BANK OF THE JAMES FINANCIAL GROUP INC - Quarter Report: 2017 March (Form 10-Q)

Large accelerated filer

Accelerated filer

Non-accelerated filer

☐ (do not check if a smaller reporting company)

Smaller reporting company

Emerging growth company

Form 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 March 31, 2017

BANK OF THE JAMES FINANCIAL GROUP, INC.

(Exact Name of Registrant as Specified in Its Charter)


Virginia	001-35402	20-0500300
(State or other jurisdiction of incorporation or organization)	(Commission file number)	(I.R.S. Employer Identification No.)

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

(434) 846-2000

(Registrant’s telephone number, including area code)

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

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

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

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

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

APPLICABLE ONLY TO CORPORATE ISSUERS

State the number of shares outstanding of each of the issuer’s classes of common equity, as of the latest practicable date: 4,378,436 shares of Common Stock, par value $2.14 per share, were outstanding at May 4, 2017.

Table of Contents


PART I – FINANCIAL INFORMATION		1

Item 1.	Consolidated Financial Statements	1

Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	32

Item 3.	Quantitative and Qualitative Disclosures About Market Risk	49

Item 4.	Controls and Procedures	49

PART II – OTHER INFORMATION		49

Item 1.	Legal Proceedings	49

Item 1A.	Risk Factors	49

Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	49

Item 3.	Defaults Upon Senior Securities	49

Item 4.	Mine Safety Disclosures	49

Item 5.	Other Information	49

Item 6.	Exhibits	50

SIGNATURES		51

PART I – FINANCIAL INFORMATION

Item 1.

Consolidated Financial Statements

Bank of the James Financial Group, Inc. and Subsidiaries

Consolidated Balance Sheets

(dollar amounts in thousands, except per share amounts) (2017 unaudited)


	March 31,			December 31,
	2017			2016
Assets
Cash and due from banks	$	19,751		$	16,938
Federal funds sold		5,508			11,745

Total cash and cash equivalents		25,259			28,683
Securities held-to-maturity (fair value of $3,272 in 2017 and $3,273 in 2016)		3,293			3,299
Securities available-for-sale, at fair value		48,220			40,776
Restricted stock, at cost		1,415			1,373

Loans, net of allowance for loan losses of $5,716 in 2017 and 2016		466,244			464,353
Loans held for sale		1,633			3,833
Premises and equipment, net		11,243			10,947
Interest receivable		1,365			1,378
Cash value - bank owned life insurance		12,759			12,673
Other real estate owned		2,750			2,370
Income taxes receivable		872			1,214
Deferred tax asset, net		2,234			2,374
Other assets		1,146			922

Total assets	$	578,433		$	574,195

Liabilities and Stockholders’ Equity

Deposits
Noninterest bearing demand	$	105,276		$	102,654
NOW, money market and savings		250,911			255,429
Time		165,012			165,029

Total deposits		521,199			523,112

Capital notes		5,000			—
Interest payable		77			88
Other liabilities		1,966			1,574

Total liabilities	$	528,242		$	524,774

Commitments and Contingencies
Stockholders’ equity
Preferred stock; authorized 1,000,000 shares; none issued and outstanding	$	—		$	—
Common stock $2.14 par value; authorized 10,000,000 shares; issued and outstanding 4,378,436 as of March 31, 2017 and December 31, 2016		9,370			9,370
Additional paid-in-capital		31,495			31,495
Retained earnings		10,653			10,156
Accumulated other comprehensive (loss)		(1,327	)		(1,600	)

Total stockholders’ equity	$	50,191		$	49,421

Total liabilities and stockholders’ equity	$	578,433		$	574,195

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
	March 31,
	2017		2016
Interest Income
Loans	$	5,188	$	4,978
Securities
US Government and agency obligations		113		139
Mortgage backed securities		66		52
Municipals - taxable		69		34
Municipals - tax exempt		11		10
Dividends		7		6
Other (Corporates)		27		6
Interest bearing deposits		15		6
Federal Funds sold		13		4

Total interest income		5,509		5,235

Interest Expense
Deposits
NOW, money market savings		169		136
Time Deposits		465		400
Federal Funds purchased		—		4
Capital notes 6% due 4/1/2017		—		8
Capital notes 4% due 1/24/2022		37		—

Total interest expense		671		548

Net interest income		4,838		4,687

Provision for loan losses		100		200

Net interest income after provision for loan losses		4,738		4,487

Noninterest income
Gain on sales of loans held for sale		371		491
Service charges, fees and commissions		405		372
Increase in cash value of life insurance		86		65
Other		9		15
Gain on sales and calls of securities, net		10		65

Total noninterest income		881		1,008

Noninterest expenses
Salaries and employee benefits		2,380		2,237
Occupancy		372		332
Equipment		348		319
Supplies		134		119
Professional, data processing, and other outside expense		680		662
Marketing		148		119
Credit expense		114		83
Other real estate expenses		12		1
FDIC insurance expense		103		92
Other		226		226

Total noninterest expenses		4,517		4,190

Income before income taxes		1,102		1,305

Income tax expense		342		418

Net Income	$	760	$	887

Weighted average shares outstanding - basic		4,378,436		4,378,436

Weighted average shares outstanding - diluted		4,378,535		4,378,436

Earnings per common share - basic	$	0.17	$	0.20

Earnings per common share - diluted	$	0.17	$	0.20

See accompanying notes to these consolidated financial statements

Bank of the James Financial Group, Inc. and Subsidiaries

Consolidated Statements of Comprehensive Income

For the Three Months Ended March 31, 2017 and 2016

(dollar amounts in thousands) (unaudited)


	Three Months Ended March 31,
	2017			2016
Net Income	$	760		$	887

Other comprehensive income:
Unrealized gains on securities available-for-sale		423			1,029
Tax effect		(144	)		(350	)
Reclassification adjustment for gains included in net income (1)		(10	)		(65	)
Tax effect (2)		4			22

Other comprehensive income, net of tax		273			636

Comprehensive income	$	1,033		$	1,523

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

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

See accompanying notes to these consolidated financial statements

Bank of the James Financial Group, Inc. and Subsidiaries

Consolidated Statements of Cash Flows

Three Months Ended March 31, 2017 and 2016

(dollar amounts in thousands) (unaudited)


	For the Three Months Ended March 31,
	2017			2016
Cash flows from operating activities
Net Income	$	760		$	887

Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization		188			196

Net amortization and accretion of premiums and discounts on securities		93			35
(Gain) on sales of available-for-sale securities		(10	)		(65	)
(Gain) on sales of loans held for sale		(371	)		(491	)
Provision for loan losses		100			200
Loss on sale of other real estate owned		8			—
(Increase) in cash value of life insurance		(86	)		(65	)
Decrease in interest receivable		13			13
(Increase) in other assets		(224	)		(66	)
Decrease in income taxes receivable		342			418
(Decrease) increase in interest payable		(11	)		20
Increase in other liabilities		392			347
Proceeds from sales of loans held for sale		15,543			14,984
Origination of loans held for sale		(12,972	)		(16,235	)

Net cash provided by operating activities	$	3,765		$	178

Cash flows from investing activities
Purchases of securities available-for-sale	$	(9,568	)	$	(5,715	)

Proceeds from maturities, calls and paydowns of securities available-for-sale		1,490			381
Proceeds from sale of securities available-for-sale		970			4,563
(Purchase) of Federal Home Loan Bank stock		(42	)		(60	)
Proceeds from sale of other real estate owned		147			—
Origination of loans, net of principal collected		(2,526	)		(3,846	)
Purchases of premises and equipment		(484	)		(50	)

Net cash (used in) investing activities	$	(10,013	)	$	(4,727	)

Cash flows from financing activities
Net (decrease) increase in deposits	$	(1,913	)	$	5,841
Dividends paid to common stockholders		(263	)		(263	)
Proceeds from sale of 4% capital notes due 1/24/2022		5,000			—
Retirement of 6% capital notes due 4/1/2017		—			(10,000	)

Net cash provided by (used in) financing activities	$	2,824		$	(4,422	)

(Decrease) in cash and cash equivalents		(3,424	)		(8,971	)

Cash and cash equivalents at beginning of period	$	28,683		$	28,655

Cash and cash equivalents at end of period	$	25,259		$	19,684

Non cash transactions
Transfer of loans to other real estate owned	$	535		$	390
Fair value adjustment for securities		413			964

Cash transactions
Cash paid for interest	$	682		$	528
Cash paid for taxes		—			—

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 Months Ended March 31, 2017 and 2016

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


										Accumulated
					Additional					Other
	Shares		Common		Paid-in		Retained			Comprehensive
	Outstanding		Stock		Capital		Earnings			Income (Loss)			Total
Balance at December 31, 2015		4,378,436	$	9,370	$	31,495	$	7,920		$	(589	)	$	48,196

Net Income		—		—		—		887			—			887

Dividends paid on common stock ($0.06 per share)		—		—		—		(263	)		—			(263	)

Other comprehensive income		—		—		—		—			636			636

Balance at March 31, 2016		4,378,436	$	9,370	$	31,495	$	8,544		$	47		$	49,456

Balance at December 31, 2016		4,378,436	$	9,370	$	31,495	$	10,156		$	(1,600	)	$	49,421

Net Income		—		—		—		760			—			760

Dividends paid on common stock ($0.06 per share)		—		—		—		(263	)		—			(263	)

Other comprehensive income		—		—		—		—			273			273

Balance at March 31, 2017		4,378,436	$	9,370	$	31,495	$	10,653		$	(1,327	)	$	50,191

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 March 31, 2017 and for the three months ended March 31, 2017 and 2016 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, 2016. These financial statements should be read in conjunction with the audited consolidated financial statements and footnotes for the year ended December 31, 2016 included in Financial’s Annual Report on Form 10-K. Results for the three month period ended March 31, 2017 are not necessarily indicative of the results that may be expected for the year ending December 31, 2017.

