10-Q 1 d61364d10q.htm 10-Q 10-Q

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

Form 10-Q

 

 

Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

For the Quarterly Period Ended June 30, 2020

 

 

BANK OF THE JAMES FINANCIAL GROUP, INC.

(Exact Name of Registrant as Specified in Its Charter)

 

 

 

Virginia   001-35402   20-0500300

(State or other jurisdiction of

incorporation or organization)

  (Commission file number)  

(I.R.S. Employer

Identification No.)

 

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

(434) 846-2000

(Registrant’s telephone number, including area code)

Securities registered or to be registered pursuant to Section 12(b) of the Act

 

Title of each class

 

Trading Symbol(s)

 

Name of each exchange on which registered

Common Stock, 2.14 per share par value   BOTJ   The NASDAQ Stock Market LLC

 

 

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

Indicate by check mark whether the registrant has submitted electronically 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  ☑    No  ☐

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

 

Large accelerated filer      Accelerated filer  
Non-accelerated filer      Smaller reporting company  
Emerging growth company       

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

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

APPLICABLE ONLY TO CORPORATE ISSUERS

State the number of shares outstanding of each of the issuer’s classes of common equity, as of the latest practicable date: 4,339,436 shares of Common Stock, par value $2.14 per share, were outstanding at August 12, 2020.

 

 

 


Table of Contents

 

PART I – FINANCIAL INFORMATION      1  

Item 1.

  Consolidated Financial Statements      1  

Item 2.

  Management’s Discussion and Analysis of Financial Condition and Results of Operations      34  

Item 3.

  Quantitative and Qualitative Disclosures About Market Risk      58  

Item 4.

  Controls and Procedures      58  
PART II – OTHER INFORMATION      59  

Item 1.

  Legal Proceedings      59  

Item 1A.

  Risk Factors      59  

Item 2.

  Unregistered Sales of Equity Securities and Use of Proceeds      59  

Item 3.

  Defaults Upon Senior Securities      60  

Item 4.

  Mine Safety Disclosures      60  

Item 5.

  Other Information      60  

Item 6.

  Exhibits      61  
SIGNATURES      61  


PART I – FINANCIAL INFORMATION

 

Item 1.

Consolidated Financial Statements

Bank of the James Financial Group, Inc. and Subsidiaries

Consolidated Balance Sheets

(dollar amounts in thousands, except per share amounts) (2020 unaudited)

 

 

Assets    June 30,
2020
     December 31,
2019
 

Cash and due from banks

   $  30,669      $  30,794  

Federal funds sold

     60,131        8,317  
  

 

 

    

 

 

 

Total cash and cash equivalents

     90,800        39,111  

Securities held-to-maturity (fair value of $4,283 in 2020 and $3,861 in 2019)

     3,679        3,688  

Securities available-for-sale, at fair value

     55,072        59,655  

Restricted stock, at cost

     1,551        1,506  

Loans, net of allowance for loan losses of $6,193 in 2020 and $4,829 in 2019

     623,564        573,274  

Loans held for sale

     6,098        4,221  

Premises and equipment, net

     16,622        16,698  

Interest receivable

     2,505        1,866  

Cash value - bank owned life insurance

     16,387        13,686  

Other real estate owned

     1,616        2,339  

Deferred tax asset, net

     622        1,177  

Other assets

     8,582        8,173  
  

 

 

    

 

 

 

Total assets

   $  827,098      $  725,394  
  

 

 

    

 

 

 

Liabilities and Stockholders’ Equity

     

Deposits

     

Noninterest bearing demand

   $  134,523      $  93,936  

NOW, money market and savings

     424,842        362,821  

Time

     186,621        192,702  
  

 

 

    

 

 

 

Total deposits

     745,986        649,459  

Capital notes

     7,275        5,000  

Income taxes payable

     107        124  

Interest payable

     172        173  

Other liabilities

     9,093        9,193  
  

 

 

    

 

 

 

Total liabilities

   $  762,633      $  663,949  
  

 

 

    

 

 

 

Commitments and Contingencies

     

Stockholders’ equity

     

Preferred stock; authorized 1,000,000 shares; none issued and outstanding

   $  —        $  —    

Common stock $2.14 par value; authorized 10,000,000 shares; issued and outstanding 4,339,436 and 4,357,436 as of June 30, 2020 and December 31, 2019

     9,286        9,325  

Additional paid-in-capital

     30,989        31,225  

Retained earnings

     22,109        20,900  

Accumulated other comprehensive income (loss)

     2,081        (5
  

 

 

    

 

 

 

Total stockholders’ equity

   $  64,465      $  61,445  
  

 

 

    

 

 

 

Total liabilities and stockholders’ equity

   $  827,098      $  725,394  
  

 

 

    

 

 

 

 

1

See accompanying notes to these consolidated financial statements


Bank of the James Financial Group, Inc. and Subsidiaries

Consolidated Statements of Income

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

 

 

     For the Three Months Ended
June 30,
     For the Six Months Ended
June 30,
 
Interest Income    2020      2019      2020      2019  

Loans

   $  6,732      $  6,816      $  13,737      $  13,470  

Securities

           

US Government and agency obligations

     151        184        338        369  

Mortgage backed securities

     55        56        114        117  

Municipals - taxable

     80        81        155        160  

Municipals - tax exempt

     —          —          —          2  

Dividends

     24        33        33        51  

Other (Corporates)

     23        24        46        47  

Interest bearing deposits

     6        74        70        165  

Federal Funds sold

     10        122        76        243  
  

 

 

    

 

 

    

 

 

    

 

 

 

Total interest income

     7,081        7,390        14,569        14,624  
  

 

 

    

 

 

    

 

 

    

 

 

 

Interest Expense

           

Deposits

           

NOW, money market savings

     166        362        492        668  

Time Deposits

     912        826        1,858        1,574  

Finance leases

     28        —          58        —    

Capital notes

     57        50        107        100  
  

 

 

    

 

 

    

 

 

    

 

 

 

Total interest expense

     1,163        1,238        2,515        2,342  
  

 

 

    

 

 

    

 

 

    

 

 

 

Net interest income

     5,918        6,152        12,054        12,282  

Provision for loan losses

     760        116        1,648        326  
  

 

 

    

 

 

    

 

 

    

 

 

 

Net interest income after provision for loan losses

     5,158        6,036        10,406        11,956  
  

 

 

    

 

 

    

 

 

    

 

 

 

Noninterest income

           

Gain on sales of loans held for sale

     1,950        1,075        3,127        1,766  

Service charges, fees and commissions

     514        461        1,002        900  

Life insurance income

     110        84        188        167  

Other

     2        39        14        45  

Gain on sales and calls of securities, net

     213        —          644        —    
  

 

 

    

 

 

    

 

 

    

 

 

 

Total noninterest income

     2,789        1,659        4,975        2,878  
  

 

 

    

 

 

    

 

 

    

 

 

 

Noninterest expenses

           

Salaries and employee benefits

     3,973        3,153        7,327        6,081  

Occupancy

     382        417        818        838  

Equipment

     569        536        1,178        994  

Supplies

     106        142        233        304  

Professional, data processing, and other outside expense

     970        859        1,894        1,674  

Marketing

     179        276        315        421  

Credit expense

     276        156        472        283  

Other real estate expenses

     21        1        120        140  

FDIC insurance expense

     87        94        144        188  

Other

     372        341        631        651  
  

 

 

    

 

 

    

 

 

    

 

 

 

Total noninterest expenses

     6,935        5,975        13,132        11,574  
  

 

 

    

 

 

    

 

 

    

 

 

 

Income before income taxes

     1,012        1,720        2,249        3,260  

Income tax expense

     191        343        433        649  
  

 

 

    

 

 

    

 

 

    

 

 

 

Net Income

   $  821      $  1,377      $  1,816      $  2,611  
  

 

 

    

 

 

    

 

 

    

 

 

 

Weighted average shares outstanding - basic

     4,339,436        4,378,436        4,343,738        4,378,436  
  

 

 

    

 

 

    

 

 

    

 

 

 

Weighted average shares outstanding - diluted

     4,339,436        4,383,021        4,343,738        4,381,994  
  

 

 

    

 

 

    

 

 

    

 

 

 

Earnings per common share - basic

   $  0.19      $  0.31      $  0.42      $  0.60  
  

 

 

    

 

 

    

 

 

    

 

 

 

Earnings per common share - diluted

   $  0.19      $  0.31      $  0.42      $  0.60  
  

 

 

    

 

 

    

 

 

    

 

 

 

 

2

See accompanying notes to these consolidated financial statements


Bank of the James Financial Group, Inc. and Subsidiaries

Consolidated Statements of Comprehensive Income

(dollar amounts in thousands) (unaudited)

 

 

     For the Three Months
Ended June 30,
    For the Six Months
Ended June 30,
 
     2020     2019     2020     2019  

Net Income

   $  821   $  1,377   $  1,816   $  2,611
  

 

 

   

 

 

   

 

 

   

 

 

 

Other comprehensive income:

        

Unrealized gains on securities available-for-sale

     998     1,180     3,285     2,491

Tax effect

     (210     (248     (690     (523

Reclassification adjustment for gains included in net income (1)

     (213     —         (644     —    

Tax effect (2)

     44     —         135     —    
  

 

 

   

 

 

   

 

 

   

 

 

 

Other comprehensive income, net of tax

     619     932     2,086     1,968
  

 

 

   

 

 

   

 

 

   

 

 

 

Comprehensive income

   $  1,440   $  2,309   $  3,902   $  4,579
  

 

 

   

 

 

   

 

 

   

 

 

 

 

  (1)

Gains are included in “gain on sales and calls of available-for-sale securities, net” on the consolidated statements of income.

 

  (2)

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

 

3

See accompanying notes to these consolidated financial statements


Bank of the James Financial Group, Inc. and Subsidiaries

Consolidated Statements of Cash Flows

For the Six Months Ended June 30, 2020 and 2019

(dollar amounts in thousands) (unaudited)

 

 

     For the Six Months Ended June 30,  
     2020     2019  

Cash flows from operating activities

    

Net Income

   $  1,816   $  2,611

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

    

Depreciation and amortization

     1,008     690

Stock based compensation expense

     53     53

Net amortization and accretion of premiums and discounts on securities

     196     199

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

     (644     —    

(Gain) on sales of loans held for sale

     (3,127     (1,766

Proceeds from sales of loans held for sale

     125,134     66,292

Origination of loans held for sale

     (123,884     (67,299

Provision for loan losses

     1,648     326

(Gain) loss on sale of other real estate owned

     (6     13

Impairment of other real estate owned

     102     115

(Increase) in cash value of life insurance

     (188     (167

(Increase) in interest receivable

     (639     (19

(Increase) decrease in other assets

     (1,040     47

(Decrease) increase in income taxes payable

     (17     648

(Decrease) increase in interest payable

     (1     32

(Decrease) in other liabilities

     7     (454
  

 

 

   

 

 

 

Net cash provided by operating activities

   $  418   $  1,321
  

 

 

   

 

 

 

Cash flows from investing activities

    

Purchases of securities available-for-sale

   $  (11,334)     $  -    

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

     1,202     1,207

Proceeds from sale of securities available-for-sale

     17,813     —    

Purchases of bank owned life insurance

     (2,750     —    

Life insurance proceeds

     588     —    

(Purchase) of Federal Home Loan Bank stock

     (45     (44

Proceeds from sale of other real estate owned

     645     349

Origination of loans, net of principal collected

     (51,956     (22,744

Purchases of premises and equipment

     (652     (2,899
  

 

 

   

 

 

 

Net cash (used in) investing activities

   $ (46,489   $ (24,131
  

 

 

   

 

 

 

Cash flows from financing activities

    

Net increase in deposits

   $  96,527   $  5,141

Principal payments on finance lease obligations

     (160     —    

Repurchases of common stock

     (275     —    

Dividends paid to common stockholders

     (607     (526

Proceeds from sale of 3.25% capital notes due 6/30/2025

     7,275     —    

Retirement of 4% capital notes due 1/24/2022

     (5,000     —    
  

 

 

   

 

 

 

Net cash provided by financing activities

   $  97,760   $  4,615
  

 

 

   

 

 

 

Increase (decrease) in cash and cash equivalents

     51,689     (18,195

Cash and cash equivalents at beginning of period

   $  39,111   $  50,325
  

 

 

   

 

 

 

Cash and cash equivalents at end of period

   $  90,800   $  32,130
  

 

 

   

 

 

 

Non cash transactions

    

Transfer of loans to other real estate owned

   $  18   $  460

Fair value adjustment for securities available-for-sale

     2,641     2,491

Lease liabilities arising from right-of-use assets

     —         6,373

Cash transactions

    

Cash paid for interest

   $  2,516   $  2,310

Cash paid for income taxes

     435     —    

 

4

See accompanying notes to these consolidated financial statements


Bank of the James Financial Group, Inc. and Subsidiaries

Consolidated Statements of Changes in Stockholders’ Equity

For the Three and Six Months Ended June 30, 2020 and 2019

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

 

 

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

Balance at December 31, 2018

     4,378,436     $  9,370     $  31,495     $  16,521     $  (2,243)      $  55,143  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

    

 

 

 

Net Income

     —         —         —         1,234       —          1,234  

Dividends paid on common stock ($0.06 per share)

     —         —         —         (263     —          (263

Other comprehensive income

     —         —         —         —         1,036        1,036  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

    

 

 

 

Balance at March 31, 2019

     4,378,436     $  9,370     $  31,495     $  17,492     $  (1,207)      $  57,150  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

    

 

 

 

Net Income

     —         —         —         1,377       —          1,377  

Dividends paid on common stock ($0.06 per share)

     —         —         —         (263     —          (263

Other comprehensive income

     —         —         —         —         932        932  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

    

 

 

 

