 
Securities
  21,844 
  41,243 
  39,475 
  25,329 
  22,305 
Deposits
  591,325 
  569,177 
  537,085 
  494,670 
  491,505 
Short-Term Debt
  40,116 
  25,296 
  40,000 
  24,954 
  14,358 
Long-Term Debt
  40,218 
  49,733 
  64,237 
  48,161 
  9,875 
Stockholders’ Equity
  91,911 
  91,275 
  86,682 
  82,950 
  77,798 
Average Common Shares Outstanding – basic
  3,238 
  3,270 
  3,282 
  3,291 
  3,119 
Average Common Shares Outstanding – diluted
  3,596 
  3,632 
  3,717 
  3,735 
  3,230 
Financial Ratios:
    
    
    
    
    
Return on Average Assets1
  1.19%
  1.21%
  1.34%
  1.31%
  1.00%
Return on Average Equity1
  9.89%
  10.01%
  11.18%
  10.46%
  8.65%
Net Interest Margin
  4.65%
  4.53%
  4.34%
  4.43%
  4.30%
Efficiency Ratio 2
  65.50%
  63.54%
  60.78%
  60.97%
  58.51%
Dividend Payout Ratio - Common
  44.78%
  35.74%
  28.88%
  30.42%
  37.36%
Capital and Credit Quality Ratios:
    
    
    
    
    
Average Equity to Average Assets1
  12.03%
  12.10%
  11.97%
  12.49%
  11.59%
Allowance for Loan Losses to Loans3
  .82%
  .98%
  1.27%
  1.61%
  1.68%
Nonperforming Loans to Total Assets4
  1.31%
  .94%
  .65%
  .98%
  1.15%
Nonperforming Assets to Total Assets5
  1.62%
  1.21%
  .94%
  1.34%
  1.73%
Net Charge-offs to Total Loans3
  .58%
  .24%
  .21%
  .04%
  .33%
       
1
Ratios are primarily based on daily average balances.
2
The Efficiency Ratio equals noninterest expenses divided by the sum of tax equivalent net interest income and noninterest income. Noninterest income excludes gains (losses) on securities transactions and LIH Partnership losses. Noninterest expense excludes amortization of intangibles. Ratio for 2015 and 2014 reflects reclassification of F&M Mortgage to report gross income/expense rather than net.
3
Calculated based on Loans Held for Investment, excludes Loans Held for Sale.
4
Calculated based on 90 day past due and non-accrual to Total Assets.
5
Calculated based on 90 day past due, non-accrual and OREO to Total Assets
6
Data for 2015 and 2016 does not reflect the reclassification of F&M Mortgage to report gross income/expense rather than net 

 
19
 
PART II, continued
 
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations (dollars in thousands)
 
The following discussion provides information about the major components of the results of operations and financial condition, liquidity and capital resources of F & M Bank Corp. and its subsidiaries. This discussion and analysis should be read in conjunction with the Consolidated Financial Statements and the Notes to the Consolidated Financial Statements presented in Item 8, Financial Statements and Supplementary Information, of this Form 10-K.
 
Lending Activities
 
Credit Policies
 
The principal risk associated with each of the categories of loans in our portfolio is the creditworthiness of our borrowers. Within each category, such risk is increased or decreased, depending on prevailing economic conditions. In an effort to manage the risk, our loan policy gives loan amount approval limits to individual loan officers based on their position and level of experience and to our loan committees based on the size of the lending relationship. The risk associated with real estate and construction loans, commercial loans and consumer loans varies, based on market employment levels, consumer confidence, fluctuations in the value of real estate and other conditions that affect the ability of borrowers to repay indebtedness. The risk associated with real estate construction loans varies, based on the supply and demand for the type of real estate under construction.
 
We have written policies and procedures to help manage credit risk. We have a loan review policy that includes regular portfolio reviews to establish loss exposure and to ascertain compliance with our loan policy.
 
We use a management loan committee and a directors’ loan committee to approve loans. The management loan committee is comprised of members of senior management, and the directors’ loan committee is comprised of any six directors. Both committees approve new, renewed and or modified loans that exceed officer loan authorities. The directors’ loan committee also reviews any changes to our lending policies, which are then approved by our board of directors.
 
