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F&M BANK CORP - Quarter Report: 2017 June (Form 10-Q)

 

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D. C. 20549
 
FORM 10-Q
 
☒        Quarterly report Under Section 13 or 15(d) of the Securities Exchange Act of 1934
 
For the quarterly period ended June 30, 2017.
 
☐         Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
 
Commission File Number:    000-13273
 
F & M BANK CORP.
 
Virginia
 
54-1280811
(State or Other Jurisdiction of Incorporation or Organization)
 
(I.R.S. Employer Identification No.)
 
P. O. Box 1111
Timberville, Virginia 22853
(Address of Principal Executive Offices) (Zip Code)
 
(540) 896-8941
(Registrant's Telephone Number, Including Area Code)
 
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 website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T 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, a smaller reporting company or an emerging growth company. See definition of “large accelerated filer”, “accelerated filer”, “smaller reporting company” and “an emerging growth company” in Rule 12b-2 of the Exchange Act. (Check one)
 
Large accelerated filer
Accelerated filer
Non-accelerated filer
☐(Do not check if a smaller reporting company)
Smaller reporting company
 
 
Emerging growth company
 
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes ☐ No ☒
 
State the number of shares outstanding of each of the registrant’s classes of common stock, as of the latest practicable date.
 
 Class
 Outstanding at August 11, 2017
 Common Stock, par value - $5 
 3,274,188 shares
 

 
 
 
 
F & M BANK CORP.
 
Index
Page
 
Part I
Financial Information
3
 
 
 
Item 1.
Financial Statements
 3
 
 
 
 
Consolidated Balance Sheets – June 30, 2017 and December 31, 2016
3
 
 
 
 
Consolidated Statements of Income – Three Months Ended June 30, 2017 and 2016
4
 
 
 
 
Consolidated Statements of Income – Six Months Ended June 30, 2017 and 2016
5
 
 
 
 
Consolidated Statements of Comprehensive Income – Three and Six Months Ended June 30, 2017 and 2016
6
 
 
 
 
Consolidated Statements of Changes in Stockholders’ Equity – Six Months Ended June 30, 2017 and 2016
7
 
    
 
 
Consolidated Statements of Cash Flows – Six Months Ended June 30, 2017 and 2016
8
 
 
 
 
Notes to Consolidated Financial Statements
9
 
 
 
Item 2.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
34
 
 
 
Item 3.
Quantitative and Qualitative Disclosures About Market Risk
48
 
 
 
Item 4.
Controls and Procedures
48
 
 
 
Part II
Other Information
49
 
 
 
Item 1.
Legal Proceedings
49
 
 
 
Item 1a.
Risk Factors
49
 
 
 
Item 2.
Unregistered Sales of Equity Securities and Use of Proceeds
49
 
 
 
Item 3.
Defaults Upon Senior Securities
49
 
 
 
Item 4.
Mine Safety Disclosures
49
 
 
 
Item 5.
Other Information
49
 
 
 
Item 6.
Exhibits
49
 
 
 
Signatures
50
 
 
 
Certifications
51

 
 
2
 
 
Part I Financial Information
Item 1 Financial Statements
 
F & M BANK CORP.
Consolidated Balance Sheets
( dollars in thousands, except share and per share data)
 
 
 
June 30,
 
 
December 31,
 
 
 
2017
 
 
2016*
 
 
 
(Unaudited)
 
 
 
 
Assets
 
 
 
 
 
 
Cash and due from banks
 $7,876 
 $7,755 
Money market funds
  614 
  674 
Federal funds sold
  3,174 
  7,926 
 Cash and cash equivalents
  11,664 
  16,355 
Securities:
    
    
 Held to maturity – fair value of $125 in 2017 and 2016
  125 
  125 
 Available for sale
  24,708 
  24,783 
 Other investments
  14,274 
  14,567 
Loans held for sale
  51,767 
  62,735 
Loans held for investment
  603,435 
  591,636 
 Less: allowance for loan losses
  (7,216)
  (7,543)
 Net loans held for investment
  596,219 
  584,093 
 
    
    
Other real estate owned
  2,008 
  2,076 
Bank premises and equipment, net
  12,024 
  10,340 
Interest receivable
  1,895 
  1,785 
Goodwill
  2,974 
  2,670 
Bank owned life insurance
  13,731 
  13,513 
Other assets
  12,874 
  11,847 
 Total assets
 $744,263 
 $744,889 
 
    
    
Liabilities
    
    
Deposits:
    
    
Noninterest bearing
 $147,133 
 $146,617 
Interest bearing
  389,353 
  390,468 
 Total deposits
  536,486 
  537,085 
 
    
    
Short-term debt
  50,000 
  40,000 
Accrued liabilities
  16,166 
  16,885 
Long-term debt
  51,938 
  64,237 
 Total liabilities
  654,590 
  658,207 
 
    
    
Stockholders’ Equity
    
    
Preferred Stock $5 par value, 400,000 shares authorized, 326,550 and 327,350
    
    
     Issued and outstanding for June 30, 2017 and December 31, 2016, respectively
  7,589 
  7,609 
Common stock, $5 par value, 6,000,000 shares authorized,
    
    
     3,274,057 and 3,270,315 shares issued and outstanding
    
    
     for June 30, 2017 and December 31, 2016, respectively
  16,370 
  16,352 
Additional paid in capital – common stock
  10,766 
  10,684 
Retained earnings
  57,540 
  54,509 
Noncontrolling interest in consolidated subsidiaries
  574 
  693 
Accumulated other comprehensive loss
  (3,166)
  (3,165)
 Total stockholders’ equity
  89,673 
  86,682 
 Total liabilities and stockholders’ equity
 $744,263 
 $744,889 
 
*2016 Derived from audited consolidated financial statements.
 
See notes to unaudited consolidated financial statements
 
 
3
 
 
F & M BANK CORP.
Consolidated Statements of Income
(dollars in thousands)
(Unaudited)
 
 
 
Three Months Ended
 
 
 
June 30,
 
Interest and Dividend income
 
2017
 
 
2016
 
 Interest and fees on loans held for investment
 $7,906 
  7,330 
 Interest and fees on loans held for sale
  271 
  530 
 Interest from money market funds and federal funds sold
  18 
  6 
 Interest on debt securities – taxable
  61 
  71 
Total interest and dividend income
  8,256 
  7,937 
 
    
    
Interest expense
    
    
       Total interest on deposits
  633 
  591 
       Interest from short-term debt
  24 
  8 
       Interest from long-term debt
  268 
  263 
Total interest expense
  925 
  862 
 
    
    
Net interest income
  7,331 
  7,075 
 
    
    
Provision for Loan Losses
  - 
  - 
 Net Interest Income After Provision for Loan Losses
  7,331 
  7,075 
 
    
    
Noninterest income
    
    
 Service charges on deposit accounts
  335 
  272 
 Investment services and insurance income (loss), net
  187 
  (29)
        Mortgage banking income, net
  613 
  752 
        Title insurance income
  355 
  - 
 Income on bank owned life insurance
  112 
  118 
        Low income housing partnership losses
  (201)
  (183)
        ATM and check card fees
  351 
  318 
        Other operating income
  130 
  130 
Total noninterest income
  1,882 
  1,378 
 
    
    
Noninterest expense
    
    
 Salaries
  2,628 
  2,133 
 Employee benefits
  852 
  661 
 Occupancy expense
  254 
  210 
 Equipment expense
  207 
  230 
 FDIC insurance assessment
  90 
  113 
       Other real estate owned, net
  12 
  35 
       Marketing expense
  122 
  131 
       Legal and professional fees
  79 
  105 
      ATM and check card fees
  178 
  172 
      Telecommunication and data processing expense
  352 
  289 
      Directors fees
  116 
  100 
      Bank franchise tax
  164 
  163 
       Other operating expenses
  963 
  828 
Total noninterest expense
  6,017 
  5,170 
 
    
    
Income before income taxes
  3,196 
  3,283 
 Income tax expense
  809 
  839 
Net Income
  2,387 
  2,444 
        Net income (loss) attributable to noncontrolling interest
  59 
  86 
Net Income attributable to F & M Bank Corp.
 $2,328 
 $2,358 
        Dividends paid/accumulated on preferred stock
  105 
  127 
Net income available to common stockholders
 $2,223 
 $2,231 
 
    
    
 
Per Common Share Data
 
 
 
 
 
 
 Net income – basic
 $.68 
 $.68 
Net income – diluted
  .64 
 $.63 
 Cash dividends on common stock
 $.23 
 $.20 
 Weighted average common shares outstanding – basic
  3,272,352 
  3,286,459 
Weighted average common shares outstanding – diluted
  3,637,030 
  3,730,859 
 
See notes to unaudited consolidated financial statements
 
 
4
 
 
F & M BANK CORP.
Consolidated Statements of Income
(dollars in thousands)
(Unaudited)
 
 
 
Six Months Ended
 
 
 
June 30,
 
Interest and Dividend income
 
2017
 
 
2016
 
 Interest and fees on loans held for investment
 $15,609 
 $14,522 
 Interest and fees on loans held for sale
  445 
  902 
 Interest from money market funds and federal funds sold
  75 
  14 
 Interest on debt securities – taxable
  137 
  140 
Total interest and dividend income
  16,266 
  15,578 
 
    
    
Interest expense
    
    
       Total interest on deposits
  1,249 
  1,149 
       Interest from short-term debt
  32 
  26 
       Interest from long-term debt
  550 
  500 
Total interest expense
  1,831 
  1,675 
 
    
    
Net interest income
  14,435 
  13,903 
 
    
    
Provision for Loan Losses
  - 
  - 
 Net Interest Income After Provision for Loan Losses
  14,435 
  13,903 
 
    
    
Noninterest income
    
    
 Service charges on deposit accounts
  651 
  506 
 Investment services and insurance income
  361 
  65 
        Mortgage banking income, net
  1,113 
  1,196 
        Title insurance income
  554 
  - 
 Income on bank owned life insurance
  224 
  237 
        Low income housing partnership losses
  (386)
  (365)
        ATM and check card fees
  681 
  692 
        Gain on prepayment of long-term debt
  504 
  - 
        Loss on sale of other investments
  (42)
  - 
        Other operating income
  268 
  250 
Total noninterest income
  3,928 
  2,581 
 
    
    
Noninterest expense
    
    
 Salaries
  5,362 
  4,543 
 Employee benefits
  1,805 
  1,414 
 Occupancy expense
  503 
  428 
 Equipment expense
  393 
  422 
 FDIC insurance assessment
  180 
  225 
       Other real estate owned, net
  26 
  53 
       Marketing expense
  257 
  268 
       Legal and professional fees
  175 
  193 
      ATM and check card fees
  346 
  333 
      Telecommunication and data processing expense
  675 
  552 
      Directors fees
  243 
  208 
      Bank franchise tax
  324 
  310 
       Other operating expenses
  1,683 
  1,464 
Total noninterest expense
  11,972 
  10,413 
 
    
    
Income before income taxes
  6,391 
  6,071 
 Income tax expense
  1,686 
  1,533 
Net Income
  4,705 
  4,538 
        Net income (loss) attributable to noncontrolling interest
  32 
  90 
Net Income attributable to F & M Bank Corp.
 $4,673 
 $4,448 
        Dividends paid/accumulated on preferred stock
  209 
  255 
Net income available to common stockholders
 $4,464 
 $4,193 
 
    
    
 
Per Common Share Data
 
 
 
 
 
 
 Net income – basic
 $1.36 
 $1.28 
Net income – diluted
  1.29 
 $1.19 
 Cash dividends on common stock
 $.45 
 $.39 
 Weighted average common shares outstanding – basic
  3,272,318 
  3,285,867 
Weighted average common shares outstanding – diluted
  3,635,999 
  3,730,267 
 
See notes to unaudited consolidated financial statements
 
 
5
 
 
F & M BANK CORP.
Consolidated Statements of Comprehensive Income
(dollars in thousands)
(Unaudited)
 
 
 
Six Months Ended
 
 
Three Months Ended
 
 
 
June 30,
 
 
June 30,
 
 
 
2017
 
 
2016
 
 
2017
 
 
2016
 
Net Income:
 
 
 
 
 
 
 
 
 
 
 
 
    Net Income – F & M Bank Corp
 $4,673 
 $4,448 
 $2,328 
 $2,358 
    Net income (loss) attributable to noncontrolling interest
  32 
  90 
  59 
  86 
Total Net Income:
  4,705 
  4,538 
  2,387 
  2,444 
 
    
    
    
    
Unrealized holding gains (losses) on available-for-sale securities
  (2)
  37 
  (1)
  8 
    Tax Effect
  1 
  ( 12)
  - 
  ( 3)
    Unrealized holding gain (loss), net of tax
  (1)
  25 
  (1)
  5 
Total other comprehensive income
  (1)
  25 
  (1)
  5 
 
    
    
    
    
Comprehensive income
 $4,704 
 $4,563 
 $2,386 
 $2,449 
 
 
See notes to unaudited consolidated financial statements
 
 
6
 
 
F & M BANK CORP.
Condensed Consolidated Statements of Changes in Stockholders’ Equity
(dollars in thousands)
(Unaudited)
 
 
 
Six Months Ended
 
 
 
June 30,
 
 
 
2017
 
 
2016
 
 
 
 
 
 
 
 
Balance, beginning of period
 $86,682 
 $82,950 
 
    
    
Comprehensive income
    
    
Net income – F & M Bank Corp
  4,673 
  4,448 
Net income (loss) attributable to noncontrolling interest
  32 
  90 
Other comprehensive income (loss)
  (1)
  25 
 Total comprehensive income
  4,704 
  4,563 
 
    
    
Minority interest capital distributions
  (150)
  (74)
Issuance of common stock
  105 
  81 
Repurchase of common stock
  - 
  (32)
Repurchase of preferred stock
  (24)
  - 
Dividends paid
  (1,644)
  (1,506)
Balance, end of period
 $89,673 
 $85,982 
 
 
See notes to unaudited consolidated financial statements
 
 
7
 
 
F & M BANK CORP.
Consolidated Statements of Cash Flows
(dollars in thousands)
(Unaudited)
 
 
 
Six Months Ended June 30,
 
 
 
2017
 
 
2016
 
Cash flows from operating activities
 
 
 
 
 
 
Net income
 $4,673 
 $4,448 
Reconcile net income to net cash provided by (used in) operating activities:
    
    
Depreciation
  430 
  401 
Amortization of securities
  2 
  78 
Proceeds from loans held for sale originated
  38,767 
  38,596 
Loans held for sale originated
  (37,445)
  (42,630)
Gain on sale of loans held for sale originated
  (1,138)
  (1,320)
Gain on prepayment of long-term debt
  (504)
  - 
Increase in interest receivable
  (110)
  (142)
Increase in other assets
  (435)
  (423)
Decrease in accrued liabilities
  (1,421)
  (965)
Amortization of limited partnership investments
  386 
  365 
Income from life insurance investment
  (224)
  (237)
Loss on sale of investments
  42 
  - 
Loss on sale and valuation adjustments for other real estate owned
  - 
  13 
Net cash provided by (used in) operating activities
  3,023 
  (1,816)
 
    
    
Cash flows from investing activities
    
    
Purchase of investments available for sale and other investments
  (41,436)
  (4,109)
Purchase of title insurance company
  (304)
  - 
Proceeds from maturity of investments available for sale
  41,316 
  4,081 
Proceeds from the sale of investments
  55 
  - 
Net increase in loans held for investment
  (12,132)
  (23,250)
Net decrease (increase) in loans held for sale participations
  10,784 
  (34,051)
Proceeds from the sale of other real estate owned
  74 
  207 
Net purchase of property and equipment
  (2,114)
  (2,073)
Net cash used in investing activities
  (3,757)
  (59,195)
 
    
    
Cash flows from financing activities
    
    
Net change in deposits
  (599)
  10,041 
Net change in short-term debt
  10,000 
  34,463 
Dividends paid in cash
  (1,644)
  (1,506)
Proceeds from issuance of common stock
  105 
  81 
Proceeds from issuance of long-term debt
  - 
  20,000 
Repurchase of preferred stock
  (24)
  - 
Repurchase of common stock
  - 
  (32)
Repayments of long-term debt
  (11,795)
  (1,964)
Net cash (used in) provided by  financing activities
  (3,957)
  61,083 
 
    
    
Net (decrease) increase in Cash and Cash Equivalents
  (4,691)
  72 
Cash and cash equivalents, beginning of period
  16,355 
  8,519 
Cash and cash equivalents, end of period
 $11,664 
 $8,591 
Supplemental Cash Flow information:
    
    
 Cash paid for:
    
    
 Interest
 $1,836 
 $1,675 
    Taxes
  2,530 
  1,300 
Supplemental non-cash disclosures:
    
    
Transfer from loans to other real estate owned
  6 
  592 
Loans originated for the sale of other real estate owned
  - 
  - 
Change in unrealized gain (loss) on securities available for sale
  (2)
  - 
 
See notes to unaudited consolidated financial statements
 
 
8
 
 
Note 1. Summary of Significant Accounting Policies
 
Principles of Consolidation
 
The accompanying unaudited consolidated financial statements including the accounts of Farmers & Merchants Bank, TEB Life Insurance Company, Farmers & Merchants Financial Services, Inc., VBS Mortgage, LLC, (net of noncontrolling interest) and VSTitle, LLC (net of noncontrolling interest) and in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”) for the interim financial information and with the instructions to Form 10-Q adopted by the Securities and Exchange Commission (“SEC”).  Accordingly, these financial statements do not include all of the information and footnotes required by U. S. GAAP for complete financial statements.  Operating results for the three and six months ended June 30, 2017 are not necessarily indicative of the results that may be expected for the year ending December 31, 2017.  These interim consolidated financial statements should be red in conjunction with the audited consolidated financial statements and notes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2016 (the “2016 Form 10-K”).
 