Balance at June 30, 2019

     4,378,436     $  9,370     $  31,495     $  18,606     $  (275)      $  59,196  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

    

 

 

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

Balance at December 31, 2019

     4,357,436     $  9,325     $  31,225     $  20,900     $  (5)      $  61,445  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

    

 

 

 

Net Income

     —         —         —         995       —          995  

Dividends paid on common stock ($0.07 per share)

     —         —         —         (304     —          (304

Repurchase of common stock

     (18,000     (39     (236     —         —          (275

Other comprehensive income

     —         —         —         —         1,467        1,467  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

    

 

 

 

Balance at March 31, 2020

     4,339,436     $  9,286     $  30,989     $  21,591     $  1,462      $  63,328  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

    

 

 

 

Net Income

     —         —         —         821       —          821  

Dividends paid on common stock ($0.07 per share)

     —         —         —         (303     —          (303

Other comprehensive income

     —         —         —         —         619        619  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

    

 

 

 

Balance at June 30, 2020

     4,339,436     $  9,286     $  30,989     $  22,109     $  2,081      $  64,465  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

    

 

 

 

 

5

See accompanying notes to these consolidated financial statements


Notes to Consolidated Financial Statements

Note 1 – Basis of Presentation

The unaudited consolidated financial statements have been prepared by Bank of the James Financial Group, Inc. (“Financial” or the “Company”) pursuant to the rules and regulations of the Securities and Exchange Commission. In management’s opinion the accompanying financial statements, which unless otherwise noted are unaudited, reflect all adjustments, consisting solely of normal recurring accruals, necessary for a fair presentation of the financial information as of June 30, 2020 and for the three and six months ended June 30, 2020 and 2019 in conformity with accounting principles generally accepted in the United States of America. Additional information concerning the organization and business of Financial, accounting policies followed, and other related information is contained in Financial’s Annual Report on Form 10-K for the year ended December 31, 2019. These financial statements should be read in conjunction with the audited consolidated financial statements and footnotes for the year ended December 31, 2019 included in Financial’s Annual Report on Form 10-K. Results for the three and six month periods ended June 30, 2020 are not necessarily indicative of the results that may be expected for the year ending December 31, 2020.

Certain immaterial reclassifications have been made to prior period balances to conform to the current period presentation.

The Company’s primary market area consists of the area commonly referred to as Region 2000 which encompasses the seven jurisdictions of the Town of Altavista, Amherst County, Appomattox County, the Town of Bedford, Bedford County, Campbell County, and the City of Lynchburg. Recently, the Company has expanded into Charlottesville, Roanoke, Blacksburg, Harrisonburg, Lexington, and Rustburg.

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

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

 

6


Note 2 – Use of Estimates

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

Note 3 – Earnings Per Common Share (EPS)

The following is a summary of the earnings per share calculation for the three and six months ended June 30, 2020 and 2019.

 

     Three Months Ended      Six Months Ended  
     June 30,      June 30,  
     2020      2019      2020      2019  

Net income

   $  821,000      $  1,377,000      $  1,816,000      $  2,611,000  

Weighted average number of shares

     4,339,436        4,378,436        4,343,738        4,378,436  

Restricted stock units affect of incremental shares

     —          4,585        —          3,558  
  

 

 

    

 

 

    

 

 

    

 

 

 

Weighted average diluted shares

     4,339,436        4,383,021        4,343,738        4,381,994  
  

 

 

    

 

 

    

 

 

    

 

 

 

Basic EPS (weighted avg shares)

   $  0.19      $  0.31      $  0.42      $  0.60  
  

 

 

    

 

 

    

 

 

    

 

 

 

Diluted EPS (Including incremental shares)

   $  0.19      $  0.31      $  0.42      $  0.60  
  

 

 

    

 

 

    

 

 

    

 

 

 

In 2020, all restricted stock units (RSUs) were excluded from calculating diluted earnings per share as the Company elected to settle units vesting in 2020 wholly in cash. Going forward, management has adopted a cash settlement policy for all currently outstanding RSUs. Prior to 2020, the presumption was that the shares would be settled in common stock and the RSUs were included in the calculation of diluted EPS. There were no potentially dilutive shares were excluded from the 2019 earnings per share calculation because they were anti-dilutive.

Note 4 – Stock Based Compensation

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

 

7


Note 4 – Stock Based Compensation (continued)

 

At the annual meeting of shareholders held on May 15, 2018, the shareholders approved the Bank of the James Financial Group, Inc. 2018 Equity Incentive Plan (the “2018 Incentive Plan”). The 2018 Incentive Plan permits the issuance of up to 250,000 shares of common stock for awards to key employees of the Company and its subsidiaries in the form of stock options, restricted stock, restricted stock units, stock awards and performance units.

On January 2, 2019, the Company granted its first block of equity compensation under the 2018 Incentive Plan consisting of 24,500 restricted stock units. The recipients of restricted stock units do not receive shares of the Company’s stock immediately, but instead may receive shares, cash in lieu of shares, or a combination thereof upon satisfying the requisite service period specified by the terms and conditions of the grant. Additionally, the recipients of restricted stock units do not enjoy the rights of holder of the Company’s common stock until the units have vested and as such, they do not have voting rights or rights to nonforfeitable dividends. The related compensation expense is based on the grant date fair value of the Company’s stock of $13.00 per share. RSUs vest over 3 years in thirds with the first one-third vesting on January 2, 2020. The value of the first one-third vested portion of the grant was settled with cash payments and no shares were issued.

The total expense recognized for the three months ended June 30, 2020 and 2019, in connection with the restricted stock unit awards was approximately $26,000 and $26,000, respectively. The total expense recognized for the six months ended June 30, 2020 and 2019, in connection with the restricted stock unit awards was approximately $53,000 and $53,000, respectively. There were no forfeitures during the three and six month periods ending June 30, 2020.

At June 30, 2020, the unrecognized stock-based compensation expense related to unvested restricted stock awards amounted to approximately $159,000. The unrecognized expense will be recognized ratably over the remaining vesting period of 1.50 years. The Company accounts for forfeitures as they occur.

Note 5 – Fair Value Measurements

Determination of Fair Value

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

 

8


Note 5 – Fair Value Measurements (continued)

 

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

Fair Value Hierarchy

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

 

   

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

 

   

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

 

   

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

Fair Value on a Recurring Basis

Securities Available-for-Sale

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

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

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

 

9


Note 5 – Fair Value Measurements (continued)

 

 

            Carrying Value at June 30, 2020 (in thousands)  

Description

   Balance as of
June 30,
2020
     Quoted Prices
in Active
Markets for
Identical Assets
(Level 1)
     Significant
Other
Observable
Inputs
(Level 2)
     Significant
Unobservable
Inputs
(Level 3)
 

US Treasuries

   $ 2,038      $ —        $ 2,038      $ —    

US agency obligations

     26,102        —          26,102        —    

Mortgage-backed securities

     9,424        —          9,424        —    

Municipals

     13,247        —          13,247        —    

Corporates

     4,261        —          4,261        —    
  

 

 

    

 

 

    

 

 

    

 

 

 

Total available-for-sale securities

   $  55,072      $ —        $  55,072      $ —    
  

 

 

    

 

 

    

 

 

    

 

 

 
            Carrying Value at December 31, 2019 (in thousands)  

Description

   Balance as of
December 31,
2019
     Quoted Prices
in Active
Markets for
Identical Assets
(Level 1)
     Significant
Other
Observable
Inputs
(Level 2)
     Significant
Unobservable
Inputs
(Level 3)
 

US Treasuries

   $ 1,964      $ —        $ 1,964      $ —    

US agency obligations

     32,108        —          32,108        —    

Mortgage-backed securities

     10,264        —          10,264        —    

Municipals

     11,222        —          11,222        —    

Corporates

     4,097        —          4,097        —    
  

 

 

    

 

 

    

 

 

    

 

 

 

Total available-for-sale securities

   $ 59,655      $ —        $ 59,655      $ —    
  

 

 

    

 

 

    

 

 

    

 

 

 

Fair Value on a Non-recurring Basis

Impaired loans

Loans are designated as impaired when, in the judgment of management based on current information and events, it is probable that all amounts due according to the contractual terms of the loan agreement will not be collected when due. The measurement of loss associated with impaired loans can be based on either the observable market price of the loan or the fair value of the collateral. Fair value is measured based on the value of the collateral securing the loans. Collateral may be in the form of real estate or business assets including equipment, inventory, and accounts receivable. The vast majority of the collateral is real estate. The value of real estate collateral is determined utilizing an income or market valuation approach based on an appraisal conducted by an independent, licensed appraiser outside of the Bank using observable market data (Level 2). However, in situations where the collateral is a house or building in the process of construction, the appraisal is more than 12 months old, management has determined the fair value of the collateral is further impaired below the appraised value, or the appraisal is not based solely on market comparables adjusted for observable inputs, the value is considered Level 3. The value of business equipment is based upon an outside appraisal if deemed significant, or the net book value on the applicable business’ financial statements if not considered significant using observable market data. Likewise, values for inventory and accounts receivables collateral are based on financial statement balances or aging reports (Level 3). Any fair value adjustments are recorded in the period incurred as provision for loan losses on the Consolidated Statements of Income.

 

10


Note 5 – Fair Value Measurements (continued)

 

Loans held for sale

Loans held for sale are carried at cost which approximates estimated fair value. These loans currently consist of one-to-four family residential loans originated for sale in the secondary market. Fair value is based on the price secondary markets are currently offering for similar loans using observable market data which is not materially different than cost due to the short duration between origination and sale (Level 2). As such, the Company records fair value adjustments on a nonrecurring basis. No nonrecurring fair value adjustments were recorded on loans held for sale during the period ended June 30, 2020. Gains and losses on the sale of loans are recorded within gains on sales of loans held for sale, net on the Consolidated Statements of Income.

Other real estate owned

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

Real estate acquired through foreclosure is transferred to OREO. The measurement of loss associated with OREO is based on the fair value of the collateral compared to the unpaid loan balance and anticipated costs to sell the property. The value of OREO property is determined utilizing an income or market valuation approach based on an appraisal conducted by an independent, licensed appraiser outside of the Bank using observable market data (Level 2).

Any fair value adjustments are recorded in the period incurred and expensed against current earnings. However, in situations where the collateral is a house or building in the process of construction, the appraisal is more than 12 months old, management has determined the fair value of the collateral is further impaired below the appraised value, or the appraisal is not based solely on market comparables adjusted for observable inputs, the value is considered Level 3.

 

11


Note 5 – Fair Value Measurements (continued)

 

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

 

            Carrying Value at June 30, 2020  

Description

   Balance as of
June 30, 2020
     Quoted Prices in
Active Markets for
Identical Assets
(Level 1)
     Significant Other
Observable Inputs
(Level 2)
     Significant
Unobservable
Inputs (Level 3)
 

Impaired loans*

   $  2,486      $ —        $ —        $  2,486  

Other real estate owned

     1,616        —          —          1,616  

 

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

 

            Carrying Value at December 31, 2019  

Description

   Balance as of
December 31,

2019
     Quoted Prices in
Active Markets for
Identical Assets
(Level 1)
     Significant Other
Observable Inputs
(Level 2)
     Significant
Unobservable
Inputs (Level 3)
 

Impaired loans*

   $  1,239      $ —        $ —        $  1,239  

Other real estate owned

     2,339        —          —          2,339  

 

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

 

12


Note 5 – Fair Value Measurements (continued)

 

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

 

     Quantitative information about Level 3 Fair Value Measurements for June 30, 2020
(dollars in thousands)
     Fair Value     

Valuation Technique(s)

 

Unobservable Input

 

Range (Weighted
Average) (1)

Assets                    

Impaired loans

   $  2,486      Discounted appraised value   Selling cost   0%—10% (8%)
       

Discount for lack of marketability and age of appraisal

  0%—20% (6%)

OREO

     1,616      Discounted appraised value   Selling cost   0%—10% (6%)
       

Discount for lack of marketability and age of appraisal

  0%—25% (15%)

 

  (1)

Weighted based on the relative value of the instruments.

 

     Quantitative information about Level 3 Fair Value Measurements for December 31, 2019
(dollars in thousands)
     Fair Value     

Valuation Technique(s)

 

Unobservable Input

 

Range (Weighted
Average) (1)

Assets                    

Impaired loans

   $  1,239      Discounted appraised value   Selling cost   0%—10% (8%)
       

Discount for lack of marketability and age of appraisal

  0%—20% (6%)

OREO

     2,339      Discounted appraised value   Selling cost   0%—10% (6%)
       

Discount for lack of marketability and age of appraisal

  0%—25% (15%)

 

  (1)

Weighted based on the relative value of the instruments.

Financial Instruments

FASB ASC 825, Financial Instruments, requires disclosure about fair value of financial instruments, including those financial assets and financial liabilities that are not required to be measured and reported at fair value on a recurring or nonrecurring basis. ASC 825 excludes certain financial instruments and all nonfinancial instruments from its disclosure requirements. Accordingly, the aggregate fair value amounts presented may not necessarily represent the underlying fair value of the Company. The carrying amounts and estimated fair values of the Company’s financial instruments are presented in the following tables whether or not recognized on the Consolidated Balance Sheets at fair value.