Construction and Development Lending
 
We make construction loans, primarily residential, and land acquisition and development loans. The construction loans are secured by residential houses under construction and the underlying land for which the loan was obtained. The average life of a construction loan is approximately 12 months, and it is typically re-priced as the prime rate of interest changes. Construction lending entails significant additional risks, compared with residential mortgage lending. Construction loans often involve larger loan balances concentrated with single borrowers or groups of related borrowers. Another risk involved in construction lending is attributable to the fact that loan funds are advanced upon the security of the land or home under construction, which value is estimated prior to the completion of construction. Thus, it is more difficult to evaluate accurately the total loan funds required to complete a project and related loan-to-value ratios. To mitigate the risks associated with construction lending, we generally limit loan amounts to 75% to 90% of appraised value, in addition to analyzing the creditworthiness of our borrowers. We also obtain a first lien on the property as security for our construction loans and typically require personal guarantees from the borrower’s principal owners.
 
 
20
 
 
PART II, continued
 
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations (dollars in thousands), Continued
 
Commercial Real Estate Lending
 
Commercial real estate loans are secured by various types of commercial real estate in our market area, including multi-family residential buildings, commercial buildings and offices, shopping centers and churches. Commercial real estate lending entails significant additional risks, compared with residential mortgage lending. Commercial real estate loans typically involve larger loan balances concentrated with single borrowers or groups of related borrowers. Additionally, the payment experience on loans secured by income producing properties is typically dependent on the successful operation of a business or a real estate project and thus may be subject, to a greater extent, to adverse conditions in the real estate market or in the economy in general. Our commercial real estate loan underwriting criteria require an examination of debt service coverage ratios and the borrower’s creditworthiness, prior credit history and reputation. We also evaluate the location of the property securing the loan and typically require personal guarantees or endorsements of the borrower’s principal owners.
 
Business Lending
 
Business loans generally have a higher degree of risk than residential mortgage loans but have higher yields. To manage these risks, we generally obtain appropriate collateral and personal guarantees from the borrower’s principal owners and monitor the financial condition of our business borrowers. Residential mortgage loans generally are made on the basis of the borrower’s ability to make repayment from employment and other income and are secured by real estate whose value tends to be readily ascertainable. In contrast, business loans typically are made on the basis of the borrower’s ability to make repayment from cash flow from its business and are secured by business assets, such as real estate, accounts receivable, equipment and inventory. As a result, the availability of funds for the repayment of business loans is substantially dependent on the success of the business itself. Furthermore, the collateral for business loans may depreciate over time and generally cannot be appraised with as much precision as residential real estate.
 
Consumer Lending
 
We offer various consumer loans, including personal loans and lines of credit, automobile loans, deposit account loans, installment and demand loans, and home equity loans and lines of credit. Such loans are generally made to clients with whom we have a pre-existing relationship. We currently originate all of our consumer loans in our geographic market area.
 
The underwriting standards employed by us for consumer loans include a determination of the applicant’s payment history on other debts and an assessment of their ability to meet existing obligations and payments on the proposed loan. The stability of the applicant’s monthly income may be determined by verification of gross monthly income from primary employment and additionally from any verifiable secondary income. Although creditworthiness of the applicant is of primary consideration, the underwriting process also includes an analysis of the value of the security in relation to the proposed loan amount. For home equity lines of credit and loans we require title insurance, hazard insurance and, if required, flood insurance.
 
Residential Mortgage Lending
 
The Bank makes residential mortgage loans for the purchase or refinance of existing loans with loan to value limits ranging between 80 and 90% depending on the age of the property, borrower’s income and credit worthiness. Loans that are retained in our portfolio generally carry adjustable rates that can change every three to five years, based on amortization periods of twenty to thirty years.
 
 
21
 
 
PART II, continued
 
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations (dollars in thousands), Continued
 
Loans Held for Sale
 
The Bank makes fixed rate mortgage loans with terms of typically fifteen or thirty years through its subsidiary F&M Mortgage. These loans are funded by F&M Mortgage utilizing a line of credit at the Bank until sold to investors in the secondary market. Similarly, the Bank also has a relationship with Northpointe Bank in Grand Rapids, MI whereby it purchases fixed rate conforming 1-4 family mortgage loans for short periods of time pending those loans being sold to investors in the secondary market. These loans have an average duration of ten days to two weeks, but occasionally remain on the Bank’s books for up to 60 days. The Bank began its relationship with Northpointe Bank in 2014 and had a similar program with a prior bank since 2003. This relationship allows the Bank to achieve a higher rate of return than is available on other short term investment opportunities.
 
Dealer Finance Division
 
In September 2012, the Bank started a loan production office in Penn Laird, VA which specializes in providing automobile financing through a network of automobile dealers. The Dealer Finance Division was originally staffed with three officers that have extensive experience in Dealer Finance. Based on the strong growth of this division the staff has been increased to six employees. This office is serving the automobile finance needs for customers of dealers throughout the existing geographic footprint of the Bank. Approximately fifty dealers have signed contracts to originate loans on behalf of the Bank. As of year end 2018, the division had total loans outstanding of $98 million.
 