The accompanying unaudited consolidated financial statements include the accounts of the Company, the Bank and its subsidiaries.  All significant intercompany balances and transactions have been eliminated in consolidation.
 
Nature of Operations
 
F & M Bank Corp. (the “Company”), through its subsidiary Farmers & Merchants Bank (the “Bank”), operates under a charter issued by the Commonwealth of Virginia and provides commercial banking services.  As a state chartered bank, the Bank is subject to regulation by the Virginia Bureau of Financial Institutions and the Federal Reserve Bank.  The Bank provides services to customers primarily located in Rockingham, Shenandoah, Page and Augusta Counties in Virginia.  Services are provided at thirteen branch offices and a Dealer Finance Division.  The Company offers insurance, mortgage lending, title insurance and financial services through its subsidiaries, TEB Life Insurance, Inc., Farmers & Merchants Financial Services, Inc (FMFS), VBS Mortgage, LLC (VBS), and VSTitle, LLC (VST).  The Company purchased a majority interest VSTitle, a title company headquartered in Harrisonburg, VA with offices in Harrisonburg, Fishersville and Charlottesville, VA on January 1, 2017.
 
Basis of Presentation
 
The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that effect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period.  Actual results could differ from those estimates.  Material estimates that are particularly susceptible to significant change in the near term relate to the determination of the allowance for loan losses, goodwill, other than temporary impairment, the valuation of deferred tax assets and liabilities, pension accounting and the valuation of foreclosed real estate.
 
Reclassification
 
Certain reclassifications have been made to prior period amounts to conform to current period presentation.  None of these reclassifications are considered material and have no impact on net income.
 
 
 
9
 
 
Note 1. Summary of Significant Accounting Policies, continued
 
 
Earnings per Share
 
Accounting guidance specifies the computation, presentation and disclosure requirements for earnings per share (“EPS”) for entities with publicly held common stock or potential common stock such as options, warrants, convertible securities or contingent stock agreements if those securities trade in a public market. Basic EPS is computed by dividing net income available to common shareholders by the weighted average number of common shares outstanding.  In calculating diluted EPS net income is used as the numerator and the denominator is increased to include the number of additional common shares that would have been outstanding if the dilutive common shares had been issued.  The dilutive effect of conversion of preferred stock is reflected in the diluted earnings per share calculation.
 
Net income available to common stockholders represents consolidated net income adjusted for preferred dividends declared.
 
The following table provides a reconciliation of net income to net income available to common stockholders for the periods presented:  
 
(dollars in thousands)
 
For the Six months ended
 
 
For the Quarter ended
 
 
For the Six months ended
 
 
For the Quarter ended
 
 
 
June 30, 2017
 
 
June 30, 2017
 
 
June 30, 2016
 
 
June 30, 2016
 
Earnings available to common stockholders:
 
 
 
 
 
 
 
 
 
 
 
 
Net income
 $4,705 
 $2,387 
 $4,538 
 $2,444 
Noncontrolling interest income (loss)
  32 
  59 
  90 
  86 
Preferred stock dividends
  209 
  105 
  255 
  127 
Net income available to common stockholders
 $4,464 
 $2,223 
 $4,193 
 $2,231 
 
The following table shows the effect of dilutive preferred stock conversion on the Company's earnings per share for the periods indicated:
 
 
 
Six months ended June 30, 2017
 
 
Six months ended June 30, 2016
 
 
 
Income
 
 
Shares
 
 
Per Share Amounts
 
 
Income
 
 
Shares
 
 
Per Share Amounts
 
Basic EPS
 $4,464,479 
  3,272,318 
 $1.36 
 $4,192,677 
  3,285,867 
 $1.28 
Effect of Dilutive Securities:
    
    
    
    
    
    
     Convertible Preferred Stock
  208,686 
  363,681 
  (0.07)
  255,000 
  444,400 
  (0.09)
Diluted EPS
 $4,673,165 
  3,635,999 
 $1.29 
 $4,447,677 
  3,730,267 
 $1.19 
 
 
 
 
Three months ended June 30, 2017
 
 
Three months ended June 30, 2016
 
 
 
Income
 
 
Shares
 
 
Per Share Amounts
 
 
Income
 
 
Shares
 
 
Per Share Amounts
 
Basic EPS
 $2,223,885 
  3,273,352 
 $.68 
 $2,230,626 
  3,286,459 
 $.68 
Effect of Dilutive Securities:
    
    
    
    
    
    
     Convertible Preferred Stock
  104,343 
  363,678 
  (0.04)
  127,500 
  444,400 
  (0.04)
Diluted EPS
 $2,328,228 
  3,637,030 
 $.64 
 $2,358,126 
  3,730,859 
 $.63 
 
 
 
10
 
 
Note 2. Investment Securities
 
Investment securities available for sale are carried in the consolidated balance sheets at their approximate fair value.  Investment securities held to maturity are carried in the consolidated balance sheets at their amortized cost at June 30, 2017 and December 31, 2016 are as follows:
 
 
 
 
 
 
Gross
 
 
Gross
 
 
 
 
 
 
Amortized
 
 
Unrealized
 
 
Unrealized
 
 
Fair
 
 
 
Cost
 
 
Gains
 
 
Losses
 
 
Value
 
June 30, 2017
 
 
 
 
 
 
 
 
 
 
 
 
U. S. Treasuries
 $125 
 $- 
 $- 
 $125 
December 31, 2016
    
    
    
    
U. S. Treasuries
 $125 
 $- 
 $- 
 $125 
 
The amortized cost and fair value of securities available for sale are as follows:
 
 
 
Amortized Cost
 
 
Gross Unrealized Gains
 
 
Gross Unrealized Losses
 
 
Fair Value
 
June 30, 2017
 
 
 
 
 
 
 
 
 
 
 
 
U. S. Treasuries
 $24,001 
 $- 
 $1 
 $24,000 
U. S. Government sponsored enterprises
  - 
  - 
  - 
  - 
Mortgage-backed obligations of federal agencies
  566 
  7 
  - 
  573 
Equity securities
  135 
  - 
  - 
  135 
Total Securities Available for Sale
 $24,702 
 $7 
 $1 
 $24,708 
 
    
    
    
    
December 31, 2016
    
    
    
    
U. S. Treasuries
 $24,005 
 $9 
 $- 
 $24,014 
Mortgage-backed obligations of federal agencies
  634 
  - 
  - 
  634 
Equity securities
  135 
  - 
  - 
  135 
Total Securities Available for Sale
 $24,774 
 $9 
 $- 
 $24,783 
 
 
 
11
 
 
Note 2. Investment Securities, continued
 
The amortized cost and fair value of securities at June 30, 2017, by contractual maturity are shown below.  Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.
 
 
 
Securities Held to Maturity
 
 
Securities Available for Sale
 
 
 
Amortized
 
 
Fair
 
 
Amortized
 
 
Fair
 
(dollars in thousands)
 
Cost
 
 
Value
 
 
Cost
 
 
Value
 
Due in one year or less
 $- 
 $- 
 $24,001 
 $24,000 
Due after one year through five years
  125 
  125 
  - 
  - 
Due after five years
  - 
  - 
  566 
  573 
Due after ten years
  - 
  - 
  135 
  135 
 Total
 $125 
 $125 
 $24,702 
 $24,708 
 
There were no gains or losses on sales of available for sale securities in the three month or six month periods ended June 30, 2017 or 2016.  There were also no securities with other than temporary impairment.
 
 In the three months ended June 30, 2017, the treasury securities were in an unrealized loss position. At March, 2017 and December 31, 2016, there were no securities in an unrealized loss position.
 
Other investments consist of investments in nineteen low-income housing and historic equity partnerships (carrying basis of $7,808,011), stock in the Federal Home Loan Bank (carrying basis $4,995,800) and various other investments (carrying basis $1,469,572).  The interests in low-income housing and historic equity partnerships have limited transferability and the interests in the other stocks are restricted as to sales.  The fair values of these securities are estimated to approximate their carrying value as of June 30, 2017.  At June 30, 2017, the Company was committed to invest an additional $4,429,838 in nine low-income housing limited partnerships.  These funds will be paid as requested by the general partner to complete the projects.  This additional investment has been reflected in the above carrying basis and in accrued liabilities on the consolidated balance sheet.  During the first quarter of 2017, both Farmers & Merchants Financial Services and VBS Mortgage ended their relationship with Bankers Title Virginia resulting in a consolidated loss of $41,914.
 
Note 3. Loans
 
Loans held for investment outstanding at June 30, 2017 and December 31, 2016 are summarized as follows:
 
(dollars in thousands)
 
2017
 
 
2016
 
Construction/Land Development
 $73,184 
 $76,172 
Farmland
  15,024 
  12,901 
Real Estate
  174,179 
  172,758 
Multi-Family
  8,607 
  7,605 
Commercial Real Estate
  149,635 
  150,061 
Home Equity – closed end
  11,392 
  11,453 
Home Equity – open end
  54,345 
  54,420 
Commercial & Industrial – Non-Real Estate
  35,708 
  31,306 
Consumer
  7,387 
  6,643 
Dealer Finance
  71,221 
  65,495 
Credit Cards
  2,753 
  2,822 
Total
 $603,435 
 $591,636 
 
The Company has pledged loans held for investment as collateral for borrowings with the Federal Home Loan Bank of Atlanta totaling $204,135,000 and $199,401,000 as of June 30, 2017 and December 31, 2016, respectively.  The Company maintains a blanket lien on its entire residential real estate portfolio and certain commercial and home equity loans.
 
 
 
12
 
 
Note 3. Loans, continued
 
The following is a summary of information pertaining to impaired loans (dollars in thousand):
 
 
 
June 30, 2017
 
 
December 31, 2016
 
 
 
 
 
 
Unpaid
 
 
 
 
 
 
 
 
Unpaid
 
 
 
 
 
 
Recorded
 
 
Principal
 
 
Related
 
 
Recorded
 
 
Principal
 
 
Related
 
 
 
Investment
 
 
Balance
 
 
Allowance
 
 
Investment
 
 
Balance
 
 
Allowance
 
Impaired loans without a valuation allowance:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
     Construction/Land Development
 $5,331 
 $5,688 
 $- 
 $3,296 
 $3,652 
 $- 
     Farmland
  1,858 
  1,858 
  - 
  - 
  - 
  - 
     Real Estate
  747 
  747 
  - 
  768 
  768 
  - 
     Multi-Family
  - 
  - 
  - 
  - 
  - 
  - 
     Commercial Real Estate
  100 
  100 
  - 
  1,958 
  1,958 
  - 
     Home Equity – closed end
  - 
  - 
  - 
  - 
  - 
  - 
     Home Equity – open end
  - 
  346 
  - 
  - 
  347 
  - 
     Commercial & Industrial – Non-Real Estate
  165 
  165 
  - 
  170 
  170 
  - 
     Consumer
  11 
  11 
  - 
  13 
  13 
  - 
     Credit cards
  - 
  - 
  - 
  - 
  - 
  - 
     Dealer Finance
  21 
  21 
  - 
  - 
  - 
  - 
 
  8,233 
  8,936 
    
  6,205 
  6,908 
    
Impaired loans with a valuation allowance
    
    
    
    
    
    
     Construction/Land Development
  5,662 
  5,662 
  1,981 
  6,592 
  6,592 
  1,853 
     Farmland
  - 
  - 
  - 
  - 
  - 
  - 
     Real Estate
  1,196 
  1,196 
  218 
  1,206 
  1,206 
  221 
     Multi-Family
  - 
  - 
  - 
  - 
  - 
  - 
     Commercial Real Estate
  - 
  - 
  - 
  952 
  952 
  60 
     Home Equity – closed end
  - 
  - 
  - 
  - 
  - 
  - 
     Home Equity – open end
  - 
  - 
  - 
  - 
  - 
  - 
     Commercial & Industrial – Non-Real Estate
  - 
  - 
  - 
  - 
  - 
  - 
     Consumer
  - 
  - 
  - 
  - 
  - 
  - 
     Credit cards
  - 
  - 
  - 
  - 
  - 
  - 
     Dealer Finance
  69 
  69 
  18 
  87 
  87 
  20 
 
  6,927 
  6,927 
  2,217 
  8,837 
  8,837 
  2,154 
Total impaired loans
 $15,160 
 $15,863 
 $2,217 
 $15,042 
 $15,745 
 $2,154 
 
The Recorded Investment is defined as the original principal balance less principal payments, charge-offs and nonaccrual payments applied to principal.
 
Loans held for sale consists of loans originated by VBS Mortgage for sale in the secondary market, and the Bank’s commitment to purchase residential mortgage loan participations from Northpointe Bank.  The volume of loans purchased from Northpointe fluctuates due to a number of factors including changes in secondary market rates, which affects demand for mortgage loans; the number of participating banks involved in the program; the number of mortgage loan originators selling loans to the lead bank and the funding capabilities of the lead bank.  Loans held for sale as of June 30, 2017 and December 31, 2016 were $51,766,953 and $62,734,803, respectively.
 