 

13


Note 5 – Fair Value Measurements (continued)

 

The estimated fair values, and related carrying or notional amounts, of Financial’s financial instruments and their placement in the fair value hierarchy at June 30, 2020 and December 31, 2019 was as follows (in thousands):

 

       Fair Value Measurements at June 30, 2020 using  
Assets    Carrying
Amounts
     Quoted Prices
in Active
Markets for
Identical Assets
(Level 1)
     Significant
Other
Observable
Inputs
(Level 2)
     Significant
Unobservable
Inputs
(Level 3)
     Balance  

Cash and due from banks

   $ 30,669      $ 30,669      $ —        $ —        $ 30,669  

Fed funds sold

     60,131        60,131        —          —          60,131  

Securities

              

Available-for-sale

     55,072        —          55,072        —          55,072  

Held-to-maturity

     3,679        —          4,283        —          4,283  

101Restricted stock

     1,551           1,551        —          1,551  

Loans, net (1)

     623,564        —          —          623,253        623,253  

Loans held for sale

     6,098        —          6,098        —          6,098  

Interest receivable

     2,505        —          2,505        —          2,505  

BOLI

     16,387        —          16,387        —          16,387  
Liabilities                                   

Deposits

   $ 745,986      $ —        $ 748,299      $ —        $ 748,299  

Capital notes

     7,275        —          6,456        —          6,456  

Interest payable

     172        —          172        —          172  
            Fair Value Measurements at December 31, 2019 using  
Assets    Carrying
Amounts
     Quoted Prices
in Active
Markets for
Identical Assets
(Level 1)
     Significant
Other
Observable
Inputs
(Level 2)
     Significant
Unobservable
Inputs
(Level 3)
     Balance  

Cash and due from banks

   $ 30,794      $ 30,794      $ —        $ —        $ 30,794  

Fed funds sold

     8,317        8,317           —          8,317  

Securities

              

Available-for-sale

     59,655        —          59,655        —          59,655  

Held-to-maturity

     3,688        —          3,861        —          3,861  

Restricted stock

     1,506        —          1,506           1,506  

Loans, net (1)

     573,274        —          —          569,850        569,850  

Loans held for sale

     4,221        —          4,221        —          4,221  

Interest receivable

     1,866        —          1,866        —          1,866  

BOLI

     13,686        —          13,686        —          13,686  

Liabilities

              

Deposits

   $ 649,459      $ —        $ 651,479      $ —        $ 651,479  

Capital notes

     5,000        —          4,795        —          4,795  

Interest payable

     173        —          173        —          173  

 

  (1)

Carrying amount is net of unearned income and the Allowance.

 

14


Note 6—Securities

The following tables summarize the Bank’s holdings for both securities held-to-maturity and securities available-for-sale as of June 30, 2020 and December 31, 2019 (amounts in thousands):

 

    

 

     June 30, 2020    

 

 
     Amortized      Gross Unrealized     Fair Value  
     Costs      Gains      (Losses)    

 

 

Held-to-Maturity

          

US agency obligations

   $ 3,679      $ 604      $ —       $ 4,283  
  

 

 

    

 

 

    

 

 

   

 

 

 

Available-for-Sale

          

US Treasuries

     2,000        38        —         2,038  

US agency obligations

     24,488        1,614        —         26,102  

Mortgage-backed securities

     9,119        305        —         9,424  

Municipals

     12,752        497        (2     13,247  

Corporates

     4,078        193        (10     4,261  
  

 

 

    

 

 

    

 

 

   

 

 

 
     $52,437      $ 2,647      $ (12)     $ 55,072  
  

 

 

    

 

 

    

 

 

   

 

 

 
    

 

     December 31, 2019    

 

 
     Amortized      Gross Unrealized     Fair Value  
     Costs      Gains      (Losses)    

 

 

Held-to-Maturity

          

US agency obligations

   $ 3,688      $  173      $ —       $ 3,861  
  

 

 

    

 

 

    

 

 

   

 

 

 

Available-for-Sale

          

US Treasuries

     1,966        —          (2     1,964  

US agency obligations

     32,163        278        (333     32,108  

Mortgage-backed securities

     10,328        42        (106     10,264  

Municipals

     11,118        117        (13     11,222  

Corporates

     4,086        32        (21     4,097  
  

 

 

    

 

 

    

 

 

   

 

 

 
     $ 59,661      $ 469      $ (475)     $ 59,655  
  

 

 

    

 

 

    

 

 

   

 

 

 

 

15


Note 6 – Securities (continued)

 

The following tables show the gross unrealized losses and fair value of the Bank’s investments with unrealized losses that are not deemed to be other-than-temporarily impaired, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position, at June 30, 2020 and December 31, 2019 (amounts in thousands):

 

     Less than 12 months      More than 12 months     

 

     Total  

June 30, 2020

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

Description of securities

                 

Held-to-maturity

                 

US agency obligations

   $ —        $ —        $ —        $ —        $ —        $ —    

Available-for-sale

                 

US Treasuries

     —          —          —          —          —          —    

US agency obligations

                   —          —          —          —    

Mortgage-backed securities

     —          —          —          —          —          —    

Municipals

     674        2        —          —          674        2  

Corporates

     —          —          1,047        10        1,047        10  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $  674      $ 2      $  1,047      $ 10      $  1,721      $ 12  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 
     Less than 12 months      More than 12 months     

 

     Total  

December 31, 2019

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

Description of securities

                 

Held-to-maturity

                 

US agency obligations

   $ —        $ —        $ —        $ —        $ —        $ —    

Available-for-sale

                 

US Treasuries

     —          —          1,964        2        1,964        2  

US agency obligations

     12,395        218        12,048        115        24,443        333  

Mortgage-backed securities

     —          —          6,609        106        6,609        106  

Municipals

     —          —          2,736        13        2,736        13  

Corporates

     —          —          1,042        21        1,042        21  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $  12,395      $  218      $  24,399      $  257      $  36,794      $  475  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

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

 

16


Note 6 – Securities (continued)

 

At June 30, 2020, the Company did not consider the unrealized losses as other-than-temporary losses due to the nature of the securities involved. As of June 30, 2020, the Bank owned two securities in an unrealized loss position that were being evaluated for other than temporary impairment. One of these securities was S&P rated AA and one was rated BBB+. As of June 30, 2020, one of these securities was a municipal issue and one was an investment in a domestic corporate issued security.

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

Gross gains on sales of available-for-sale securities were $213 and $644 during the three and six months ended June 30, 2020 as compared to $0 during the same periods in 2019. There were no gross losses on sales of available-for-sale securities during the three and six month periods ended June 30, 2020 and 2019. There were no sales of held-to-maturity securities during the three and six month periods ended June 30, 2020 and 2019.

Note 7 – Business Segments

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

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

 

17


Note 7 – Business Segments (continued)

 

Information about reportable business segments and reconciliation of such information to the consolidated financial statements for the three and six months ended June 30, 2020 and 2019 was as follows (dollars in thousands):

 

Business Segments

        
     Community                
     Banking      Mortgage      Total  

Six months ended June 30, 2020

        

Net interest income

   $  12,054      $  —        $  12,054  

Provision for loan losses

     1,648        —          1,648  
  

 

 

    

 

 

    

 

 

 

Net interest income after provision for loan losses

     10,406        —          10,406  

Noninterest income

     1,848        3,127        4,975  

Noninterest expenses

     10,949        2,183        13,132  
  

 

 

    

 

 

    

 

 

 

Income before income taxes

     1,305        944        2,249  

Income tax expense

     235        198        433  
  

 

 

    

 

 

    

 

 

 

Net income

   $  1,070      $  746      $  1,816  
  

 

 

    

 

 

    

 

 

 

Total assets

   $  820,623      $  6,475      $  827,098  
  

 

 

    

 

 

    

 

 

 

Six months ended June 30, 2019

        

Net interest income

   $  12,282      $  —        $  12,282  

Provision for loan losses

     326        —          326  
  

 

 

    

 

 

    

 

 

 

Net interest income after provision for loan losses

     11,956        —          11,956  

Noninterest income

     1,112        1,766        2,878  

Noninterest expenses

     10,247        1,327        11,574  
  

 

 

    

 

 

    

 

 

 

Income before income taxes

     2,821        439        3,260  

Income tax expense

     557        92        649  
  

 

 

    

 

 

    

 

 

 

Net income

   $  2,264      $  347      $  2,611  
  

 

 

    

 

 

    

 

 

 

Total assets

   $  685,516      $  4,579      $  690,095  
  

 

 

    

 

 

    

 

 

 
     Community                
     Banking      Mortgage      Total  

Three months ended June 30, 2020

        

Net interest income

   $  5,918      $  —        $  5,918  

Provision for loan losses

     760        —          760  
  

 

 

    

 

 

    

 

 

 

Net interest income after provision for loan losses

     5,158        —          5,158  

Noninterest income

     839        1,950        2,789  

Noninterest expenses

     5,609        1,326        6,935  
  

 

 

    

 

 

    

 

 

 

Income before income taxes

     388        624        1,012  

Income tax expense

     60        131        191  
  

 

 

    

 

 

    

 

 

 

Net income

   $  328      $  493      $  821  
  

 

 

    

 

 

    

 

 

 

Total assets

   $  820,623      $  6,475      $  827,098  
  

 

 

    

 

 

    

 

 

 

Three months ended June 30, 2019

        

Net interest income

   $  6,152      $  —        $  6,152  

Provision for loan losses

     116        —          116  
  

 

 

    

 

 

    

 

 

 

Net interest income after provision for loan losses

     6,036        —          6,036  

Noninterest income

     584        1,075        1,659  

Noninterest expenses

     5,222        753        5,975  
  

 

 

    

 

 

    

 

 

 

Income before income taxes

     1,398        322        1,720  

Income tax expense

     276        67        343  
  

 

 

    

 

 

    

 

 

 

Net income

   $  1,122      $  255      $  1,377  
  

 

 

    

 

 

    

 

 

 

Total assets

   $  685,516      $  4,579      $  690,095  
  

 

 

    

 

 

    

 

 

 

 

18


Note 8 – Loans, allowance for loan losses and OREO

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

 

Loan Segments:

  

Loan Classes:

Commercial

  

Commercial and industrial loans

Commercial real estate

  

Commercial mortgages – owner occupied

  

Commercial mortgages – non-owner occupied

  

Commercial construction

Consumer

  

Consumer unsecured

  

Consumer secured

Residential

  

Residential mortgages

  

Residential consumer construction

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

 

     As of:  
     June 30,      December 31,  
     2020      2019  

Commercial

   $ 175,646      $ 114,257  

Commercial real estate

     301,700        303,900  

Consumer

     87,155        89,945  

Residential

     65,256        70,001  
  

 

 

    

 

 

 

Total loans (1)

     629,757        578,103  

Less allowance for loan losses

     6,193        4,829  
  

 

 

    

 

 

 

Net loans

   $ 623,564      $ 573,274  
  

 

 

    

 

 

 

 

 

(1)

Includes net deferred (fees) and costs/premiums of ($1,429) and $572 as of June 30, 2020 and December 31, 2019, respectively.

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

 

19


Note 8 – Loans, allowance for loan losses and OREO (continued)

 

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

 

RATING 1

  

Excellent

RATING 2

  

Above Average

RATING 3

  

Satisfactory

RATING 4

  

Acceptable / Low Satisfactory

RATING 5

  

Monitor

RATING 6

  

Special Mention

RATING 7

  

Substandard

RATING 8

  

Doubtful

RATING 9

  

Loss

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

 

   

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

 

   

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

 

   

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

 

   

“Substandard.” These are loans having a risk rating of 7. Substandard loans are considered to have specific and well-defined weaknesses that jeopardize the viability of the Bank’s credit extension. The payment history for the loan has been inconsistent and the expected or projected primary repayment source may be inadequate to service the loan. The estimated net liquidation value of the collateral pledged and/or ability of the personal guarantor(s) to pay the loan may

 

20


Note 8 – Loans, allowance for loan losses and OREO (continued)

 

 

not adequately protect the Bank. There is a distinct possibility that the Bank will sustain some loss if the deficiencies associated with the loan are not corrected in the near term. A substandard loan would not automatically meet our definition of impaired unless the loan is significantly past due and the borrower’s performance and financial condition provides evidence that it is probable that the Bank will be unable to collect all amounts due.

 

   

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

 

   

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

 

Loans on Non-Accrual Status  
(dollars in thousands)  
     As of  
     June 30, 2020      December 31, 2019  

Commercial

   $ 313      $ 262  

Commercial Real Estate:

 

Commercial Mortgages-Owner Occupied

     3,970        262  

Commercial Mortgages-Non-Owner Occupied

     447        450  

Commercial Construction

     —          —    

Consumer

     

Consumer Unsecured

     —          —    

Consumer Secured

     284        47  

Residential:

 

  

Residential Mortgages

     171        280  

Residential Consumer Construction

     —          —    
  

 

 

    

 

 

 

Totals

   $ 5,185      $ 1,301  
  

 

 

    

 

 

 

 

21


Note 8 – Loans, allowance for loan losses and OREO (continued)

 

We also classify other real estate owned (OREO) as a nonperforming asset. OREO represents real property owned by the Bank which was acquired through purchase at foreclosure or from the borrower through a deed in lieu of foreclosure. OREO decreased to $1,616 on June 30, 2020 from $2,339 on December 31, 2019. The following table represents the changes in OREO balance during the six months ended June 30, 2020 and year ended December 31, 2019.

 

OREO Changes  
(dollars in thousands)  
     Six Months Ended     Year Ended  
     June 30, 2020     December 31, 2019  

Balance at the beginning of the year (net)

   $ 2,339     $ 2,430  

Transfers from loans

     18       785  

Capitalized costs

     —         —    

Valuation adjustments

     (102     (287

Sales proceeds

     (645     (570

(Gain) loss on disposition

     6       (19
  

 

 

   

 

 

 

Balance at the end of the period (net)

   $ 1,616     $ 2,339  
  

 

 

   

 

 

 

At June 30, 2020 and December 31, 2019, the Company had no consumer mortgage loans secured by residential real estate for which foreclosure was in process. The Company held one residential real estate property carried on the books in other real estate owned at a value of $18 as of June 30, 2020 and four residential real estate properties carried on the books at a value of $325 in other real estate owned as of December 31, 2019.