Critical Accounting Policies
 
General
 
The Company’s financial statements are prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”). The financial information contained within the statements is, to a significant extent, financial information that is based on measures of the financial effects of transactions and events that have already occurred. The Company’s financial position and results of operations are affected by management’s application of accounting policies, including estimates, assumptions and judgments made to arrive at the carrying value of assets and liabilities and amounts reported for revenues, expenses and related disclosures. Different assumptions in the application of these policies could result in material changes in the Company’s consolidated financial position and/or results of operations.
 
In addition, GAAP itself may change from one previously acceptable method to another method. Although the economics of these transactions would be the same, the timing of events that would impact these transactions could change. Following is a summary of the Company’s significant accounting policies that are highly dependent on estimates, assumptions and judgments.
 
Allowance for Loan Losses
 
The allowance for loan losses is an estimate of the losses that may be sustained in the loan portfolio. The allowance is based on two basic principles of accounting: (i) ASC 450 “Contingencies”, which requires that losses be accrued when they are probable of occurring and estimable and (ii) ASC 310, “Receivables”, which requires that losses 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. The Company’s allowance for loan losses is the accumulation of various components that are calculated based on independent methodologies. All components of the allowance represent an estimation performed pursuant to either ASC 450 or ASC 310. Management’s estimate of each ASC 450 component is based on certain observable data that management believes are most reflective of the underlying credit losses being estimated. This evaluation includes credit quality trends; collateral values; loan volumes; geographic, borrower and industry concentrations; seasoning of the dealer loan portfolio; the findings of internal credit quality assessments, results from external bank regulatory examinations and third-party loan reviewer. These factors, as well as historical losses and current economic and business conditions, are used in developing estimated loss factors used in the calculations.
 
 
22
 
 
PART II, continued
 
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations (dollars in thousands), continued
 
Allowance for Loan Losses, continued
 
Allowances for loan losses are determined by applying estimated loss factors to the portfolio based on management’s evaluation and “risk grading” of the loan portfolio. Specific allowances are typically provided on all impaired loans in excess of a defined loan size threshold that are classified in the Substandard or Doubtful risk grades. The specific reserves are determined on a loan-by-loan basis based on management’s evaluation of the Company’s exposure for each credit, given the current payment status of the loan and the value of any underlying collateral.
 
While management uses the best information available to establish the allowance for loan and lease losses, future adjustments to the allowance may be necessary if economic conditions differ substantially from the assumptions used in making the valuations or, if required by regulators, based upon information available to them at the time of their examinations. Such adjustments to original estimates, as necessary, are made in the period in which these factors and other relevant considerations indicate that loss levels may vary from previous estimates.
 
Goodwill and Intangibles
 
In June 2001, the Financial Accounting Standards Board issued ASC 805, Business Combinations and ASC 350, Intangibles. The provisions of ASC 350 discontinue the amortization of goodwill and intangible assets with indefinite lives. Instead, these assets are subject to an annual impairment review and more frequently if certain impairment indicators are in evidence. ASC 350 also requires that reporting units be identified for the purpose of assessing potential future impairments of goodwill.
 
The Company adopted ASC 350 on January 1, 2002. Goodwill totaled $2,639 at January 1, 2002. As of December 31, 2008, the Company recognized $31 in additional goodwill related to the purchase of 70% ownership in VBS Mortgage. In 2017, the Company recognized $211 in goodwill and $285 in intangibles related to the purchase of VST. The intangibles related to the VST purchase are amortized over periods up to 15 years with $53 recorded in 2018. In 2018, the Company recognized $3 in goodwill and $72 in intangibles related to the purchase of a small title company by VST. The intangible asset related to the purchase are amortized over 10 years.
 
The goodwill is not amortized but is tested for impairment at least annually. Based on this testing, there were no impairment charges for 2018, 2017 or 2016.
 
Income Tax
 
The determination of income taxes represents results in income and expense being recognized in different periods for financial reporting purposes versus for the purpose of computing income taxes currently payable. Deferred taxes are provided on such temporary differences and are measured using the enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be realized or settled. Further, the Company seeks opportunities that minimize the tax effect of implementing its business strategies. Management makes judgments regarding the ultimate consequence of long-term tax planning strategies, including the likelihood of future recognition of deferred tax benefits. As a result, it is considered a significant estimate.
 