 
 
13
 
 
Note 3. Loans Held for Investment, continued
 
The following is a summary of the average investment and interest income recognized for impaired loans (dollars in thousands):
 
 
 
Three Months Ended June 30,
 
 
Six Months Ended June 30,
 
 
 
2017
 
 
2016
 
 
2017
 
 
2016
 
 
 
Average Recorded
 
 
Interest Income
 
 
Average Recorded
 
 
Interest Income
 
 
Average Recorded
 
 
Interest Income
 
 
Average Recorded
 
 
Interest Income
 
 
 
Investment
 
 
Recognized
 
 
Investment
 
 
Recognized
 
 
Investment
 
 
Recognized
 
 
Investment
 
 
Recognized
 
Impaired loans without a valuation allowance:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
     Construction/Land Development
 $4,734 
 $47 
 $1,164 
 $(7)
 $4,374
 $50 
 $1,295 
 $17 
     Farmland
  1,858 
  - 
  - 
  - 
 1,239
  - 
  - 
  - 
     Real Estate
  750 
  14 
  784 
  9 
  756
  17 
  939 
  20 
     Multi-Family
  - 
  - 
  - 
  - 
  - 
  - 
  - 
  - 
     Commercial Real Estate
  100 
  2 
  203 
  - 
 719
  3 
  153 
  2 
     Home Equity – closed end
  - 
  - 
  - 
  - 
  - 
  - 
  - 
  - 
     Home Equity – open end
  347 
  6 
  1,582 
  - 
  347 
  - 
  1,370 
  35 
     Commercial & Industrial – Non-Real Estate
  166 
  - 
  177 
  3 
  167 
  6 
  178 
  6 
     Consumer and credit cards
  11 
  - 
  9 
  - 
  12 
  - 
  9 
  - 
     Dealer Finance
  20 
  1 
  16 
  1 
  13
  1 
  15 
  2 
 
  7,986 
  70 
  3,935 
  6 
  7,627
  77 
  3,959 
  82 
Impaired loans with a valuation allowance:
    
    
    
    
    
    
    
    
     Construction/Land Development
  6,512 
  97 
  10,337 
  47 
 $6,539
 $140 
 $10,778 
 $100 
     Farmland
  - 
  - 
  - 
  - 
  - 
  - 
  - 
  - 
     Real Estate
  1,199 
  31 
  1,221 
  10 
  1,201 
  31 
  771 
  26 
     Multi-Family
  - 
  - 
  - 
  - 
  - 
  - 
  - 
  - 
     Commercial Real Estate
  - 
  - 
  965 
  14 
 317
  - 
  926 
  28 
     Home Equity – closed end
  - 
  - 
  - 
  - 
  - 
  - 
  - 
  - 
     Home Equity – open end
  - 
  - 
  1,407 
  9 
  - 
  - 
  1,411 
  19 
     Commercial & Industrial – Non-Real Estate
  - 
  - 
  27 
  1 
  - 
  - 
  13 
  1 
     Consumer and credit card
  - 
  - 
  - 
  - 
  - 
  - 
  - 
  - 
     Dealer Finance
  65 
  - 
  82 
  1 
 72
  1 
  77 
  3 
 
  7,776 
  128 
  14,039 
  82 
 8,129
  172 
  13,976 
  177 
Total Impaired Loans
 $15,762 
 $198 
 $17,974 
 $88 
 $15,756
 $249 
 $17,935 
 $259 
 
 
 
14
 
 
Note 3. Loans, continued
 
The following table presents the aging of the recorded investment of past due loans (dollars in thousands) as of June 30, 2017 and December 31, 2016:
 
 
 
30-59 Days Past due
 
 
60-89 Days Past Due
 
 
Greater than 90 Days (excluding non-accrual)
 
 
Non-Accrual Loans
 
 
Total Past Due
 
 
Current
 
 
Total Loan Receivable
 
June 30, 2017
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Construction/Land Development
 $632 
 $88 
 $- 
 $3,162 
 $3,882 
 $69,302 
 $73,184 
Farmland
  1,912 
  - 
  - 
  - 
  1,912 
  13,112 
  15,024 
Real Estate
  2,159 
  621 
  159 
  1,386 
  4,325 
  169,854 
  174,179 
Multi-Family
  - 
  - 
  - 
  - 
  - 
  8,607 
  8,607 
Commercial Real Estate
  2,609 
  135 
  - 
  350 
  3,094 
  146,541 
  149,635 
Home Equity – closed end
  - 
  - 
  - 
  - 
  - 
  11,392 
  11,392 
Home Equity – open end
  105 
  25 
  - 
  382 
  512 
  53,833 
  54,345 
Commercial & Industrial – Non- Real Estate
  31 
  18 
  - 
  - 
  49 
  35,659 
  35,708 
Consumer
  50 
  12 
  - 
  - 
  62 
  7,325 
  7,387 
Dealer Finance
  485 
  187 
    
  237 
  909 
  70,312 
  71,221 
Credit Cards
  46 
  5 
  1 
  - 
  52 
  2,701 
  2,753 
Total
 $8,029 
 $1,091 
 $160 
 $5,517 
 $14,797 
 $588,638 
 $603,435 
 
 
 
30-59 Days Past due
 
 
60-89 Days Past Due
 
 
Greater than 90 Days (excluding non-accrual)
 
 
Non-Accrual Loans
 
 
Total Past Due
 
 
Current
 
 
Total Loan Receivable
 
December 31, 2016
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Construction/Land Development
 $73 
 $101 
 $- 
 $2,805 
 $2,979 
 $73,193 
 $76,172 
Farmland
  - 
  - 
  - 
  - 
  - 
  12,901 
  12,901 
Real Estate
  2,114 
  340 
  81 
  1,399 
  3,934 
  168,824 
  172,758 
Multi-Family
  - 
  - 
  - 
  - 
  - 
  7,605 
  7,605 
Commercial Real Estate
  139 
  - 
  - 
  - 
  139 
  149,922 
  150,061 
Home Equity – closed end
  101 
  - 
  - 
  32 
  133 
  11,320 
  11,453 
Home Equity – open end
  309 
  - 
  - 
  279 
  588 
  53,832 
  54,420 
Commercial & Industrial – Non- Real Estate
  313 
  5 
  - 
  70 
  388 
  30,918 
  31,306 
Consumer
  35 
  4 
  - 
  - 
  39 
  6,604 
  6,643 
Dealer Finance
  790 
  187 
  26 
  178 
  1,181 
  64,314 
  65,495 
Credit Cards
  18 
  4 
  - 
  - 
  22 
  2,800 
  2,822 
Total
 $3,892 
 $641 
 $107 
 $4,763 
 $9,403 
 $582,233 
 $591,636 
 
At June 30, 2017 and December 31, 2016, other real estate owned included $571,000 and $565,000 of foreclosed residential real estate.  The Company has $256,000 of consumer mortgages for which foreclosure is in process at June 30, 2017 and $40,000 at December 31, 2016.
 
Nonaccrual loans at June 30, 2017 and June 30, 2016, would have earned approximately $60,000 and $28,000, respectively, in interest income had they been accruing loans.
 
 
 
15
 
 
Note 4. Allowance for Loan Losses
 
A summary of changes in the allowance for loan losses (dollars in thousands) for June 30, 2017 and December 31, 2016 is as follows:
 
June 30, 2017
 
Beginning Balance
 
 
Charge-offs
 
 
Recoveries
 
 
Provision
 
 
Ending Balance
 
 
Individually Evaluated for Impairment
 
 
Collectively Evaluated for Impairment
 
Allowance for loan losses:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Construction/Land Development
 $3,381 
 $- 
 $- 
 $(134)
 $3,247 
 $1,981 
 $1,266 
Farmland
  34 
  - 
  - 
  (7)
  27 
  - 
  27 
Real Estate
  843 
  - 
  2 
  (73)
  772 
  218 
  554 
Multi-Family
  23 
  - 
  - 
  (7)
  16 
  - 
  16 
Commercial Real Estate
  705 
  - 
  8 
  (72)
  641 
  - 
  641 
Home Equity – closed end
  75 
  6 
  - 
  4 
  73 
  - 
  73 
Home Equity – open end
  470 
  1 
  - 
  (92)
  377 
  - 
  377 
 Commercial & Industrial – Non-Real Estate
  586 
  31 
  54 
  (201)
  408 
  - 
  408 
 Consumer
  78 
  23 
  5 
  46 
  106 
  - 
  106 
Dealer Finance
  1,289 
  941 
  618 
  525 
  1,491 
  18 
  1,473 
Credit Cards
  59 
  28 
  16 
  11 
  58 
  - 
  58 
Total
 $7,543 
 $1,030 
 $703 
 $- 
 $7,216 
 $2,217 
 $4,999 
 
December 31, 2016
 
Beginning Balance
 
 
Charge-offs
 
 
Recoveries
 
 
Provision
 
 
Ending Balance
 
 
Individually Evaluated for Impairment
 
 
Collectively Evaluated for Impairment
 
Allowance for loan losses:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Construction/Land Development
 $4,442 
 $356 
 $7 
 $(712)
 $3,381 
 $1,853 
 $1,528 
Farmland
  95 
  - 
  - 
  (61)
  34 
  - 
  34 
Real Estate
  806 
  23 
  4 
  56 
  843 
  221 
  622 
Multi-Family
  71 
  - 
  - 
  (48)
  23 
  - 
  23 
Commercial Real Estate
  445 
  19 
  135 
  144 
  705 
  - 
  705 
Home Equity – closed end
  174 
  8 
  - 
  (91)
  75 
  - 
  75 
Home Equity – open end
  634 
  370 
  120 
  86 
  470 
  60 
  410 
 Commercial & Industrial – Non-Real Estate
  1,055 
  293 
  267 
  (443)
  586 
  - 
  586 
 Consumer
  108 
  37 
  19 
  (12)
  78 
  - 
  78 
Dealer Finance
  836 
  1,081 
  417 
  1,117 
  1,289 
  20 
  1,269 
Credit Cards
  115 
  74 
  54 
  (36)
  59 
  - 
  59 
Total
 $8,781 
 $2,261 
 $1,023 
 $- 
 $7,543 
 $2,154 
 $5,389 
 
 
 
16
 
 
Note 4. Allowance for Loan Losses, continued
 
The following table presents the recorded investment in loans (dollars in thousands) based on impairment method as of June 30, 2017 and December 31, 2016:
 
June 30, 2017
 
Loan Receivable
 
 
Individually Evaluated for Impairment
 
 
Collectively Evaluated for Impairment
 
Construction/Land Development
 $73,184 
 $10,993 
 $62,191 
Farmland
  15,024 
  1,858 
  13,166 
Real Estate
  174,179 
  1,943 
  172,236 
Multi-Family
  8,607 
  - 
  8,607 
Commercial Real Estate
  149,635 
  100 
  149,535 
Home Equity – closed end
  11,392 
  - 
  11,392 
Home Equity –open end
  54,345 
  - 
  54,345 
Commercial & Industrial – Non-Real Estate
  35,708 
  165 
  35,543 
Consumer
  7,387 
  11 
  7,376 
Dealer Finance
  71,221 
  90 
  71,131 
Credit Cards
  2,753 
  - 
  2,753 
 
 $603,435 
 $15,160 
 $588,275 
Total
    
    
    
 
December 31, 2016
 
Loan Receivable
 
 
Individually Evaluated for Impairment
 
 
Collectively Evaluated for Impairment
 
Construction/Land Development
 $76,172 
 $9,888 
 $66,284 
Farmland
  12,901 
  - 
  12,901 
Real Estate
  172,758 
  1,974 
  170,784 
Multi-Family
  7,605 
  - 
  7,605 
Commercial Real Estate
  150,061 
  2,910 
  147,151 
Home Equity – closed end
  11,453 
  - 
  11,453 
Home Equity –open end
  54,420 
  - 
  54,420 
Commercial & Industrial – Non-Real Estate
  31,306 
  170 
  31,136 
Consumer
  6,643 
  13 
  6,630 
Dealer Finance
  65,495 
  87 
  65,408 
Credit Cards
  2,822 
  - 
  2,822 
 
 $591,636 
 $15,042 
 $576,594 
Total
    
    
    
 
 
 
17
 
 
Note 4. Allowance for Loan Losses, continued
 
The following table shows the Company’s loan portfolio broken down by internal loan grade (dollars in thousands) as of June 30, 2107 and December 31, 2016:
 
June 30, 2017
 
Grade 1 Minimal Risk
 
 
Grade 2 Modest Risk
 
 
Grade 3 Average Risk
 
 
Grade 4 Acceptable Risk
 
 
Grade 5 Marginally Acceptable
 
 
Grade 6 Watch
 
 
Grade 7 Substandard
 
 
Grade 8 Doubtful
 
 
Total
 
Construction/Land Development
 $- 
 $602 
 $13,683 
 $34,210 
 $9,709 
 $5,588 
 $9,392 
 $- 
 $73,184 
Farmland
  64 
  333 
  3,146 
  4,336 
  3,440 
  1,847 
  1,858 
  - 
  15,024 
Real Estate
  - 
  1,104 
  53,276 
  91,305 
  20,840 
  5,162 
  2,492 
  - 
  174,179 
Multi-Family
  - 
  270 
  4,935 
  3,221 
  181 
  - 
  - 
  - 
  8,607 
Commercial Real Estate
  - 
  2,771 
  38,935 
  95,832 
  10,241 
  1,265 
  591 
  - 
  149,635 
Home Equity – closed end
  - 
  283 
  3,883 
  4,335 
  1,457 
  1,428 
  6 
  - 
  11,392 
Home Equity – open end
  84 
  1,962 
  16,294 
  31,336 
  4,046 
  173 
  450 
  - 
  54,345 
Commercial & Industrial (Non-Real Estate)
  293 
  840 
  13,218 
  19,125 
  1,485 
  735 
  12 
  - 
  35,708 
Consumer (excluding dealer)
  55 
  315 
  2,497 
  795 
  1,235 
  2,031 
  459 
  - 
  7,387 
Total
 $496 
 $8,480 
 $149,867 
 $284,495 
 $52,634 
 $18,229 
 $15,260 
 $- 
 $529,461 
 
 
 
Credit Cards
 
 
Dealer Finance
 
Performing
 $2,752 
 $70,984 
Non performing
  1 
  237 
Total
 $2,753 
 $71,221 
 
 
 
 
18
 
 
Note 4. Allowance for Loan Losses, continued
 
December 31, 2016
 
Grade 1 Minimal Risk
 
 
Grade 2 Modest Risk
 
 
Grade 3 Average Risk
 
 
Grade 4 Acceptable Risk
 
 
Grade 5 Marginally Acceptable
 
 
Grade 6 Watch
 
 
Grade 7 Substandard
 
 
Grade 8 Doubtful
 
 
Total
 
Construction/Land Development
 $- 
 $1,478 
 $10,870 
 $43,863 
 $8,399 
 $2,473 
 $9,089 
 $- 
 $76,172 
Farmland
  65 
  - 
  3,073 
  3,456 
  4,446 
  1,861 
  - 
  - 
  12,901 
Real Estate
  - 
  1,149 
  62,168 
  74,242 
  28,266 
  4,680 
  2,253 
  - 
  172,758 
Multi-Family
  - 
  311 
  3,009 
  4,099 
  186 
  - 
  - 
  - 
  7,605 
Commercial Real Estate
  - 
  2,793 
  32,986 
  91,157 
  19,181 
  1,840 
  2,104 
  - 
  150,061 
Home Equity – closed end
  - 
  150 
  3,966 
  4,139 
  1,746 
  1,414 
  38 
  - 
  11,453 
Home Equity – open end
  124 
  1,724 
  16,415 
  30,974 
  4,547 
  125 
  511 
  - 
  54,420 
Commercial & Industrial (Non-Real Estate)
  1,375 
  1,267 
  6,827 
  19,530 
  2,198 
  39 
  70 
  - 
  31,306 
Consumer (excluding dealer)
  67 
  174 
  1,837 
  607 
  1,242 
  2,252 
  466 
  - 
  6,643 
Total
 $1,631 
 $9,046 
 $141,151 
 $272,065 
 $70,211 
 $14,684 
 $14,531 
 $- 
 $523,319 
 
 
 
Credit Cards
 
 
Dealer Finance
 
Performing
 $2,822 
 $65,291 
Non performing
  - 
  204 
Total
 $2,822 
 $65,495 
 
Description of internal loan grades:
 
Grade 1 – Minimal Risk:   Excellent credit, superior asset quality, excellent debt capacity and coverage, and recognized management capabilities.
 
Grade 2 – Modest Risk:  Borrower consistently generates sufficient cash flow to fund debt service, excellent credit, above average asset quality and liquidity.
 
Grade 3 – Average Risk:  Borrower generates sufficient cash flow to fund debt service.  Employment (or business) is stable with good future trends.  Credit is very good.
 
Grade 4 – Acceptable Risk:  Borrower’s cash flow is adequate to cover debt service; however, unusual expenses or capital expenses must be covered through additional long term debt.  Employment (or business) stability is reasonable, but future trends may exhibit slight weakness. Credit history is good. No unpaid judgments or collection items appearing on credit report.
 
 
 
19
 
 
Note 4. Allowance for Loan Losses, continued
 
Grade 5 – Marginally acceptable:  Credit to borrowers who may exhibit declining earnings, may have leverage that is materially above industry averages, liquidity may be marginally acceptable.  Employment or business stability may be weak or deteriorating.  May be currently performing as agreed, but would be adversely affected by developing factors such as layoffs, illness, reduced hours or declining business prospects.  Credit history shows weaknesses, past dues, paid or disputed collections and judgments, but does not include borrowers that are currently past due on obligations or with unpaid, undisputed judgments.
 