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

Financial’s critical accounting policy relates to 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 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 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.

Note 2 – Use of Estimates

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

Note 3 – Earnings Per Common Share (EPS)

Currently, only the option shares granted to certain officers and other employees of Financial pursuant to the Amended and Restated Stock Option Plan of 1999 Financial (the “1999 Plan”) are considered in calculating diluted earnings per share. The following is a summary of the earnings per share calculation for the three months ended March 31, 2017 and 2016.


	Three Months Ended March 31,
	2017		2016
Net income	$	760,000	$	887,000

Weighted average number of shares		4,378,436		4,378,436
Options affect of incremental shares		99		—

Weighted average diluted shares		4,378,535		4,378,436

Basic EPS (weighted avg shares)	$	0.17	$	0.20

Diluted EPS (Including Option Shares)	$	0.17	$	0.20

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


	Three Months Ended
	March 31,
	2017		2016
Options excluded from calculating diluted EPS because their effect was anti-dilutive		—		636

The foregoing shares were anti-dilutive because the exercise price of the options was greater than the market price on March 31, 2016.

Note 4 – Stock Based Compensation

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

Note 4 – Stock Based Compensation (continued)

Stock option plan activity for the three months ended March 31, 2017 is summarized below:


					Weighted
			Weighted		Average
			Average		Remaining
			Exercise		Contractual		Intrinsic
	Shares		Price		Life (in years)		Value
Options outstanding, January 1, 2017		636	$	12.79
Granted		—		—
Exercised		—		—
Forfeited		—		—

Options outstanding, March 31, 2017		636	$	12.79		1.17	$	1

Options exercisable, March 31, 2017		636	$	12.79		1.17	$	1

Intrinsic value is calculated by subtracting the exercise price of option shares from the market price of underlying shares as of March 31, 2017 and multiplying that amount by the number of options outstanding. No intrinsic value exists where the exercise price is greater than the market price on a given date.

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

Note 5 – Fair Value Measurements

Determination of Fair Value

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

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

Note 5 – Fair Value Measurements (continued)

Fair Value Hierarchy

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

•

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

•

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

•

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

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

Fair Value on a Recurring Basis

Securities Available-for-Sale

Fair values of securities, excluding restricted investments in Federal Reserve Bank stock, Federal Home Loan Bank stock, and Community Bankers’ Bank stock are based on quoted prices available in an active market. If quoted prices are available, these securities are classified within Level 1 of the valuation hierarchy. Level 1 securities would include highly liquid government bonds, mortgage products and exchange traded equities. If quoted market prices are not available, then fair values are estimated by using pricing models, quoted prices of securities with similar characteristics, or discounted cash flow.

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

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

Restricted securities noted above are classified as such because their ownership is restricted to certain types of entities and there is no established market for their resale. When the stock is repurchased, the shares are repurchased at the stock’s book value; therefore, the carrying amount of restricted securities approximate fair value. Restricted securities are considered to be Level 2.

Note 5 – Fair Value Measurements (continued)


			Carrying Value at March 31, 2017 (in thousands)
Description	Balance as of March 31, 2017		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
US Treasuries	$	1,849	$	—	$	1,849	$	—
US agency obligations		13,302		—		13,302		—
Mortgage-backed securities		15,534		—		15,534		—
Municipals		12,598		—		12,598		—
Corporates		4,937		—		4,937		—

Total available-for-sale securities	$	48,220	$	—	$	48,220	$	—


			Carrying Value at December 31, 2016 (in thousands)
Description	Balance as of December 31, 2016		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
US Treasuries	$	1,833	$		$	1,833	$
US agency obligations		13,113		—		13,113		—
Mortgage-backed securities		12,005		—		12,005		—
Municipals		9,947		—		9,947		—
Corporates		3,878		—		3,878		—

Total available-for-sale securities	$	40,776	$	—	$	40,776	$	—

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, if the collateral is a house or building in the process of construction or if an appraisal of the real estate property is over one year old, then the fair value is considered Level 3. The value of business equipment is based upon an outside appraisal if deemed significant, or the net book value on the applicable business’ financial statements if not considered significant using observable market data. Likewise, values for inventory and accounts receivables collateral are based on financial statement balances or aging reports (Level 3). Any fair value adjustments are recorded in the period incurred as provision for loan losses on the Consolidated Statements of Income.

Note 5 – Fair Value Measurements (continued)

Loans held for sale

Loans held for sale are carried at cost which approximates estimated fair value. These loans currently consist of one-to-four family residential loans originated for sale in the secondary market. Fair value is based on the price secondary markets are currently offering for similar loans using observable market data which is not materially different than cost due to the short duration between origination and sale (Level 2). As such, the Company records fair value adjustments on a nonrecurring basis. No nonrecurring fair value adjustments were recorded on loans held for sale during the period ended March 31, 2017. 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 collateral is determined utilizing an income or market valuation approach based on an appraisal conducted by an independent, licensed appraiser outside of the Bank using observable market data.

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

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


			Carrying Value at March 31, 2017
Description	Balance as of March 31, 2017		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Impaired loans*	$	1,972	$	—	$	—	$	1,972
Loans held for sale		1,633		—		1,633		—
Other real estate owned		2,750		—		—		2,750

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


			Carrying Value at December 31, 2016
Description	Balance as of December 31, 2016		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Impaired loans*	$	2,830	$	—	$	—	$	2,830
Loans held for sale		3,833		—		3,833		—
Other real estate owned		2,370		—		—		2,370

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

Note 5 – Fair Value Measurements (continued)

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

Quantitative information about Level 3 Fair Value Measurements for March 31, 2017
(dollars in thousands)

Fair
Value

Valuation Technique(s)

Unobservable Input

Range (Weighted
Average)

Assets

Impaired loans

1,972

Discounted appraised value

Selling cost

5% - 10% (6%

)

Discount for lack of marketability and age of appraisal

0% - 25% (15%

)

OREO

2,750

Discounted appraised value

Selling cost

5% - 10% (6%

)

Discount for lack of marketability and age of appraisal

0% - 25% (15%)

Quantitative information about Level 3 Fair Value Measurements for December 31, 2016
(dollars in thousands)

Fair
Value

Valuation Technique(s)

Unobservable Input

Range (Weighted
Average)

Assets

Impaired loans

2,830

Discounted appraised value

Selling cost

5% - 10% (6%)

Discount for lack of marketability and age of appraisal

0% - 25% (15%)

OREO

2,370

Discounted appraised value

Selling cost

5% - 10% (6%)

Discount for lack of marketability and age of appraisal

0% - 25% (15%)

Financial Instruments

Cash, cash equivalents and Federal Funds sold

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

Loans

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

Bank Owned Life Insurance (BOLI)

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

Note 5 – Fair Value Measurements (continued)

Deposits

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

FHLB borrowings

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

Short-term borrowings

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

Capital notes

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

Accrued interest

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

Off-balance sheet credit-related instruments

Fair values for off-balance sheet, credit-related financial instruments are based on fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the counterparties’ credit standing. Fair value of off-balance sheet credit-related instruments were deemed to be immaterial at March 31, 2017 and December 31, 2016 and therefore are not included in the table below.

Note 5 – Fair Value Measurements (continued)

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


			Fair Value Measurements at March 31, 2017 using
			Quoted Prices		Significant
			in Active		Other		Significant
			Markets for		Observable		Unobservable
	Carrying		Identical Assets		Inputs		Inputs
	Amounts		(Level 1)		(Level 2)		(Level 3)		Balance
Assets
Cash and due from banks	$	19,751	$	19,751	$	—	$	—	$	19,751
Fed funds sold		5,508		5,508						5,508
Securities
Available-for-sale		48,220		—		48,220		—		48,220
Held-to-maturity		3,293		—		3,272		—		3,272
Restricted stock		1,415				1,415				1,415
Loans, net		466,244		—		—		470,300		470,300
Loans held for sale		1,633		—		1,633		—		1,633
Interest receivable		1,365		—		1,365		—		1,365
BOLI		12,759		—		12,759		—		12,759

Liabilities
Deposits	$	521,199	$	—	$	522,309	$	—	$	522,309
Capital notes		5,000		—		5,012		—		5,012
Interest payable		77		—		77		—		77

			Fair Value Measurements at December 31, 2016 using
			Quoted Prices		Significant
			in Active		Other		Significant
			Markets for		Observable		Unobservable
	Carrying		Identical Assets		Inputs		Inputs
	Amounts		(Level 1)		(Level 2)		(Level 3)		Balance
Assets
Cash and due from banks	$	16,938	$	16,938	$	—	$	—	$	16,938
Fed funds sold		11,745		11,745						11,745
Securities
Available-for-sale		40,776		—		40,776		—		40,776
Held-to-maturity		3,299		—		3,273		—		3,273
Restricted stock		1,373		—		1,373				1,373
Loans, net		464,353		—		—		468,393		468,393
Loans held for sale		3,833		—		3,833		—		3,833
Interest receivable		1,378		—		1,378		—		1,378
BOLI		12,673		—		12,673		—		12,673

Liabilities
Deposits	$	523,112	$	—	$	524,222	$	—	$	524,222
Interest payable		88		—		88		—		88

Note 5 – Fair Value Measurements (continued)

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

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

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

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

Note 6 – Capital Notes

As of December 31, 2015, Financial had $10,000,000 categorized as “Capital Notes” which represented the proceeds of the private placement of $10,000,000 in unregistered debt securities as previously disclosed (the “2012 Notes”). The 2012 Notes bore interest at the rate of 6% per year with interest payable quarterly in arrears. On December 3, 2015, Financial closed a private placement of common stock pursuant to which it received gross proceeds of $11,520,000 by selling an aggregate of 1,000,000 shares of Financials’ Common Stock at a price of $11.52 per share, as part of a private placement (the “Common Stock Private Placement”). Financial used $10,000,000 of the proceeds from the Common Stock Private Placement to prepay in full the 2012 Notes on January 5, 2016.