 
 
23
 
 
PART II, continued
 
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations (dollars in thousands), continued
 
Fair Value
 
The estimate of fair value involves the use of (1) quoted prices for identical instruments traded in active markets, (2) quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active, and model-based valuation techniques using significant assumptions that are observable in the market or (3) model-based techniques that use significant assumptions not observable in the market. When observable market prices and parameters are not fully available, management’s judgment is necessary to arrive at fair value including estimates of current market participant expectations of future cash flows, risk premiums, among other things. Additionally, significant judgment may be required to determine whether certain assets measured at fair value are classified within the fair value hierarchy as Level 2 or Level 3. The estimation process and the potential materiality of the amounts involved result in this item being identified as critical.
 
Pension Plan Accounting
 
The accounting guidance for the measurement and recognition of obligations and expense related to pension plans generally applies the concept that the cost of benefits provided during retirement should be recognized over the employees’ active working life. Inherent in this concept is the requirement to use various actuarial assumptions to predict and measure costs and obligations many years prior to the settlement date. Major actuarial assumptions that require significant management judgment and have a material impact on the measurement of benefits expense and accumulated benefit obligation include discount rates, expected return on assets, mortality rates, and projected salary increases, among others. Changes in assumptions or judgments related to any of these variables could result in significant volatility in the Company’s financial condition and results of operations. As a result, accounting for the Company’s pension expense and obligation is considered a significant estimate. The estimation process and the potential materiality of the amounts involved result in this item being identified as critical.
 
Other Real Estate Owned (OREO)
 
OREO is held for sale and represents real estate acquired through or in lieu of foreclosure. OREO is initially recorded at fair value less costs to sell when acquired, establishing a new cost basis. Physical possession of residential real estate property collateralizing a consumer mortgage loan occurs when legal title is obtained upon completion of foreclosure or when the borrower conveys all interest in the property to satisfy the loan through completion of a deed in lieu of foreclosure or through a similar legal agreement. The Company’s policy is to carry OREO on its balance sheet at the lower of cost or fair value less estimated costs to sell. If fair value declines subsequent to foreclosure, a valuation allowance is recorded through expense. Operating costs after acquisition are expensed.
 
 
24
 
 
PART II, continued
 
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations (dollars in thousands), continued
 
Overview
 
The Company’s net income for 2018 totaled $9,085 or $2.68 per common share basic, an increase of 83% from $9,010 or $2.63 a share in 2017. Return on average equity decreased in 2018 to 9.89% versus 10.01% in 2017, and the return on average assets decreased from 1.21% in 2017 to 1.19% in 2018.
 
Reference the five-year summary of selected financial data.
 
Changes in Net Income per Common Share (Basic)
 
 
 
2018
 
 
2017
 
 
 
to 2017
 
 
to 2016
 
 
 
 
 
 
 
 
Prior Year Net Income Per Common Share (Basic)
 $2.63 
 $2.77 
Change from differences in:
    
    
Net interest income
  .52 
  .52 
Provision for loan losses
  (.90)
  - 
Noninterest income, excluding securities gains
  .03 
  1.36 
Security gains (losses), net
  .01 
  (.01)
Noninterest expenses
  (.63)
  (1.66)
Income taxes
  .99 
  (.38)
Effect of preferred stock dividend
  .00 
  .02 
Change in average shares outstanding
  .03 
  .01 
Total Change
  .05 
  (.14)
Net Income Per Common Share (Basic)
 $2.68 
 $2.63 
 
Net Interest Income
 
The largest source of operating revenue for the Company is net interest income, which is calculated as the difference between the interest earned on earning assets and the interest expense paid on interest bearing liabilities. Net interest income increased 5.56% from 2017 to 2018 following an increase of 5.77% from 2016 to 2017. The net interest margin is the net interest income expressed as a percentage of interest earning assets. Changes in the volume and mix of interest earning assets and interest bearing liabilities, along with their yields and rates, have a significant impact on the level of net interest income. Tax equivalent net interest income for 2018 was $31,957 representing an increase of $1,615 or 5.32% over the prior year. A 5.78% increase in 2017 versus 2016 resulted in total tax equivalent net interest income of $30,342.
 
In this discussion and in the tabular analysis of net interest income performance, entitled “Consolidated Average Balances, Yields and Rates,”, the interest earned on tax exempt loans and investment securities has been adjusted to reflect the amount that would have been earned had these investments been subject to normal income taxation. This is referred to as tax equivalent net interest income. For a reconciliation of tax equivalent net interest income to GAAP measures, see the following table.
 
Tax equivalent income on earning assets increased $2,550 in 2018 compared to 2017. Loans held for investment, expressed as a percentage of total earning assets, increased in 2018 to 92.72% as compared to 90.29% in 2017. During 2018, yields on earning assets increased 23 basis points (BP), primarily due to rate increases during 2018 specifically in real estate loans, investments and federal funds sold. The average cost of interest bearing liabilities increased 19BP in 2018, following an increase of 6BP in 2017. The increase in 2018 is due to increased cost of deposits and debt as rates increased.
 