 

22


Note 8 – Loans, allowance for loan losses and OREO (continued)

 

         Impaired Loans  
         (dollars in thousands)  
         As of and For the Six Months Ended June 30, 2020  
                Unpaid             Average      Interest  
         Recorded      Principal      Related      Recorded      Income  
2020        Investment      Balance      Allowance      Investment      Recognized  

With No Related Allowance Recorded:

              
 

Commercial

   $  588    $  1,181    $  —        $  528    $  19
 

Commercial Real Estate

              
 

Commercial Mortgages-Owner Occupied

     4,503      4,970      —          3,485      92
 

Commercial Mortgage Non-Owner Occupied

     556      582      —          560      21
 

Commercial Construction

     —          —          —          —          —    
 

Consumer

              
 

Consumer Unsecured

     —          —          —          —          —    
 

Consumer Secured

     266      266      —          187      6
 

Residential

              
 

Residential Mortgages

     1,365      1,428      —          1,328      34
 

Residential Consumer Construction

     —          —          —          —          —    

With an Allowance Recorded:

              
 

Commercial

   $  88    $  88    $  66    $  48    $  -    
 

Commercial Real Estate

              
 

Commercial Mortgages-Owner Occupied

     822      850      240      417      3
 

Commercial Mortgage Non-Owner Occupied

     —          —          —          7      —    
 

Commercial Construction

     —          —          —          —          —    
 

Consumer

              
 

Consumer Unsecured

     —          —          —          —          —    
 

Consumer Secured

     —          —          —          —          —    
 

Residential

              
 

Residential Mortgages

     —          —          —          70      —    
 

Residential Consumer Construction

     —          —          —          —          —    

Totals:

              
 

Commercial

   $  676    $  1,269    $  66    $  576    $  19
 

Commercial Real Estate

              
 

Commercial Mortgages-Owner Occupied

     5,325      5,820      240      3,902      95
 

Commercial Mortgage Non-Owner Occupied

     556      582      —          567      21
 

Commercial Construction

     —          —          —          —          —    
 

Consumer

              
 

Consumer Unsecured

     —          —          —          —          —    
 

Consumer Secured

     266      266      —          187      6
 

Residential

              
 

Residential Mortgages

     1,365      1,428      —          1,398      34
 

Residential Consumer Construction

     —          —          —          —          —    
    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 
     $  8,188    $  9,365    $  306    $  6,630    $  175
    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

23


Note 8 – Loans, allowance for loan losses and OREO (continued)

 

          Impaired Loans  
          (dollars in thousands)  
          As of and For the Year Ended December 31, 2019  
                 Unpaid             Average      Interest  
          Recorded      Principal      Related      Recorded      Income  
2019         Investment      Balance      Allowance      Investment      Recognized  

With No Related Allowance Recorded:

              
  

Commercial

   $  468    $  1,036    $  —        $  949    $  26
  

Commercial Real Estate

              
  

Commercial Mortgages-Owner Occupied

     2,467      2,643      —          2,441      183
  

Commercial Mortgage Non-Owner Occupied

     563      585      —          347      32
  

Commercial Construction

     —          —          —          —          —    
  

Consumer

              
  

Consumer Unsecured

     —          —          —          —          —    
  

Consumer Secured

     107      107      —          98      7
  

Residential

              
  

Residential Mortgages

     1,290      1,290      —          1,583      68
  

Residential Consumer Construction

     —          —          —          —          —    

With an Allowance Recorded:

              
  

Commercial

   $  7    $  7    $  7    $  19    $  1
  

Commercial Real Estate

              
  

Commercial Mortgages-Owner Occupied

     12      12      12      26      1
  

Commercial Mortgage Non-Owner Occupied

     14      14      3      52      1
  

Commercial Construction

     —          —          —          —          —    
  

Consumer

              
  

Consumer Unsecured

     —          —          —          1      —    
  

Consumer Secured

     —          —          —          53      —    
  

Residential

              
  

Residential Mortgages

     139      158      33      257      4
  

Residential Consumer Construction

     —          —          —          —          —    

Totals:

              
  

Commercial

   $  475    $  1,043    $  7    $  968    $  27
  

Commercial Real Estate

              
  

Commercial Mortgages-Owner Occupied

     2,479      2,655      12      2,467      184
  

Commercial Mortgage Non-Owner Occupied

     577      599      3      399      33
  

Commercial Construction

     —          —          —          —          —    
  

Consumer

              
  

Consumer Unsecured

     —          —          —          1      —    
  

Consumer Secured

     107      107      —          151      7
  

Residential

              
  

Residential Mortgages

     1,429      1,448      33      1,840      72
  

Residential Consumer Construction

     —          —          —          —          —    
     

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 
      $  5,067    $  5,852    $  55    $  5,826    $  323
     

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

24


Note 8 – Loans, allowance for loan losses and OREO (continued)

 

     Allowance for Loan Losses and Recorded Investment in Loans  
     (dollars in thousands)  
     As of and For the Six Months Ended June 30, 2020  
           Commercial                    
2020    Commercial     Real Estate     Consumer     Residential     Total  

Allowance for Credit Losses:

          

Beginning Balance

   $  1,330   $  1,932   $  865   $  702   $  4,829

Charge-Offs

     (69     (211     (8     (51     (339

Recoveries

     7     24     22     2     55

Provision

     812     924     (68     (20     1,648
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Ending Balance

     2,080     2,669     811     633     6,193

Ending Balance: Individually evaluated for impairment

     66     240     —         —         306
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Ending Balance: Collectively evaluated for impairment

     2,014     2,429     811     633     5,887
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Totals:

   $  2,080   $  2,669   $  811   $  633   $  6,193
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Financing Receivables:

          

Ending Balance: Individually evaluated for impairment

     676     5,881     266     1,365     8,188
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Ending Balance: Collectively evaluated for impairment

     174,970     295,819     86,889     63,891     621,569
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Totals:

   $  175,646   $  301,700   $  87,155   $  65,256   $  629,757
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

25


Note 8 – Loans, allowance for loan losses and OREO (continued)

 

     Allowance for Loan Losses and Recorded Investment in Loans  
     (dollars in thousands)  
     As of and For the Year Ended December 31, 2019  
           Commercial                    
2019    Commercial     Real Estate     Consumer     Residential     Total  

Allowance for Credit Losses:

          

Beginning Balance

   $  1,136   $  1,831   $  956   $  658   $  4,581

Charge-Offs

     (106     (26     (189     (42     (363

Recoveries

     35     5     44     4     88

Provision

     265     122     54     82     523
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Ending Balance

     1,330     1,932     865     702     4,829

Ending Balance: Individually evaluated for impairment

     7     15     —         33     55
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Ending Balance: Collectively evaluated for impairment

     1,323     1,917     865     669     4,774
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Totals:

   $  1,330   $  1,932   $  865   $  702   $  4,829
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Financing Receivables:

          

Ending Balance: Individually evaluated for impairment

     475     3,056     107     1,429     5,067
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Ending Balance: Collectively evaluated for impairment

     113,782     300,844     89,838     68,572     573,036
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Totals:

   $  114,257   $  303,900   $  89,945   $  70,001   $  578,103
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

26


Note 8 – Loans, allowance for loan losses and OREO (continued)

 

     Age Analysis of Past Due Loans as of  
     June 30, 2020  
     (dollars in thousands)  
2020    30-59
Days
Past
Due
     60-89
Days
Past
Due
     Greater
than
90 Days
     Total
Past
Due
     Current      Total
Loans
     Recorded
Investment
> 90 Days
&
Accruing
 

Commercial

   $ 521      $ 284      $ 185      $ 990      $ 174,656      $ 175,646      $ —    

Commercial Real Estate:

                    

Commercial Mortgages- Owner Occupied

     230        587        3,854        4,671        99,691        104,362        —    

Commercial Mortgages-Non-Owner Occupied

     550        157        422        1,129        176,015        177,144        —    

Commercial Construction

     —          —          —          —          20,194        20,194        —    

Consumer:

                    

Consumer Unsecured

     14        —          —          14        4,880        4,894        —    

Consumer Secured

     458        9        253        720        81,541        82,261        —    

Residential:

                    

Residential Mortgages

     835        —          171        1,006        49,367        50,373        —    

Residential Consumer Construction

     —          —          —          —          14,883        14,883        —    
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 2,608      $ 1,037      $ 4,885      $ 8,530      $ 621,227      $ 629,757      $ —    
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

     Age Analysis of Past Due Loans as of  
     December 31, 2019  
     (dollars in thousands)  

2019

   30-59
Days
Past
Due
     60-89
Days
Past
Due
     Greater
than
90 Days
     Total
Past
Due
     Current      Total
Loans
     Recorded
Investment
> 90 Days
&
Accruing
 

Commercial

   $ 146      $ 1,084      $ 116      $ 1,346      $ 112,911      $ 114,257      $ —    

Commercial Real Estate:

                    

Commercial Mortgages-Owner Occupied

     234        192        143        569        104,223        104,792        —    

Commercial Mortgages-Non-Owner Occupied

     58        9        450        517        181,730        182,247        —    

Commercial Construction

     —          —          —          —          16,861        16,861        —    

Consumer:

                    

Consumer Unsecured

     52        3        —          55        6,812        6,867        —    

Consumer Secured

     316        130        21        467        82,611        83,078        —    

Residential:

                    

Residential Mortgages

     595        576        280        1,451        53,833        55,284        —    

Residential Consumer Construction

     492        —          —          492        14,225        14,717        —    
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 1,893      $ 1,994      $ 1,010      $ 4,897      $ 573,206      $ 578,103      $ —    
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

27


Note 8 – Loans, allowance for loan losses and OREO (continued)

 

     Credit Quality Information—by Class  
     June 30, 2020  
     (dollars in thousands)  
2020    Pass      Monitor      Special
Mention
     Substandard      Doubtful      Totals  

Commercial

   $ 161,709      $ 4,918      $ 8,426      $ 593      $ —        $ 175,646  

Commercial Real Estate:

 

              

Commercial Mortgages-Owner Occupied

     93,318        1,276        4,436        5,332        —          104,362  

Commercial Mortgages-Non-Owner Occupied

     170,078        5,637        793        636        —          177,144  

Commercial Construction

     20,194        —          —          —          —          20,194  

Consumer

                 

Consumer Unsecured

     4,854        —          —          40        —          4,894  

Consumer Secured

     81,833        —          —          428        —          82,261  

Residential:

                 

Residential Mortgages

     48,531        409        —          1,433        —          50,373  

Residential Consumer Construction

     14,883        —          —          —          —          14,883  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Totals

   $ 595,400      $ 12,240      $ 13,655      $ 8,462      $ —        $ 629,757  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

     Credit Quality Information—by Class  
     December 31, 2019  
     (dollars in thousands)  
2019    Pass      Monitor      Special
Mention
     Substandard      Doubtful      Totals  

Commercial

   $ 108,907      $ 313      $ 4,518      $ 519      $ —        $ 114,257  

Commercial Real Estate:

 

              

Commercial Mortgages-Owner Occupied

     93,553        446        8,316        2,477        —          104,792  

Commercial Mortgages-Non -Owner Occupied

     175,471        5,118        994        664        —          182,247  

Commercial Construction

     16,572        289        —          —          —          16,861  

Consumer

                 

Consumer Unsecured

     6,867        —          —          —          —          6,867  

Consumer Secured

     82,860        —          —          218        —          83,078  

Residential:

                 

Residential Mortgages

     53,714        —          —          1,570        —          55,284  

Residential Consumer Construction

     14,416        301        —          —          —          14,717  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Totals

   $ 552,360      $ 6,467      $ 13,828      $ 5,448      $ —        $ 578,103  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

28


Note 8 – Loans, allowance for loan losses and OREO (continued)

 

Troubled Debt Restructurings (TDR)

There were no loan modifications that would have been classified as TDRs during the three and six months ended June 30, 2020 and 2019.

There were no loan modifications classified as TDRs within the last twelve months that defaulted during the three and six months ended June 30, 2020 and 2019.

At June 30, 2020 and December 31, 2019, the Bank had no outstanding commitments to disburse additional funds on loans classified as TDRs.

We have developed relief programs to assist borrowers in financial need due to the effects of the COVID-19 pandemic. Accordingly, we are offering short-term modifications made in response to COVID-19 to certain borrowers who are current and otherwise not past due. These include short-term, 90 days or less, modifications in the form of payment deferrals, fee waivers, extensions of repayment terms, deferral of principal only (interest only payments), or other delays in payment that are insignificant.

As of June 30, 2020, modifications described in the preceding paragraph attributed to COVID-19 were $94,504,000 representing the 184 loans. This represented 15.01% of the total loan portfolio as of June 30, 2020. Of that total 164 were commercial loan borrowers representing $91,821,000 in loans, or 14.58% of our total loan portfolio as of June 30, 2020 and 20 were retail loan borrowers representing $2,683,000, or 0.43% of our total loan portfolio as of June 30, 2020. Of the total deferrals, 33.68% are for deferrals of principal only. In accordance with the March 22, 2020 (revised April 2020) Joint Interagency Regulatory Guidance, the above modifications were not considered to be troubled debt restructurings and were excluded from the discussion above.

Note 9 – Revenue Recognition

Topic 606 does not apply to revenue associated with financial instruments, including revenue from loans and securities. Topic 606 is applicable to noninterest revenue streams such as deposit related fees, interchange fees, merchant income, and annuity and insurance commissions. Noninterest revenue streams in-scope of Topic 606 are discussed below.