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

Note 7 – Securities

The following tables summarize the Bank’s holdings for both securities held-to-maturity and securities available-for-sale as of March 31, 2017 and December 31, 2016 (amounts in thousands):


	March 31, 2017
	Amortized Costs		Gross Unrealized					Fair Value
	Amortized Costs		Gains		(Losses)			Fair Value
Held-to-Maturity
US agency obligations	$	3,293	$	50	$	(71	)	$	3,272

Available-for-Sale
US Treasuries		1,953		—		(104	)		1,849
US agency obligations		14,291		5		(994	)		13,302
Mortgage-backed securities		15,881		1		(348	)		15,534
Municipals		12,955		70		(427	)		12,598
Corporates		5,151		—		(214	)		4,937

	$	50,231	$	76	$	(2,087	)	$	48,220


	December 31, 2016
	Amortized Costs		Gross Unrealized					Fair Value
	Amortized Costs		Gains		(Losses)			Fair Value
Held-to-Maturity
US agency obligations	$	3,299	$	65	$	(91	)	$	3,273

Available-for-Sale
US Treasuries		1,952		—		(119	)		1,833
US agency obligations		14,332		5		(1,224	)		13,113
Mortgage-backed securities		12,358		—		(353	)		12,005
Municipals		10,425		55		(534	)		9,947
Corporates		4,132		—		(254	)		3,878

	$	43,200	$	60	$	(2,484	)	$	40,776

Note 7 – Securities (continued)

The following tables show the gross unrealized losses and fair value of the Bank’s investments with unrealized losses that are not deemed to be other-than-temporarily impaired, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position, at March 31, 2017 and December 31, 2016 (amounts in thousands):


	Less than 12 months				More than 12 months				Total
	Fair		Unrealized		Fair		Unrealized		Fair		Unrealized
March 31, 2017	Value		Losses		Value		Losses		Value		Losses
Description of securities
Held-to-maturity
US agency obligations	$	1,210	$	71	$	—	$	—	$	1,210	$	71

Available-for-sale
US Treasuries		1,848		104		—		—		1,848		104
US agency obligations		13,297		994		—		—		13,297		994
Mortgage-backed securities		13,908		347		638		1		14,546		348
Municipals		8,563		427		—		—		8,563		427
Corporates		—		—		4,937		214		4,937		214

Total	$	38,826	$	1,943	$	5,575	$	215	$	44,401	$	2,158


	Less than 12 months				More than 12 months				Total
	Fair		Unrealized		Fair		Unrealized		Fair		Unrealized
December 31, 2016	Value		Losses		Value		Losses		Value		Losses
Description of securities
Held-to-maturity
US agency obligations	$	1,193	$	91	$	—	$	—	$	1,193	$	91

Available-for-sale
US Treasuries		1,833		119		—		—		1,833		119
US agency obligations		13,109		1,224		—		—		13,109		1,224
Mortgage-backed securities		11,331		353		—		—		11,331		353
Municipals		7,170		534		—		—		7,170		534
Corporates		3,878		254		—		—		3,878		254

Total	$	38,514	$	2,575	$	—	$	—	$	38,514	$	2,575

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).

Note 7 – Securities (continued)

At March 31, 2017, the Company did not consider the unrealized losses as other-than-temporary losses due to the nature of the securities involved. As of March 31, 2017, the Bank owned 46 securities in an unrealized loss position that were being evaluated for other than temporary impairment. Nine of these securities were S&P rated AAA, 32 were rated AA and five were rated A. As of March 31, 2017, 23 of these securities were direct obligations of the U.S. government or government sponsored entities, 16 were municipal issues, and seven were investments in domestic corporate issued securities.

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

Gross gains on available-for-sale securities were $10 and $65 during the three month periods ended March 31, 2017 and 2016 respectively. There were no losses on sales of available-for-sale securities and no sales of held-to-maturity securities during the three month periods ended March 31, 2017 and 2016.

Note 8 – Business Segments

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

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

Note 8 – Business Segments (continued)

Information about reportable business segments and reconciliation of such information to the consolidated financial statements for the three months ended March 31, 2017 and 2016 was as follows (dollars in thousands):

Business Segments


	Community
	Banking		Mortgage		Total
Three months ended March 31, 2017
Net interest income	$	4,838	$	—	$	4,838
Provision for loan losses		100		—		100

Net interest income after provision for loan losses		4,738		—		4,738
Noninterest income		510		371		881
Noninterest expenses		4,148		369		4,517

Income before income taxes		1,100		2		1,102
Income tax expense		341		1		342

Net income (loss)	$	759	$	1	$	760

Total assets	$	576,675	$	1,758	$	578,433

Three months ended March 31, 2016
Net interest income	$	4,687	$	—	$	4,687
Provision for loan losses		200		—		200

Net interest income after provision for loan losses		4,487		—		4,487
Noninterest income		508		500		1,008
Noninterest expenses		3,733		457		4,190

Income before income taxes		1,262		43		1,305
Income tax expense		403		15		418

Net income	$	859	$	28	$	887

Total assets	$	520,801	$	3,810	$	524,611

Note 9 – Loans, allowance for loan losses and OREO

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


Loan

Segments:		Loan Classes:

Commercial		Commercial and industrial loans

Commercial real estate		Commercial mortgages – owner occupied

		Commercial mortgages – non-owner occupied

		Commercial construction

Consumer		Consumer unsecured

		Consumer secured

Residential		Residential mortgages

		Residential consumer construction

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


	As of:
	March 31,		December 31,
	2017		2016
Commercial	$	89,288	$	88,085
Commercial real estate		239,520		237,638
Consumer		85,023		85,099
Residential		58,129		59,247

Total loans (1)		471,960		470,069

Less allowance for loan losses		5,716		5,716

Net loans	$	466,244	$	464,353

(1)	Includes net deferred costs of $235 and $182 as of March 31, 2017 and December 31, 2016, 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.

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

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


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

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

•

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

•

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

•

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

•

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

•

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

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

•

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


Loans on Non-Accrual Status
(dollars in thousands)
	As of
	March 31, 2017		December 31, 2016
Commercial	$	894	$	915
Commercial Real Estate:
Commercial Mortgages-Owner Occupied		827		855
Commercial Mortgages-Non-Owner Occupied		71		—
Commercial Construction		239		256
Consumer
Consumer Unsecured		—		—
Consumer Secured		177		80
Residential:
Residential Mortgages		874		1,292
Residential Consumer Construction		65		67

Totals	$	3,147	$	3,465

We also classify other real estate owned (OREO) as a nonperforming asset. OREO represents real property owned by the Bank either through purchase at foreclosure or received from the borrower through a deed in lieu of foreclosure. OREO increased to $2,750 on March 31, 2017 from $2,370 on December 31, 2016. The following table represents the changes in OREO balance during the three months ended March 31, 2017 and year ended December 31, 2016.


OREO Changes
(dollars in thousands)
	Three months ended March 31, 2017			Year ended December 31, 2016
Balance at the beginning of the year (net)	$	2,370		$	1,965
Transfers from loans		535			470
Capitalized costs		—			—
Valuation adjustments		—			(45	)
Sales proceeds		(147	)		(21	)
Gain (loss) on disposition		(8	)		1

Balance at the end of the period (net)	$	2,750		$	2,370

At March 31, 2017 and December 31, 2016, the Company had $76 and $294 of consumer mortgage loans secured by residential real estate for which foreclosure was in process. The Company held three residential real estate properties in other real estate owned as of March 31, 2017 and no residential real estate property in other real estate owned as of December 31, 2016.