 
25
 
 
PART II, Continued
 
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations (dollars in thousands), Continued
 
The following table provides detail on the components of tax equivalent net interest income:
GAAP Financial Measurements:
(Dollars in thousands).
 
2018
 
 
2017
 
 
2016
 
 
 
 
 
 
 
 
 
 
 
         Interest Income – Loans
 $36,129 
 $33,591 
 $31,740 
         Interest Income - Securities and Other Interest-Earnings Assets
  579 
  504 
  410 
         Interest Expense – Deposits
  3,425 
  2,688 
  2,380 
         Interest Expense - Other Borrowings
  1,407 
  1,209 
  1,219 
Total Net Interest Income
  31,876 
  30,198 
  28,551 
 
    
    
    
Non-GAAP Financial Measurements:
    
    
    
Add: Tax Benefit on Tax-Exempt Interest Income – Loans
  81 
  144 
  132 
Total Tax Benefit on Tax-Exempt Interest Income
  81 
  144 
  132 
Tax-Equivalent Net Interest Income
 $31,957 
 $30,342 
 $28,683 

Interest Income
 
Tax equivalent interest income increased $2,550 or 7.45% in 2018, after increasing 6.06% or $1,957 in 2017. Overall, the yield on earning assets increased .23%, from 5.12% to 5.35%. Average loans held for investment grew during 2018, with average loans outstanding increasing $33,217 to $637,478. Average real estate loans increased 4.04%, commercial loans increased 2.93% and consumer installment loans increased 15.97% on average. The increase in average consumer loans is a result of the growth in our Dealer Finance Division which opened at the end of 2012. The increase in tax equivalent interest income is due to the growth in the loan portfolio, with commercial loans contributing the most interest income growth and rate increases experienced during the year.
 
Interest Expense
 
Interest expense increased $935 or 23.99% during 2018, which followed a 8.28% increase or $298 in 2017. The average cost of funds of 1.02% increased 19BP compared to 2017, which followed an increase of 6BP in 2017 compared to 2016. Average interest bearing liabilities increased $7,577 or 1.62% in 2018 following a relatively flat 2017. Changes in the cost of funds attributable to rate and volume variances are in a following table.
 
The analysis on the next page reveals an increase in the net interest margin to 4.65% in 2018 from 4.53% in 2017, primarily due to changes in balance sheet leverage and increased interest rates during the year.
 
 
26
 
 
PART II, Continued
 
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations (dollars in thousands), Continued
 
Consolidated Average Balances, Yields and Rates1
 
 
 
2018
 
 
2017
 
 
2016
 
 
 
Balance
 
 
Interest
 
 
Rate
 
 
Balance
 
 
Interest
 
 
Rate
 
 
Balance
 
 
Interest
 
 
Rate
 
ASSETS
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Loans2
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
     Commercial
 $187,999 
 $9,754 
  5.19%
 $182,646 
 $9,475 
  5.19%
 $176,389 
 $8,362 
  4.74%
     Real estate
  344,191 
  17,967 
  5.22%
  330,828 
  16,678 
  5.04%
  312,435 
  15,781 
  5.05%
     Consumer
  105,288 
  7,425 
  7.05%
  90,787 
  6,470 
  7.13%
  78,524 
  5,805 
  7.39%
 
    
    
    
    
    
    
    
    
    
     Loans held for investment4
  637,478 
  35,146 
  5.52%
  604,261 
  32,623 
  5.40%
  567,348 
  29,948 
  5.28%
     Loans held for sale
  29,971 
  1,064 
  3.48%
  37,008 
  1,112 
  3.00%
  68,438 
  1,924 
  2.81%
 
    
    
    
    
    
    
    
    
    
Investment securities3
    
    
    
    
    
    
    
    
    
     Fully taxable
  13,702 
  457 
  3.34%
  10,886 
  338 
  3.10%
  15,714 
  372 
  2.37%
     Partially taxable
  124 
  2 
  1.61%
  125 
  - 
  - 
  125 
  - 
  - 
 
    
    
    
    
    
    
    
    
    
     Total investment securities
  13,826 
  459 
  3.32%
  11,011 
  338 
  3.07%
  15,839 
  372 
  2.37%
 
    
    
    
    
    
    
    
    
    
Interest bearing deposits in banks
  924 
  15 
  1.62%
  1,512 
  10 
  .66%
  727 
  3 
  .41%
Federal funds sold
  5,364 
  105 
  1.96%
  15,475 
  156 
  1.01%
  7,195 
  35 
  .49%
     Total Earning Assets
  687,563 
  36,789 
  5.35%
  669,267 
  34,239 
  5.12%
  659,547 
  32,282 
  4.89%
 