Grade 6 – Watch:  Loans are currently protected, but are weak due to negative balance sheet or income statement trends.  There may be a lack of effective control over collateral or the existence of documentation deficiencies.  These loans have potential weaknesses that deserve management’s close attention.  Other reasons supporting this classification include adverse economic or market conditions, pending litigation or any other material weakness.  Existing loans that become 60 or more days past due are placed in this category pending a return to current status.
 
Grade 7 – Substandard: Loans having well-defined weaknesses where a payment default and or loss is possible, but not yet probable.  Cash flow is inadequate to service the debt under the current payment, or terms, with prospects that the condition is permanent.  Loans classified as substandard are inadequately protected by the current net worth and paying capacity of the borrower and there is the likelihood that collateral will have to be liquidated and/or guarantor(s) called upon to repay the debt.  Generally, the loan is considered collectible as to both principal and interest, primarily because of collateral coverage, however, if the deficiencies are not corrected quickly; there is a probability of loss.
 
Grade 8 – Doubtful:  The loan has all the characteristics of a substandard credit, but available information indicates it is unlikely the loan will be repaid in its entirety.  Cash flow is insufficient to service the debt.  It may be difficult to project the exact amount of loss, but the probability of some loss is great.  Loans are to be placed on non-accrual status when any portion is classified doubtful.
 
Credit card and dealer finance loans are classified as performing or nonperforming.  A loan is nonperforming when payments of principal and interest are past due 90 days or more.
 
 
 
20
 
 
Note 5. Employee Benefit Plan
 
The Bank has a qualified noncontributory defined benefit pension plan which covers substantially all of its full-time employees hired before April 1, 2012.  The benefits are primarily based on years of service and earnings.  The Company uses December 31st as the measurement date for the defined benefit pension plan.  The Bank does not expect to contribute to the pension plan in 2017.
 
The following is a summary of net periodic pension costs for the three and six month periods ended June 30, 2017 and 2016:
 
 
 
Six Months Ended
 
 
Three Months Ended
 
 
 
June 30, 2017
 
 
June 30, 2016
 
 
June 30, 2017
 
 
June 30, 2016
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Service cost
 $347,922 
 $315,936 
 $173,961 
 $157,968 
Interest cost
  243,604 
  226,448 
  121,802 
  113,224 
Expected return on plan assets
  (425,548)
  (427,208)
  (212,774)
  (213,604)
Amortization of prior service cost
  (7,618)
  (7,618)
  (3,809)
  (3,809)
Amortization of net (gain) or loss
  142,048 
  111,572 
  71,024 
  55,786 
 Net periodic pension cost
 $300,408 
 $219,130 
 $150,204 
 $109,565 
 
Note 6. Fair Value
 
The fair value of a financial instrument is the current amount that would be exchanged between willing parties, other than in a forced liquidation. 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. Accounting guidance for fair value 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 Company records fair value adjustments to certain assets and liabilities and determines fair value disclosures utilizing a definition of fair value of assets and liabilities that states that fair value is an exit price, representing the amount that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants. Additional considerations are involved to determine the fair value of financial assets in markets that are not active.
 
The Company uses a hierarchy of valuation techniques based on whether the inputs to those valuation techniques are observable or unobservable. Observable inputs reflect market data obtained from independent sources, while unobservable inputs reflect the Company’s market assumptions. The three levels of the fair value hierarchy based on these two types of inputs are as follows:
 
 
Level 1 –
 
Valuation is based on quoted prices in active markets for identical assets and liabilities.
 
Level 2 –
 
Valuation is based on observable inputs including quoted prices in active markets for similar assets and liabilities, quoted prices for identical or similar assets and liabilities in less active markets, and model-based valuation techniques for which significant assumptions can be derived primarily from or corroborated by observable data in the market.
 
Level 3 –
 
Valuation is based on model-based techniques that use one or more significant inputs or assumptions that are unobservable in the market.
 
 
 
21
 
 
Note 6. Fair Value, continued
 
The following describes the valuation techniques used by the Company to measure certain financial assets and liabilities recorded at fair value on a recurring basis in the financial statements:
 
Securities
 
Where quoted prices are available in an active market, 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. The carrying value of restricted Federal Reserve Bank and Federal Home Loan Bank stock approximates fair value based upon the redemption provisions of each entity and is therefore excluded from the following table.
 
Derivatives
 
The Company’s derivatives are recorded at fair value based on third party vendor supplied information using discounted cash flow analysis from observable-market based inputs, which are considered Level 2 inputs.
 
The following tables present the balances of financial assets measured at fair value on a recurring basis as of June 30, 2017 and December 31, 2016 (dollars in thousands):
 
June 30, 2017
 
Total
 
 
Level 1
 
 
Level 2
 
 
Level 3
 
 
 
 
 
 
 
 
 
 
 
 
 
 
U. S. Treasuries
 $24,000 
 $24,000 
 $- 
 $- 
Mortgage-backed obligations of federal agencies
  573 
  - 
  573 
  - 
Equity securities
  135 
  - 
  135 
  - 
Total securities available for sale
 $24,708 
 $24,000 
 $708 
  - 
 
    
    
    
    
 
December 31, 2016
 
Total
 
 
Level 1
 
 
Level 2
 
 
Level 3
 
 
 
 
 
 
 
 
 
 
 
 
 
 
U. S. Treasuries
 $24,014 
 $24,014 
 $- 
 $- 
Mortgage-backed obligations of federal agencies
  634 
  - 
  634 
  - 
Equity securities
  135 
  - 
  135 
  - 
Total securities available for sale
 $24,783 
 $24,014 
 $769 
  - 
 
Certain financial assets are measured at fair value on a nonrecurring basis in accordance with GAAP. Adjustments to the fair value of these assets usually result from the application of lower-of-cost-or-market accounting or write-downs of individual assets.
 
The following describes the valuation techniques used by the Company to measure certain financial assets recorded at fair value on a nonrecurring basis in the financial statements:
 
Loans Held for Sale
 
Loans held for sale are short-term loans purchased at par for resale to investors at the par value of the loan and loans originated by VBS for sale in the secondary market.  Loan participations are generally repurchased within 15 days.  Loans originated for sale by VBS are recorded at lower of cost or market.  No market adjustments were required at June 30, 2017 or December 31, 2016; therefore, loans held for sale were carried at cost.  Because of the short-term nature and fixed repurchase price, the book value of these loans approximates fair value at June 30, 2017 and December 31, 2016.
 
 
 
22
 
 
Note 6. Fair Value, continued
 
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 will not be collected according to the contractual terms of the loan agreement. Troubled debt restructurings are impaired loans. Impaired loans are measured at fair value on a nonrecurring basis. If an individually-evaluated impaired loan’s balance exceeds fair value, the amount is allocated to the allowance for loan losses. Any fair value adjustments are recorded in the period incurred as provision for loan losses on the Consolidated Statements of Income.
 
The fair value of an impaired loan and measurement of associated loss is based on one of three methods: the observable market price of the loan, the present value of projected cash flows, or the fair value of the collateral. The observable market price of a loan is categorized as a Level 1 input. The present value of projected cash flows method results in a Level 3 categorization because the calculation relies on the Company’s judgment to determine projected cash flows, which are then discounted at the current rate of the loan, or the rate prior to modification if the loan is a troubled debt restructure.
 
Loans measured using the fair value of collateral method are categorized in Level 3. Collateral may be in the form of real estate or business assets including equipment, inventory, and accounts receivable. Most collateral is real estate. The Company bases collateral method fair valuation upon the “as-is” value of independent appraisals or evaluations.
 
The value of real estate collateral is determined by an independent appraisal utilizing an income or market valuation approach.  Appraisals conducted by an independent, licensed appraiser outside of the Company using observable market data is categorized as Level 3. The value of business equipment is based upon an outside appraisal (Level 3) if deemed significant, or the net book value on the applicable business’ financial statements (Level 3) if not considered significant. Likewise, values for inventory and accounts receivables collateral are based on financial statement balances or aging reports (Level 3).
 
As of June 30, 2017 and December 31, 2016, the fair value measurements for impaired loans with specific allocations were primarily based upon the fair value of the collateral.
 
The following table summarizes the Company’s financial assets that were measured at fair value on a nonrecurring basis during the period (dollars in thousands):
 
June 30, 2017
 
Total
 
 
Level 1
 
 
Level 2
 
 
Level 3
 
 
 
 
 
 
 
 
 
 
 
 
 
 
     Construction/Land Development
 $3,681 
  - 
  - 
 $3,681 
     Real Estate
  978 
  - 
  - 
  978 
     Dealer Finance
  51 
  - 
  - 
  51 
Impaired loans
 $4,710 
  - 
  - 
 $4,710 
 
    
    
    
    
 
December 31, 2016
 
Total
 
 
Level 1
 
 
Level 2
 
 
Level 3
 
 
 
 
 
 
 
 
 
 
 
 
 
 
     Construction/Land Development
 $4,739 
  - 
  - 
 $4,739 
     Real Estate
  985 
  - 
  - 
  985 
     Commercial Real Estate
  892 
  - 
  - 
  892 
     Dealer Finance
  67 
  - 
  - 
  67 
Impaired loans
 $6,683 
  - 
  - 
 $6,683 
 
 
 
23
 
 
Note 6. Fair Value, continued
 
The following table presents information about Level 3 Fair Value Measurements for June 30, 2017:
 
 
 
Fair Value at
June 30, 2017
 
Valuation Technique
 
Significant Unobservable Inputs
 
Range
(dollars in thousands)   
Impaired Loans
 $4,710 
Discounted appraised value
 
Discount for selling costs and marketability
 
2%-50% (Average 4.7%)
 
The following table presents information about Level 3 Fair Value Measurements for December 31, 2016:
 
 
 
Fair Value at
December 31, 2016
 
Valuation Technique
 
Significant Unobservable Inputs
 
Range
(dollars in thousands)   
Impaired Loans
 $6,683 
Discounted appraised value
 
Discount for selling costs and marketability
 
2%-50% (Average 4.7%)
 
Other Real Estate Owned
 
Certain assets such as other real estate owned (OREO) are measured at fair value less cost to sell. Valuation of other real estate owned is determined using current appraisals from independent parties, a level two input. If current appraisals cannot be obtained prior to reporting dates, or if declines in value are identified after a recent appraisal is received, appraisal values are discounted, resulting in Level 3 estimates. If the Company markets the property with a realtor, estimated selling costs reduce the fair value, resulting in a valuation based on Level 3 inputs.
 
The Company markets other real estate owned both independently and with local realtors. Properties marketed by realtors are discounted by selling costs. Properties that the Company markets independently are not discounted by selling costs.
 
The following table summarizes the Company’s other real estate owned that were measured at fair value on a nonrecurring basis as of June 30, 2017 and December 31, 2016 (dollars in thousands).
 
June 30, 2017
 
Total
 
 
Level 1
 
 
Level 2
 
 
Level 3
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Other real estate owned
 $2,008 
  - 
  - 
 $2,008 
 
 
December 31, 2016
 
Total
 
 
Level 1
 
 
Level 2
 
 
Level 3
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Other real estate owned
 $2,076 
  - 
  - 
 $2,076 
 
The following table presents information about Level 3 Fair Value Measurements for June 30, 2017:
 
 
 
Fair Value at
June 30, 2017
 
Valuation Technique
 
Significant Unobservable Inputs
 
Range
(dollars in thousands)
 
 
 
 
 
 
 
 
Other real estate owned
 $2,008 
Discounted appraised value
 
Discount for selling costs
 
5%-15% (Average 8%)
 
The following table presents information about Level 3 Fair Value Measurements for December 31, 2016:
 
 
 
Fair Value at
December 31, 2016
 
Valuation Technique
 
Significant Unobservable Inputs
 
Range
(dollars in thousands)
 
 
 
 
 
 
 
 
Other real estate owned
 $2,076 
Discounted appraised value
 
Discount for selling costs
 
5%-15% (Average 8%)
 
The following methods and assumptions were used by the Company in estimating fair value disclosures for financial instruments:
 
Cash and Cash Equivalents
 
 The carrying amounts approximate fair value.
 
 
 
24
 
 
Note 6. Fair Value, continued
 
Securities
 
 The fair values of securities, excluding restricted stock, are determined by quoted market prices or dealer quotes. The fair value of certain state and municipal securities is not readily available through market sources other than dealer quotations, so fair value estimates are based on quoted market prices of similar instruments adjusted for differences between the quoted instruments and the instruments being valued. The carrying value of restricted securities and other investments approximates fair value and are therefore excluded from the following table.
 
Loans Held for Sale
 
Fair values of loans held for sale are based on commitments on hand from investors or prevailing market prices.
 
Loans Held for Investment
 
Fair values are estimated for portfolios of loans with similar financial characteristics. Loans are segregated by type such as commercial, real estate – commercial, real estate – construction, real estate – mortgage, credit card and other consumer loans. Each loan category is further segmented into fixed and adjustable rate interest terms and by performing and nonperforming categories.
 
The fair value of performing loans is calculated by discounting scheduled cash flows through the estimated maturity using estimated market discount rates that reflect the credit and interest rate risk inherent in the loan, as well as estimates for prepayments. The estimate of maturity is based on the Company’s historical experience with repayments for loan classification, modified, as required, by an estimate of the effect of economic conditions on lending.
 
Fair value for significant nonperforming loans is based on estimated cash flows which are discounted using a rate commensurate with the risk associated with the estimated cash flows. Assumptions regarding credit risk, cash flows and discount rates are determined within management’s judgment, using available market information and specific borrower information.
 
Bank-Owned Life Insurance
 
Bank-owned life insurance represents insurance policies on certain officers of the Company.  The cash values of the policies are estimates using information provided by insurance carriers. These policies are carried at their cash surrender value, which approximates fair value.
 
Deposits
 
The fair value of demand and savings deposits is the amount payable on demand. The fair value of fixed maturity term deposits and certificates of deposit is estimated using the rates currently offered for deposits with similar remaining maturities.
 
Short-Term Debt
 
The carrying amounts of short-term debt maturing within 90 days approximate their fair values. Fair values of any other short-term debt are estimated using discounted cash flow analyses based on the current incremental borrowing rates for similar types of debt.
 
Long-Term Debt
 
The fair value of the Company’s long-term debt is estimated using discounted cash flow analyses based on the Company’s incremental borrowing rates for similar types of debt arrangements.
 
Accrued Interest
 
The carrying amounts of accrued interest approximate fair value.
 