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


	Impaired Loans (dollars in thousands) As of and For the Three Months Ended March 31, 2017
2017	Recorded Investment		Unpaid Principal Balance		Related Allowance		Average Recorded Investment		Interest Income Recognized
With No Related Allowance Recorded:
Commercial	$	252	$	255	$	—	$	475	$	2
Commercial Real Estate
Commercial Mortgages-Owner Occupied		2,262		2,348		—		2,641		46
Commercial Mortgage Non-Owner Occupied		418		421		—		384		5
Commercial Construction		—		—		—		—		—
Consumer
Consumer Unsecured		—		—		—		—		—
Consumer Secured		18		18		—		18		—
Residential
Residential Mortgages		1,588		1,673		—		1,572		10
Residential Consumer Construction		—		—		—		—		—

With An Allowance Recorded:
Commercial	$	1,499	$	1,511	$	1,128	$	1,510	$	9
Commercial Real Estate
Commercial Mortgages-Owner Occupied		1,225		1,225		233		1,406		16
Commercial Mortgage Non-Owner Occupied		74		74		19		74		1
Commercial Construction		169		666		78		169		—
Consumer
Consumer Unsecured		3		3		3		2		—
Consumer Secured		109		109		109		110		2
Residential
Residential Mortgages		262		276		17		481		2
Residential Consumer Construction		—		—		—		—		—

Totals:
Commercial	$	1,751	$	1,766	$	1,128	$	1,985	$	11
Commercial Real Estate
Commercial Mortgages-Owner Occupied		3,487		3,573		233		4,047		62
Commercial Mortgage Non-Owner Occupied		492		495		19		458		6
Commercial Construction		169		666		78		169		—
Consumer
Consumer Unsecured		3		3		3		2		—
Consumer Secured		127		127		109		128		2
Residential
Residential Mortgages		1,850		1,949		17		2,053		12
Residential Consumer Construction		—		—		—		—		—

	$	7,879	$	8,579	$	1,587	$	8,842	$	93

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


	Impaired Loans (dollars in thousands) As of and For the Year Ended December 31, 2016
2016	Recorded Investment		Unpaid Principal Balance		Related Allowance		Average Recorded Investment		Interest Income Recognized
With No Related Allowance Recorded:
Commercial	$	698	$	698	$	—	$	349	$	37
Commercial Real Estate
Commercial Mortgages-Owner Occupied		3,019		3,077		—		3,051		142
Commercial Mortgage Non-Owner Occupied		349		349		—		263		23
Commercial Construction		—		—		—		14		—
Consumer
Consumer Unsecured		—		—		—		—		—
Consumer Secured		18		18		—		19		1
Residential
Residential Mortgages		1,555		1,687		—		1,776		55
Residential Consumer Construction		—		—		—		86		—

With An Allowance Recorded:
Commercial	$	1,521	$	1,521	$	1,233	$	1,351	$	81
Commercial Real Estate
Commercial Mortgages-Owner Occupied		1,587		1,618		249		1,232		81
Commercial Mortgage Non-Owner Occupied		74		74		20		373		6
Commercial Construction		169		657		76		255		—
Consumer
Consumer Unsecured		—		—		—		16		—
Consumer Secured		110		110		110		150		8
Residential
Residential Mortgages		699		736		83		675		30
Residential Consumer Construction		—		—		—		—		—

Totals:
Commercial	$	2,219	$	2,219	$	1,233	$	1,700	$	118
Commercial Real Estate
Commercial Mortgages-Owner Occupied		4,606		4,695		249		4,283		223
Commercial Mortgage Non-Owner Occupied		423		423		20		636		29
Commercial Construction		169		657		76		269		—
Consumer
Consumer Unsecured		—		—		—		16		—
Consumer Secured		128		128		110		169		9
Residential
Residential Mortgages		2,254		2,423		83		2,451		85
Residential Consumer Construction		—		—		—		86		—

	$	9,799	$	10,545	$	1,771	$	9,610	$	464

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


	Allowance for Loan Losses and Recorded Investment in Loans (dollars in thousands) As of and For the Three Months Ended March 31, 2017
2017	Commercial			Commercial Real Estate			Consumer			Residential			Total
Allowance for Loan Losses:
Beginning Balance	$	2,192		$	2,109		$	954		$	461		$	5,716
Charge-offs		(5	)		(17	)		(3	)		(105	)		(130	)
Recoveries		1			13			15			1			30
Provision		(67	)		115			(7	)		59			100

Ending Balance	$	2,121		$	2,220		$	959		$	416		$	5,716

Ending Balance: Individually evaluated for impairment	$	1,128		$	330		$	112		$	17		$	1,587

Ending Balance: Collectively evaluated for impairment		993			1,890			847			399			4,129

Totals:	$	2,121		$	2,220		$	959		$	416		$	5,716

Loans:
Ending Balance: Individually evaluated for impairment	$	1,751		$	4,148		$	130		$	1,850		$	7,879

Ending Balance: Collectively evaluated for impairment		87,537			235,372			84,893			56,279			464,081

Totals:	$	89,288		$	239,520		$	85,023		$	58,129		$	471,960

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


	Allowance for Loan Losses and Recorded Investment in Loans (dollars in thousands) As of and For the Year Ended December 31, 2016
2016	Commercial			Commercial Real Estate			Consumer			Residential			Total
Allowance for Loan Losses:
Beginning Balance	$	1,195		$	1,751		$	1,073		$	664		$	4,683
Charge-offs		(328	)		(156	)		(275	)		—			(759	)
Recoveries		7			127			44			2			180
Provision		1,318			387			112			(205	)		1,612

Ending Balance	$	2,192		$	2,109		$	954		$	461		$	5,716

Ending Balance: Individually evaluated for impairment	$	1,233		$	345		$	110		$	83		$	1,771

Ending Balance: Collectively evaluated for impairment		959			1,764			844			378			3,945

Totals:	$	2,192		$	2,109		$	954		$	461		$	5,716

Loans:
Ending Balance: Individually evaluated for impairment	$	2,219		$	5,198		$	128		$	2,254		$	9,799

Ending Balance: Collectively evaluated for impairment		85,866			232,440			84,971			56,993			460,270

Totals:	$	88,085		$	237,638		$	85,099		$	59,247		$	470,069

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


	Age Analysis of Past Due Loans as of
	March 31, 2017
	(dollars in thousands)
					Greater								Recorded Investment
	30-59 Days		60-89 Days		than		Total Past				Total		> 90 Days &
2017	Past Due		Past Due		90 Days		Due		Current		Loans		Accruing
Commercial	$	155	$	819	$	150	$	1,124	$	88,164	$	89,288	$	—
Commercial Real Estate:
Commercial Mortgages-Owner Occupied		57		937		495		1,489		89,542		91,031		—
Commercial Mortgages-Non-Owner Occupied		48		—		71		119		134,493		134,612		—
Commercial Construction		—		—		239		239		13,638		13,877		—
Consumer:
Consumer Unsecured		39		—		—		39		8,435		8,474		—
Consumer Secured		319		245		129		693		75,856		76,549		—
Residential:
Residential Mortgages		684		34		498		1,216		50,146		51,362		—
Residential Consumer Construction		—		—		65		65		6,702		6,767		—

Total	$	1,302	$	2,035	$	1,647	$	4,984	$	466,976	$	471,960	$	—


	Age Analysis of Past Due Loans as of
	December 31, 2016
	(dollars in thousands)
					Greater								Recorded Investment
	30-59 Days		60-89 Days		than		Total Past				Total		> 90 Days &
2016	Past Due		Past Due		90 Days		Due		Current		Loans		Accruing
Commercial	$	283	$	5	$	78	$	366	$	87,719	$	88,085	$	—
Commercial Real Estate:
Commercial Mortgages-Owner Occupied		1,136		72		855		2,063		88,698		90,761		—
Commercial Mortgages-Non-Owner Occupied		140		—		—		140		134,262		134,402		—
Commercial Construction		—		—		256		256		12,219		12,475		—
Consumer:
Consumer Unsecured		9		—		—		9		8,558		8,567		—
Consumer Secured		531		301		—		832		75,700		76,532		—
Residential:
Residential Mortgages		539		161		1,063		1,763		49,525		51,288		—
Residential Consumer Construction		—		—		67		67		7,892		7,959		—

Total	$	2,638	$	539	$	2,319	$	5,496	$	464,573	$	470,069	$	—

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


	Credit Quality Information - by Class
	March 31, 2017
	(dollars in thousands)
2017	Pass		Monitor		Special		Substandard		Doubtful		Totals
2017	Pass		Monitor		Mention		Substandard		Doubtful		Totals
Commercial	$	85,272	$	1,250	$	837	$	1,185	$	744	$	89,288
Commercial Real Estate:
Commercial Mortgages-Owner Occupied		83,365		4,011		100		3,555		—		91,031
Commercial Mortgages-Non Owner Occupied		131,716		1,754		519		623		—		134,612
Commercial Construction		12,550		1,088		—		239		—		13,877
Consumer
Consumer Unsecured		8,474		—		—		—		—		8,474
Consumer Secured		76,098		—		—		451		—		76,549
Residential:
Residential Mortgages		48,972		—		243		2,147		—		51,362
Residential Consumer Construction		6,702		—		—		65		—		6,767

Totals	$	453,149	$	8,103	$	1,699	$	8,265	$	744	$	471,960


	Credit Quality Information - by Class
	December 31, 2016
	(dollars in thousands)
2016	Pass		Monitor		Special		Substandard		Doubtful		Totals
2016	Pass		Monitor		Mention		Substandard		Doubtful		Totals
Commercial	$	83,912	$	1,473	$	301	$	1,484	$	915	$	88,085
Commercial Real Estate:
Commercial Mortgages-Owner Occupied		83,008		2,975		101		4,677		—		90,761
Commercial Mortgages-Non Owner Occupied		129,794		3,525		525		558		—		134,402
Commercial Construction		11,774		—		445		256		—		12,475
Consumer
Consumer Unsecured		8,567		—		—		—		—		8,567
Consumer Secured		76,215		—		—		317		—		76,532
Residential:
Residential Mortgages		48,366		—		245		2,677		—		51,288
Residential Consumer Construction		7,892		—		—		67		—		7,959

Totals	$	449,528	$	7,973	$	1,617	$	10,036	$	915	$	470,069

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

There were no loan modifications that would have been classified as TDRs during the three months ended March 31, 2017 and 2016.

