BANK OF THE JAMES FINANCIAL GROUP INC - Quarter Report: 2019 March (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, 2019

 

 

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 every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).    Yes  ☒    No  ☐

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

 

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

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

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

APPLICABLE ONLY TO CORPORATE ISSUERS

State the number of shares outstanding of each of the issuer’s classes of common equity, as of the latest practicable date: 4,378,436 shares of Common Stock, par value $2.14 per share, were outstanding at May 9, 2019.

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

 

Title of each class		Trading Symbol(s)		Name of each exchange on which registered
Common Stock, 2.14 per share par value		BOTJ		The NASDAQ Stock Market LLC

 

 

 

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			31
Item 3.		Quantitative and Qualitative Disclosures About Market Risk			47
Item 4.		Controls and Procedures			47
PART II – OTHER INFORMATION					48
Item 1.		Legal Proceedings			48
Item 1A.		Risk Factors			48
Item 2.		Unregistered Sales of Equity Securities and Use of Proceeds			48
Item 3.		Defaults Upon Senior Securities			48
Item 4.		Mine Safety Disclosures			48
Item 5.		Other Information			49
Item 6.		Exhibits			49
SIGNATURES					49

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) (2019 unaudited)

 

Assets		March 31, 2019				December 31, 2018
Cash and due from banks		$	28,533			$	26,725
Federal funds sold			20,207				23,600
Total cash and cash equivalents			48,740				50,325
Securities held-to-maturity (fair value of $3,640 in 2019 and $3,515 in 2018)			3,697				3,700
Securities available-for-sale, at fair value			53,497				52,727
Restricted stock, at cost			1,462				1,462
Loans, net of allowance for loan losses of $4,673 in 2019 and $4,581 in 2018			535,959				530,016
Loans held for sale			2,604				1,670
Premises and equipment, net			14,473				13,426
Interest receivable			1,946				1,742
Cash value – bank owned life insurance			13,442				13,359
Other real estate owned			2,253				2,430
Income taxes receivable			797				1,102
Deferred tax asset, net			1,480				1,755
Other assets			4,038				1,183
Total assets		$	684,388			$	674,897
Liabilities and Stockholders’ Equity
Deposits
Noninterest bearing demand		$	93,624			$	91,356
NOW, money market and savings			331,848				331,298
Time			191,272				189,389
Total deposits			616,744				612,043
Capital notes			5,000				5,000
Interest payable			154				127
Other liabilities			5,313				2,584
Total liabilities		$	627,211			$	619,754
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, 2019 and December 31, 2018			9,370				9,370
Additional paid-in-capital			31,522				31,495
Retained earnings			17,492				16,521
Accumulated other comprehensive (loss)			(1,207	)			(2,243	)
Total stockholders’ equity		$	57,177			$	55,143
Total liabilities and stockholders’ equity		$	684,388			$	674,897

See accompanying notes to these consolidated financial statements

 

1

Bank of the James Financial Group, Inc. and Subsidiaries

Consolidated Statements of Income

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

 

		For the Three Months Ended March 31,
Interest Income		2019				2018
Loans		$	6,654			$	5,674
Securities
US Government and agency obligations			185				198
Mortgage backed securities			61				68
Municipals – taxable			78				79
Municipals – tax exempt			3				3
Dividends			18				8
Other (Corporates)			23				23
Interest bearing deposits			91				35
Federal Funds sold			121				67
Total interest income			7,234				6,155
Interest Expense
Deposits
NOW, money market savings			306				192
Time Deposits			748				581
FHLB borrowings			—				1
Capital notes			50				50
Total interest expense			1,104				824
Net interest income			6,130				5,331
Provision for loan losses			210				22
Net interest income after provision for loan losses			5,920				5,309
Noninterest income
Gain on sales of loans held for sale			691				620
Service charges, fees and commissions			439				464
Increase in cash value of life insurance			83				85
Other			6				17
Total noninterest income			1,219				1,186
Noninterest expenses
Salaries and employee benefits			2,928				2,713
Occupancy			421				395
Equipment			458				379
Supplies			162				149
Professional, data processing, and other outside expense			815				815
Marketing			145				140
Credit expense			127				125
Other real estate expenses			139				40
FDIC insurance expense			94				101
Other			310				240
Total noninterest expenses			5,599				5,097
Income before income taxes			1,540				1,398
Income tax expense			306				275
Net Income		$	1,234			$	1,123
Weighted average shares outstanding – basic			4,378,436				4,378,436
Weighted average shares outstanding – diluted			4,380,959				4,378,526
Earnings per common share – basic		$	0.28			$	0.26
Earnings per common share – diluted		$	0.28			$	0.26