Service Charges on Deposit Accounts

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

 

29


Note 9 – Revenue Recognition (continued)

 

Fees, Exchange, and Other Service Charges

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

Other

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

Note 10 – Recent accounting pronouncements and other authoritative guidance

In June 2016, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) No. 2016-13, “Financial Instruments – Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments.” The amendments in this ASU, among other things, require the measurement of all expected credit losses for financial assets held at the reporting date based on historical experience, current conditions, and reasonable and supportable forecasts. Financial institutions and other organizations will now use forward-looking information to better inform their credit loss estimates. Many of the loss estimation techniques applied today will still be permitted, although the inputs to those techniques will change to reflect the full amount of expected credit losses. In addition, the ASU amends the accounting for credit losses on available-for-sale debt securities and purchased financial assets with credit deterioration. The FASB has issued multiple updates to ASU 2016-13 as codified in Topic 326, including ASU’s 2019-04, 2019-05, 2019-10, 2019-11, 2020-02, and 2020-03. These ASU’s have provided for various minor technical corrections and improvements to the codification as well as other transition

 

30


Note 10 – Recent accounting pronouncements and other authoritative guidance (continued)

 

matters. Smaller reporting companies who file with the U.S. Securities and Exchange Commission (SEC) and all other entities who do not file with the SEC are required to apply the guidance for fiscal years, and interim periods within those years, beginning after December 15, 2022. The Company is currently assessing the impact that ASU 2016-13 will have on its consolidated financial statements. The Company has been in discussions with its core processor to coordinate plans for implementation and has contracted with an additional vendor to begin implementation.

Effective November 25, 2019, the SEC adopted Staff Accounting Bulletin (SAB) 119. SAB 119 updated portions of SEC interpretative guidance to align with FASB ASC 326, “Financial Instruments – Credit Losses.” It covers topics including (1) measuring current expected credit losses; (2) development, governance, and documentation of a systematic methodology; (3) documenting the results of a systematic methodology; and (4) validating a systematic methodology.

In December 2019, the FASB issued ASU 2019-12, “Income Taxes (Topic 740) – Simplifying the Accounting for Income Taxes.” The ASU is expected to reduce cost and complexity related to the accounting for income taxes by removing specific exceptions to general principles in Topic 740 (eliminating the need for an organization to analyze whether certain exceptions apply in a given period) and improving financial statement preparers’ application of certain income tax-related guidance. This ASU is part of the FASB’s simplification initiative to make narrow-scope simplifications and improvements to accounting standards through a series of short-term projects. For public business entities, the amendments are effective for fiscal years beginning after December 15, 2020, and interim periods within those fiscal years. Early adoption is permitted. The Company is currently assessing the impact that ASU 2019-12 will have on its consolidated financial statements.

In March 2020, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) No. 2020-04 “Reference Rate Reform (Topic 848): Facilitation of the Effects of Reference Rate Reform on Financial Reporting.” These amendments provide temporary optional guidance to ease the potential burden in accounting for reference rate reform. The ASU provides optional expedients and exceptions for applying generally accepted accounting principles to contract modifications and hedging relationships, subject to meeting certain criteria, that reference LIBOR or another reference rate expected to be discontinued. It is intended to help stakeholders during the global market-wide reference rate transition period. The guidance is effective for all entities as of March 12, 2020 through December 31, 2022. The Company has identified a small number of affected loans and is evaluating other benchmarks to substitute for LIBOR such as SOFR. The Company is assessing ASU 2020-04 and its impact on the Company’s transition away from LIBOR for its loan and other financial instruments.

On March 12, 2020, the SEC finalized amendments to its “accelerated filer” and “large accelerated filer” definitions. The amendments increase the threshold criteria for meeting these filer classifications and were effective on April 27, 2020. Any changes in filer status are to be applied beginning with the filer’s first annual report filed with the SEC subsequent to the effective date. The rule change revises the definition of “accelerated filers” to exclude entities with public float of less than $700 million and less than $100 million in annual revenues. The Company expects to continue to meet this expanded category of small reporting company and will remain a non-accelerated filer.

 

31


Note 10 – Recent accounting pronouncements and other authoritative guidance (continued)

 

In March 2020 (Revised in April 2020), various regulatory agencies, including the Board of Governors of the Federal Reserve System and the Federal Deposit Insurance Corporation, (“the agencies”) issued an interagency statement on loan modifications and reporting for financial institutions working with customers affected by the Coronavirus. The interagency statement was effective immediately and impacted accounting for loan modifications. Under Accounting Standards Codification 310-40, “Receivables – Troubled Debt Restructurings by Creditors,” (“ASC 310-40”), a restructuring of debt constitutes a troubled debt restructuring (“TDR”) if the creditor, for economic or legal reasons related to the debtor’s financial difficulties, grants a concession to the debtor that it would not otherwise consider. The agencies confirmed with the staff of the FASB that short-term modifications made on a good faith basis in response to COVID-19 to borrowers who were current prior to any relief, are not to be considered TDRs. This includes short-term (e.g., six months) modifications such as payment deferrals, fee waivers, extensions of repayment terms, or other delays in payment that are insignificant. Borrowers considered current are those that are less than 30 days past due on their contractual payments at the time a modification program is implemented. In addition, upon expiration of the initial loan modification period, the Bank, pursuant to the “Joint Statement on Additional Loan Accommodations Related to COVID-19” published August 3, 2020, is encouraged to continue to work with effected borrowers on additional loan modifications. This interagency guidance is expected to continue have a material impact on the Company’s financial statements; however, this impact cannot be quantified at this time.

Note 11—COVID-19 and Current Economic Conditions

On March 11, 2020, the World Health Organization announced that the COVID-19 outbreak was deemed a pandemic, and on March 13, 2020, the President declared the ongoing COVID-19 pandemic of sufficient magnitude to warrant an emergency declaration. The extent of COVID-19’s effect on the Company’s operational and financial performance will depend on future developments, including the duration, spread and intensity of the pandemic, and when state and local economies will return to operational norms, all of which are uncertain and difficult to predict considering the rapidly evolving landscape. In addition, we rely upon our third-party vendors to conduct business and to process, record and monitor transactions. If any of these vendors are unable to continue to provide us with these services, it could negatively impact our ability to serve our customers. Furthermore, the outbreak could negatively impact our employees

and customers’ ability to engage in banking and other financial transactions. We also could be adversely affected if key personnel or a significant number of employees were to become unavailable due to the effects and restrictions of a COVID-19 outbreak in our market areas.

Management will continue to evaluate current economic conditions to determine the impact of the pandemic on the ability of our customers to fulfill their financial obligations to the Company, as well as the values of our financial and nonfinancial assets resulting from the market disruption. Accordingly, significant estimates used in the preparation of our financial statements including those associated with the evaluation of the allowance for loan losses as well as other

 

32


Note 11—COVID-19 and Current Economic Conditions (continued)

 

valuation-based estimates may be subject to significant adjustments in future periods. As the full effects are not yet known, it is not currently possible to ascertain the overall impact of COVID-19 on the Company’s business. However, as the pandemic continues to evolve into a prolonged worldwide health crisis, the pandemic could have a material adverse effect on the Company’s business, results of operations, financial condition and cash flows.

Note 12 – Subsequent Events

On April 13, 2020, the Company commenced a private placement of unregistered debt securities (the “2020 Offering”). In the 2020 Offering, the Company sold $10,050,000 in principal of notes (the “2020 Notes”). As of June 30, 2020, the Company had closed $7,275,000 of the offering. Subsequent to June 30, 2020 the Company closed an additional $2,775,000 before officially ending the 2020 Offering on July 8, 2020. The 2020 Notes will bear interest at the rate of 3.25% per year with interest payable quarterly in arrears. The 2020 Notes will mature on June 30, 2025 and are subject to full or partial repayment on or after June 30, 2021.

One June 24, 2020 the Bank used $5,000,000 of the proceeds for the payment of principal of the Company’s previously outstanding 4.00% notes that were issued in 2017. The Company intends to use the balance of the proceeds from the 2020 Offering for general corporate purposes in the discretion of Company’s management such as payment of interest on the 2020 Notes and as a contribution of additional capital to the Bank.

 

33


Item 2.

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

CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS

This report contains statements that constitute “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended, and the Private Securities Litigation Reform Act of 1995. Statements made in this document and in any documents that are incorporated by reference which are not purely historical are forward-looking statements, including any statements regarding descriptions of management’s plans, objectives, or goals for future operations, products or services, and forecasts of its revenues, earnings, or other measures of performance. Forward-looking statements are based on current management expectations and, by their nature, are subject to risks and uncertainties. These statements generally may be identified by the use of words such as “believe,” “expect,” “anticipate,” “plan,” “estimate,” “should,” “will,” “intend,” or similar expressions. Shareholders should note that many factors, some of which are discussed elsewhere in this document, could affect the future financial results of Financial and could cause those results to differ materially from those expressed in forward-looking statements contained in this document. These factors, many of which are beyond Financial’s control, include, but are not necessarily limited to the following:

 

   

the effects of the COVID-19 pandemic on the business, customers, employees and third-party service providers of Financial or any of its acquisition targets;

 

   

operating, legal and regulatory risks, including the effects of legislative or regulatory developments affecting the financial industry generally or Financial specifically;

 

   

government legislation and policies (including the impact of the Dodd-Frank Wall Street Reform and the Consumer Protection Act and its related regulations), including changes to address the impact of COVID-19;

 

   

economic, market, political and competitive forces affecting Financial’s banking and other businesses;

 

   

competition for our customers from other providers of financial services; government legislation and regulation relating to the banking industry (which changes from time to time and over which we have no control) including but not limited to the Dodd-Frank Wall Street Reform and Consumer Protection Act;

 

   

changes in interest rates, monetary policy and general economic conditions, which may impact Financial’s net interest income;

 

   

changes in the value of real estate securing loans made by the Bank;

 

   

diversion of management time on pandemic-related issues;

 

   

adoption of new accounting standards or changes in existing standards;

 

34


   

changes to statutes, regulations, or regulatory policies or practices resulting from the COVID-19 pandemic;

 

   

compliance or operational risks related to new products, services, ventures, or lines of business, if any, that Financial may pursue or implement; and

 

   

the risk that Financial’s analysis of these risks and forces could be incorrect and/or that the strategies developed to address them could be unsuccessful.

Other risks, uncertainties and factors could cause our actual results to differ materially from those projected in any forward-looking statements we make.

These factors should be considered in evaluating the forward-looking statements, and you should not place undue reliance on such statements. Financial specifically disclaims any obligation to update factors or to publicly announce the results of revisions to any of the forward-looking statements or comments included herein to reflect future events or developments.

IMPACT OF COVID-19

The progression of the COVID-19 pandemic in the United States has had an adverse impact on our financial condition and results of operations as of and for the three and six months ended June 30, 2020. Management anticipates that the pandemic will have a significant adverse impact on the economy, the banking industry and our Company in future periods.

Effects on Market Areas

The broad suspension of business activities in the Commonwealth is likely to lead to a significant increase in the Commonwealth’s and our market areas’ unemployment rate. Because these developments commenced late in the first quarter, and because the public health effects of COVID-19 are generally expected to peak later this year in the communities in which we operate, we believe the economic consequences of the pandemic are difficult to quantify and are expected to continue to worsen.

Policy and Regulatory Developments

Federal, state and local governments and regulatory authorities have enacted and issued a range of policy responses to the COVID-19 pandemic, including the following:

 

   

The Federal Reserve decreased the range for the Federal Funds Target Rate by 0.50% on March 3, 2020, and by another 1.0% on March 16, 2020, reaching a current range of 0.0—0.25%.

 

   

On March 27, 2020, President Trump signed the Coronavirus Aid, Relief and Economic Security Act, or CARES Act, which established a $2.0 trillion economic stimulus package, including cash payments to individuals, supplemental unemployment insurance benefits and a $349 billion loan program administered through the U.S. Small Business Administration (SBA), referred to as the Paycheck Protection Program, or PPP program, which was subsequently increased by $320 billion on April 24, 2020. Under the PPP program, small businesses, sole proprietorships, independent contractors and self-employed individuals may apply for

 

35


 

loans from existing SBA lenders and other approved regulated lenders that enroll in the program, subject to numerous limitations and eligibility criteria. The Bank participated as a lender in the PPP program. Effective August 8, 2020, banks cannot accept new loan applications under the PPP program. In addition, the CARES Act provides financial institutions the option to temporarily suspend certain requirements under GAAP related to loan modifications and classification as troubled debt restructurings (“TDRs”) for a limited period of time to account for the effects of COVID-19.

 

   

On April 7, 2020, federal banking regulators issued a revised Interagency Statement on Loan Modifications and Reporting for Financial Institutions, which, among other things, encouraged financial institutions to work prudently with borrowers who are or may be unable to meet their contractual payment obligations because of the effects of COVID-19, and stated that institutions generally do not need to categorize COVID-19-related modifications as TDRs, and that the agencies will not direct supervised institutions to automatically categorize all COVID-19 related loan modifications as TDRs. In addition, upon expiration of the initial loan modification period, the Bank, pursuant to the “Joint Statement on Additional Loan Accommodations Related to COVID-19” published August 3, 2020, is encouraged to continue to work with effected borrowers on additional loan modifications. Loan modifications made through June 30, 2020 are disclosed within Note 8 – Loans, allowance for loan losses and OREO.

Effects on Our Business

The COVID-19 pandemic and the specific developments referred to above are expected to have a significant impact on our business. As a result, we anticipate that our financial condition, capital levels and results of operations could be significantly adversely affected, as described in further detail below.

COVID-19 Crisis Management

As an essential service provider, Bank of the James has continued to provide uninterrupted service to its clients throughout the COVID-19 crisis. On March 2, 2020 the Company’s Management Committee initiated plans in response to the emerging risk related to the pandemic.

From the beginning, our management of the crisis has focused on protecting the health and well-being of our employees and clients while continuing to provide our clients with full access to banking services. As the operational risk related to the COVID-19 crisis evolved, the Company took proactive measures to manage operational risk, including the following:

 

   

The Company has fully implemented its Business Continuity Plan.

 

   

All branches remain open, with routine banking services offered through online banking, drive-thru, ATMs, and limited lobby access.