There were no loan modifications classified as TDRs within the last twelve months that defaulted during the three months ended March 31, 2017 and 2016.

At March 31, 2017 and December 31, 2016, the Bank had no outstanding commitments to disburse additional funds on loans classified as TDRs.

Note 10 – Recent accounting pronouncements

In January 2016, the FASB issued ASU 2016-01, “Financial Instruments – Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities.” The amendments in ASU 2016-01, among other things: 1) Requires equity investments (except those accounted for under the equity method of accounting, or those that result in consolidation of the investee) to be measured at fair value with changes in fair value recognized in net income. 2) Requires public business entities to use the exit price notion when measuring the fair value of financial instruments for disclosure purposes. 3) Requires separate presentation of financial assets and financial liabilities by measurement category and form of financial asset (i.e., securities or loans and receivables). 4) Eliminates the requirement for public business entities to disclose the method(s) and significant assumptions used to estimate the fair value that is required to be disclosed for financial instruments measured at amortized cost. The amendments in this ASU are effective for public companies for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years. The Company is currently assessing the impact that ASU 2016-01 will have on its consolidated financial statements.

In February 2016, the FASB issued ASU No. 2016-02, “Leases (Topic 842).” Among other things, in the amendments in ASU 2016-02, lessees will be required to recognize the following for all leases (with the exception of short-term leases) at the commencement date: (1) A lease liability, which is a lessee‘s obligation to make lease payments arising from a lease, measured on a discounted basis; and (2) A right-of-use asset, which is an asset that represents the lessee’s right to use, or control the use of, a specified asset for the lease term. Under the new guidance, lessor accounting is largely unchanged. Certain targeted improvements were made to align, where necessary, lessor accounting with the lessee accounting model and Topic 606, Revenue from Contracts with Customers. The amendments in this ASU are effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. Early application is permitted upon issuance. Lessees (for capital and operating leases) and lessors (for sales-type, direct financing, and operating leases) must apply a modified retrospective transition approach for leases existing at, or entered into after, the beginning of the earliest comparative period presented in the financial statements. The modified retrospective approach would not require any transition accounting for leases that expired before the earliest comparative period presented. Lessees and lessors may not apply a full retrospective transition approach. The Company is currently assessing the impact that ASU 2016-02 will have on its consolidated financial statements.

During June 2016, the FASB issued ASU No. 2016-13, “Financial Instruments – Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments.” The amendments in this ASU, among other things, require the measurement of all expected credit losses for financial assets held at the reporting date based on historical experience, current conditions, and reasonable and supportable forecasts. Financial institutions and other organizations will now use forward-looking information to better inform their credit loss estimates. Many of the loss estimation techniques applied today will still be permitted, although the inputs to those techniques will change to reflect the full amount of expected credit losses. In addition, the ASU amends the accounting for credit losses on available-for-sale debt securities and purchased financial assets with credit deterioration. The amendments in this ASU are effective for SEC

Note 10 – Recent accounting pronouncements (continued)

filers for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2019. The Company is currently assessing the impact that ASU 2016-13 will have on its consolidated financial statements.

During August 2016, the FASB issued ASU No. 2016-15, “Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments”, to address diversity in how certain cash receipts and cash payments are presented and classified in the statement of cash flows. The amendments are effective for public business entities for fiscal years beginning after December 15, 2017, and interim periods within those fiscal years. The amendments should be applied using a retrospective transition method to each period presented. If retrospective application is impractical for some of the issues addressed by the update, the amendments for those issues would be applied prospectively as of the earliest date practicable. Early adoption is permitted, including adoption in an interim period. The Company does not expect the adoption of ASU 2016-15 to have a material impact on its consolidated financial statements.

During January 2017, the FASB issued ASU No. 2017-01, “Business Combinations (Topic 805): Clarifying the Definition of a Business”. The amendments in this ASU clarify the definition of a business with the objective of adding guidance to assist entities with evaluating whether transactions should be accounted for as acquisitions (or disposals) of assets or businesses. Under the current implementation guidance in Topic 805, there are three elements of a business—inputs, processes, and outputs. While an integrated set of assets and activities (collectively referred to as a “set”) that is a business usually has outputs, outputs are not required to be present. In addition, all the inputs and processes that a seller uses in operating a set are not required if market participants can acquire the set and continue to produce outputs. The amendments in this ASU provide a screen to determine when a set is not a business. If the screen is not met, the amendments (1) require that to be considered a business, a set must include, at a minimum, an input and a substantive process that together significantly contribute to the ability to create output and (2) remove the evaluation of whether a market participant could replace missing elements. The ASU provides a framework to assist entities in evaluating whether both an input and a substantive process are present. The amendments in this ASU are effective for annual periods beginning after December 15, 2017, including interim periods within those annual periods. The amendments in this ASU should be applied prospectively on or after the effective date. No disclosures are required at transition. The Company does not expect the adoption of ASU 2017-01 to have a material impact on its consolidated financial statements.

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

During March 2017, the FASB issued ASU 2017-07, “Compensation — Retirement Benefits (Topic 715): Improving the Presentation of Net Periodic Pension Cost and Net Periodic Postretirement Benefit Cost.” The amendments in this ASU require an employer that offers defined benefit pension plans, other postretirement benefit plans, or other types of benefits accounted for under Topic 715 to report the service

Note 10 – Recent accounting pronouncements (continued)

cost component of net periodic benefit cost in the same line item(s) as other compensation costs arising from services rendered during the period. The other components of net periodic benefit cost are required to be presented in the income statement separately from the service cost component. If the other components of net periodic benefit cost are not presented on a separate line or lines, the line item(s) used in the income statement must be disclosed. In addition, only the service cost component will be eligible for capitalization as part of an asset, when applicable. The amendments are effective for annual periods beginning after December 15, 2017, including interim periods within those annual periods. Early adoption is permitted. The Company does not expect the adoption of ASU 2017-07 to have a material impact on its consolidated financial statements.

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

Item 2.

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

CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS

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

GENERAL

Critical Accounting Policies

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

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

are carried at fair value less estimated costs to sell at the date of foreclosure. Losses from the acquisition of property in full or partial satisfaction of loans are charged against the allowance for loan losses. Subsequent write-downs, if any, are charged against expense. Gains and losses on the sales of foreclosed properties are included in determining net income in the year of the sale. Operating costs after acquisition are expensed.

Overview

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

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

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

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

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

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

Full Service Branches

•

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

•

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

•

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

•

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

•

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

•

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

•

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

•

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

•

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

•

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

•

A branch located at 180 Old Courthouse Rd, Appomattox, VA (the “Appomattox Branch”),

•

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

•

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

Limited Service Branches

•

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

•

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

•

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

Loan Production Offices

•

Residential mortgage loan production office located at the Forest Branch,

•

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

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

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

Subject to regulatory approval, the Bank anticipates opening additional branches during the next two fiscal years. Although numerous factors could influence the Bank’s expansion plans, the following

discussion provides a general overview of the additional branch locations that the Bank currently is considering, including the following properties that we own and are holding for expansion:

•

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

•

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

•

Real property located near the intersection of Confederate Boulevard and Moses Avenue in Appomattox, Virginia. There is no structure on the property. The Bank began construction of a permanent full service location in April 2017. At the completion of construction and upfit, the Bank will relocate its temporary location (180 Old Courthouse Road referenced in the location table above) to this permanent location. The Bank anticipates that construction will be complete in late 2017 or early 2018.

•

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

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

In addition, the Bank determined that a portion of real property located on Route 460 (Bedford County) is suitable for branch expansion and has reclassified the property accordingly.

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

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

OFF-BALANCE SHEET ARRANGEMENTS

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

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

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


	March 31, 2017 (in thousands)
Commitments to extend credit	$	94,654
Letters of Credit		3,377

Total	$	98,031

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

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

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

SUMMARY OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following discussion represents management’s discussion and analysis of the financial condition of Financial as of March 31, 2017 and December 31, 2016 and the results of operations of Financial for the three month periods ended March 31, 2017 and 2016. This discussion should be read in conjunction with the financial statements included elsewhere herein.

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

Financial Condition Summary

March 31, 2017 as Compared to December 31, 2016

Total assets were $578,433,000 on March 31, 2017 compared with $574,195,000 at December 31, 2016, an increase of 0.74%. The increase in total assets was primarily due to the issuance of $5,000,000 of notes (the “2017 Notes”) in a private placement that closed on January 25, 2017. The increase in assets was offset in part by a decrease in deposits.