    
    
    
    
    
    
    
    
    
Allowance for loan losses
  (6,416)
    
    
  (6,793)
    
    
  (8,162)
    
    
Nonearning assets
  82,732 
    
    
  81,552 
    
    
  63,205 
    
    
     Total Assets
 $763,879 
    
    
 $744,026 
    
    
 $714,590 
    
    
 
    
    
    
    
    
    
    
    
    
LIABILITIES AND STOCKHOLDERS’ EQUITY
    
    
    
    
    
    
    
    
    
Deposits
    
    
    
    
    
    
    
    
    
     Demand –interest bearing
 $128,086 
 $814 
  .64%
 $121,095 
 $538 
  .44%
 $113,525 
 $499 
  .44%
     Savings
  121,711 
  544 
  .45%
  114,489 
  516 
  .45%
  100,298 
  441 
  .44%
     Time deposits
  161,635 
  2,067 
  1.28%
  159,415 
  1,634 
  1.02%
  160,221 
  1,440 
  .90%
 
    
    
    
    
    
    
    
    
    
     Total interest bearing deposits
  411,432 
  3,425 
  .83%
  394,999 
  2,688 
  .68%
  374,044 
  2,380 
  .64%
 
    
    
    
    
    
    
    
    
    
Short-term debt
  24,336 
  456 
  1.87%
  20,398 
  63 
  .31%
  37,716 
  55 
  .15%
Long-term debt
  40,210 
  951 
  2.37%
  53,004 
  1,146 
  2.16%
  56,253 
  1,164 
  2.07%
 
    
    
    
    
    
    
    
    
    
     Total interest bearing liabilities
  475,978 
  4,832 
  1.02%
  468,401 
  3,897 
  .83%
  468,013 
  3,599 
  .77%
 
    
    
    
    
    
    
    
    
    
Noninterest bearing deposits
  161,860 
    
    
  153,640 
    
    
  141,180 
    
    
Other liabilities
  34,138 
    
    
  31,936 
    
    
  19,824 
    
    
 
    
    
    
    
    
    
    
    
    
     Total liabilities
  671,976 
    
    
  653,977 
    
    
  629,017 
    
    
Stockholders’ equity
  91,903 
    
    
  90,049 
    
    
  85,572 
    
    
 
    
    
    
    
    
    
    
    
    
     Total liabilities and stockholders’ equity
 $763,879 
    
    
 $744,026 
    
    
 $714,590 
    
    
 
    
 $17,508 
    
    
 $17,508 
    
    
 $17,508 
    
     Net interest earnings
    
 $31,957 
    
    
 $30,342 
    
    
 $28,683 
    
 
    
    
    
    
    
    
    
    
    
     Net yield on interest earning assets (NIM)
    
    
  4.65%
    
    
  4.53%
    
    
  4.34%
 
    
    
    
    
    
    
    
    
    
1      
Income and yields are presented on a tax-equivalent basis using the applicable federal income tax rate of 21% in 2018 and 34% in 2017 and 2016.
2      
Interest income on loans includes loan fees.
3      
Average balance information is reflective of historical cost and has not been adjusted for changes in market value.
4      
Includes nonaccrual loans.
 
27
 
 
PART II, Continued
 
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations (dollars in thousands), Continued
 
The following table illustrates the effect of changes in volumes and rates.
 
 
 
2018 Compared to 2017
 
 
2017 Compared to 2016
 
 
 
Increase (Decrease)
 
 
Increase (Decrease)
 
 
 
Due to Change
 
 
Increase
 
 
Due to Change
 
 
Increase
 
 
 
in Average:
 
 
Or
 
 
in Average:
 
 
or
 
 
 
Volume
 
 
Rate
 
 
(Decrease)
 
 
Volume
 
 
Rate
 
 
(Decrease)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Interest income
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Loans held for investment
 $1,794 
  729 
  2,523 
 $1,949 
 $726 
 $2,675 
Loans held for sale
  (211)
  163 
  (48)
  (884)
  72 
  (812)
Investment securities
    
    
    
    
    
    
Fully taxable 
  87 
  32 
  119 
  (114)
  80 
  (34)
Partially taxable
  - 
  - 
  - 
  - 
  - 
  - 
 
    
    
    
    
    
    
Interest bearing deposits in banks
  (4)
  9 
  5 
  3 
  4 
  7 
Federal funds sold
  (102)
  51 
  (51)
  40 
  81 
  121 
Total Interest Income
  1,564 
  984 
  2,548 
  994 
  963 
  1,957 
 