See accompanying notes to these consolidated financial statements

 

2

Bank of the James Financial Group, Inc. and Subsidiaries

Consolidated Statements of Comprehensive Income

For the Three Months Ended March 31, 2019 and 2018

(dollar amounts in thousands) (unaudited)

 

		For the Three Months Ended March 31,
		2019				2018
Net Income		$	1,234			$	1,123
Other comprehensive income (loss):
Unrealized gains (losses) on securities available-for-sale			1,311				(1,076	)
Tax effect			(275	)			226
Other comprehensive income (loss), net of tax			1,036				(850	)
Comprehensive income		$	2,270			$	273

See accompanying notes to these consolidated financial statements

 

3

Bank of the James Financial Group, Inc. and Subsidiaries

Consolidated Statements of Cash Flows

Three Months Ended March 31, 2019 and 2018

(dollar amounts in thousands) (unaudited)

 

		For the Three Months Ended March 31,
		2019				2018
Cash flows from operating activities
Net Income		$	1,234			$	1,123
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization			239				213
Stock-based compensation expense			27				—
Net amortization and accretion of premiums and discounts on securities			100				104
(Gain) on sales of loans held for sale			(691	)			(620	)
Proceeds from sales of loans held for sale			20,428				24,947
Origination of loans held for sale			(20,671	)			(25,149	)
Provision for loan losses			210				22
Loss (gain) on sale of other real estate owned			13				(5	)
Impairment of other real estate owned			115				34
(Increase) in cash value of life insurance			(83	)			(85	)
(Increase) in interest receivable			(204	)			(114	)
Decrease (increase) in other assets			135				(78	)
Decrease in income taxes receivable			305				354
Increase (decrease) in interest payable			27				(3	)
(Decrease) increase in other liabilities			(261	)			264
Net cash provided by operating activities		$	923			$	1,007
Cash flows from investing activities
Proceeds from calls of securities held-to-maturity		$	—			$	2,000
Purchases of securities available-for-sale			—				(998	)
Proceeds from maturities, calls and paydowns of securities available-for-sale			444				502
Purchase of Federal Home Loan Bank stock			—				(382	)
Proceeds from sale of other real estate owned			349				525
Origination of loans, net of principal collected			(6,453	)			(10,877	)
Purchases of premises and equipment			(1,286	)			(267	)
Net cash (used in) investing activities		$	(6,946	)		$	(9,497	)
Cash flows from financing activities
Net increase in deposits		$	4,701			$	17,023
Proceeds from Federal Home Loan Bank advances			—				10,000
Dividends paid to common stockholders			(263	)			(263	)
Net cash provided by financing activities		$	4,438			$	26,760
(Decrease) increase in cash and cash equivalents			(1,585	)			18,270
Cash and cash equivalents at beginning of period		$	50,325			$	37,018
Cash and cash equivalents at end of period		$	48,740			$	55,288
Non cash transactions
Transfer of loans to other real estate owned		$	300			$	—
Fair value adjustment for securities available-for-sale			1,311				(1,076	)
Lease liabilities arising from right-of-use assets			2,990				—
Cash transactions
Cash paid for interest		$	1,077			$	827
Cash paid for income taxes			—				—

See accompanying notes to these consolidated financial statements

 

4

Bank of the James Financial Group, Inc. and Subsidiaries

Consolidated Statements of Changes in Stockholders’ Equity

For the Three Months Ended March 31, 2019 and 2018

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

 