 
 
25
 
 
Note 7. Disclosures About Fair Value of Financial Instruments
 
The estimated fair values, and related carrying amounts (dollars in thousands), of the Company’s financial instruments are as follows:
 
 
 
 
 
 
Fair Value Measurements at June 30, 2017 Using
 
(dollars in thousands)
 
Carrying Amount
 
 
Quoted Prices in Active Markets for Identical Assets (Level 1)
 
 
Significant Other Observable Inputs (Level 2)
 
 
Significant Unobservable Inputs (Level 3)
 
 
Fair Value at June 30, 2017
 
Assets:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Cash and cash equivalents
 $11,664 
 $11,664 
 $- 
 $- 
 $11,664 
Securities
  24,833 
  - 
  24,833 
  - 
  24,833 
Loans held for sale
  51,767 
  - 
  51,767 
  - 
  51,767 
Loans held for investment, net
  596,219 
  - 
  - 
  622,449 
  622,449 
Interest receivable
  1,895 
  - 
  1,895 
  - 
  1,895 
Bank owned life insurance
  13,731 
  - 
  13,731 
  - 
  13,731 
Total
 $700,109 
 $11,664 
 $92,226 
 $622,449 
 $726,339 
Liabilities:
    
    
    
    
    
Deposits
 $536,486 
 $- 
 $377,661 
 $159,669 
 $537,330 
Short-term debt
  50,000 
  - 
  50,000 
  - 
  50,000 
Long-term debt
  51,938 
  - 
  - 
  52,048 
  52,048 
Interest payable
  223 
  - 
  223 
  - 
  223 
Total
 $638,647 
 $- 
 $427,884 
 $211,717 
 $639,601 

 
 
 
 
 
Fair Value Measurements at December 31, 2016 Using
 
(dollars in thousands)
 
Carrying Amount
 
 
Quoted Prices in Active Markets for Identical Assets (Level 1)
 
 
Significant Other Observable Inputs (Level 2)
 
 
Significant Unobservable Inputs (Level 3)
 
 
Fair Value at December 31, 2016
 
Assets:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Cash and cash equivalents
 $16,355 
 $16,355 
 $- 
 $- 
 $16,355 
Securities
  24,908 
  - 
  24,908 
  - 
  24,908 
Loans held for sale
  62,735 
  - 
  62,735 
  - 
  62,735 
Loans held for investment, net
  584,093 
  - 
  - 
  598,991 
  598,991 
Interest receivable
  1,785 
  - 
  1,785 
  - 
  1,785 
Bank owned life insurance
  13,513 
  - 
  13,513 
  - 
  13,513 
Total
 $703,389 
 $16,355 
 $102,941 
 $598,991 
 $718,287 
Liabilities:
    
    
    
    
    
Deposits
 $537,085 
 $- 
 $379,857 
 $158,073 
 $537,930 
Short-term debt
  40,000 
  - 
  40,000 
  - 
  40,000 
Long-term debt
  64,237 
  - 
  - 
  63,945 
  63,945 
Interest payable
  228 
  - 
  228 
  - 
  228 
Total
 $641,550 
 $- 
 $420,085 
 $222,018 
 $642,103 
 
 
 
26
 
 
Note 8. Troubled Debt Restructuring
 
In the determination of the allowance for loan losses, management considers troubled debt restructurings and subsequent defaults in these restructurings by adjusting the loan grades of such loans, which are considered in the qualitative factors within the allowance. Defaults resulting in charge-offs affect the historical loss experience ratios which are a component of the allowance for loan loss methodology. Additionally, specific reserves may be established on restructured loans which are evaluated individually for impairment.
 
During the six months ended June 30, 2017, there was one loan modification that was considered to be troubled debt restructuring. This loan was modified during the three months ended June 30, 2017, there were no loan modifications that would be considered a troubled debt restructuring during the first quarter of 2017. Modifications may have included rate adjustments, revisions to amortization schedules, suspension of principal payments for a temporary period, re-advancing funds to be applied as payments to bring the loan(s) current, or any combination thereof.
 
 
 
June 30, 2017
 
 
 
 
 
 
Pre-Modification
 
 
Post-Modification
 
(dollars in thousands)
 
 
 
 
Outstanding
 
 
Outstanding
 
Troubled Debt Restructurings
 
Number of Contracts
 
 
Recorded Investment
 
 
Recorded Investment
 
 
 
 
 
 
 
 
 
 
 
Consumer
  1 
 $20 
 $20 
Total
  1 
 $20 
 $20 
 
 At June 30, 2017, there was one loan restructured in the previous 12 months in default or on nonaccrual status.  A restructured loan is considered in default when it becomes 90 days past due.
 
 
 
June 30, 2017
 
 
 
 
 
 
Pre-Modification
 
 
Post-Modification
 
(dollars in thousands)
 
 
 
 
Outstanding
 
 
Outstanding
 
Troubled Debt Restructurings
 
Number of Contracts
 
 
Recorded Investment
 
 
Recorded Investment
 
 
 
 
 
 
 
 
 
 
 
Real Estate
  1 
 $67 
 $67 
Total
  1 
 $67 
 $67 
 
During the six months ended June 30, 2016, there were six loan modifications that were considered to be troubled debt restructurings.
 
 
 
Six Months ended June 30, 2016
 
 
 
 
 
 
Pre-Modification
 
 
Post-Modification
 
(dollars in thousands)
 
 
 
 
Outstanding
 
 
Outstanding
 
 
 
Number of Contracts
 
 
Recorded Investment
 
 
Recorded Investment
 
Troubled Debt Restructurings
 
 
 
 
 
 
 
 
 
Commercial
  1 
 $27 
 $27 
Real Estate
  2 
  143 
  143 
Consumer
  3 
  36 
  36 
Total
  6 
 $206 
 $206 
 
During the quarter ended June 30, 2016, there were five loans modifications that were considered to be troubled debt restructurings.
 
 
 
Three Months ended June 30, 2016
 
 
 
 
 
 
Pre-Modification
 
 
Post-Modification
 
(dollars in thousands)
 
 
 
 
Outstanding
 
 
Outstanding
 
 
 
Number of Contracts
 
 
Recorded Investment
 
 
Recorded Investment
 
Troubled Debt Restructurings
 
 
 
 
 
 
 
 
 
Commercial
  1 
 $27 
 $27 
Real Estate
  2 
  143 
  143 
Consumer
  2 
  19 
  19 
Total
  5 
 $189 
 $189 
 
 
 
27
 
 
Note 8. Troubled Debt Restructuring, continued
 
At June 30, 2016, six loans that had been restructured in the previous 12 months, were in default or were on nonaccrual status.  A restructured loan is considered in default when it becomes 90 days past due.
 
 
 
June 30, 2016
 
 
 
 
 
 
Pre-Modification
 
 
Post-Modification
 
 
 
 
 
 
Outstanding
 
 
Outstanding
 
 
 
Number of Contracts
 
 
Recorded Investment
 
 
Recorded Investment
 
Troubled Debt Restructurings
 
 
 
 
 
 
 
 
 
Real Estate
  5 
 $1,528 
 $1,528 
Consumer
  1 
  16 
  16 
Total
  6 
 $1,544 
 $1,544 
 
Note 9. Accumulated Other Comprehensive Loss
 
The balances in accumulated other comprehensive loss are shown in the following tables for June 30, 2017 and 2016:
 
(dollars in thousands)
 
Unrealized Securities Gains (Losses)
 
 
Adjustments Related to Pension Plan
 
 
Accumulated Other Comprehensive Loss
 
Balance at December 31, 2016
 $6 
 $(3,171)
 $(3,165)
  Change in unrealized securities gains (losses), net of tax
  (1)
  - 
  (1)
  Change in unfunded pension liability, net of tax
  - 
  - 
  - 
Balance at June 30, 2017
 $5 
 $(3,171)
 $(3,166)
 
(dollars in thousands)
 
Unrealized Securities Gains (Losses)
 
 
Adjustments Related to Pension Plan
 
 
Accumulated Other Comprehensive Loss
 
Balance at December 31, 2015
 $3 
 $(2,683)
 $(2,680)
  Change in unrealized securities gains (losses), net of tax
  25 
  - 
  25 
  Change in unfunded pension liability, net of tax
  - 
  - 
  - 
Balance at June 30, 2016
 $28 
 $(2,683)
 $(2,655)
 
There were no reclassifications adjustments reported on the consolidated statements of income during the three or six months periods ended June 30, 2017 or 2016.
 
Note 10. Business Segments
 
The Company utilizes its subsidiaries to provide multiple business segments including retail banking, mortgage banking, title insurance services, investment services and credit life and accident and health insurance products related to lending.  Revenues from retail banking operations consist primarily of interest earned on loans and investment securities and service charges on deposit accounts. Mortgage Banking operating revenues consist principally of gains on sales of loans in the secondary market, loan origination fee income and interest earned on mortgage loans held for sale. Revenues from title insurance services, investment services and insurance products consist of commissions on products provided.  The following tables represent revenues and expenses by segment for the three and six months ended June 30, 2017 and June 30, 2016.
 
 
 
28
 
 
Note 10. Business Segments, continued
 
 
 
Six Months Ended June 30, 2017
 
 
 
F&M Bank
 
 
VBS Mortgage
 
 
TEB Life/FMFS
 
 
VS Title
 
 
Parent Only
 
 
Eliminations
 
 
F&M Bank Corp. Consolidated
 
Revenues:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Interest Income
 $16,170,387 
 $65,347 
 $74,993 
 $- 
 $13 
 $(44,763)
 $16,265,977 
Service charges on deposits
  650,718 
  - 
  - 
  - 
  - 
  - 
  650,718 
Investment services and insurance income
  585 
  - 
  360,416 
  - 
  - 
  - 
  361,001 
Mortgage banking income, net
  - 
  1,112, 521 
  - 
  - 
  - 
  - 
  1,112,521 
Title insurance income
  - 
  - 
  - 
  553,897 
  - 
  - 
  553,897 
Income from bank owned life insurance
  223,711 
  - 
  - 
  - 
  - 
  - 
  223,771 
Low income housing partnership losses
  (386,142)
  - 
  - 
  - 
  - 
  - 
  (386,142)
ATM and check card fees
  681,448 
  - 
  - 
  - 
  - 
  - 
  681,448 
Gain on prepayment of long-term debt
  503,830 
  - 
  - 
  - 
  - 
  - 
  503,830 
Loss on investments
  - 
  (39,474)
  (2,440)
  - 
  - 
  - 
  (41,914)
Other operating income
  268,370 
  - 
  - 
  - 
  - 
  - 
  268,370 
Total income
  18,112,967 
  1,138,394 
  432,969 
  553,897 
  13 
  (44,763)
  20,193,477 
Expenses:
    
    
    
    
    
    
    
Interest Expense
  1,834,272 
  41,268 
  - 
  - 
  - 
  (44,763)
  1,830,777 
Provision for loan losses
  - 
  - 
  - 
  - 
  - 
  - 
  - 
Salary expense
  4,453,744 
  449,5 73 
  234,209 
  224,572 
  - 
  - 
  5,362,098 
Employee benefit expense
  1,523,051 
  166,785 
  - 
  114,808 
  - 
  - 
  1,804,644 
Occupancy expense
  403,120 
  66,596 
  - 
  33,505 
  - 
  - 
  503,221 
Equipment expense
  359,175 
  18,903 
  - 
  15,039 
  - 
  - 
  393,117 
FDIC insurance assessment
  180,000 
  - 
  - 
  - 
  - 
  - 
  180,000 
Other real estate owned, net
  25,608 
  - 
  - 
  - 
  - 
  - 
  25,608 
Marketing expense
  216,205 
  33,850 
  4,315 
  2,536 
  - 
  - 
  256,906 
Legal and professional fees
  170,299 
  4,725 
  - 
  - 
  - 
  - 
  175,024 
ATM and check card fees
  344,257 
  1,923 
  - 
  - 
  - 
  - 
  346,180 
Telecom and data processing expense
  624,886 
  50,513 
  - 
  - 
  - 
  - 
  675,399 
Directors fees
  210,000 
  33,334 
  - 
  - 
  - 
  - 
  243,334 
Bank franchise Tax
  324,255 
  - 
  - 
  - 
  - 
  - 
  324,255 
Other operating expenses
  1,360,275 
  260,440 
  12,844 
  44,099 
  3,825 
  - 
  1,681,483 
Total expense
  12,029,147 
  1,127,910 
  251,368 
  434,559 
  3,825 
  (44,763)
  13,802,046 
Income tax expense
  1,669,606 
  - 
  52,842 
  - 
  (35,968)
  - 
  1,686,480 
Net income (loss)
 $4,414,214 
 $10,484 
 $128,759 
 $119,338 
 $32,156 
 $- 
 $4,704,951 
Net income (loss) attributable to noncontrolling interest
  - 
  3,145 
  - 
  28,641 
  - 
  - 
  31,786 
Net Income attributable to F & M Bank Corp.
 $4,414,214 
 $7,339 
 $128,759 
 $90,697 
 $32,156 
 $- 
 $4,673,165 
Total Assets
 $746,193,130 
 $6,027,200 
 $6,630,313 
 $274,400 
 $89,908,521 
 $(104,770,806)
 $744,262,758 
Goodwill
 $2,669,517 
 $- 
 $- 
 $- 
 $304,000 
 $- 
 $2,973,517 
 
 
 
29
 
 
Note 10. Business Segments, continued
 
 
 
Three months ended June 30, 2017
 
 
 
F&M Bank
 
 
VBS Mortgage
 
 
TEB Life/FMFS
 
 
VS Title
 
 
Parent Only
 
 
Eliminations
 
 
F&M Bank Corp. Consolidated
 
Revenues:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Interest Income
 $8,209,919 
 $30,051 
 $37,719 
 $- 
 $- 
 $(22,052)
 $8,255,637 
Service charges on deposits
  335,382 
  - 
  - 
  - 
  - 
  - 
  335,382 
Investment services and insurance income
  489 
  - 
  186,625 
  - 
  - 
  - 
  187,114 
Mortgage banking income, net
  - 
  612,594 
  - 
  - 
  - 
  - 
  612,594 
Title insurance income
  - 
  - 
  - 
  355,351 
  - 
  - 
  355,351 
Income from bank owned life insurance
  111,455 
  - 
  - 
  - 
  - 
  - 
  111,455 
Low income housing partnership losses
  (200,813)
  - 
  - 
  - 
  - 
  - 
  (200,813)
ATM and check card fees
  351,505 
  - 
  - 
  - 
  - 
  - 
  351,505 
Gain on prepayment of long-term debt
  - 
  - 
  - 
  - 
  - 
  - 
  - 
Loss on investments
  - 
  - 
  - 
  - 
  - 
  - 
  - 
Other operating income
  129,815 
  - 
  - 
  - 
  - 
  - 
  129,815 
Total income
  8,937,752 
  642,645 
  224,344 
  355,351 
  - 
  (22,052)
  10,138,040 
Expenses:
    
    
    
    
    
    
    
Interest Expense
  926,890 
  20,123 
  - 
  - 
  - 
  (22,052)
  924,961 
Provision for loan losses
  - 
  - 
  - 
  - 
  - 
  - 
  - 
Salary expense
  2,260,954 
  129,586 
  118,650 
  118,846 
  - 
  - 
  2,628,036 
Employee benefit expense
  707,438 
  81,160 
  - 
  63,226 
  - 
  - 
  851,824 
Occupancy expense
  202,205 
  36,398 
  - 
  15,645 
  - 
  - 
  254,248 
Equipment expense
  189,060 
  9,587 
  - 
  8,353 
  - 
  - 
  207,000 
FDIC insurance assessment
  90,000 
  - 
  - 
  - 
  - 
  - 
  90,000 
Other real estate owned, net
  11,843 
  - 
  - 
  - 
  - 
  - 
  11,843 
Marketing expense
  99,963 
  17,339 
  3,910 
  791 
  - 
  - 
  122,003 
Legal and professional fees
  76,663 
  2,475 
  - 
  - 
  - 
  - 
  79,138 
ATM and check card fees
  176,934 
  990 
  - 
  - 
  - 
  - 
  177,924 
Telecom and data processing expense
  325,679 
  26,345 
  - 
  - 
  - 
  - 
  352,024 
Directors fees
  105,000 
  11,334 
  - 
  - 
  - 
  - 
  116,334 
Bank franchise Tax
  164,249 
  - 
  - 
  - 
  - 
  - 
  164,249 
Other operating expenses
  717,539 
  215,934 
  9,453 
  18,064 
  1,125 
  - 
  962,115 
Total expense
  6,054,417 
  551,271 
  132,013 
  224,925 
  1,125 
  (22,052)
  6,941,699 
Income tax expense
  800,944 
  - 
  26,172 
  - 
  (17,717)
  - 
  809,399 
Net income (loss)
 $2,082,391 
 $91,374 
 $66,159 
 $130,426 
 $16,592 
 $- 
 $2,386,942 
Net income (loss) attributable to noncontrolling interest
  - 
  27,412 
  - 
  31,302 
  - 
  - 
  58,714 
Net Income attributable to F & M Bank Corp.
 $2,082,391 
 $63,982 
 $66,159 
 $99,124 
 $16,592 
 $- 
 $2,328,228 
 
 
 
30
 
 
Note 10. Business Segments, continued
 
 
 
Six Months Ended June 30, 2016
 
 
 