Total deposits decreased from $523,112,000 as of December 31, 2016 to $521,199,000 on March 31, 2017, an decrease of 0.37%. The decrease resulted in large part from some note purchasers using funds on deposit with the Bank to purchase the 2017 Notes. NOW, Money Market, and Savings deposits decreased from $255,429,000 on December 31, 2016 to $250,911,000 on March 31, 2017. Noninterest bearing demand deposits increased from $102,654,000 on December 31, 2016 to $105,276,000 on March 31, 2017.

Total loans, excluding loans held for sale, increased to $471,960,000 on March 31, 2017 from $470,069,000 on December 31, 2016. Loans, excluding loans held for sale and net of deferred fees and costs and the allowance for loan losses, increased to $466,244,000 on March 31, 2017 from $464,353,000 on December 31, 2016, an increase of 0.41%. The following summarizes the position of the Bank’s loan portfolio as of the dates indicated by dollar amount and percentages (dollar amounts in thousands):


	March 31, 2017					December 31, 2016
	Amount		Percentage			Amount		Percentage
Commercial	$	89,288		18.92	%	$	88,085		18.74	%
Commercial Real Estate		239,520		50.75	%		237,638		50.55	%
Consumer		85,023		18.01	%		85,099		18.11	%
Residential		58,129		12.32	%		59,247		12.60	%

Total loans	$	471,960		100.00	%	$	470,069		100.00	%

Total nonperforming assets, which consist of non-accrual loans, loans past due 90 days or more and still accruing, and other real estate owned (“OREO”) increased to $5,897,000 on March 31, 2017 from $4,920,000 on December 31, 2016. OREO increased to $2,750,000 on March 31, 2017 from $2,370,000 on December 31, 2016. This increase was due to the Bank’s foreclosure on four properties in the three months ended March 31, 2017 on real estate that secured loans then classified as non-performing. Following a) the foreclosure and subsequent re-categorization from non-performing to OREO along; and b) the reclassification of the obligations of one borrower to non-performing, non-performing loans increased from $2,550,000 at December 31, 2016 to $3,147,000 at March 31, 2017. As discussed in more detail below under “Results of Operations—Allowance for Loan Losses,” management had 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. These loans were included in the non-performing loan totals listed above.

OREO represents real property acquired by the Bank for debts previously contracted, including through foreclosure, deeds in lieu of foreclosure or repossession. On December 31, 2016, the Bank was carrying six OREO properties on its books at a value of $2,370,000. During the three months ended March 31, 2017, the Bank acquired four additional OREO properties and disposed of two OREO properties, and as of March 31, 2017 the Bank is carrying eight OREO properties at a value of $2,750,000. The OREO properties are available for sale and are being actively marketed on the Bank’s website and through other means.

The Bank had loans in the amount of $452,000 at March 31, 2017 classified as performing Troubled Debt Restructurings (“TDRs”) as compared to $455,000 at December 31, 2016. None of these TDRs were included in non-accrual loans. These loans have had their original terms modified to facilitate payment by the borrower. The loans have been classified as TDRs primarily due to a change to interest only payments and the maturity of these modified loans is primarily less than one year.

Cash and cash equivalents decreased to $25,259,000 on March 31, 2017 from $28,683,000 on December 31, 2016. Cash and cash equivalents consist of cash due from correspondents, cash in vault, and overnight investments (including federal funds sold). The decrease in cash and cash equivalents was due primarily to a decrease in federal funds sold, the proceeds of which were used to purchase securities available-for-sale. In addition, cash and cash equivalents are subject to routine fluctuations in deposits, including fluctuations in transactional accounts and professional settlement accounts.

Securities held-to-maturity decreased to $3,293,000 on March 31, 2017 from $3,299,000 on December 31, 2016. Securities available-for-sale increased to $48,220,000 on March 31, 2017, from $40,776,000 on December 31, 2016. The increase resulted from the Bank’s desire to build on-balance sheet liquidity and because of a slight increase in interest rates. During the three months ended March 31, 2017 the Bank received $1,490,000 in proceeds from calls, maturities, and paydowns of securities available-for-sale and $970,000 in proceeds from the sale of securities available-for-sale. The Bank purchased $9,568,000 in securities available-for sale during the same period.

Financial’s investment in Federal Home Loan Bank of Atlanta (FHLBA) stock totaled $607,000 at March 31, 2017 and $565,000 at December 31, 2016, an increase of $42,000. This increase is attributable to the FHLBA’s increase in minimum ownership requirements. FHLBA stock is generally viewed as a long-term investment and because there is no market for the stock other than other Federal Home Loan Banks or member institutions, FHLBA stock is viewed as a restricted security. Therefore, when evaluating FHLBA stock for impairment, its value is based on the ultimate recoverability of the par value rather than by recognizing temporary declines in value.

Liquidity and Capital

At March 31, 2017, Financial, on a consolidated basis, had liquid assets of $73,479,000 in the form of cash, interest-bearing and noninterest-bearing deposits with banks, and available-for-sale investments. Of this amount, approximately $13,798,000 of the available-for-sale securities are pledged as collateral with $9,114,000 pledged as security for public deposits and $4,684,000 pledged as security on a line of credit the Bank may draw on from time to time to meet liquidity needs. This line of credit currently has a zero balance. Management believes that liquid assets were adequate at March 31, 2017. Management anticipates that additional liquidity will be provided by the growth in deposit accounts and loan repayments at the Bank. In addition, if additional liquidity is needed, the Bank has the ability to purchase federal funds on the open market, borrow from the FHLBA using loans or investments within the Bank’s portfolio as collateral, and to borrow from the Federal Reserve Bank’s discount window.

Management is not aware of any trends, events or uncertainties that are reasonably likely to have a material negative impact on Financial’s short-term or long-term liquidity. Based in part on recent loan growth, the Bank is monitoring liquidity to ensure it is able to fund future loans.

As of December 31, 2015, Financial had $10,000,000 categorized as “Capital Notes” which represents the proceeds of the private placement of $10,000,000 in unregistered debt securities as previously disclosed (the “2012 Notes”). The 2012 Notes bore interest at the rate of 6% per year with interest payable quarterly in arrears. On December 3, 2015, Financial closed a private placement of common stock pursuant to which it received gross proceeds of $11,520,000 by selling an aggregate of 1,000,000 shares of Financials’ Common Stock at a price of $11.52 per share, as part of a private placement (the “Common Stock Private Placement”). Financial used $10,000,000 of the proceeds from the Common Stock Private Placement to prepay in full the 2012 Notes on January 5, 2016.

At March 31, 2017, the Bank had a leverage ratio of approximately 9.53%, a Tier 1 risk-based capital ratio and a CET1 ratio of approximately 11.02% and a total risk-based capital ratio of approximately 12.17%. As of March 31, 2017 and December 31, 2016 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 March 31, 2017 and December 31, 2016:

Bank Level Only Capital Ratios


	March 31,		December 31,
Analysis of Capital (in 000’s)	2017		2016
Tier 1 capital
Common Stock	$	3,742	$	3,742
Surplus		22,325		19,325
Retained earnings		28,408		27,582

Total Tier 1 capital	$	54,475	$	50,649

Common Equity Tier 1 Capital (CET1)	$	54,475	$	50,649

Tier 2 capital
Allowance for loan losses	$	5,716	$	5,716

Total Tier 2 capital:	$	5,716	$	5,716

Total risk-based capital	$	60,191	$	56,365

Risk weighted assets	$	494,504	$	488,607
Average total assets	$	571,845	$	566,399


	Actual						Regulatory Benchmarks
							For Capital			For Well
	March 31,			December 31,			Adequacy			Capitalized
	2017			2016			Purposes (1)			Purposes
Capital Ratios:
Tier 1 capital to average total assets		9.526	%		8.942	%		4.625	%		5.000	%
Common Equity Tier 1 Ratio		11.016	%		10.366	%		5.750	%		6.500	%
Tier 1 risk-based capital ratio		11.016	%		10.366	%		7.250	%		8.000	%
Total risk-based capital ratio		12.172	%		11.536	%		9.250	%		10.000	%

(1)	Minimum capital requirements for CET1, Tier 1, and Total Capital ratios include the capital conservation buffer of 1.25%, which is being phased in until January, 2019.

The above tables set forth the capital position and analysis for the Bank only. Because total assets on a consolidated basis are less than $1,000,000,000, Financial is not subject to the consolidated capital requirements imposed by the Bank Holding Company Act. Consequently, Financial does not calculate its financial ratios on a consolidated basis. If calculated, the capital ratios for the Company on a consolidated basis at March 31, 2017 would be comparable to those of the Bank.

In July 2013, the Federal Reserve Board approved a final rule establishing a regulatory capital framework for smaller, less complex financial institutions. The rule implements in the United States the Basel III regulatory capital reforms from the Basel Committee on Banking Supervision and certain changes required by the Dodd-Frank Wall Street Reform and Consumer Protection Act. The phase-in

period for this rule began in January 2015. Under the final rule, minimum requirements were increased for both the quantity and quality of capital held by banking organizations. The rule included a new minimum ratio of common equity Tier 1 capital to risk-weighted assets of 4.5% and a common equity Tier 1 capital conservation buffer of 2.5% of risk-weighted assets that applies to all supervised financial institutions. The capital conservation buffer began its phase-in on January 1, 2016 at 0.625% and increases by an additional 0.625% annually until it reaches 2.5% on January 1, 2019. This will result in an effective Tier 1 capital ratio of 8.5% upon full implementation. The capital conservation buffer will limit capital distributions, stock redemptions, and certain discretionary bonuses. Beginning January 1, 2016, failure to maintain the capital conservation buffer will limit the ability of the Bank and Financial to pay dividends, repurchase shares or pay discretionary bonuses. The rule also raised the minimum ratio of Tier 1 capital to risk-weighted assets from 4% to 6% and includes a minimum leverage ratio of 4% for all banking organizations.