		Shares Outstanding				Common Stock				Additional Paid-in Capital				Retained Earnings				Accumulated Other Comprehensive (Loss)				Total
Balance at December 31, 2017			4,378,436			$	9,370			$	31,495			$	12,269				(1,469	)		$	51,665
Net Income			—				—				—				1,123				—				1,123
Dividends paid on common stock ($0.06 per share)			—				—				—				(263	)			—				(263	)
Other comprehensive loss			—				—				—				—				(850	)			(850	)
Balance at March 31, 2018			4,378,436			$	9,370			$	31,495			$	13,129				(2,319	)		$	51,675
Balance at December 31, 2018			4,378,436			$	9,370			$	31,495			$	16,521				(2,243	)		$	55,143
Net Income			—				—				—				1,234				—				1,234
Dividends paid on common stock ($0.06 per share)			—				—				—				(263	)			—				(263	)
Stock-based compensation expense			—				—				27				—				—				27
Other comprehensive income			—				—				—				—				1,036				1,036
Balance at March 31, 2019			4,378,436			$	9,370			$	31,522			$	17,492			$	(1,207	)		$	57,177

See accompanying notes to these consolidated financial statements

 

5

Notes to Consolidated Financial Statements

Note 1 – Basis of Presentation

The unaudited consolidated financial statements have been prepared by Bank of the James Financial Group, Inc. (“Financial” or the “Company”) pursuant to the rules and regulations of the Securities and Exchange Commission. In management’s opinion the accompanying financial statements, which unless otherwise noted are unaudited, reflect all adjustments, consisting solely of normal recurring accruals, necessary for a fair presentation of the financial information as of March 31, 2019 and for the three months ended March 31, 2019 and 2018 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, 2018. These financial statements should be read in conjunction with the audited consolidated financial statements and footnotes for the year ended December 31, 2018 included in Financial’s Annual Report on Form 10-K. Results for the three-month period ended March 31, 2019 are not necessarily indicative of the results that may be expected for the year ending December 31, 2019.

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

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

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

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

 

6

Note 2 – Use of Estimates

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

Note 3 – Earnings Per Common Share (EPS)

The following is a summary of the earnings per share calculation for the three months ended March 31, 2019 and 2018.

 

		Three Months Ended March 31,
		2019				2018
Net income		$	1,234,000			$	1,123,000
Weighted average number of shares			4,378,436				4,378,436
Restricted stock units/stock options affect of incremental shares			2,523				90
Weighted average diluted shares			4,380,959				4,378,526
Basic EPS (weighted avg shares)		$	0.28			$	0.26
Diluted EPS (Including incremental shares)		$	0.28			$	0.26

No restricted stock units or stock options were excluded in calculating diluted earnings per share for any of the periods presented.

Note 4 – Stock Based Compensation

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

 

7

Note 4 – Stock Based Compensation (continued)

 

At December 31, 2018, there were no stock-based compensation awards outstanding that were issued under the Company’s 1999 Stock Option Plan. The final stock-based compensation issued under this plan consisting solely of employee stock options expired during the second quarter of 2018,

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

On January 2, 2019, the Company granted its first block of equity compensation under the 2018 Incentive Plan consisting of 24,500 restricted stock units. The recipients of restricted stock units do not receive shares of the Company’s stock immediately, but instead receive shares upon satisfying the requisite service period specified by the terms and conditions of the grant. Additionally, the recipients of restricted stock units do not enjoy the rights of holder of the Company’s common stock until the units have vested and as such, they do not have voting rights or rights to nonforfeitable dividends. The related compensation expense is based on the grant date fair value of the Company’s stock of $13.00 per share. Shares vest over 3 years in thirds with the first one-third vesting one year from the grant date. The total expense recognized for the three months ended March 31, 2019, in connection with the restricted stock unit awards was approximately $27,000. There were no forfeitures during the three-month period ending March 31, 2019.

At March 31, 2019, the unrecognized stock-based compensation expense related to unvested restricted stock awards amounted to $292,000. The unrecognized expense will be recognized ratably over the remaining vesting period of 2.75 years. The Company accounts for forfeitures as they occur.