 

   

Implemented a number of actions to support a healthy workforce, including:

 

36


   

Flexible work practices such as work-from-home options, working in shifts and placing greater distances between employees;

 

   

Discontinuation of non-essential business travel and meetings; and

 

   

Use of online meeting platforms, including successfully conducting the 2020 Annual Meeting of Shareholders in a virtual format.

GENERAL

Critical Accounting Policies

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

Financial’s critical accounting policies include the evaluation of the allowance for loan losses which is based on management’s estimate of an amount that is adequate to absorb probable losses inherent in the loan portfolio of the Bank. The allowance for loan losses is established through a provision for loan loss based on available information including the composition of the loan portfolio, historical loan losses, specific impaired loans, availability and quality of collateral, age of the various portfolios, changes in local economic conditions, and loan performance and quality of the portfolio. Different assumptions used in evaluating the adequacy of the Bank’s allowance for loan losses could result in material changes in Financial’s financial condition and results of operations.

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

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

 

37


See “Management Discussion and Analysis Results of Operations – Allowance for Provision for Loan Losses” below for further discussion of the allowance for loan losses.

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

Overview

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

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

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

Our operating results depend primarily upon the Bank’s net interest income, which is determined by the difference between (i) interest and dividend income on earning assets, which consist primarily of loans, investment securities and other investments, and (ii) interest expense on interest-bearing liabilities, which consist principally of deposits and other borrowings. The Bank’s net income also is affected by its provision for loan losses, as well as the level of its non-interest income, including gains on sales of loans held for sale and service charges, and its non-interest expenses, including salaries and employee benefits, occupancy expense, data processing expenses, Federal Deposit Insurance Corporation premiums, expense in complying with the Sarbanes-Oxley Act of 2002, miscellaneous other expenses, franchise taxes, and income taxes.

 

38


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

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

Full-Service Branches

 

   

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

 

   

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

 

   

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

 

   

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

 

   

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

 

   

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

 

   

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

 

   

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

 

   

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

 

   

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

 

   

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

 

   

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

 

   

A branch located at 45 South Main St., Lexington, VA (the “Lexington Branch”),

 

   

A branch located at 550 Water St., Charlottesville, VA (the “Water Street Branch”),

 

   

A branch located at 2101 Electric Rd, Roanoke, VA (the “Oak Grove Branch”), and

 

   

A branch located at 13 Village Highway, Rustburg, VA (the “Rustburg Branch”).

 

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Limited Service Branches

 

   

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

 

   

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

Loan Production Offices

 

   

Residential mortgage loan production office located at the Forest Branch,

 

   

Residential mortgage loan production office located at 2001 South Main Street, Blacksburg, Virginia, and

 

   

Commercial, consumer and residential mortgage loan production office located at the Water Street Branch.

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

In 2019, the Bank recently closed its location formerly located at 615 Church Street, Lynchburg, Virginia and has consolidated its operations into an expanded Main Street Office.

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

Subject to regulatory approval, the Bank may open additional branches during the next two fiscal years. Although numerous factors could influence the Bank’s expansion plans, the following discussion provides a general overview of the additional branch location that the Bank currently is considering, including the following property that we own and are holding for expansion:

 

   

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

The Bank estimates that the cost of improvements, furniture, fixtures, and equipment necessary to upfit and construct a branch at this location could be between $900,000 and $1,500,000.

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

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

 

40


OFF-BALANCE SHEET ARRANGEMENTS

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

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

 

     June 30, 2020
(in thousands)
 

Commitments to extend credit

   $ 149,268  

Letters of Credit

     3,535  
  

 

 

 

Total

   $ 152,803  
  

 

 

 

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

Standby letters of credit are conditional commitments issued by the Bank to guarantee the performance of a customer to a third party. Those letters of credit are primarily issued to support public and private borrowing arrangements. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loans to customers. The amount of collateral obtained, if deemed necessary by the Bank upon extension of credit, is based on the Bank’s credit evaluation of the customer.

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

SUMMARY OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following discussion represents management’s discussion and analysis of the financial condition of Financial as of June 30, 2020 and December 31, 2019 and the results of operations of Financial for the three and six-month periods ended June 30, 2020 and 2019. This discussion should be read in conjunction with the financial statements included elsewhere herein.

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

 

41


Financial Condition Summary

June 30, 2020 as Compared to December 31, 2019

Total assets were $827,098,000 on June 30, 2020 compared with $725,394,000 at December 31, 2019, an increase of 14.02%. The increase in total assets was funded from the growth in deposits.

Total deposits increased from $649,459,000 as of December 31, 2019 to $745,986,000 on June 30, 2020, an increase of 14.86%. The increase resulted in large part from increases in the following deposit categories: non-interest-bearing demand deposits, NOW, money market, and savings accounts. The increase was attributable in part to PPP loan funds that had yet to be deployed.

Total loans, excluding loans held for sale, increased to $629,757,000 on June 30, 2020 from $578,103,000 on December 31, 2019, resulting from the origination of PPP loans. Loans, excluding loans held for sale and net of deferred fees and costs and the allowance for loan losses, increased to $623,564,000 on June 30, 2020 from $573,274,000 on December 31, 2019, an increase of 8.77%. The following summarizes the position of the Bank’s loan portfolio as of the dates indicated by dollar amount and percentages (dollar amounts in thousands):

 

     June 30, 2020     December 31, 2019  
     Amount      Percentage     Amount      Percentage  

Commercial

   $ 175,646        27.89   $ 114,257        19.76

Commercial Real Estate

     301,700        47.91     303,900        52.57

Consumer

     87,155        13.84     89,945        15.56

Residential

     65,256        10.36     70,001        12.11
  

 

 

    

 

 

   

 

 

    

 

 

 

Total loans

   $ 629,757        100.00   $ 578,103        100.00
  

 

 

    

 

 

   

 

 

    

 

 

 

Total nonperforming assets, which consist of non-accrual loans, loans past due 90 days or more and still accruing, and OREO increased to $6,801,000 on June 30, 2020 from $3,640,000 on December 31, 2019. OREO decreased to $1,616,000 on June 30, 2020 from $2,339,000 on December 31, 2019. The decrease in OREO was due in large part to the sale of one large OREO property during the first quarter. Non-performing loans increased from $1,301,000 at December 31, 2019 to $5,185,000 at June 30, 2020. The increase primarily reflected one relationship of approximately $3.3 million. Management anticipates a significant curtailment of the loan balance upon the sale of the collateral. The Bank has entered into a contract for the sale of the collateral, and the sale is scheduled to close later in the third quarter.

As discussed in more detail below under “Results of Operations—Allowance and Provision for Loan Losses,” management has provided for the anticipated losses on these loans in the allowance for loan losses. Loan payments received on non-accrual loans are first applied to principal. When a loan is placed on non-accrual status there are several negative implications. First, all interest accrued but unpaid at the time of the classification is reversed and deducted from the interest income totals for the Bank. Second, accruals of interest are discontinued until it becomes certain that both principal and interest can be repaid. Third, there may be actual losses that necessitate additional provisions for loan losses charged against earnings.

As a result of the COVID-19 pandemic, we anticipate that our commercial, commercial real estate, residential and consumer borrowers will continue to encounter economic difficulties, which could lead to increases in our levels of nonperforming assets, impaired loans and troubled debt restructurings. Any potential financial impacts are unknown at this time.

 

42


OREO represents real property acquired by the Bank for debts previously contracted, including through foreclosure or deeds in lieu of foreclosure. On December 31, 2019, the Bank was carrying ten OREO properties on its books at a value of $2,339,000. During the six months ended June 30, 2020, the Bank acquired one additional OREO property and disposed of six OREO properties, and as of June 30, 2020 the Bank is carrying five OREO properties at a value of $1,616,000. In addition, the Bank wrote down $102,000 on the value of its OREO properties. The OREO properties are available for sale and are being actively marketed.

The Bank had loans in the amount of $402,000 at June 30, 2020 classified as performing TDRs as compared to $410,000 at December 31, 2019. None of these TDRs were included in non-accrual loans. These loans have had their original terms modified to facilitate payment by the borrower. The loans have been classified as TDRs primarily due to a change to interest only payments and the maturity of these modified loans is primarily less than one year. As of June 30, 2020, modifications attributed to COVID-19 were $94,504,000 representing the 184 loans. This represented 15.01% of the total loan portfolio as of June 30, 2020. Of that total 164 were commercial loan borrowers representing $91,821,000 in loans, or 14.58% of our total loan portfolio as of June 30, 2020 and 20 were retail loan borrowers representing $2,683,000, or 0.43% of our total loan portfolio as of June 30, 2020. Of the total deferrals, 33.68% are for deferrals of principal only. In accordance with the March 22, 2020 (as revised in April 2020) Joint Interagency Regulatory Guidance, the above modifications were not considered to be troubled debt restructurings and were excluded from the discussion above.

Management has reviewed loan segments that it believes could be adversely impacted by the COVID-19 pandemic, and identified the following segments: education/childcare, entertainment, hospitality, oil & gas (gas stations), religious/charitable, restaurants, retail & services. At June 30, 2020, the loan balances in those segments were as follows:

 

Industry

   Principal
Balance
(in
thousands)
     Number
of
Loans
     Percent
of Total
Loan
Portfolio
 

Education/Childcare

   $ 6,307        14        1.00

Entertainment

     6,949        24        1.10

Hospitality

     15,335        9        2.44

Oil & Gas (Gas Stations)

     271        7        0.04

Religious/Charitable

     19,365        44        3.07

Restaurants

     16,856        44        2.68

Retail & Services

     8,858        45        1.41
  

 

 

    

 

 

    

 

 

 

Total

   $ 73,941        187        12.83
  

 

 

    

 

 

    

 

 

 

Management continues to closely monitor loans in these categories.

Cash and cash equivalents increased to $90,800,000 on June 30, 2020 from $39,111,000 on December 31, 2019. Cash and cash equivalents consist of cash due from correspondents, cash in vault, and overnight investments (including federal funds sold). This increase was due in large part to an increase in deposits related to PPP loan funds that had yet to be deployed and management’s decision to carry additional liquidity in order to accommodate the use of PPP loan proceeds. Cash and cash equivalents are subject to routine fluctuations in deposits, including fluctuations in transactional accounts and professional settlement accounts.

 

43


Securities held-to-maturity were flat, decreasing to $3,679,000 on June 30, 2020 from $3,688,000 on December 31, 2019. This slight decrease is a result of normal amortization of premiums within the held-to-maturity portfolio.

Securities available-for-sale which are carried on the balance sheet at fair market value, decreased to $55,072,000 on June 30, 2020, from $59,655,000 on December 31, 2019. Out of an abundance of caution, the Bank sold available-for-sale securities to increase liquidity in light of the uncertainties surrounding the COVID-19 pandemic. During the six months ended June 30, 2020 the Bank received $1,202,000 in proceeds from calls, maturities, and paydowns of securities available-for-sale. During the six months ended June 30, 2020 the Bank received $17,813,000 from the sale of securities available-for-sale. During the same period, the Bank purchased $11,334,000 in available-for-sale securities.

Financial’s investment in Federal Home Loan Bank of Atlanta (FHLBA) stock totaled $653,000 at June 30, 2020 as compared with $608,000 at December 31, 2019. FHLBA stock is generally viewed as a long-term investment and because there is no market for the stock other than other Federal Home Loan Banks or member institutions, FHLBA stock is viewed as a restricted security. Therefore, when evaluating FHLBA stock for impairment, its value is based on the ultimate recoverability of the par value rather than by recognizing temporary declines in value.

Liquidity and Capital

At June 30, 2020, Financial, on a consolidated basis, had liquid assets of $145,872,000 in the form of cash, interest-bearing and noninterest-bearing deposits with banks, and available-for-sale investments. Of this amount, approximately $25,751,000 (representing current market value) of the available-for-sale securities are pledged as collateral with $16,772,000 pledged as security for public deposits, and $8,979,000 pledged as security on a line of credit the Bank may draw on from time to time to meet liquidity needs. This line of credit currently has a zero balance. Management believes that liquid assets were adequate at June 30, 2020. Management anticipates that additional liquidity will be provided by the growth in deposit accounts and loan repayments at the Bank. In addition, if additional liquidity is needed, the Bank has the ability to purchase federal funds on the open market, borrow from the FHLBA using loans or investments within the Bank’s portfolio as collateral, and to borrow from the Federal Reserve Bank’s discount window.

The COVID-19 pandemic could have a material negative impact on Financial’s short-term or long-term liquidity. For example, if customers unexpectedly draw down on existing lines of credit, our liquidity could be impacted. While we have not experienced any unusual pressure on our deposit balances or our liquidity position as a result of the COVID-19 pandemic, management is closely monitoring our sources and uses of funds in order to meet our cash flow requirements while maximizing profits. Based in part on recent loan activity including loans made pursuant to the PPP as discussed below under “Allowance and Provision for Loan Losses,” the Bank is monitoring liquidity to ensure it is able to fund future loans and withdrawals related to the use of PPP funds.