F&M Bank
 
 
VBS Mortgage
 
 
TEB Life/FMFS
 
 
VS Title
 
 
Parent Only
 
 
Eliminations
 
 
F&M Bank Corp. Consolidated
 
Revenues:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Interest Income
 $15,492,768 
 $13,213 
 $75,030 
 $- 
 $- 
 $(3,037)
 $15,577,974 
Service charges on deposits
  506,028 
  - 
  - 
  - 
  - 
  - 
  506,028 
Investment services and insurance income
  508 
  - 
  64,830 
  - 
  - 
  - 
  65,338 
Mortgage banking income, net
  - 
  1,196,444 
  - 
  - 
  - 
  - 
  1,196,444 
Title insurance income
  - 
  - 
  - 
  - 
  - 
  - 
  - 
Income from bank owned life insurance
  236,652 
  - 
  - 
  - 
  - 
  - 
  236,652 
Low income housing partnership losses
  (365,387)
  - 
  - 
  - 
  - 
  - 
  (365,387)
ATM and check card fees
  692,194 
  - 
  - 
  - 
  - 
  - 
  692,194 
Gain on prepayment of long-term debt
  - 
  - 
  - 
  - 
  - 
  - 
  - 
Loss on investments
  - 
  - 
  - 
  - 
  - 
  - 
  - 
Other operating income
  249,751 
  - 
  - 
  - 
  - 
  - 
  249,751 
Total income
  16,812,514 
  1,209,657 
  139,860 
  - 
  - 
  (3,037)
  18,158,994 
Expenses:
    
    
    
    
    
    
    
Interest Expense
  1,678,349 
  - 
  - 
  - 
  - 
  (3,037)
  1,675,312 
Provision for loan losses
  - 
  - 
  - 
  - 
  - 
  - 
  - 
Salary expense
  4,023,139 
  380,298 
  139,463 
  - 
  - 
  - 
  4,542,900 
Employee benefit expense
  1,299,406 
  114,529 
  - 
  - 
  - 
  - 
  1,413,935 
Occupancy expense
  367,578 
  60,471 
  - 
  - 
  - 
  - 
  428,049 
Equipment expense
  354,155 
  68,137 
  - 
  - 
  - 
  - 
  422,292 
FDIC insurance assessment
  225,000 
  - 
  - 
  - 
  - 
  - 
  225,000 
Other real estate owned, net
  52,841 
  - 
  - 
  - 
  - 
  - 
  52,841 
Marketing expense
  234,904 
  32,593 
  549 
  - 
  - 
  - 
  268,046 
Legal and professional fees
  188,310 
  5,049 
  - 
  - 
  - 
  - 
  193,359 
ATM and check card fees
  330,966 
  2,155 
  - 
  - 
  - 
  - 
  333,121 
Telecom and data processing expense
  509,256 
  42,828 
  - 
  - 
  - 
  - 
  552,084 
Directors fees
  192,000 
  15,500 
  - 
  - 
  - 
  - 
  207,500 
Bank franchise Tax
  310,303 
  - 
  - 
  - 
  - 
  - 
  310,303 
Other operating expenses
  1,254,784 
  187,519 
  21,051 
  - 
  400 
  - 
  1,463,754 
Total expense
  11,020,991 
  909,079 
  161,063 
  - 
  400 
  (3,037)
  12,088,496 
Income tax expense
  1,582,813 
  - 
  31,828 
  - 
  (81,993)
  - 
  1,532,648 
Net income (loss)
 $4,208,710 
 $300,578 
 $(53,031)
 $- 
 $81,593 
 $- 
 $4,537,850 
Net income (loss) attributable to noncontrolling interest
  - 
  90,173 
  - 
  - 
  - 
  - 
  90,173 
Net Income attributable to F & M Bank Corp.
 $4,208,710 
 $210,405 
 $(53,031)
 $- 
 $81,593 
 $- 
 $4,447,677 
Total Assets
 $733,417,958 
 $2,296,877 
 $6,328,376 
 $- 
 $86,082,770 
 $(98,088,075)
 $730,037,906 
Goodwill
 $2,669,517 
 $- 
 $- 
 $- 
 $- 
 $- 
 $2,669,517 
 
 
 
31
 
 
Note 10. Business Segments, continued
 
 
 
Three Months Ended June 30, 2016
 
 
 
F&M Bank
 
 
VBS Mortgage
 
 
TEB Life/FMFS
 
 
VS Title
 
 
Parent Only
 
 
Eliminations
 
 
F&M Bank Corp. Consolidated
 
Revenues:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Interest Income
 $7,893,961 
 $6,885 
 $37,914 
 $- 
 $- 
 $(1,550)
 $7,937,210 
Service charges on deposits
  272,329 
  - 
  - 
  - 
  - 
  - 
  272,329 
Investment services and insurance income
  163 
  - 
  (29,057)
  - 
  - 
  - 
  (28,894)
Mortgage banking income, net
  - 
  751,388 
  - 
  - 
  - 
  - 
  751,388 
Title insurance income
  - 
  - 
  - 
  - 
  - 
  - 
  - 
Income from bank owned life insurance
  118,068 
  - 
  - 
  - 
  - 
  - 
  118,068 
Low income housing partnership losses
  (182,694)
  - 
  - 
  - 
  - 
  - 
  (182,694)
ATM and check card fees
  318,287 
  - 
  - 
  - 
  - 
  - 
  318,287 
Gain on prepayment of long-term debt
  - 
  - 
  - 
  - 
  - 
  - 
  - 
Loss on investments
  - 
  - 
  - 
  - 
  - 
  - 
  - 
Other operating income
  129,743 
  - 
  - 
  - 
  - 
  - 
  129,743 
Total income
  8,549,857 
  758,273 
  8,857 
  - 
  - 
  (1,550)
  9,315,437 
Expenses:
    
    
    
    
    
    
    
Interest Expense
  863,306 
  - 
  - 
  - 
  - 
  (1,550)
  861,756 
Provision for loan losses
  - 
  - 
  - 
  - 
  - 
  - 
  - 
Salary expense
  1,940,505 
  117,122 
  75,767 
  - 
  - 
  - 
  2,133,394 
Employee benefit expense
  602,158 
  58,833 
  - 
  - 
  - 
  - 
  660,991 
Occupancy expense
  179,648 
  30,150 
  - 
  - 
  - 
  - 
  209,798 
Equipment expense
  170,651 
  59,690 
  - 
  - 
  - 
  - 
  230,341 
FDIC insurance assessment
  112,500 
  - 
  - 
  - 
  - 
  - 
  112,500 
Other real estate owned, net
  35,142 
  - 
  - 
  - 
  - 
  - 
  35,142 
Marketing expense
  118,924 
  12,169 
  198 
  - 
  - 
  - 
  131,291 
Legal and professional fees
  102,037 
  2,574 
  - 
  - 
  - 
  - 
  104,611 
ATM and check card fees
  170,791 
  1,571 
  - 
  - 
  - 
  - 
  172,362 
Telecom and data processing expense
  266,194 
  22,537 
  - 
  - 
  - 
  - 
  288,731 
Directors fees
  96,000 
  3,500 
  - 
  - 
  - 
  - 
  99,500 
Bank franchise Tax
  162,643 
  - 
  - 
  - 
  - 
  - 
  162,643 
Other operating expenses
  655,378 
  154,862 
  18,456 
  - 
  200 
  - 
  828,896 
Total expense
  5,475,877 
  463,008 
  94,421 
  - 
  200 
  (1,550)
  6,031,956 
Income tax expense
  878,180 
  - 
  12,321 
  - 
  (51,556)
  - 
  838,945 
Net income (loss)
 $2,195,800 
 $295,265 
 $(97,885)
 $- 
 $51,356 
 $- 
 $2,444,536 
Net income (loss) attributable to noncontrolling interest
  - 
  86,410 
  - 
  - 
  - 
  - 
  86,410 
Net Income attributable to F & M Bank Corp.
 $2,195,800 
 $208,855 
 $(97,885)
 $- 
 $51,356 
 $- 
 $2,358,126 
 
 
 
32
 
 
Note 11. Debt
 
Short-term Debt
 
The Company utilizes short-term debt such as Federal funds purchased and Federal Home Loan Bank of Atlanta (FHLB) short term borrowings to support the loans held for sale participation program and provide liquidity.  Federal funds purchased are unsecured overnight borrowings from other financial institutions. FHLB short term debt, which is secured by the loan portfolio, can be a daily rate variable loan that acts as a line of credit or a fixed rate advance, depending on the need of the Company.  Short-term debt totaled $50 million at June 30, 2017 and has decreased $10 million from $40 million at December 31, 2016 due to the cyclical decline in the loans held for sale participation program.
 
Long-term Debt
 
The Company utilizes the FHLB advance program to fund loan growth and provide liquidity.  The interest rates on long-term debt are fixed at the time of the advance and range from 1.16% to 2.56%; the weighted average interest rate was 1.86% and 1.80% at June 30, 2017 and December 31, 2016, respectively.  The balance of these obligations at June 30, 2017 and December 31, 2016 were $51,768,000 and $63,982,000 respectively.  The Company recognized a gain of $504,000 on prepayment of two FHLB advances totaling $10,000,000 during the first quarter of 2017 and there were no additional borrowings in 2017.  FHLB advances include a $5,000,000 line of credit at FHLB that is pledged to the Commonwealth of Virginia to secure public funds.
 
In addition, the Company has a note payable to purchase a lot adjacent to one of the Bank branches for $170,000 at June 30, 2017 that is payable in two annual payments on January 1, 2018 and 2019.  There was $255,000 outstanding on this note at December 31, 2016.
 
 
 
33
 
 
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations
 
F & M Bank Corp. (Company), incorporated in Virginia in 1983, is a financial holding company pursuant to section 3(a)(1) of the Bank Holding Company Act of 1956, which provides financial services through its wholly-owned subsidiary Farmers & Merchants Bank (Bank), TEB Life Insurance Company (TEB) and Farmers & Merchants Financial Services (FMFS) are wholly-owned subsidiaries of the Bank. The Bank also holds a majority ownership in VBS Mortgage LLC (VBS) and F & M Bank Corp. holds a majority ownership in VS Title LLC (VST).
 
The Bank is a full service commercial bank offering a wide range of banking and financial services through its thirteen branch offices as well as its loan production office located in Penn Laird, VA (which specializes in providing automobile financing through a network of automobile dealers).  TEB reinsures credit life and accident and health insurance sold by the Bank in connection with its lending activities. FMFS provides, brokerage services and property/casualty insurance to customers of the Bank. VBS originates conventional and government sponsored mortgages through their offices in Harrisonburg and Woodstock, VA.  VS Title provides title insurance services through their offices in Harrisonburg, Fishersville, and Charlottesville, VA.
 
The Company’s primary trade area services customers in Rockingham County, Shenandoah County, Page County and Augusta County.
 
Management’s discussion and analysis is presented to assist the reader in understanding and evaluating the financial condition and results of operations of the Company.  The analysis focuses on the consolidated financial statements, footnotes, and other financial data presented.  The discussion highlights material changes from prior reporting periods and any identifiable trends which may affect the Company.  Amounts have been rounded for presentation purposes. This discussion and analysis should be read in conjunction with the Consolidated Financial Statements and the Notes to the Consolidated Financial Statements presented in Item 1, Part 1 of this Form 10-Q and in conjunction with the audited Consolidated Financial Statements included in the Company’s December 31, 2016 Form 10-K.
 
Forward-Looking Statements
 
Certain statements in this report may constitute “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. Forward-looking statements are statements that include projections, predictions, expectations or beliefs about future events or results or otherwise are not statements of historical fact.  Such statements are often characterized by the use of qualified words (and their derivatives) such as “expect,” “believe,” “estimate,” “plan,” “project,” or other statements concerning opinions or judgment of the Company and its management about future events. 
 
Although the Company believes that its expectations with respect to certain forward-looking statements are based upon reasonable assumptions within the bounds of its existing knowledge of its business and operations, there can be no assurance that actual results, performance or achievements of the Company will not differ materially from any future results, performance or achievements expressed or implied by such forward-looking statements. Actual future results and trends may differ materially from historical results or those anticipated depending on a variety of factors, including, but not limited to, the effects of and changes in: general economic conditions, the interest rate environment, legislative and regulatory requirements, competitive pressures, new products and delivery systems, inflation, changes in the stock and bond markets, technology, and consumer spending and savings habits.
 
We do not update any forward-looking statements that may be made from time to time by or on behalf of the Company.
 
 
 
34
 
 
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations (Continued)
 
Critical Accounting Policies
 
General
 
The Company’s financial statements are prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”). The financial information contained within the statements is, to a significant extent, financial information that is based on measures of the financial effects of transactions and events that have already occurred. 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. The Company uses historical loss factors as one factor in determining the inherent loss that may be present in its loan portfolio. Actual losses could differ significantly from the historical factors that are used. The fair value of the investment portfolio is based on period end valuations but changes daily with the market. In addition, GAAP itself may change from one previously acceptable method to another method. Although the economics of these transactions would be the same, the timing of events that would impact these transactions could change.
 
Allowance for Loan Losses
 
Allowances for loans are determined by applying estimated loss factors to the portfolio based on management’s evaluation and “risk grading” of the loan portfolio.  Specific allowances are typically provided on all impaired loans in excess of a defined loan size threshold that are classified in the Substandard or Doubtful risk grades.  The specific reserves are determined on a loan-by-loan basis based on management’s evaluation of the Company’s exposure for each credit, given the current payment status of the loan and the value of any underlying collateral.
 
While management uses the best information available to establish the allowance for loan and lease losses, future adjustments to the allowance may be necessary if economic conditions differ substantially from the assumptions used in making the valuations or, if required by regulators, based upon information available to them at the time of their examinations.  Such adjustments to original estimates, as necessary, are made in the period in which these factors and other relevant considerations indicate that loss levels may vary from previous estimates.  For further discussion refer to page 40 in the Management Discussion and Analysis.
 
Goodwill and Intangibles
 
ASC 805 “Business Combinations” and ASC 350 “Intangibles” require that the acquisition method of accounting be used for all business combinations initiated after June 30, 2001. Additionally, it further clarifies the criteria for the initial recognition and measurement of intangible assets separate from goodwill. ASC 350 prescribes the accounting for goodwill and intangible assets subsequent to initial recognition. The provisions of ASC 350 discontinue the amortization of goodwill and intangible assets with indefinite lives. Instead, these assets will be subject to at least an annual impairment review and more frequently if certain impairment indicators are in evidence. ASC 350 also requires that reporting units be identified for the purpose of assessing potential future impairments of goodwill.
 
 At June 30, 2017, preliminary goodwill of $304,000 was reported for the purchase of VSTitle, LLC.  This amount is subject to change after expert evaluation.
 
Income Tax
 
The determination of income taxes represents results in income and expense being recognized in different periods for financial reporting purposes versus for the purpose of computing income taxes currently payable.  Deferred taxes are provided on such temporary differences and are measured using the enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be realized or settled.  Further, the Company seeks strategies that minimize the tax effect of implementing its business strategies.  Management makes judgments regarding the ultimate consequence of long-term tax planning strategies, including the likelihood of future recognition of deferred tax benefits.  As a result, it is considered a significant estimate.
 
 
 
35
 
 
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations (Continued)
 
Critical Accounting Policies (continued)
 
Pension Plan Accounting
 
The accounting guidance for the measurement and recognition of obligations and expense related to pension plans generally applies the concept that the cost of benefits provided during retirement should be recognized over the employees’ active working life. Inherent in this concept is the requirement to use various actuarial assumptions to predict and measure costs and obligations many years prior to the settlement date. Major actuarial assumptions that require significant management judgment and have a material impact on the measurement of benefits expense and accumulated obligation include discount rates, expected return on assets, mortality rates, and projected salary increases, among others. Changes in assumptions or judgments related to any of these variables could result in significant volatility in the Company’s financial condition and results of operations. As a result, accounting for the Company’s pension expense and obligation is considered a significant estimate. The estimation process and the potential materiality of the amounts involved result in this item being identified as critical.
 
Securities
 
The Company follows the accounting guidance related to recognition and presentation of other-than-temporary impairment. The guidance specifies that if (a) an entity does not have the intent to sell a debt security prior to recovery and (b) it is more likely than not that the entity will not have to sell the debt security prior to recovery, the security would not be considered other-than-temporarily impaired, unless there is a credit loss. When criteria (a) and (b) are met, the entity will recognize the credit component of other-than-temporary impairment of a debt security in earnings and the remaining portion in other comprehensive income. For held-to-maturity debt securities, the amount of other-than-temporary impairment recorded in other comprehensive income for the noncredit portion of a previous other-than- temporary impairment is amortized prospectively over the remaining life of the security on the basis of the timing of future estimated cash flows of the security.
 