Note 5 – Fair Value Measurements

Determination of Fair Value

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

The fair value guidance provides a consistent definition of fair value, which focuses on exit price in the principal or most advantageous market and in an orderly transaction (that is, not a forced liquidation or distressed sale) between market participants at the measurement date under current market conditions. If there has been a significant decrease in the volume

 

8

Note 5 – Fair Value Measurements (continued)

 

and level of activity for the asset or liability, a change in valuation technique or the use of multiple valuation techniques may be appropriate. In such instances, determining the price at which willing market participants would transact at the measurement date under current market conditions depends on the facts and circumstances and requires the use of significant judgment. The fair value is a reasonable point within the range that is most representative of fair value under current market conditions.

Fair Value Hierarchy

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

 

•

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

 

•

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

 

•

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

Fair Value on a Recurring Basis

Securities Available-for-Sale

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

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

 

9

Note 5 – Fair Value Measurements (continued)

 

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

 

						Carrying Value at March 31, 2019 (in thousands)
Description		Balance as of March 31, 2019				Quoted Prices in Active Markets for Identical Assets (Level 1)				Significant Other Observable Inputs (Level 2)				Significant Unobservable Inputs (Level 3)
US Treasuries		$	1,893			$	—			$	1,893			$	—
US agency obligations			23,880				—				23,880				—
Mortgage-backed securities			11,604				—				11,604				—
Municipals			12,198				—				12,198				—
Corporates			3,922				—				3,922				—
Total available-for-sale securities		$	53,497			$	—			$	53,497			$	—
						Carrying Value at December 31, 2018 (in thousands)
Description		Balance as of December 31, 2018				Quoted Prices in Active Markets for Identical Assets (Level 1)				Significant Other Observable Inputs (Level 2)				Significant Unobservable Inputs (Level 3)
US Treasuries		$	1,845			$				$	1,845			$
US agency obligations			23,267				—				23,267				—
Mortgage-backed securities			11,876				—				11,876				—
Municipals			12,009				—				12,009				—
Corporates			3,730				—				3,730				—
Total available-for-sale securities		$	52,727			$	—			$	52,727			$	—

Fair Value on a Non-recurring Basis

Impaired loans

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

 

10

Note 5 – Fair Value Measurements (continued)

 

Loans held for sale

Loans held for sale are carried at cost which approximates estimated fair value. These loans currently consist of one-to-four family residential loans originated for sale in the secondary market. Fair value is based on the price secondary markets are currently offering for similar loans using observable market data which is not materially different than cost due to the short duration between origination and sale (Level 2). As such, the Company records fair value adjustments on a nonrecurring basis. No nonrecurring fair value adjustments were recorded on loans held for sale during the period ended March 31, 2019. Gains and losses on the sale of loans are recorded within gains on sales of loans held for sale, net on the Consolidated Statements of Income.

Other real estate owned

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

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

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

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

 

						Carrying Value at March 31, 2019
Description		Balance as of March 31, 2019				Quoted Prices in Active Markets for Identical Assets (Level 1)				Significant Other Observable Inputs (Level 2)				Significant Unobservable Inputs (Level 3)
Impaired loans*		$	1,680			$	—			$	—			$	1,680
Other real estate owned			2,253				—				—				2,253

 

*

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

 

						Carrying Value at December 31, 2018
Description		Balance as of December 31, 2018				Quoted Prices in Active Markets for Identical Assets (Level 1)				Significant Other Observable Inputs (Level 2)				Significant Unobservable Inputs (Level 3)
Impaired loans*		$	1,587			$	—			$	—			$	1,587
Other real estate owned			2,430				—				—				2,430

 

*

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

 

11

Note 5 – Fair Value Measurements (continued)

 

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

 

		Quantitative information about Level 3 Fair Value Measurements for March 31, 2019 (dollars in thousands)
		Fair Value				Valuation Technique(s)		Unobservable Input		Range (Weighted Average)
Assets
Impaired loans		$	1,680			Discounted appraised value		Selling cost		0% – 10% (8%)
								Discount for lack of marketability and age of appraisal		0% – 20% (6%)
OREO			2,253			Discounted appraised value		Selling cost		0% – 10% (6%)
								Discount for lack of marketability and age of appraisal		0% –25% (15%)

 