    
    
    
    
    
    
Interest expense
    
    
    
    
    
    
Deposits
    
    
    
    
    
    
Demand                       - interest bearing
  31 
  245 
  276 
  33 
  6 
  39 
Savings
  32 
  (4)
  28 
  62 
  13 
  75 
Time deposits
  251 
  182 
  433 
  (7)
  201 
  194 
 
    
    
    
    
    
    
Short-term debt
  12 
  381 
  393 
  (25)
  33 
  8 
Long-term debt
  (276)
  81 
  (195)
  (67)
  49 
  (18)
Total Interest Expense
  50 
  885 
  935 
  (4)
  302 
  298 
Net Interest Income
  1,514 
  99 
  1,613 
 $998 
 $661 
 $1,659 
 
Note: Volume changes have been determined by multiplying the prior years’ average rate by the change in average balances outstanding. The rate change is determined by multiplying the current year average balance outstanding by the change in rate from the prior year to the current year.
 
Noninterest Income
 
Noninterest income continues to be an increasingly important factor in maintaining and growing profitability. Management is conscious of the need to constantly review fee income and develop additional sources of complementary revenue. During 2017, F&M Mortgage’s income was reclassified to report gross income and gross expenses in the appropriate income statement categories rather than netting in noninterest income, the 2016 income statements were reclassified to be comparative.
 
Noninterest income, exclusive of security gains or losses and FHLB prepayment gain, increased 8.88% or $715, in 2018, following an increase of 27.59% in 2017. In 2017, the Company recognized a FHLB prepayment gain of $504 which was recorded in noninterest income. The 2018 increase is due to growth in the gross revenue of VST Title, F & M Financial services and F&M Mortgage and service charges on deposit accounts. The losses on low income housing projects increased of 22.72% in 2018, an amount that is more consistent with our historical average, after a decrease of 14.5% for 2017 due to recognition of $162,000 in gains related to a fund that was dissolved.
 
The Company reported an investment loss related to both the Bank and VBS exiting the Bankers Title investment in 2017. The total loss was $42. There were no other security transactions in 2018, 2017 or 2016 which resulted in a gain or loss.
 
 
28
 
PART II, Continued
 
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations (dollars in thousands), Continued
 
Noninterest Expense
 
Noninterest expenses increased from $24,719 in 2017 to $26,744 in 2018, a 8.19% increase. Salary and benefits increased 10.65% to $16,436 in 2018 following an increase of 16.05% in 2017. This increase was the result of normal salary increases, additions to executive staff, overlapping positions during CEO transition and increasing benefit costs (specifically pension expense). Occupancy and Equipment expenses increased $289 or 15.45% due to the growth in our branch network following an increase of 16.72% in 2017. All other operating expenses increased $154 in 2018, following a $1,125 increase in 2017. Total noninterest expense as a percentage of average assets totaled 3.50%, 3.32%, and 2.98%, in 2018, 2017 and 2016, respectively. With the growth in branches and executive position changes noninterest expenses have shown increase relative to peer data. Peer group averages (as reported in the most recent Uniform Bank Performance Report) have ranged between 2.81%, 2.80% and 2.84% over the same time period.
 
Provision for Loan Losses
 
Management evaluates the loan portfolio in light of national and local economic trends, changes in the nature and volume of the portfolio and industry standards. Specific factors considered by management in determining the adequacy of the level of the allowance for loan losses include internally generated and third-party loan review reports, past due reports and historical loan loss experience. This review also considers concentrations of loans in terms of geography, business type and level of risk. Management evaluates nonperforming loans relative to their collateral value, when deemed collateral dependent, and makes the appropriate adjustments to the allowance for loan losses when needed. Based on the factors outlined above, the current year provision for loan losses totaled $2,930 compared to $0 for 2017 and 2016. The current levels of the allowance for loan losses reflect increased net charge-off activity, loan growth, and other credit risk factors that the Company considers in assessing the adequacy of the allowance for loan losses. The Company has experienced an increase in nonperforming loans compared to the prior year end. However due to collection efforts in the fourth quarter nonperforming loans decreased verses second and third quarter 2018. Exclusive of nonaccrual loans, past due loans and adversely risk rated loans decreased during 2018. The decline in past due loans and adversely risk rated loans reduced the allowance for loan losses. The allowance was also reduced due to improved real estate conditions. Management will continue to monitor nonperforming and past due loans and will make necessary adjustments to specific reserves and record provision for loan losses if conditions change regarding collateral values or cash flow expectations
 