Results of Operations

Comparison of the Three Months Ended March 31, 2017 and 2016

Earnings Summary

Financial had net income including all operating segments of $760,000 for the three months ended March 31, 2017, compared to $887,000 for the comparable period in 2016. Basic and diluted earnings per common share for the three months ended March 31, 2017 were $0.17, compared to basic and diluted earnings per share of $0.20 for the three months ended March 31, 2016.

The decrease in net income for the three months ended March 31, 2017 as compared to the prior year was due primarily to a decrease in non-interest income, an increase in interest expense, and increase in non-interest expense. The increases were partially offset by an increase in interest income. Non-interest expense increased in large part because of the Bank’s recent expansion into Charlottesville, Harrisonburg, and Roanoke. These expansions resulted in increases in personnel expense, occupancy expense, professional and data processing expense, and marketing expense.

These operating results represent an annualized return on average stockholders’ equity of 6.05% for the three months ended March 31, 2017, compared with 7.30% for the three months ended March 31, 2016. This decrease for the three months was a direct result of the decrease in net income. The Company had an annualized return on average assets of 0.53% for the three months ended March 31, 2017 compared with 0.68% for the same period in 2016. The decrease for the three months ended March 31, 2017 largely resulted from an increase in average assets since March 31, 2016 along with 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 increased to $5,509,000 for the three months ended March 31, 2017 from $5,235,000 for the same period in 2016, an increase of 5.23%. Interest income increased primarily because of increased balances in the loan and investment portfolios. The average rate received on earning assets decreased to 4.16% for the three months ended March 31, 2017 as compared with 4.35% for the comparable period in 2016. The rate on total average earning assets decreased primarily because of a decrease in the rate received on loans resulting from a competitive banking environment. Management expects that competition will continue to pressure the rates we receive on loans and therefore may negatively impact our interest income.

Interest expense increased to $671,000 for the three months ended March 31, 2017 from $548,000 for the same period in 2016, an increase of 22.45%. The increase in interest expense resulted primarily from an increase interest paid on time deposits and interest bearing demand deposits and the interest paid on 2017 Notes. The Bank’s average rate paid on interest bearing deposits was 0.62% during the three month period ended March 31, 2017 as compared to 0.58% for the same period in 2016.

The fundamental source of the Bank’s net revenue is net interest income, which is determined by the difference between (i) interest and dividend income on interest earning assets, which consist primarily of loans, investment securities and other investments, and (ii) interest expense on interest-bearing liabilities, which consist principally of deposits and other borrowings. Net interest income for the three months ended March 31, 2017 was $4,838,000 compared to $4,687,000 for the same period in 2016, an increase of 3.22%. The change in net interest income for the three months ended March 31, 2017 as compared with the comparable period in 2016 primarily is attributable to the increase in interest income resulting from increased loan balances. The net interest margin was 3.65% for the three months ended March 31, 2017, as compared to 3.89% for the same period a year ago.

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

Non-Interest Income

Non-interest income is comprised primarily of fees and charges on transactional deposit accounts, gains on sales of mortgage loans held for sale, commissions on sales of investments and the Bank’s ownership interest in a title insurance agency. Non-interest income decreased to $881,000 for the three months ended March 31, 2017 from $1,008,000 for the three months ended March 31, 2016. This decrease for the three months ended March 31, 2017 as compared to the same period last year was due primarily due to a decrease in gains on sales of loans held for sale from $491,000 for the three months ended March 31, 2016 to $371,000 for the period ended March 31, 2017 and a decrease in gains on sales of securities from $65,000 for three months ended March 31, 2016 to $10,000 for the same period this year. The decrease for the three months ended March 31, 2017 was partially offset by increases in service charges, fees, and commissions and an increase in the cash value of life insurance from three months ended March 31, 2016 as compared to the three months ended March 31, 2017. These areas increased due to customer activity and utilization of services and additional purchases of BOLI in the third quarter of 2016.

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 approximately $6,022,000 or 46.42% of the total mortgage loans originated in the three months ended March 31, 2017 as compared to approximately $11,040,000 or 68.00% of the total mortgage loans originated in the same period in 2016. The decrease in amount of purchase mortgage originations resulted from a decrease in for-sale residential real estate inventory in the Region 2000 market and a slight increase in longer-term interest rates. However, despite the increase in longer-term rates, refinancing activity continued primarily due to the relatively low interest rate environment as compared to long-term historical interest rate levels. Management anticipates that purchase mortgage originations going forward will represent a majority of mortgage originations as they have in the recent past.

Despite the recent fluctuations in rates, management anticipates that residential mortgage rates will remain near the current historic lows for the remainder of 2017. Management expects that attractive rates coupled with the Mortgage division’s reputation in Region 2000, increased residential real estate seasonal inventory and the recent hiring of additional mortgage loan originators in Roanoke, Harrisonburg and Charlottesville will result in increased mortgage originations through the remainder of 2017 as compared to the three month period ended March 31, 2017. In addition, Management believes that

regulatory pressure may result in a decreased number of competitors to the Mortgage division and this could result in an increase in market share. Management also believes that in the event that interest rates rise, revenue from the mortgage segment could be under pressure.

Our Investment division provides brokerage services through an agreement with a third-party broker-dealer. Pursuant to this arrangement, the third party broker-dealer operates a service center adjacent to one of the branches of the Bank. The center is staffed by dual employees of the Bank and the broker-dealer. Investment receives commissions on transactions generated and in some cases ongoing management fees such as mutual fund 12b-1 fees. The Investment division’s financial impact on our consolidated revenue has been immaterial. Although management cannot predict the financial impact of Investment with certainty, management anticipates the Investment division’s impact on noninterest income will remain immaterial in 2017.

The Bank provides insurance and annuity products to Bank customers and others, through the Bank’s Insurance subsidiary. The Bank has three full-time employees that are dedicated to selling insurance products through Insurance. Insurance generates minimal revenue and its financial impact on our consolidated revenue has been immaterial. Management anticipates that Insurance’s impact on noninterest income will remain immaterial in 2017.

Non-Interest Expense

Non-interest expense for the three months ended March 31, 2017 increased to $4,517,000 from $4,190,000, an increase of 7.80% from the comparable period in 2016. This resulted from increases for personnel expense primarily related to the expansion into Charlottesville, Harrisonburg, and Roanoke, as well as increases in professional, data processing and outside expenses, credit expense, marketing expenses, occupancy expenses, equipment expenses, and supplies expense. Total personnel expense was $2,380,000 for the three month period ended March 31, 2017 as compared to $2,237,000 for the same period in 2016.

Allowance for Loan Losses

The allowance for loan losses represents an amount that, in our judgment, will be adequate to absorb probable losses inherent in the loan portfolio. The provision for loan losses increases the allowance, and loans charged off, net of recoveries, reduce the allowance. The provision to the allowance for loan losses is charged to earnings to bring the total allowance to a level deemed appropriate by management and is based upon two components – specific impairment and general reserves. As discussed below, loans having a risk rating of 7 or below that are significantly past due, and the borrower’s performance and financial condition provide evidence that it is probable that the Bank will be unable to collect all amounts when due, 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 $100,000 to the allowance for loan losses for the three month period ended March 31, 2017. This compares to the provision of $200,000 for the comparable period in 2016, representing a decrease of 50.00%.

Charged-off loans, which are loans that management deems uncollectible, are charged against the allowance for loan losses and constitute a realized loss. Charged-off loans were $130,000 for the three months ended March 31, 2017 as compared to $251,000 for the comparable period in 2016. While a charged off loan may subsequently be collected, such recoveries generally are realized over an extended period of time. In the three months ended March 31, 2017, the Bank had recoveries of charged off loans of $30,000 as compared with $118,000 for the comparable period in 2016.

In light of the current economic environment, management continues its ongoing assessment of specific impairment in the Bank’s loan portfolio. As set forth in the tables below, the Bank’s allowance arising from the specific impairment evaluation as of March 31, 2017 decreased as compared to December 31, 2016.

The percentage of the allowance for loan losses to total loans was 1.21% as of March 31, 2017 and 1.22% as of December 31, 2016. The overall balance in the allowance for loan losses was unchanged at $5,716,000 as of December 31, 2016 and March 31, 2017. The inherent risks associated with the increasing industry concentrations and commercial real estate concentrations within the portfolio have increased the qualitative portion of the general reserve. Management believes that the current allowance for loan losses is adequate.