		Quantitative information about Level 3 Fair Value Measurements for December 31, 2018 (dollars in thousands)
		Fair Value				Valuation Technique(s)		Unobservable Input		Range (Weighted Average)
Assets
Impaired loans		$	1,587			Discounted appraised value		Selling cost		0% –10% (8%)
								Discount for lack of marketability and age of appraisal		0% – 20% (6%)
OREO			2,430			Discounted appraised value		Selling cost		0% – 10% (6%)
								Discount for lack of marketability and age of appraisal		0% –25% (15%)

Financial Instruments

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

 

12

Note 5 – Fair Value Measurements (continued)

 

The estimated fair values, and related carrying or notional amounts, of Financial’s financial instruments and their placement in the fair value hierarchy at March 31, 2019 and December 31, 2018 was as follows (in thousands):

 

						Fair Value Measurements at March 31, 2019 using
Assets		Carrying Amounts				Quoted Prices in Active Markets for Identical Assets (Level 1)				Significant Other Observable Inputs (Level 2)				Significant Unobservable Inputs (Level 3)				Balance
Cash and due from banks		$	28,533			$	28,533			$	—			$	—			$	28,533
Fed funds sold			20,207				20,207				—				—				20,207
Securities
Available-for-sale			53,497				—				53,497				—				53,497
Held-to-maturity			3,697				—				3,640				—				3,640
Restricted stock			1,462								1,462				—				1,462
Loans, net (1)			535,959				—				—				534,401				534,401
Loans held for sale			2,604				—				2,604				—				2,604
Interest receivable			1,946				—				1,946				—				1,946
BOLI			13,442				—				13,442				—				13,442
Liabilities
Deposits		$	616,744			$	—			$	617,404			$	—			$	617,404
Capital notes			5,000				—				4,731				—				4,731
Interest payable			154				—				154				—				154

 

						Fair Value Measurements at December 31, 2018 using
Assets		Carrying Amounts				Quoted Prices in Active Markets for Identical Assets (Level 1)				Significant Other Observable Inputs (Level 2)				Significant Unobservable Inputs (Level 3)				Balance
Cash and due from banks		$	26,725			$	26,725			$	—			$	—			$	26,725
Fed funds sold			23,600				23,600												23,600
Securities
Available-for-sale			52,727				—				52,727				—				52,727
Held-to-maturity			3,700				—				3,515				—				3,515
Restricted stock			1,462				—				1,462								1,462
Loans, net (1)			530,016				—				—				522,782				522,782
Loans held for sale			1,670				—				1,670				—				1,670
Interest receivable			1,742				—				1,742				—				1,742
BOLI			13,359				—				13,359				—				13,359
Liabilities
Deposits		$	612,043			$	—			$	612,532			$	—			$	612,532
Capital notes			5,000				—				4,710								4,710
Interest payable			127				—				127				—				127

 

(1)

Carrying amount is net of unearned income and the Allowance.

 

13

Note 6 – Leases

On January 1, 2019, the Company adopted ASU No. 2016-02 “Leases (Topic 842)” and all subsequent ASUs that modified Topic 842. The Company elected the prospective application approach provided by ASU 2018-11 and did not adjust prior periods for ASC 842. The Company also elected certain practical expedients within the standard and consistent with such elections did not reassess whether any expired or existing contracts are or contain leases, did not reassess the lease classification for any expired or existing leases, and did not reassess any initial direct costs for existing leases. As stated in the Company’s 2018 Form 10-K, the implementation of the new standard resulted in recognition of right-of-use assets and lease liabilities of $3.0 million at the date of adoption, which is related to the Company’s lease of premises used in operations. The right-of-use assets and lease liabilities are included in other assets and other liabilities, respectively, in the Consolidated Balance Sheets.

Lease liabilities represent the Company’s obligation to make lease payments and are presented at each reporting date as the net present value of the remaining contractual cash flows. Cash flows are discounted at the Company’s incremental borrowing rate in effect at the commencement date of the lease. Right-of-use assets represent the Company’s right to use the underlying asset for the lease term and are calculated as the sum of the lease liability and if applicable, prepaid rent, initial direct costs and any incentives received from the lessor.