 

44


At June 30, 2020, the Bank had a leverage ratio of approximately 8.30%, a Tier 1 risk-based capital ratio and a CET1 ratio of approximately 10.99% and a total risk-based capital ratio of approximately 12.00%. As of June 30, 2020 and December 31, 2019, the Bank’s regulatory capital levels exceeded those established for well-capitalized institutions. The following table sets forth the minimum capital requirements and the Bank’s capital position as of June 30, 2020 and December 31, 2019:

Bank Level Only Capital Ratios

 

Analysis of Capital (in 000’s)

   June 30,
2020
     December 31,
2019
 

Tier 1 capital

     

Common Stock

   $  3,742      $  3,742  

Surplus

     22,325        22,325  

Retained earnings

     41,217        40,194  
  

 

 

    

 

 

 

Total Tier 1 capital

   $  67,284      $  66,261  
  

 

 

    

 

 

 

Tier 2 capital

     

Allowance for loan losses

   $  6,193      $  4,829  

Total Tier 2 capital:

   $  6,193      $  4,829  
  

 

 

    

 

 

 

Total risk-based capital

   $  73,477      $  71,090  
  

 

 

    

 

 

 

Risk weighted assets

   $  612,176      $  616,269  

Average total assets

   $  810,293      $  725,395  

 

     Actual     Regulatory Benchmarks  
     June 30,
2020
    December 31,
2019
    For
Capital
Adequacy
Purposes
(1)
    For Well
Capitalized
Purposes
 

Capital Ratios:

        

Tier 1 capital to average total assets

     8.30     9.13     4.000     5.000

Common Equity Tier 1 capital

     10.99     10.75     7.000     6.500

Tier 1 risk-based capital ratio

     10.99     10.75     8.500     8.000

Total risk-based capital ratio

     12.00     11.54     10.500     10.000

 

(1)

Includes the capital conservation buffer of 2.50% for all ratios, excluding the Tier 1 capital to average total assets ratio.

The above tables set forth the capital position and analysis for the Bank only. Because total assets on a consolidated basis are less than $3,000,000,000, Financial is not subject to the consolidated capital requirements imposed by the Bank Holding Company Act. Consequently, Financial does not calculate its financial ratios on a consolidated basis. If calculated, the capital ratios for the Company on a consolidated basis at June 30, 2020 would be slightly lower than those of the Bank because proceeds from the sale of the notes issued in 2017 were contributed to the Bank and counted as equity at the Bank level.

In July 2013, the Federal Reserve Board approved a final rule establishing a regulatory capital framework for smaller, less complex financial institutions. The rule was fully implemented on January 1, 2019 and implemented a capital conservation buffer of 2.5%. As a result, the Bank is required to have a minimum ratio of common equity Tier 1 capital to risk-

 

45


weighted assets of 7.0% (inclusive of the capital conservation buffer) and a Tier 1 risk-based capital ratio of 8.5% (inclusive of the capital conservation buffer). The capital conservation buffer will limit capital distributions, stock redemptions, and certain discretionary bonuses. Failure to maintain the capital conservation buffer will limit the ability of the Bank and Financial to pay dividends, repurchase shares or pay discretionary bonuses. The rule also raised the minimum ratio of Tier 1 capital to risk-weighted assets from 4% to 6% and includes a minimum leverage ratio of 4% for all banking organizations.

On September 17, 2019 the Federal Deposit Insurance Corporation finalized a rule that introduces an optional simplified measure of capital adequacy for qualifying community banking organizations (i.e., the community bank leverage ratio (CBLR) framework), as required by the Economic Growth, Regulatory Relief and Consumer Protection Act. The CBLR framework is designed to reduce burden by removing the requirements for calculating and reporting risk-based capital ratios for qualifying community banking organizations that opt into the framework.

In order to qualify for the CBLR framework, a community banking organization must have a tier 1 leverage ratio of greater than 9 percent, less than $10 billion in total consolidated assets, and limited amounts of off-balance-sheet exposures and trading assets and liabilities. A qualifying community banking organization that opts into the CBLR framework and meets all requirements under the framework will be considered to have met the well-capitalized ratio requirements under the Prompt Corrective Action regulations and will not be required to report or calculate risk-based capital. In response to the COVID-19 pandemic, regulatory authorities have lowered the tier 1 leverage ratio required under the CBLR framework to 8% and 8.5% for the remainder of 2020 and 2021, respectively.

While the CBLR framework is currently available for banks to use in their June 30, 2020 Call Report, the Company has elected not to opt into the CBLR framework at this time.

Results of Operations

Comparison of the Three and Six Months Ended June 30, 2020 and 2019

Earnings Summary

Financial had net income including all operating segments of $821,000 and $1,816,000 for the three and six months ended June 30, 2020, compared to $1,377,000 and $2,611,000 for the comparable periods in 2019. Basic and diluted earnings per common share for the three and six months ended June 30, 2020 were $0.19 and $0.42, compared to basic and diluted earnings per share of $0.31 and $0.60 for the three and six months ended June 30, 2019.

The decrease in net income for the three and six months ended June 30, 2020, as compared to the prior year periods was due primarily to an increase in loan loss provision related to uncertainty surrounding the COVID-19 pandemic along with an increase in non-interest expenses, which was offset in part by an increase in non-interest income. We anticipate that our net income for future fiscal periods will continue to be impacted as a result of the economic developments resulting from the COVID-19 pandemic. Specifically, while we are not yet able to measure the impact of COVID-19 crisis on our borrowers, we anticipate provision expense may remain elevated as the economic impact of COVID-19 may negatively affect them.

These operating results represent an annualized return on average stockholders’ equity of 5.33% and 5.95% for the three and six months ended June 30, 2020, compared with 9.47% and

 

46


9.11% for the three and six months ended June 30, 2019. This decrease for the three and six months ended June 30, 2020 was due to an increase in total average equity resulting from an increase in the market value of the securities available-for-sale portfolio coupled with a decrease in net income. The increase in the market value of the securities available-for-sale portfolio resulted from a decrease in market interest rates. The Company had an annualized return on average assets of 0.41% and 0.47% for the three and six months ended June 30, 2020 compared with 0.80% and 0.77% for the same period in 2019. The decrease for the three and six months ended June 30, 2020 largely resulted from an increase in the Bank’s assets and a decrease in net income.

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

Interest Income, Interest Expense, and Net Interest Income

Interest income decreased to $7,081,000 and $14,569,000 for the three and six months ended June 30, 2020 from $7,390,000 and $14,624,000 for the same periods in 2019, decreases of 4.18% and 0.38%, respectively. Interest income decreased because of a decrease in interest rates and was partially offset by an increase in loan balances. The average rate received on loans decreased from 4.97% and 4.98% for the three and six months ended June 2019 to 4.33% and 4.61% for the comparable periods in 2020. The rate on total average earning assets decreased for the three and six months ended June 30, 2020 as compared to the three and six months ended June 30, 2019 primarily because a decrease in the rates paid by borrowers on loans, particularly the lower yielding PPP loans.

Interest expense decreased to $1,163,000 for the three months ended June 30, 2020 from $1,238,000 for the same period in 2019, a decrease of 6.06%. The decrease for the quarter resulted primarily from a decrease in interest rates as a result of the FOMC’s decision to decrease the fed funds rate. Interest expense increased to $2,515,000 for the six months ended June 30, 2020 from $2,342,000 for the same period in 2019. The increase in interest expense resulted primarily because the FOMC rate cuts occurred late in the first quarter and as a result, the increase in interest expense in the first quarter of 2020 more than offset the reduction in the second quarter. The Bank’s average rate paid on interest bearing deposits were 0.71% and 0.81% during the three and six months ended June 30, 2020 as compared to 0.90% and 0.86% for the same periods in 2019.

The fundamental source of the Bank’s net revenue is net interest income, which is determined by the difference between (i) interest and dividend income on interest earning assets, which consist primarily of loans, investment securities and other investments, and (ii) interest expense on interest-bearing liabilities, which consist principally of deposits and other borrowings. Net interest income for the three and six months ended June 30, 2020 was $5,918,000 and $12,054,000 as compared to $6,152,000 and $12,282,000 for the same periods in 2019, a decrease of 3.80% and 1.86%, respectively. The decrease occurred because the impact of the decrease in interest paid on interest-bearing liabilities was less than the impact on the decrease in the rates on interest-earning assets. The net interest margin was 3.13% and 3.37% for the three and six months ended June 30, 2020 as compared with 3.82% and 3.87% for the same periods in 2019. The decrease was primarily caused by the impact of lower-yielding PPP loans. As a result of the spread of COVID-19, economic uncertainties have arisen that are likely to negatively impact net interest margin. Other financial impacts could occur, though such potential impacts are unknown at this time.

 

47


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

Non-Interest Income

Non-interest income is comprised primarily of fees and charges on transactional deposit accounts, gains on sales of mortgage loans held for sale, commissions on sales of investments, fees generated from treasury management services, and bank-owned life insurance income. Non-interest income increased to $2,789,000 and $4,975,000 for the three and six months ended June 30, 2020 from $1,659,000 and $2,878,000 for the three and six months ended June 30, 2019.

These increases for the three and six months ended June 30, 2020 as compared to the same periods last year were due primarily to an increase in gains on sales of loans held for sale from $1,075,000 and $1,766,000 for the three and six months ended June 30, 2019 to $1,950,000 $3,127,000 for the periods ended June 30, 2020. In addition, gains on sales of available-for-sale securities increased from $0 for the three and six month periods ended June 30, 2019 to $213,000 and $644,000 for the same periods in 2020.

The Bank, through its Mortgage division, originates both conforming and non-conforming consumer residential mortgage loans in the markets we serve. As part of the Bank’s overall risk management strategy, all of the loans originated and closed by the Mortgage division are presold to major national mortgage banking or financial institutions. The Mortgage division assumes, except in limited circumstances such as first payment default, no credit or interest rate risk on these mortgages.

Purchase mortgage originations totaled $40,145,000 and $65,138,000 or 51.90% and 52.58% respectively of the total mortgage loans originated in the three and six months ended June 30, 2020 as compared to $37,551,000 and $48,774,000 or 87.69% and 72.47%, respectively of the total mortgage loans originated in the same periods in 2019. Management anticipates that in the short term purchase mortgage originations will continue to represent a majority of mortgage originations as they have in the recent past. However, management also believes that further decreases in long term market interest rates could trigger increased refinancing activity. While uncertainty remains, management expects mortgage rates stay near historic lows for the foreseeable future.

Although mortgage rates fluctuated dramatically in the first quarter of 2020, rates generally decreased in the first three months of 2020 and remained at or near historical lows during the second quarter of 2020. Because of the uncertainty surrounding current and near-term economic conditions arising from the COVID-19 pandemic, management cannot predict future mortgage rates. Nevertheless, management expects that the Mortgage division’s reputation in Region 2000, steady residential real estate inventory and the recent hiring of additional mortgage loan originators in Roanoke, Harrisonburg and Charlottesville, and Blacksburg, will result in strong mortgage originations through the remainder of 2020. Management also believes that in the event that interest rates rise, revenue from the mortgage segment could be under pressure.

Our Investment division provides brokerage services through an agreement with a third-party broker-dealer. Pursuant to this arrangement, the third-party broker-dealer operates a service center adjacent to one of the branches of the Bank. The center is staffed by two dual employees of the Bank and the broker-dealer. Investment receives commissions on transactions

 

48


generated and in some cases ongoing management fees such as mutual fund 12b-1 fees. The Investment division’s financial impact on our consolidated revenue has been immaterial. Although management cannot predict the financial impact of Investment with certainty, management anticipates the Investment division’s impact on noninterest income will remain immaterial in 2020.

The Bank provides insurance and annuity products to Bank customers and others, through the Bank’s Insurance subsidiary. The Bank has three employees that are licensed to sell insurance products through Insurance. Insurance generates minimal revenue and its financial impact on our consolidated revenue has been immaterial. Management anticipates that Insurance’s impact on noninterest income will remain immaterial in 2020.

Non-Interest Expense

Non-interest expense for the three and six months ended June 30, 2020 increased to $6,935,000 and $13,132,000 from $5,975,000 and $11,574,000, increases of 16.07% and 13.46% from the comparable periods in 2019. This increase resulted from increases in personnel expenses from variable compensation, additional compensation of $245,000 paid in connection with the execution of the PPP Loan Program, and $750,000 related to the Bank’s previously disclosed early retirement plan. These were offset in part by the deferral of loan origination costs of $400,000 related to the PPP program, which will be amortized to interest income along with the related fees over the lives of the related loans. Income recognition may be accelerated due to repayment or forgiveness of the loans. In addition, credit expenses related to the volume of mortgage loan production, equipment expense, and an increase in professional expenses. Total personnel expense was $3,973,000 and $7,327,000 for the three and six month periods ended June 30, 2020 as compared to $3,153,000 and $6,081,000 for the same periods in 2019.

Allowance and Provision for Loan Losses

The allowance for loan losses represents an amount that, in our judgment, will be adequate to absorb probable losses inherent in the loan portfolio. The provision for loan losses increases the allowance, and loans charged-off, net of recoveries, reduce the allowance. The provision for the allowance for loan losses is charged to earnings to bring the total allowance to a level deemed appropriate by management and is based upon two components – specific impairment and general reserves. As discussed below, loans having a risk rating of 7 or below that are significantly past due, and the borrower’s performance and financial condition provide evidence that it is probable that the Bank will be unable to collect all amounts when due as well as all TDRs, are evaluated for specific impairment. The general reserve component is based on an evaluation of general economic conditions, actual and expected credit losses, and loan performance measures. Based on the application of the loan loss calculation, the Bank provided $760,000 and $1,648,000 to the allowance for loan losses for the three and six month periods ended June 30, 2020. This compares to a provision of $116,000 and $326,000 for the comparable periods in 2019, representing increases of 555.17% and 405.52%.

The increase in the provision was largely due to adjustments to qualitative factors used in determining the general portion of the allowance as well as a $300,000 specific reserve for the large loan relationship previously mentioned as migrating to a nonperforming status during the quarter. These adjustments resulted in the higher provision for credit losses given the unprecedented economic disruptions and uncertainty surrounding the COVID-19 pandemic that emerged in March 2020 as described in further detail in the “Overview” section. Of the

 

49


$1,648,000 in provision in the first six months of 2020, approximately $1,048,000 is attributed to qualitative factors related to the COVID-19 pandemic and its effect on economic conditions, loan concentrations in sectors adversely affected by the pandemic, and loans that have been granted payment deferrals or have been granted interest only payment status in the short term. The components of the allowance are detailed further in table below.