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


	Allowance for Loan Losses and Recorded Investment in Loans (dollars in thousands)
	As of and For the Three months Ended March 31, 2017
	Commercial			Commercial Real Estate			Consumer			Residential			Total
2017	Commercial			Commercial Real Estate			Consumer			Residential			Total
Allowance for Loan Losses:
Beginning Balance	$	2,192		$	2,109		$	954		$	461		$	5,716
Charge-offs		(5	)		(17	)		(3	)		(105	)		(130	)
Recoveries		1			13			15			1			30
Provision		(67	)(1)		115	(2)		(7	)(1)		59			100

Ending Balance	$	2,121		$	2,220		$	959		$	416		$	5,716

Ending Balance: Individually evaluated for impairment	$	1,128		$	330		$	112		$	17		$	1,587

Ending Balance: Collectively evaluated for impairment		993			1,890			847			399			4,129

Totals:	$	2,121		$	2,220		$	959		$	416		$	5,716

Loans:
Ending Balance: Individually evaluated for impairment	$	1,751		$	4,148		$	130		$	1,850		$	7,879

Ending Balance: Collectively evaluated for impairment		87,537			235,372			84,893			56,279			464,081

Totals:	$	89,288		$	239,520		$	85,023		$	58,129		$	471,960

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

(2)	The increased concentration of loan balances in the commercial segments resulted in an increase in the provision for these categories. Management has a process for the ongoing evaluation of our loans and the specific risks associated with concentrations in each segment.


	Allowance for Loan Losses and Recorded Investment in Loans (dollars in thousands)
	As of and For the Year Ended December 31, 2016
	Commercial			Commercial Real Estate			Consumer			Residential			Total
2016	Commercial			Commercial Real Estate			Consumer			Residential			Total
Allowance for Loan Losses:
Beginning Balance	$	1,195		$	1,751		$	1,073		$	664		$	4,683
Charge-offs		(328	)		(156	)		(275	)		—			(759	)
Recoveries		7			127			44			2			180
Provision		1,318	(2)		387	(2)		112			(205	)(1)		1,612

Ending Balance	$	2,192		$	2,109		$	954		$	461		$	5,716

Ending Balance: Individually evaluated for impairment	$	1,233		$	345		$	110		$	83		$	1,771

Ending Balance: Collectively evaluated for impairment		959			1,764			844			378			3,945

Totals:	$	2,192		$	2,109		$	954		$	461		$	5,716

Loans:
Ending Balance: Individually evaluated for impairment	$	2,219		$	5,198		$	128		$	2,254		$	9,799

Ending Balance: Collectively evaluated for impairment		85,866			232,440			84,971			56,993			460,270

Totals:	$	88,085		$	237,638		$	85,099		$	59,247		$	470,069

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

(2)

The increased concentration of loan balances in the commercial segments resulted in an increase in the provision for these categories. Management has a process for the ongoing evaluation of our loans and the specific risks associated with concentrations in each segment. Specific reserves increases accounted for the majority of the increase related to the commercial segment.

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


	Three months ended March 31, (in thousands)
	2017			2016
Balance, beginning of period	$	5,716		$	4,683
Provision for loan losses		100			200
Loans charged off		(130	)		(251	)
Recoveries of loans charged off		30			118

Net (charge offs) recoveries		(100	)		(133	)

Balance, end of period	$	5,716		$	4,750

No nonaccrual loans were excluded from impaired loan disclosure under current accounting rules at March 31, 2017 and December 31, 2016. If interest on these loans had been accrued, such income cumulatively would have approximated $368,000 and $391,000 on March 31, 2017 and December 31, 2016, 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.

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

•

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.

•

Income Taxes

For the three months ended March 31, 2017, Financial had an income tax expense of $342,000 as compared to $418,000 for the same period in 2016. This represents an effective tax rate of 31.03% for the three months ended March 31, 2017 as compared with 32.03% for the three months ended March 31, 2016. Our effective rate was lower than the statutory corporate tax rate in both quarters because of federal income tax benefits resulting from the tax treatment of earnings on bank owned life insurance and certain tax free municipal securities.

Schedule I

Net Interest Margin Analysis

Average Balance Sheets

For the Quarter Ended March 31, 2017 and 2016

(dollars in thousands)


	2017								2016
	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)	$	470,005		$	5,173		4.46	%	$	436,927		$	4,961		4.60	%
Loans held for sale		1,390			15		4.38	%		2,302			17		2.99	%
Fed funds sold		7,072			13		0.75	%		3,071			4		0.53	%
Interest bearing bank balances		7,000			15		0.87	%		6,000			6		0.41	%
Securities (3)		50,916			291		2.32	%		38,982			246		2.56	%
Federal agency equities		1,259			7		2.25	%		1,200			6		2.03	%
CBB equity		116			—		—			116			—		—

Total earning assets		537,758			5,514		4.16	%		488,598			5,240		4.35	%

Allowance for loan losses		(5,712	)							(4,739	)
Non-earning assets		44,521								35,537

Total assets	$	576,567							$	519,396


LIABILITIES AND STOCKHOLDERS’ EQUITY
Deposits
Demand interest bearing	$	140,190		$	111		0.32	%	$	118,718		$	76		0.26	%
Savings		108,414			58		0.22	%		113,135			60		0.22	%
Time deposits		163,990			465		1.15	%		144,869			400		1.12	%

Total interest bearing deposits		412,594			634		0.62	%		376,722			536		0.58	%

Other borrowed funds
Fed funds purchased		—			—		—			1,487			4		1.09	%
Capital Notes		3,667			37		4.00	%		330			8		6.00	%

Total interest-bearing liabilities		416,261			671		0.65	%		378,539			548		0.59	%

Non-interest bearing deposits		108,287								90,181
Other liabilities		1,049								1,945

Total liabilities		525,597								470,665
Stockholders’ equity		50,970								48,731

Total liabilities and Stockholders’ equity	$	576,567							$	519,396

Net interest income				$	4,843							$	4,692

Net interest margin							3.65	%							3.89	%

Interest spread							3.51	%							3.76	%

(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. An assumed income tax rate of 34% was used in the calculation.

Item 3.

Quantitative and Qualitative Disclosures About Market Risk

Not applicable

Item 4.

Controls and Procedures

EVALUATION OF DISCLOSURE CONTROLS AND PROCEDURES

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

There have been no significant changes during the three months ended March 31, 2017, in the Company’s internal controls over financial reporting (as defined in Rules 13a-15(e) and 15d-15(e) of the Securities Exchange Act of 1934) or in other factors that could have significantly affected those controls subsequent to the date of our most recent evaluation of internal controls over financial reporting, including any corrective actions with regard to significant deficiencies and material weaknesses.

PART II – OTHER INFORMATION

Item 1.

Legal Proceedings

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

Item 1A.

Risk Factors

Not required for smaller reporting companies.

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

Not applicable

Item 3.

Defaults Upon Senior Securities

Not applicable

Item 4.

Mine Safety Disclosures

Not applicable

Item 5.

Other Information

Not applicable

Item 6.

Exhibits


Exhibit No.		Description of Exhibit

31.1		Certification of Robert R. Chapman III Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002, dated May 10, 2017

31.2		Certification of J. Todd Scruggs Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002, dated May 10, 2017

32.1		Certification Pursuant To 18 U.S.C. Section 1350, As Adopted Pursuant To Section 906 Of The Sarbanes-Oxley Act Of 2002, dated May 10, 2017

101		The following materials from Bank of the James Financial Group, Inc.’s Quarterly Report on Form 10-Q for the quarter ended March 31, 2017, formatted in eXtensible Business Reporting Language (XBRL): (i) Consolidated Balance Sheets (unaudited) as of March 31, 2017 and December 31, 2016; (ii) Consolidated Statements of Income (unaudited) for the three months ended March 31, 2017 and 2016; (iii) Consolidated Statements of Comprehensive Income (unaudited) for the three months ended March 31, 2017 and 2016 (iv) Consolidated Statements of Cash Flows (unaudited) for the three months ended March 31, 2017 and 2016 (v) Unaudited Consolidated Statements of Changes in Stockholders’ Equity for the three months ended March 31, 2017 and 2016; (vi) Notes to Unaudited Consolidated Financial Statements.

SIGNATURES

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


	BANK OF THE JAMES FINANCIAL GROUP, INC.

Date: May 10, 2017	By	/S/ Robert R. Chapman III
		Robert R. Chapman III, President
		(Principal Executive Officer)

Date: May 10, 2017	By	/S/ J. Todd Scruggs
		J. Todd Scruggs, Secretary and Treasurer
		(Principal Financial Officer and Principal Accounting Officer)

Index of Exhibits


Exhibit No.		Description of Exhibit

31.1		Certification of Robert R. Chapman III Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002, dated May 10, 2017

31.2		Certification of J. Todd Scruggs Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002, dated May 10, 2017

32.1		Certification Pursuant To 18 U.S.C. Section 1350, As Adopted Pursuant To Section 906 Of The Sarbanes-Oxley Act Of 2002, dated May 10, 2017

101		The following materials from Bank of the James Financial Group, Inc.’s Quarterly Report on Form 10-Q for the quarter ended March 31, 2017, formatted in eXtensible Business Reporting Language (XBRL): (i) Consolidated Balance Sheets (unaudited) as of March 31, 2017 and December 31, 2016; (ii) Consolidated Statements of Income (unaudited) for the three months ended March 31, 2017 and 2016; (iii) Consolidated Statements of Comprehensive Income (unaudited) for the three months ended March 31, 2017 and 2016 (iv) Consolidated Statements of Cash Flows (unaudited) for the three months ended March 31, 2017 and 2016 (v) Unaudited Consolidated Statements of Changes in Stockholders’ Equity for the three months ended March 31, 2017 and 2016; (vi) Notes to Unaudited Consolidated Financial Statements.