The Company’s long-term lease agreements are classified as operating leases. Certain of these leases offer the option to extend the lease term and the Company has included such extensions in its calculation of the lease liabilities to the extent the options are reasonably assured of being exercised. The lease agreements do not provide for residual value guarantees and have no restrictions or covenants that would impact dividends or require incurring additional financial obligations.

The following tables present information about the Company’s leases:

 

(Dollars in thousands)		March 31, 2019
Lease liabilities		$	2,856
Right-of-use assets		$	2,852
Weighted average remaining lease term			10.8 years
Weighted average discount rate			3.08	%

 

Lease cost (in thousands)		For the Three Months Ended March 31, 2019
Operating lease cost		$	161
Total lease cost		$	161
Cash paid for amounts included in the measurement of lease liabilities		$	156

 

14

Note 6 – Leases (continued)

 

A maturity analysis of operating lease liabilities and reconciliation of the undiscounted cash flows to the total of operating lease liabilities is as follows:

 

Lease payments due (in thousands)		As of March 31, 2019
Nine months ending December 31, 2019		$	381
Twelve months ending December 31, 2020			418
Twelve months ending December 31, 2021			346
Twelve months ending December 31, 2022			344
Twelve months ending December 31, 2023			346
Twelve months ending December 31, 2024			249
Thereafter			1,352
Total undiscounted cash flows		$	3,436
Discount			(580	)
Lease liabilities		$	2,856

 

15

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, 2019 and December 31, 2018 (amounts in thousands):

 

		March 31, 2019
		Amortized Costs				Gross Unrealized								Fair Value
						Gains				(Losses)
Held-to-Maturity
US agency obligations		$	3,697			$	2			$	(59	)		$	3,640
Available-for-Sale
US Treasuries			1,962				—				(69	)			1,893
US agency obligations			24,658				6				(784	)			23,880
Mortgage-backed securities			11,932				5				(333	)			11,604
Municipals			12,375				17				(194	)			12,198
Corporates			4,098				—				(176	)			3,922
		$	55,025			$	28			$	(1,556	)		$	53,497
		December 31, 2018
		Amortized Costs				Gross Unrealized								Fair Value
						Gains				(Losses)
Held-to-Maturity
US agency obligations		$	3,700			$	3			$	(185	)		$	3,515
Available-for-Sale
US Treasuries			1,961				—				(116	)			1,845
US agency obligations			24,701				—				(1,434	)			23,267
Mortgage-backed securities			12,390				—				(514	)			11,876
Municipals			12,412				3				(406	)			12,009
Corporates			4,102				—				(372	)			3,730
		$	55,566			$	3			$	(2,842	)		$	52,727

 

16

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, 2019 and December 31, 2018 (amounts in thousands):

 

		Less than 12 months								More than 12 months								Total
March 31, 2019		Fair Value				Unrealized Losses				Fair Value				Unrealized Losses				Fair Value				Unrealized Losses
Description of securities
Held-to-maturity
US agency obligations		$	—			$	—			$	3,640			$	59			$	3,640			$	59
Available-for-sale
US Treasuries			—				—				1,893				69				1,893				69
US agency obligations			—				—				21,504				784				21,504				784
Mortgage-backed securities			—				—				10,617				333				10,617				333
Municipals			—				—				9,994				194				9,994				194
Corporates			—				—				3,922				176				3,922				176
Total		$	—			$	—			$	47,930			$	1,556			$	47,930			$	1,556
		Less than 12 months								More than 12 months								Total
December 31, 2018		Fair Value				Unrealized Losses				Fair Value				Unrealized Losses				Fair Value				Unrealized Losses
Description of securities
Held-to-maturity
US agency obligations		$	—			$	—			$	3,515			$	185			$	3,515			$	185
Available-for-sale
US Treasuries			—				—				1,845				116				1,845				116
US agency obligations			—				—				23,267				1,434				23,267				1,434
Mortgage-backed securities			966				20				10,910				494				11,876				514
Municipals			—				—				10,994				406				10,994				406
Corporates			—				—				3,730				372				3,730				372
Total		$	966			$	20			$	50,746			$	2,822			$	51,712			$	2,842

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).