At June 30, 2020, the allowance for loan losses was 0.98% of total loans outstanding, versus 0.84% of total loans outstanding at December 31, 2019. The allowance to total loans, excluding PPP loans, increased to 1.11% at June 30, 2020. Because the PPP loans are guaranteed in full by the U.S. Small Business Administration, management determined that these loans should be excluded from the calculation. At June 30, 2020, management believed the allowance for loan losses was at a level commensurate with the overall risk exposure of the loan portfolio. However, if economic conditions continue to deteriorate due to the COVID-19 pandemic, certain borrowers may experience difficulty and the level of nonperforming loans, charge-offs and delinquencies could rise and require increases in the allowance for loan losses. The process of identifying potential credit losses is a subjective process. Therefore, the Company maintains a general reserve to cover credit losses within the portfolio. The methodology management uses to determine the adequacy of the loan loss reserve includes the considerations below.

We have developed relief programs to assist borrowers in financial need due to the effects of the COVID-19 pandemic. The March 22, 2020 (revised April 2020) statement issued by our banking regulators and titled the “Interagency Statement on Loan Modifications and Reporting for Financial Institutions Working with Customers Affected by the Coronavirus” encourages financial institutions to work prudently with borrowers who are or may be unable to meet their contractual payment obligations due to the effects of COVID-19. Additionally, Section 4013 of the Coronavirus Aid, Relief and Economic Security Act (“CARES Act”), passed on March 27, 2020 provides that a qualified loan modification is exempt by law from classification as a TDR as defined by GAAP, from the period beginning March 1, 2020 until the earlier of December 31, 2020 or the date that is 60 days after the date on which the national emergency concerning the COVID-19 outbreak declared by the President of the United States under the National Emergencies Act (50 U.S.C. 1601 et seq.) terminates. Accordingly, we are offering short-term modifications made in response to COVID-19 to certain borrowers who are current and otherwise not past due. These include short-term, 180 days or less, modifications in the form of payment deferrals, fee waivers, extensions of repayment terms, short-term interest only payments, or other delays in payment that are insignificant.

As of June 30, 2020, the Bank had modified a total of 184 loans as described in the preceding paragraph. As of June 30, 2020, modifications described in the preceding paragraph attributed to COVID-19 were $94,504,000 representing the 184 loans. This represented 15.01% of the total loan portfolio as of June 30, 2020. Of that total 164 were commercial loan borrowers representing $91,821,000 in loans, or 14.58% of our total loan portfolio as of June 30, 2020 and 20 were retail loan borrowers representing $2,683,000, or 0.43% of our total loan portfolio as of June 30, 2020. Of the total deferrals, 33.68% are for deferrals of principal only. In accordance with the March 22, 2020 Joint Interagency Regulatory Guidance, the above modifications were not considered to be troubled debt restructurings and were excluded from the discussion above.

Section 1102 of the CARES Act created the Paycheck Protection Program (“PPP”), which appropriated $349 billion (which was subsequently increased by an additional $320 billion including $60 billion set aside for small, midsize, and community lenders) in loans designed to

 

50


provide a direct incentive for sole proprietors, independent contractors, self-employed persons, non-profits and small businesses with less than 500 employees, allowing for narrow exceptions with businesses greater than 500 employees, to keep their workers on the payroll. These loans will be fully forgiven by the Small Business Administration if the funds are used for payroll costs, interest on mortgages, rent, or utilities as long as at least 75% of the forgiven amount was used for payroll. Additionally, loan payments will also be deferred for six months. The Program started on April 3, 2020 and was available through June 30, 2020, or as long as the appropriated funding is available. No collateral or personal guarantees were required. Neither the government nor lenders are permitted to charge the recipients any fees.

The Bank began accepting applications from qualified customers on April 3, 2020 and, as of June 30, 2020, has helped provide over $68,000,000 in funding to over 550 clients through the PPP.

Charged-off loans, which are loans that management deems uncollectible, are charged against the allowance for loan losses and constitute a realized loss. Charged-off loans were $79,000 and $339,000 for the three and six months ended June 30, 2020 as compared to $86,000 and $219,000 for the comparable period in 2019. While a charged-off loan may subsequently be collected, such recoveries generally are realized over an extended period of time. In the three and six months ended June 30, 2020, the Bank had recoveries of charged-off loans of $38,000 and $55,000 as compared with $21,000 and $36,000 for the comparable periods in 2019.

In light of the current economic environment, management continues its ongoing assessment of specific impairment in the Bank’s loan portfolio. As set forth in the tables below, the Bank’s allowance arising from the specific impairment evaluation as of June 30, 2020 increased as compared to December 31, 2019.

As shown in the table below, the total balance in the allowance increased, from $4,829,000 as of December 31, 2019 to $6,193,000 on June 30, 2020. The allowance for loan losses as a percent of loans increased to 0.98% as of June 30, 2020 from 0.84% as of December 31, 2019. The allowance for loan losses as a percent of unimpaired loans was 0.96% at June 30, 2020 as compared to 0.84% at December 31, 2019. The general reserve as a percentage of unimpaired loan balances increased to 0.96% (or 1.06% excluding PPP loans) as of June 30, 2020 as compared to 0.83% as of December 31, 2019. This increase was primarily due to an increase in the rate of qualitative factors assessed in the general reserve based on management’s evaluation of those factors at June 30, 2020 in light of COVID-19, as discussed above. Management will continue to evaluate the adequacy of the allowance for loan losses as more economic data becomes available and as changes within the Company’s portfolio are known. The effects of the pandemic may require the Company to fund additional increases in the allowance for loan losses in future periods.

 

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

 

     Allowance for Loan Losses and Recorded Investment in Loans  
     (dollars in thousands)  
     As of and For the Six Months Ended June 30, 2020  
           Commercial                    
2020    Commercial     Real Estate     Consumer     Residential     Total  

Allowance for Credit Losses:

          

Beginning Balance

   $  1,330   $  1,932   $  865   $  702   $  4,829

Charge-Offs

     (69     (211     (8     (51     (339

Recoveries

     7     24     22     2     55

Provision

     812     924     (68     (20     1,648
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Ending Balance

     2,080     2,669     811     633     6,193

Ending Balance: Individually evaluated for impairment

     66     240     —         —         306
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Ending Balance: Collectively evaluated for impairment

     2,014     2,429     811     633     5,887
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Totals:

   $  2,080   $  2,669   $  811   $  633   $  6,193
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Financing Receivables:

          

Ending Balance: Individually evaluated for impairment

     676     5,881     266     1,365     8,188
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Ending Balance: Collectively evaluated for impairment

     174,970     295,819     86,889     63,891     621,569
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Totals:

   $  175,646   $  301,700   $  87,155   $  65,256   $  629,757
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

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     Allowance for Loan Losses and Recorded Investment in Loans  
     (dollars in thousands)  
     As of and For the Year Ended December 31, 2019  
           Commercial                    
2019    Commercial     Real Estate     Consumer     Residential     Total  

Allowance for Credit Losses:

          

Beginning Balance

   $  1,136   $  1,831   $  956   $  658   $  4,581

Charge-Offs

     (106     (26     (189     (42     (363

Recoveries

     35     5     44     4     88

Provision

     265     122     54     82     523
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Ending Balance

     1,330     1,932     865     702     4,829

Ending Balance: Individually evaluated for impairment

     7     15     —         33     55
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Ending Balance: Collectively evaluated for impairment

     1,323     1,917     865     669     4,774
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Totals:

   $  1,330   $  1,932   $  865   $  702   $  4,829
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Financing Receivables:

          

Ending Balance: Individually evaluated for impairment

     475     3,056     107     1,429     5,067
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Ending Balance: Collectively evaluated for impairment

     113,782     300,844     89,838     68,572     573,036
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Totals:

   $  114,257   $  303,900   $  89,945   $  70,001   $  578,103
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

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

 

     Three Months Ended     Six Months Ended  
     June 30,     June 30,  
     (in thousands)     (in thousands)  
     2020     2019     2020     2019  

Balance, beginning of period

   $  5,474     $  4,673     $  4,829     $  4,581  

Provision for loan losses

     760       116       1,648       326  

Loans charged off

     (79     (86     (339     (219

Recoveries of loans charged off

     38       21       55       36  
  

 

 

   

 

 

   

 

 

   

 

 

 

Net (charge offs)

     (41     (65     (284     (183
  

 

 

   

 

 

   

 

 

   

 

 

 

Balance, end of period

   $  6,193     $  4,724     $  6,193     $  4,724  
  

 

 

   

 

 

   

 

 

   

 

 

 

 

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No nonaccrual loans were excluded from the impaired loan disclosures at June 30, 2020 and December 31, 2019. If interest on these loans had been accrued, such income cumulatively would have approximated $302,000 and $207,000 on June 30, 2020 and December 31, 2019, respectively. Loan payments received on nonaccrual loans are applied to principal. When a loan is placed on nonaccrual status there are several negative implications. First, all interest accrued but unpaid at the time of the classification is deducted from the interest income totals for the Bank. Second, accruals of interest are discontinued until it becomes certain that both principal and interest can be repaid. Third, there may be actual losses that necessitate additional provisions for credit losses charged against earnings.

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

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

 

RATING 1

  

Excellent

RATING 2

  

Above Average

RATING 3

  

Satisfactory

RATING 4

  

Acceptable / Low Satisfactory

RATING 5

  

Monitor

RATING 6

  

Special Mention

RATING 7

  

Substandard

RATING 8

  

Doubtful

RATING 9

  

Loss

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

 

   

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

 

   

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

 

   

“Special Mention.” These are loans having a risk rating of 6. Special Mention loans have weaknesses that deserve management’s close attention. If left uncorrected, these potential weaknesses may result in deterioration of the

 

54


 

repayment prospects for the asset or in the bank’s credit position at some future date. Special Mention loans are not adversely classified and do not expose an institution to sufficient risk to warrant adverse classification. These loans do warrant more than routine monitoring due to a weakness caused by adverse events.

 

   

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

 

   

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

 

   

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

Income Taxes

For the three and six months ended June 30, 2020, Financial had an income tax expense of $191,000 and $433,000 as compared to $343,000 and $649,000 for the three and six months ended June 30, 2019. This represents an effective tax rate of 18.87% and 19.25% for the three and six months ended June 30, 2020 as compared with 19.94% and 19.91% for the three and six months ended June 30, 2019. Our effective rate was lower than the statutory corporate tax rate in all periods primarily because of federal income tax benefits resulting from the tax treatment of earnings on bank owned life insurance.

 

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Schedule I

Net Interest Margin Analysis

Average Balance Sheets

For the Quarter Ended June 30, 2020 and 2019

(dollars in thousands)

 

     2020     2019  
     Average
Balance
Sheet
    Interest
Income/
Expense
     Average
Rates
Earned/
Paid
    Average
Balance
Sheet
    Interest
Income/
Expense
     Average
Rates
Earned/
Paid
 

ASSETS

              

Loans, including fees (1) (2)

   $ 620,572     $ 6,701        4.33   $ 546,859     $ 6,780        4.97

Loans held for sale

     5,653       31        2.20     3,948       36        3.66

Fed funds sold

     56,248       10        0.07     20,263       122        2.41

Interest bearing bank balances

     18,664       6        0.13     14,626       74        2.03

Securities (3)

     56,647       309        2.19     58,214       345        2.38

Federal agency equities

     1,406       24        6.85     1,386       33        9.55

CBB equity

     116       —          —         116       —          —    
  

 

 

   

 

 

    

 

 

   

 

 

   

 

 

    

 

 

 

Total earning assets

     759,306       7,081        3.74     645,406       7,390        4.59
    

 

 

    

 

 

     

 

 

    

 

 

 

Allowance for loan losses

     (5,478          (4,691     

Non-earning assets

     54,774            49,922       
  

 

 

        

 

 

      

Total assets

   $ 808,602          $ 690,637       
  

 

 

        

 

 

      

LIABILITIES AND STOCKHOLDERS’ EQUITY

              

Deposits

              

Demand interest bearing

   $ 325,126     $ 129        0.16   $ 246,051     $ 307        0.50

Savings

     89,996       37        0.16     93,274       55        0.24

Time deposits

     189,951       912        1.93     191,039       826        1.73
  

 

 

   

 

 

    

 

 

   

 

 

   

 

 

    

 

 

 

Total interest bearing deposits

     605,073       1,078        0.71     530,364       1,188        0.90

Other borrowed funds

              

Financing leases

     4,330       28        2.59     —         —          —    

Capital Notes

     4,940       57        4.62     5,000       50        4.00
  

 

 

   

 

 

    

 

 

   

 

 

   

 

 

    

 

 

 

Total interest-bearing liabilities

     614,343       1,163        0.76     535,364       1,238        0.93
    

 

 

    

 

 

     

 

 

    

 

 

 

Non-interest bearing deposits

     125,936            92,026       

Other liabilities

     6,547            4,952       
  

 

 

        

 

 

      

Total liabilities

     746,826            632,342       

Stockholders’ equity

     61,776            58,295       
  

 

 

        

 

 

      

Total liabilities and Stockholders’ equity

   $ 808,602          $ 690,637       
  

 

 

        

 

 

      

Net interest income

     $ 5,918          $ 6,152     
    

 

 

        

 

 

    

Net interest margin

          3.13          3.82
       

 

 

        

 

 

 

Interest spread

          2.98          3.66
       

 

 

        

 

 

 

 

(1)

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

(2)

Nonperforming loans are included in the average balances. However, interest income and yields calculated do not reflect any accrued interest associated with non-accrual loans.

(3)

The interest income and yields calculated on securities have been tax affected to reflect any tax exempt interest on municipal securities. Assumed income tax rates of 21% were used for the periods presented.

 

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Net Interest Margin Analysis

Average Balance Sheets

For the Six Months Ended June 30, 2020 and 2019

(dollars in thousands)

 

<
     2020     2019  
     Average
Balance
Sheet
    Interest
Income/
Expense