Other Real Estate Owned (OREO)
 
OREO is held for sale and represents real estate acquired through or in lieu of foreclosure. OREO is initially recorded at fair value less costs to sell when acquired, establishing a new cost basis. Physical possession of residential real estate property collateralizing a consumer mortgage loan occurs when legal title is obtained upon completion of foreclosure or when the borrower conveys all interest in the property to satisfy the loan through completion of a deed in lieu of foreclosure or through a similar legal agreement. The Company’s policy is to carry OREO on its balance sheet at the lower of cost or fair value less estimated costs to sell.  If fair value declines subsequent to foreclosure, a valuation allowance is recorded through expense.  Operating costs after acquisition are expensed.
 
Overview
 
Net income for the six months ended June 30, 2017 was $4,673,000 or $1.29 per diluted share, compared to $4,448,000 or $1.19 in the same period in 2016, an increase of 5.06%. During the six months ended June 30, 2017, noninterest income increased 52.19% and noninterest expense increased 14.97% during the same period.  Net income from Bank operations adjusted for income from Parent activities is as follows:
 
In thousands
 
2017
 
 
2016
 
Net Income from Bank Operations
 $4,550 
 $4,366 
Income from Parent Company Activities (2017 includes VSTitle)
  123 
  82 
Net Income for the six months ended June 30
 $4,673 
 $4,448 
 
During the three months ended June 30, 2017, net income was $2,328,000 or $.64 per diluted share, compared to $2,358,000 or $.63 in the same period in 2016, a decrease of 1.27%.  In the three months ended June 30, 2017, noninterest income increased 36.57% and noninterest expense increased 16.38%.
 
In thousands
 
2017
 
 
2016
 
Net Income from Bank Operations
 $2,213 
 $2,307 
Income from Parent Company Activities (2017 includes VSTitle)
  115 
  51 
Net Income for the three months ended June 30
 $2,328 
 $2,358 
 
 
 
36
 
 
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations (Continued)
 
Results of Operations
 
As shown in Table I on page 46, the 2017 year to date tax equivalent net interest income increased $551,000 or 3.95% compared to the same period in 2016.  The tax equivalent adjustment to net interest income totaled $70,000 for the first six months of 2017.  The yield on earning assets increased .11%, while the cost of funds increased .03% compared to the same period in 2016.
 
The three months ended June 30, 2017 tax equivalent net interest income increased $265,000 or 3.73% compared to the same period in 2016.  The tax equivalent adjustment to net interest income totaled $36,000 for the three months.
 
Year to date, the combination of the increase in yield on assets and the increase in cost of funds coupled with changes in balance sheet leverage has resulted in the net interest margin increasing to 4.46% at June 30, 2017, an increase of 7 basis points when compared to the same period in 2016.  A schedule of the net interest margin for the three and six month periods ended June 30, 2017 and 2016 can be found in Table I on page 46.
 
The following table provides detail on the components of tax equivalent net interest income:
 
GAAP Financial Measurements:
(Dollars in thousands).
 
June 30, 2017
 
 
 
June 30, 2016
 
 
 
Six Months
 
 
Three Months
 
 
Six Months
 
 
Three Months
 
         Interest Income – Loans
 $16,054 
 $8,177 
 $15,424 
 $7,860 
Interest Income - Securities and Other Interest-Earnings Assets
  212 
  79 
  154 
  77 
         Interest Expense – Deposits
  1,249 
  633 
  1,149 
  591 
         Interest Expense - Other Borrowings
  582 
  292 
  526 
  271 
Total Net Interest Income
  14,435 
  7,331 
  13,903 
  7,075 
 
    
    
    
    
Non-GAAP Financial Measurements:
    
    
    
    
Add: Tax Benefit on Tax-Exempt Interest Income – Loans
  70 
  36 
  51 
  27 
Total Tax Benefit on Tax-Exempt Interest Income
  70 
  36 
  51 
  27 
Tax-Equivalent Net Interest Income
 $14,505 
 $7,367 
 $13,954 
 $7,102 
 
The Interest Sensitivity Analysis contained in Table II on page 47 indicates the Company is in an asset sensitive position in the one year time horizon.  As the notes to the table indicate, the data was based in part on assumptions as to when certain assets or liabilities would mature or reprice. Approximately 44.21% of rate sensitive assets and 35.73% of rate sensitive liabilities are subject to repricing within one year.  Due to the relatively flat yield curve, management has kept deposit rates low. The growth in earning assets and the growth in noninterest bearing accounts has resulted in the decrease in the positive GAP position in the one year time period.
 
The increase in noninterest income of $1,347,000 for the six-month period and $504,000 for the three-month period ended June 30, 2017 is primarily due to the gain on prepayment of FHLB debt of $504,000 (first quarter) and the acquisition of VS Title LLC which contributed $554,000 in 2017.  Exclusive of the FHLB debt gain, noninterest income increased 32.66%.  Other areas of increase are service charges on deposits ($145,000) and investment services and insurance ($296,000).  For the three months ended June 30, 2017 noninterest income increased 36.57%.
 
Noninterest expense for the six months ended June 30, 2017 increased $1,559,000 as compared to 2016.  For the three months ended June 30, 2017 noninterest expense increased $847,000.  Expenses increased in the areas of salaries and benefits ($1,210,000), occupancy expense ($75,000) and telecommunications and data processing ($123,000) for the six months ended June 30, 2017.  During the three months ended June 30, 2017 areas of increase were salary and benfits ($686,000) and telecommunications and data processing ($63,000).  Increases in salaries and benefits relate to normal salary increases, additional staff to support new branch locations and growth at VBS Mortgage, increased cost of insurance and the acquisition of VSTitle.  Occupancy and telecommunications and data processing also increased as a result of branching activities.
 
 
 
37
 
 
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations (Continued)
 
Balance Sheet
 
Federal Funds Sold and Interest Bearing Bank Deposits
 
The Company’s subsidiary bank invests a portion of its excess liquidity in either federal funds sold or interest bearing bank deposits. Federal funds sold offer daily liquidity and pay market rates of interest that at quarter end were benchmarked at 1.00% to 1.25% by the Federal Reserve. Actual rates received vary slightly based upon money supply and demand among banks. Interest bearing bank deposits are held either in money market accounts or as short-term certificates of deposits. Balances in federal funds sold have decreased and interest bearing bank deposits have remained flat since year end due to changes in the composition of the balances sheet.
 
Securities
 
The Company’s securities portfolio serves to assist the Company with asset liability management and to provide tax benefits.
 
The securities portfolio consists of investment securities commonly referred to as securities held to maturity and securities available for sale.  Securities are classified as Held to Maturity investment securities when management has the intent and ability to hold the securities to maturity.  Held to Maturity Investment securities are carried at amortized cost.  Securities available for sale include securities that may be sold in response to general market fluctuations, liquidity needs and other similar factors.  Securities available for sale are recorded at fair value.  Unrealized holding gains and losses on available for sale securities are excluded from earnings and reported (net of deferred income taxes) as a separate component of stockholders’ equity.  The low income housing projects included in other investments are held for the tax losses and credits that they provide.
 
As of June 30, 2017, the fair value of securities available for sale exceeded their cost by $6,000. The portfolio is made up of primarily agency securities with an average portfolio life of just over three years. This short average life results in less portfolio volatility and positions the Bank to redeploy assets in response to rising rates. There are $24,000,000 in securities that will mature in 2017.
 
In reviewing investments as of June 30, 2017 and December 31, 2016, there were no securities which met the definition for other than temporary impairment.  Management continues to re-evaluate the portfolio for impairment on a quarterly basis.
 
Loan Portfolio
 
The Company operates in a predominately rural area that includes the counties of Rockingham, Page, Shenandoah and Augusta in the western portion of Virginia. The local economy benefits from a variety of businesses including agri-business, manufacturing, service businesses and several universities and colleges.  The Bank is an active residential mortgage and residential construction lender and generally makes commercial loans to small and mid-size businesses and farms within its primary service area.
 
Lending is geographically diversified within the service area.  The Company has loan concentrations within the portfolio in construction and development lending.  Management and the Board of Directors review this concentration and other potential areas of concentration quarterly.
 
Loans Held for Investment of $603,435,000 increased $11,799,000 at June 30, 2017 compared to December 31, 2016.  The following categories experienced growth:   farmland, real estate, multi-family, commercial and industrial, consumer and dealer finance.
 
Loans Held for Sale totaled $51,767,000 at June 30, 2017, a decrease of $10,968,000 compared to December 31, 2016.  The Northpointe participation loan program is typically subject to seasonal fluctuations in the early part of the year which is reflected in the decrease.
 
 
 
38
 
 
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations (Continued)
 
Loan Portfolio (continued)
 
Nonperforming loans include nonaccrual loans and loans 90 days or more past due.   Nonaccrual loans are loans on which interest accruals have been suspended or discontinued permanently.  Nonperforming loans totaled $5,677,000 at June 30, 2017 compared to $4,870,000 at December 31, 2016.  Loans added to nonaccrual since December 31, 2016 were past due and were not specifically reviewed for impairment as they were below the impairment review threshold.  Although the potential exists for loan losses, management believes the bank is generally well secured and continues to actively work with its customers to effect payment.  As of June 30, 2017 and December 31, 2016, the Company held $2,008,000 and $2,076,000 of real estate which was acquired through foreclosure, respectively.
 
The following is a summary of information pertaining to risk elements and nonperforming loans (in thousands):
 
 
 
 June 30, 2017
 
 
December 31, 2016
 
 
 
 
 
 
 
 
Nonaccrual Loans
 
 
 
 
 
 
     Real Estate
 $4,548 
 $4,204 
     Commercial
  350 
  70 
     Home Equity
  382 
  311 
     Other
  237 
  178 
 
  5,517 
  4,763 
 
    
    
Loans past due 90 days or more (excluding nonaccrual)
    
    
     Real Estate
  159 
  81 
     Commercial
  - 
  - 
     Home Equity
  - 
  - 
     Other
  1 
  26 
 
  160 
  107 
 
    
    
Total Nonperforming loans
 $5,677 
 $4,870 
 
    
    
Restructured Loans current and performing:
    
    
      Real Estate
  4,190 
  8,641 
      Commercial
  165 
  1,121 
      Home Equity
  - 
  - 
       Other
  81 
  76 
 
    
    
Nonperforming loans as a percentage of loans held for investment
  .94%
  .82%
 
    
    
Net charge offs to total loans held for investment
  .05%
  .21%
 
    
    
Allowance for loan and lease losses to nonperforming loans
  127.11%
  154.89%
 
 
 
39
 
 
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations (Continued)
 
Allowance for Loan Losses
 
The allowance for loan losses provides for the risk that borrowers will be unable to repay their obligations.  The risk associated with real estate and installment notes to individuals is based upon employment, the local and national economies and consumer confidence.  All of these affect the ability of borrowers to repay indebtedness.  The risk associated with commercial lending is substantially based on the strength of the local and national economies.
 
Management evaluates the allowance for loan losses on a quarterly basis in light of national and local economic trends, changes in the nature and volume of the loan portfolio and trends in past due and criticized loans.  Specific factors evaluated include internally generated loan review reports, past due reports, historical loan loss experience and changes in the financial strength of individual borrowers that have been included on the Bank’s watch list or schedule of classified loans.
 
In evaluating the portfolio, loans are segregated into loans with identified potential losses, pools of loans by type, with separate weighting for past dues and a general allowance based on a variety of criteria.  Loans with identified potential losses include examiner and bank classified loans. Classified relationships in excess of $500,000 and loans identified as troubled debt restructurings are reviewed individually for impairment under ASC 310. A variety of factors are considered when reviewing these credits, including borrower cash flow, payment history, fair value of collateral, company management, industry and economic factors.
 
With the exception of Dealer finance loans, loans that are not impaired are categorized by call report code and an estimate is calculated based on actual loss experience over the last five years.  Due to the rapid turnover in the Dealer finance portfolio, a two-year loss rate is utilized in that category as management feels this lookback period properly reflects the losses currently inherent in the portfolio.  The Company monitors the net losses for this division and adjusts based on how the portfolio performs since the department was established in 2012. A general allowance for inherent losses has been established to reflect other unidentified losses within the portfolio. The general allowance is calculated using the nine qualitative factors identified in the 2006 Interagency Policy Statement on the allowance for loan losses.  The general allowance assists in managing recent changes in portfolio risk that may not be captured in individually impaired loans, or in the homogeneous pools based on loss histories. The Board approves the provision for each quarter based on this evaluation.
 
The allowance for loan losses of $7,216,000 at June 30, 2017 is equal to 1.20% of loans held for investment. This compares to an allowance of $7,543,000 (1.27%) at December 31, 2016.  The company has experienced a decline in historical losses and improvements in the qualitative factors since year end.  There has been an increase in past dues this quarter however a large amount of those were brought current just after quarter end.  Increases to nonaccrual have been minimal with a majority of the increase coming from cyclical increases on a development property.  Due to these factors, management did not fund the allowance in the first six months of 2017.
 
Net charge-offs at June 30, 2017 totaled $327,000 which is equivalent to .05% of total loans outstanding.  At December 31, 2016, net charge-offs totaled $1,238,000 or .21% of total loans outstanding.
 
 
 
40
 
 
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations (Continued)
 
Deposits and Other Borrowings
 
The Company's main source of funding is comprised of deposits received from individuals, governmental entities and businesses located within the Company's service area.  Deposit accounts include demand deposits, savings, money market and certificates of deposit.  Total deposits at June 30, 2017 have decreased $599,000 since December 31, 2016.  Noninterest bearing deposits increased $516,000 while interest bearing decreased $1,115,000.  The decrease in deposits is consistent with the first half of 2016, after which deposits grew substantially.  The decrease is not attributable to any one customer or geographic location within the bank.  The Bank also participates in the CDARS program.  CDARS (Certificate of Deposit Account Registry Service) is a program that allows the bank to accept customer deposits in excess of FDIC limits and through reciprocal agreements with other network participating banks by offering FDIC insurance up to as much as $50 million in deposits. The CDARS program also allows the Bank to purchase funds through its One-Way Buy program. At June 30, 2017 and December 31, 2016,  the Company had a total of $1.3 million in CDARS funding.
 
Short-term borrowings
 
Short-term debt consists of federal funds purchased, daily rate credit obtained from the Federal Home Loan Bank (FHLB), and short-term fixed rate FHLB borrowings.  Federal funds purchased are overnight borrowings obtained from the Bank’s primary correspondent bank to manage short-term liquidity needs. Borrowings from the FHLB have been used to finance loans held for sale and also to finance the increase in short-term residential and commercial construction loans.  As of June 30, 2017, short-term debt consisted of  $50,000,000 in FHLB short-term borrowings.  This compared to FHLB short-term borrowings of $40,000,000 at December 31, 2016.  There were no balances in Federal funds purchased or daily rate credit at June 30, 2017 or December 31, 2016.
 
Long-term borrowings
 
Borrowings from the FHLB continue to be an important source of funding.  The Company’s subsidiary bank borrows funds on a fixed rate basis.  These borrowings are used to fund loan growth and also assist the Bank in matching the maturity of its fixed rate real estate loan portfolio with the maturity of its debt and thus reduce its exposure to interest rate changes.  During the first quarter of 2017, the Company recognized a $504,000 gain on prepayment of two FHLB long term advances and there were no new borrowings.
 
 
 
41
 
 
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations (Continued)
 
Capital
 
The Company seeks to maintain a strong capital base to expand facilities, promote public confidence, support current operations and grow at a manageable level.
 