 

17

Note 7 – Securities (continued)

 

At March 31, 2019, 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, 2019, the Bank owned 53 securities in an unrealized loss position that were being evaluated for other than temporary impairment. Eleven of these securities were S&P rated AAA, 39 were rated AA, two were rated A, and one was rated BBB+. As of March 31, 2019, 32 of these securities were direct obligations of the U.S. government or government sponsored entities, 16 were municipal issues, and five were investments in domestic corporate issued securities.

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

There were no gross gains on sales of available-for-sale securities during the three-month periods ended March 31, 2019 and 2018. There were no gross losses on sales of available-for-sale securities and no sales of held-to-maturity securities during the three-month periods ended March 31, 2019 and 2018.

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.

 

18

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, 2019 and 2018 was as follows (dollars in thousands):

Business Segments

		Community Banking				Mortgage				Total
Three months ended March 31, 2019
Net interest income		$	6,130			$	—			$	6,130
Provision for loan losses			210				—				210
Net interest income after provision for loan losses			5,920				—				5,920
Noninterest income			528				691				1,219
Noninterest expenses			5,025				574				5,599
Income before income taxes			1,423				117				1,540
Income tax expense			281				25				306
Net income		$	1,142			$	92			$	1,234
Total assets		$	681,531			$	2,857			$	684,388
Three months ended March 31, 2018
Net interest income		$	5,331			$	—			$	5,331
Provision for loan losses			22				—				22
Net interest income after provision for loan losses			5,309				—				5,309
Noninterest income			566				620				1,186
Noninterest expenses			4,604				493				5,097
Income before income taxes			1,271				127				1,398
Income tax expense			248				27				275
Net income		$	1,023			$	100			$	1,123
Total assets		$	650,068			$	3,567			$	653,635

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

 

19

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

 

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

 

		As of:
		March 31,				December 31,
		2019				2018
Commercial		$	99,327			$	92,877
Commercial real estate			289,964				289,171
Consumer			85,289				86,191
Residential			66,052				66,358
Total loans (1)			540,632				534,597
Less allowance for loan losses			4,673				4,581
Net loans		$	535,959			$	530,016

 

(1)

Includes net deferred costs and premiums of $454 and $457 as of March 31, 2019 and December 31, 2018, respectively.

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

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

 

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

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

 

•

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

 

•

“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.

 

20

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

 

•

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

 

•

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

 

•

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

 

•

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

 

21

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

 

Loans on Non-Accrual Status
(dollars in thousands)
		As of
		March 31, 2019				December 31, 2018
Commercial		$	992			$	973
Commercial Real Estate:
Commercial Mortgages-Owner Occupied			308				317
Commercial Mortgages-Non-Owner Occupied			629				173
Commercial Construction			—				—
Consumer
Consumer Unsecured			—				—
Consumer Secured			254				84
Residential:
Residential Mortgages			1,439				1,391
Residential Consumer Construction			—				—
Totals		$	3,622			$	2,939

We also classify other real estate owned (OREO) as a nonperforming asset. OREO represents real property owned by the Bank which was acquired through purchase at foreclosure or from the borrower through a deed in lieu of foreclosure. OREO decreased to $2,253 on March 31, 2019 from $2,430 on December 31, 2018. The following table represents the changes in OREO balance during the three months ended March 31, 2019 and year ended December 31, 2018.

 

OREO Changes
(dollars in thousands)
		Three months ended March 31, 2019				Year ended December 31, 2018
Balance at the beginning of the year (net)		$	2,430			$	2,650
Transfers from loans			300				850
Capitalized costs			—				—
Valuation adjustments			(115	)			(185	)
Sales proceeds			(349	)			(846	)
Loss on disposition			(13	)			(39	)
Balance at the end of the period (net)		$	2,253			$	2,430

At March 31, 2019 and December 31, 2018, the Company had no consumer mortgage loans secured by residential real estate for which foreclosure was in process. The Company held one residential real estate property carried on the books in other real estate owned at a value of $68 as of March 31, 2019 and four residential real estate properties carried on the books at a value of $156 in other real estate owned as of December 31, 2018.

 

22