Net loan charge-offs were $3,734 in 2018 and $1,499 in 2017. The increase in charge-offs is primarily related to one large commercial relationship ($4.3 million) that was written down from $5.8 million based on the current impaired value of the collateral. The relationship remains on nonaccrual and is included in impaired loans without a specific reserve. At this time, management expects no additional loss on this relationship, but continue to monitor it closely. Net charge-offs as a percentage of loans held for investment totaled .58% and .24% in 2018 and 2017, respectively. The commercial real estate charge-off percentage is the largest category at .24% of loans held for investment and dealer finance was .19%. As stated in the most recently available Uniform Bank Performance Report (UPBR), peer group loss averages were .08% in 2018 and .10% in 2017. The Bank anticipates losses will remain above peer due to the Dealer Finance Division, however these losses have been in line with expectations and are more than offset by the increased yield derived from this portfolio.
 
Balance Sheet
 
Total assets increased 3.58% during the year to $780,253, an increase of $26,983 from $753,270 in 2017. Loans held for investment grew $21,825, Loans held for sale increased $16,135, premises and equipment increased $1,872, Bank owned life insurance increased $5,514, investments decreased $19,399, and other asset categories experienced modest fluctuations. Average earning assets increased 2.73% or $18,296 to $687,563 at December 31, 2018. The increase in earning assets is due largely to the growth in the loans held for investment offset by the decrease in short-term loan participation program with Northpointe Bank and federal funds sold. Deposits grew $22,148 and other liabilities increased $4,199 in 2018. Average interest bearing deposits increased $16,433 for 2018 or 4.16%, with increases in interest-bearing demand accounts, savings accounts and time deposits. The Company continues to utilize its assets well, with 90.01% of average assets consisting of earning assets.
 
 
 
 
29
 
 
PART II, Continued
 
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations (dollars in thousands), Continued
 
Investment Securities
 
Total securities decreased $19,399 or 47.04% in 2018 to $21,844 at December 31, 2018 from $41,243 at December 31, 2017. Average balances in investment securities increased 25.57% in 2018 to $13,826. At year end, 2.01% of average earning assets of the Company were held as investment securities, all of which are unpledged. Management strives to match the types and maturities of securities owned to balance projected liquidity needs, interest rate sensitivity and to maximize earnings through a portfolio bearing low credit risk. Portfolio yields averaged 3.32% for 2018, up from 3.07% in 2017.
 
There were no Other Than Temporary Impairments (OTTI) write-downs in 2018, 2017 or 2016. In 2017, the Company recognized a $42 loss on exit of the Banker’s Title investment; there were no security gains or losses in 2018, 2017 or 2016.
 
The composition of securities at December 31 was:
(Dollars in thousands)
 
2018
 
 
2017
 
 
2016
 
Available for Sale1
 
 
 
 
 
 
 
 
 
    U.S. Treasury and Agency
 $7,886 
 $27,978 
 $24,014 
    Mortgage-backed obligations of federal agencies2
  403 
  502 
  634 
    Equity securities3
  - 
  135 
  135 
Total
  8,289 
  28,615 
  24,783 
 
    
    
    
Held to Maturity
    
    
    
    U.S. Treasury and Agency
  123 
  125 
  125 
Total
 123
  125 
  125 
 
    
    
    
Other Equity Investments
  13,432 
  12,503 
  14,567 
Total Securities
 $21,844 
 $41,243 
 $39,475 
1         
At estimated fair value. See Note 4 to the Consolidated Financial Statements for amortized cost.
2         
Issued by a U.S. Government Agency or secured by U.S. Government Agency collateral.
3         
Transferred to other equity investments on January 1, 2018 upon adoption of ASU 2016-01.
 
Maturities and weighted average yields of securities at December 31, 2018 are presented in the table below. Amounts are shown by contractual maturity; expected maturities will differ as issuers may have the right to call or prepay obligations. Maturities of other investments are not readily determinable due to the nature of the investment; see Note 4 to the Consolidated Financial Statements for a description of these investments.
 
 
 
Less
 
 
One to
 
 
Five to
 
 
Over
 
 
 
 
 
 
 
 
 
Than one Year
 
 
Five Years
 
 
Ten Years
 
 
Ten Years
 
 
 
 
 
 
 
(Dollars in thousands)
 
Amount
 
 
Yield
 
 
Amount
 
 
Yield
 
 
Amount
 
 
Yield
 
 
Amount
 
 
Yield
 
 
Total
 
 
Yield
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Debt Securities Available for Sale
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
U.S. Treasury & Agency
 $- 
  - 
 $7,886 
  2.06%
 $- 
  - 
 $- 
  - 
 $7,886 
  2.06%
Mortgage-backed obligations of federal agencies
    
    
    
    
  403