In March 2015, the Bank implemented the Basel III capital requirements, which introduced the Common Equity Tier I ratio in addition to the two previous capital guidelines of Tier I capital (referred to as core capital) and Tier II capital (referred to as supplementary capital).  At June 30, 2017, the Bank had Common Equity Tier I capital of 14.10%, Tier I capital of 14.10% of risk weighted assets and combined Tier I and II capital of 15.25% of risk weighted assets.  Regulatory minimums at this date were 4.5%, 6% and 8%, respectively.  At December 30, 2016, the Bank had Common Equity Tier I capital of 13.86%, Tier I capital of 13.86% of risk weighted assets and combined Tier I and II capital of 15.08% of risk weighted assets.  Regulatory minimums at this date were 4.5%, 6% and 8%, respectively.  The Bank has maintained capital levels far above the minimum requirements throughout the year.  In the unlikely event that such capital levels are not met, regulatory agencies are empowered to require the Bank to raise additional capital and/or reallocate present capital.
 
In addition, the regulatory agencies have issued guidelines requiring the maintenance of a capital leverage ratio. The leverage ratio is computed by dividing Tier I capital by average total assets. The regulators have established a minimum of 4% for this ratio, but can increase the minimum requirement based upon an institution's overall financial condition. At June 30, 2017 and December 31, 2016, the Bank reported a leverage ratio of 12.49% and 11.83%, respectively, which was also substantially above the minimum. The Bank also reported a capital conservation buffer of 7.25% at June 30, 2017 and 7.08% at December 31, 2016. The capital conservation buffer is designed to strengthen an institution’s financial resilience during economic cycles. Financial institutions are required to maintain a minimum buffer as required by the Basel III final rules in order to avoid restrictions on capital distributions and other payments. Beginning January 1, 2016, a capital conservation buffer of 0.625% became effective. The capital conservations buffer for 2017 is 1.25% and will gradually be increased through January 1, 2019 to 2.5%.
 
Liquidity
 
Liquidity is the ability to meet present and future financial obligations through either the sale or maturity of existing assets or the acquisition of additional funds through liability management. Liquid assets include cash, interest-bearing deposits with banks, federal funds sold, investments and loans maturing within one year.  The Company's ability to obtain deposits and purchase funds at favorable rates determines its liquidity exposure.  As a result of the Company's management of liquid assets and the ability to generate liquidity through liability funding, management believes that the Company maintains overall liquidity sufficient to satisfy its depositors' requirements and meet its customers' credit needs.
 
Additional sources of liquidity available to the Company include, but are not limited to, loan repayments, the ability to obtain deposits through the adjustment of interest rates and the purchasing of federal funds.  To further meet its liquidity needs, the Company’s subsidiary bank also maintains a line of credit with its primary correspondent financial institution and with Zions Bank.  The Bank also has a line of credit with the Federal Home Loan Bank of Atlanta that allows for secured borrowings.
 
Interest Rate Sensitivity
 
In conjunction with maintaining a satisfactory level of liquidity, management must also control the degree of interest rate risk assumed on the balance sheet.  Managing this risk involves regular monitoring of interest sensitive assets relative to interest sensitive liabilities over specific time intervals. The Company monitors its interest rate sensitivity periodically and makes adjustments as needed. There are no off balance sheet items that will impair future liquidity.
 
As of June 30, 2017, the Company had a cumulative Gap Rate Sensitivity Ratio of 18.54% for the one year repricing period. This generally indicates that earnings would increase in an increasing interest rate environment as assets reprice more quickly than liabilities. However, in actual practice, this may not be the case as balance sheet leverage, funding needs and competitive factors within the market could dictate the need to raise deposit rates more quickly.  Management constantly monitors the Company’s interest rate risk and has decided the current position is acceptable for a well-capitalized community bank.
 
A summary of asset and liability repricing opportunities is shown in Table II, on page 47.
 
 
 
42
 
 
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations (Continued)
 
Effect of Newly Issued Accounting Standards
 
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 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.
 
 
 
43
 
 
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations (Continued)
 
Effect of Newly Issued Accounting Standards, continued
 
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.
 
 
 
44
 
 
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations (Continued)
 
Effect of Newly Issued Accounting Standards, continued
 
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 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.
 
During May 2017, the FASB issued ASU 2017‐09, “Compensation – Stock Compensation (Topic 718): Scope of Modification Accounting.” The amendments provide guidance on determining which changes to the terms and conditions of share-based payment awards require an entity to apply modification accounting under Topic 718.  The amendments are effective for all entities for annual periods, including interim periods within those annual periods, beginning after December 15, 2017. Early adoption is permitted, including adoption in any interim period, for reporting periods for which financial statements have not yet been issued. The Company is currently assessing the impact that ASU 2017‐08 will have on its consolidated financial statements.
 
Other accounting standards that have been issued by the FASB or other standards-setting bodies are not expected to have a material effect on the Company’s financial position, result of operations or cash flows.
  
Existence of Securities and Exchange Commission Web Site
 
The Securities and Exchange Commission maintains a Web site that contains reports, proxy and information statements and other information regarding registrants that file electronically with the Commission, including F & M Bank Corp. and the address is (http: //www.sec.gov).
 
 
 
45
 
 
TABLE I
F & M BANK CORP.
Net Interest Margin Analysis
(on a fully taxable equivalent basis)
(Dollar Amounts in Thousands)
 
 
 
 
Six Months Ended
 
 
Six Months Ended
 
 
Three Months Ended
 
 
Three Months Ended
 
 
 
June 30, 2017
 
 
June 30, 2016
 
 
June 30, 2017
 
 
June 30, 2016
 
Average
 
 
 
 
Income/
 
 
Average
 
 
 
 
 
Income/
 
 
Average
 
 
 
 
 
Income/
 
 
Average
 
 
 
 
 
Income/
 
 
Average
 
 
 
Balance2,4
 
 
Expense
 
 
Rates
 
 
Balance2,4
 
 
Expense
 
 
Rates
 
 
Balance2,4
 
 
Expense
 
 
Rates
 
 
Balance2,4
 
 
Expense
 
 
Rates
 
Interest income
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
     Loans held for investment1,2
 $592,729 
 $15,679 
  5.33%
 $555,532 
 $14,587 
  5.28%
 $597,126 
 $7,942 
  5.33%
 $560,509 
 $7,370 
  5.27%
     Loans held for sale
  32,145 
  445 
  2.79%
  59,210 
  890 
  3.02%
  38,193 
  271 
  2.85%
  68,511 
  518 
  3.03%
     Federal funds sold
  18,143 
  71 
  .79%
  5,159 
  12 
  .47%
  7,695 
  17 
  .89%
  4,070 
  5 
  .49%
     Interest bearing deposits
  1,098 
  4 
  .73%
  872 
  2 
  .46%
  670 
  1 
  .60%
  851 
  1 
  .47%
     Investments
    
    
    
    
    
    
    
    
    
    
    
    
 Taxable 3
  11,194 
  137 
  2.47%
  17,798 
  139 
  1.57%
  11,022 
  61 
  2.22%
  17,434 
  70 
  1.61%
 Partially taxable
  125 
  - 
  - 
  125 
  - 
  - 
  125 
  - 
  - 
  125 
  - 
  - 
     Total earning assets
 $655,434 
 $16,336 
  5.03%
 $638,696 
 $15,630 
  4.92%
 $654,831 
 $8,292 
  5.08%
 $651,500 
 $7,964 
  4.90%
Interest Expense
    
    
    
    
    
    
    
    
    
    
    
    
     Demand deposits
  119,388 
  254 
  .43%
  109,842 
  245 
  .45%
  118,560 
  129 
  .43%
  112,131 
  126 
  .45%
     Savings
  111,755 
  247 
  .45%
  95,299 
  208 
  .44%
  112,015 
  126 
  .45%
  97,741 
  108 
  .44%
     Time deposits
  155,593 
  748 
  .97%
  162,265 
  695 
  .86%
  154,971 
  378 
  .98%
  162,894 
  356 
  .87%
     Short-term debt
  15,982 
  32 
  .42%
  36,133 
  26 
  .14%
  18,688 
  24 
  .52%
  42,941 
  8 
  .07%
     Long-term debt
  71,373 
  550 
  1.55%
  47,497 
  501 
  2.12%
  70,999 
  268 
  1.52%
  47,546 
  263 
  2.22%
     Total interest bearing liabilities
 $474,091 
 $1,831 
  .78%
 $451,036 
 $1,676 
  .75%
 $475,233 
 $925 
  .78%
 $463,253 
 $862 
  .75%
 
    
    
    
    
    
    
    
    
    
    
    
    
Tax equivalent net interest income
    
 $14,505 
    
    
 $13,954 
    
    
 $7,367 
    
    
 $7,102 
    
 
    
    
    
    
    
    
    
    
    
    
    
    
Net interest margin
    
    
  4.46%
    
    
  4.39%
    
    
  4.51%
    
    
  4.37%
 
1      Interest income on loans includes loan fees.
2      Loans held for investment include nonaccrual loans.
3     An incremental income tax rate of 34% was used to calculate the tax equivalent income on nontaxable and partially taxable investments and loans.
4      Average balance information is reflective of historical cost and has not been adjusted for changes in market value annualized.
 
 
 
46
 
 
TABLE II
 
F & M BANK CORP.
Interest Sensitivity Analysis
 
June 30, 2017
(Dollars In Thousands)
 
The following table presents the Company’s interest sensitivity.
 
 
 
0 – 3
 
 
4 – 12
 
 
1 – 5
 
 
Over 5
 
 
Not
 
 
 
 
 
 
Months
 
 
Months
 
 
Years
 
 
Years
 
 
Classified
 
 
Total
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Uses of funds
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Loans
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Commercial
 $31,164 
 $28,407 
 $122,411 
 $26,992 
 $- 
 $208,974 
Installment
  4,225 
  1,146 
  57,782 
  15,455 
  - 
  78,608 
Real estate loans for investments
  99,407 
  55,506 
  153,465 
  4,722 
  - 
  313,100 
Loans held for sale
  51,767 
  - 
  - 
  - 
  - 
  51,767 
Credit cards
  2,753 
  - 
  - 
  - 
  - 
  2,753 
Interest bearing bank deposits
  614 
  - 
  - 
  - 
  - 
  614 
Federal funds sold
  3,174 
    
    
    
    
  3,174 
Investment securities
  24,000 
  125 
  - 
  573 
  135 
  24,833 
 Total
 $217,104 
 $85,184 
 $333,658 
 $47,742 
 $135 
 $683,823 
 
    
    
    
    
    
    
Sources of funds
    
    
    
    
    
    
Interest bearing demand deposits
 $- 
 $32,215 
 $67,942 
 $17,864 
 $- 
 $118,021 
Savings deposits
  - 
  22,502 
  67,504 
  22,501 
  - 
  112,507 
Certificates of deposit $100,000 and over
  4,268 
  15,099 
  35,169 
  - 
  - 
  54,536 
Other certificates of deposit
  12,615 
  34,315 
  57,359 
  - 
  - 
  104,289 
Short-term borrowings
  50,000 
  - 
  - 
  - 
  - 
  50,000 
Long-term borrowings
  1,108 
  3,406 
  36,121 
  11,303 
  - 
  51,938 
 Total
 $67,991 
 $107,537 
 $264,095 
 $51,668 
 $- 
 $491,291 
 
    
    
    
    
    
    
Discrete Gap
 $149,113 
 $(22,353)
 $69,563 
 $(3,926)
 $135 
 $192,532 
 
    
    
    
    
    
    
Cumulative Gap
 $149,113 
 $126,760 
 $196,323 
 $192,397 
 $192,532 
    
 
    
    
    
    
    
    
Ratio of Cumulative Gap to Total Earning Assets
  21.81%
  18.54%
  28.71%
  28.14%
  28.16%
    
 
 Table II reflects the earlier of the maturity or repricing dates for various assets and liabilities as of June 30, 2017.  In preparing the above table, no assumptions were made with respect to loan prepayments. Loan principal payments are included in the earliest period in which the loan matures or can reprice.  Investment securities included in the table consist of securities held to maturity and securities available for sale.  Principal payments on installment loans scheduled prior to maturity are included in the period of maturity or repricing. Proceeds from the redemption of investments and deposits are included in the period of maturity.  Estimated maturities of deposits, which have no stated maturity dates, were derived from guidance contained in FDICIA 305.
 
 
 
47
 
 
Item 3. Quantitative and Qualitative Disclosures About Market Risk
 
Not Applicable
 
Item 4. Controls and Procedures
 
Evaluation of Disclosure Controls and Procedures
 
As a result of the enactment of the Sarbanes-Oxley Act of 2002, issuers such as F & M Bank Corp. that file periodic reports under the Securities Exchange Act of 1934 (the "Act") are required to include in those reports certain information concerning the issuer's controls and procedures for complying with the disclosure requirements of the federal securities laws.  These disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by an issuer in the reports it files or submits under the Act, is recorded , processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms and is accumulated and communicated to the issuer's management, including its principal executive officer or officers and principal financial officer or officers, or persons performing similar functions, as appropriate to allow timely decisions regarding required disclosure.
 
As required, we will evaluate the effectiveness of these disclosure controls and procedures on a quarterly basis, and most recently did so as of the end of the period covered by this report.
 
The Company’s Chief Executive Officer and Chief Financial Officer, based on their evaluation as of the end of the period covered by this quarterly report of the Company’s disclosure controls and procedures (as defined in Rule 13(a)-15(e) of the Act), have concluded that the Company’s disclosure controls and procedures are effective for purposes of Rule 13(a)-15(b).
 
Changes in Internal Controls
 
The findings of the internal auditor are presented to management of the Bank and to the Audit Committee of the Company.  During the period covered by this report, there were no changes to the internal controls over financial reporting of the Company that have materially affected, or are reasonably likely to materially affect, the Company’s internal controls over financial reporting.
 
 
 
48
 
 
 
Part II Other Information
 
Item 1. Legal Proceedings
 
There are no material pending legal proceedings other than ordinary routine litigation incidental to its business, to which the Company is a party or of which the property of the Company is subject.
 
Item 1a. Risk Factors –
 
There have been no material changes to the risk factors disclosed in the Company’s Annual Report on Form 10-K for the year ended December 31, 2016.
 
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds –None
 
Item 3. Defaults Upon Senior Securities – None
 
Mine Safety Disclosures  None
 
Item 5. Other Information – None
 
Item 6. Exhibits
 
 (a)           Exhibits
 
 
Certification of Chief Executive Officer pursuant to Rule 13a-14(a) (filed herewith).
 
Certification of Chief Financial Officer pursuant to Rule 13a-14(a) (filed herewith).
 
Certifications of Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sabanes-Oxley Act of 2002 (filed herewith).
 
101
The following materials from F&M Bank Corp.’s Quarterly Report on Form 10Q for the period ended June 30, 2017, formatted in Extensible Business Reporting Language (XBRL), include: (i) Consolidated Balance Sheets, (ii) Consolidated Statements of Income, (iii) Consolidated Statements of Comprehensive Income, (iv) Consolidated Statements of Changes in Stockholders’ Equity, (v) Consolidated Statements of Cash Flows and (vi) related notes (filed herewith).
 
 
 
49
 
 
Signatures
 
Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
 
 
F & M BANK CORP.
 
 
 
 
 
 
By:  
/s/ Dean W. Withers
 
 
 
Dean W. Withers 
 
 
 
President and Chief Executive Officer 
 
 
 
 
 
 
 
 
 
By:  
/s/ Carrie A. Comer
 
 
 
Carrie A. Comer 
 
 
 
Senior Vice President and Chief Financial Officer 
 
 
August 14, 2017
 
 
 
 
 
50
 
 
Exhibit Index:
 
Certification of Chief Executive Officer pursuant to Rule 13a-14(a) (filed herewith).
 
Certification of Chief Financial Officer pursuant to Rule 13a-14(a) (filed herewith).
 
Certifications of Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (filed herewith).
 
101
The following materials from F&M Bank Corp.’s Quarterly Report on Form 10Q for the period ended June 30, 2017, formatted in Extensible Business Reporting Language (XBRL), include: (i) Consolidated Balance Sheets, (ii) Consolidated Statements of Income, (iii) Consolidated Statements of Comprehensive Income, (iv) Consolidated Statements of Changes in Stockholders’ Equity, (v) Consolidated Statements of Cash Flows and (vi) related notes (filed herewith).
 
 
 
 
51