F&M BANK CORP - Annual Report: 2019 (Form 10-K)

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D. C. 20549

 

FORM 10-K

 

ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE

SECURITIES EXCHANGE ACT OF 1934

 

For fiscal year ended December 31, 2019

 

Commission file number: 0-13273

 

F & M BANK CORP.

(Exact name of registrant as specified in its charter)

 

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)

 

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

 

Title of each class		Trading Symbol(s)		Name of each exchange on which registered
None

 

Securities registered pursuant to Section 12(g) of the Act:

Common Stock - $5 Par value per share

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Sarbanes Act. Yes ☐ No ☒

 

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes ☐ No ☒

 

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

 

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

  

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

 

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

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

 

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

 

The registrant’s Common Stock is quoted on the OTC Market’s OTCQX tier under the symbol FMBM. The aggregate market value of the 2,823,448 shares of Common Stock of the registrant issued and outstanding held by non-affiliates on June 30, 2019 was approximately $79,621,228 based on the closing sales price of $28.20 per share on that date. For purposes of this calculation, the term “affiliate” refers to all directors and executive officers of the registrant.

 

As of the close of business on March 11, 2020, there were 3,192,462 shares of the registrant's Common Stock outstanding.

 

DOCUMENTS INCORPORATED BY REFERENCE:

 

Part III: Portions of the Proxy Statement for the Annual Meeting of Shareholders to be held on May 2, 2020 (the “Proxy Statement”).

 

Table of Contents           

			Page
	PART I
Item 1.	Business		2
Item 1A	Risk Factors		8
Item 1B	Unresolved Staff Comments		9
Item 2	Properties		9
Item 3	Legal Proceedings		9
Item 4	Mine Safety Disclosures		10
	PART II
Item 5	Market for Registrant's Common Equity and Related Stockholder Matters and Issuer Purchases of Equity Securities		10
Item 6	Selected Financial Data		12
Item 7	Management's Discussion and Analysis of Financial Condition and Results of Operations		13
Item 7A	Quantitative and Qualitative Disclosures About Market Risk		34
Item 8	Financial Statements and Supplementary Data		34
Item 9	Changes in and Disagreements with Accountants on Accounting and Financial Disclosures		90
Item 9A	Controls and Procedures		90
Item 9B	Other Information		90
	PART III
Item 10	Directors, Executive Officers and Corporate Governance		91
Item 11	Executive Compensation		91
Item 12	Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters		91
Item 13	Certain Relationships and Related Transactions, and Director Independence		91
Item 14	Principal Accounting Fees and Services		91
	PART IV
Item 15	Exhibits, Financial Statement Schedules		92
Item 16	Form 10-K Summary		93
SIGNATURES			94

PART I

 

Item 1. Business

 

General

 

F & M Bank Corp. (the “Company” or “we”), incorporated in Virginia in 1983, is a one bank holding company under the Bank Holding Company Act of 1956 that has elected to become a financial holding company. The Company owns 100% of the outstanding stock of its banking subsidiary, Farmers & Merchants Bank (“Bank”) and a majority interest in VSTitle, LLC (“VST”). TEB Life Insurance Company (“TEB”) and Farmers & Merchants Financial Services, Inc. (“FMFS”) are wholly owned subsidiaries of the Bank. The Bank also holds a majority ownership in VBS Mortgage, LLC ( “F&M Mortgage”).

 

The Bank was chartered on April 15, 1908, as a state chartered bank under the laws of the Commonwealth of Virginia. TEB was incorporated on January 27, 1988, as a captive life insurance company under the laws of the State of Arizona. FMFS is a Virginia chartered corporation and was incorporated on February 25, 1993. F&M Mortgage was incorporated on May 11, 1999. The Bank purchased a majority interest in F&M Mortgage on November 3, 2008 and the Company purchased a majority interest in VST on January 1, 2017. F&M Mortgage owns the remaining minority interest in VST.

 

As a commercial bank, the Bank offers a wide range of banking services including commercial and individual demand and time deposit accounts, commercial and individual loans, internet and mobile banking, drive-in banking services, ATMs at all branch locations and several off-site locations, as well as a courier service for its commercial banking customers. TEB was organized to re-insure credit life and accident and health insurance currently being sold by the Bank in connection with its lending activities. FMFS was organized to write title insurance but now provides brokerage services, commercial and personal lines of insurance to customers of the Bank. F&M Mortgage originates conventional and government sponsored mortgages through their offices in Harrisonburg, Woodstock and Fishersville. VST provides title insurance and real estate settlement services through their offices in Harrisonburg, Fishersville and Charlottesville, Virginia.

 

The Bank makes various types of commercial and consumer loans and has a large portfolio of residential mortgages and indirect auto lending. The local economy is relatively diverse with strong employment in the agricultural, manufacturing, service and governmental sectors.

 

The Company’s and the Bank’s principal executive office is located at 205 South Main Street, Timberville, Virginia 22853, and its phone number is (540) 896-8941.

 

Filings with the SEC

 

The Company files annual, quarterly and other reports under the Securities Exchange Act of 1934 with the Securities and Exchange Commission (“SEC”). These reports are posted and are available at no cost on the Company’s website, www.FMBankVA.com, as soon as reasonably practicable after the Company files such documents with the SEC. The Company’s filings are also available through the SEC’s website at www.sec.gov.

 

Employees

 

On December 31, 2019, the Bank had 173 full-time and part-time employees, including executive officers, loan and other banking officers, branch personnel, operations personnel and other support personnel. None of the Company’s employees is represented by a union or covered under a collective bargaining agreement. Management of the Company considers their employee relations to be excellent. No one employee devotes full-time services to F & M Bank Corp.

 

Competition

 

The Bank's offices face strong competition from numerous other financial institutions. These other institutions include large national and regional banks, other community banks, nationally chartered savings banks, credit unions, consumer finance companies, mortgage companies, loan production offices, marketplace lenders and other financial technology firms, mutual funds and life insurance companies. Competition for loans and deposits is affected by a variety of factors including interest rates, types of products offered, the number and location of branch offices, marketing strategies and the reputation of the Bank within the communities served.

 

 

PART I, continued

 

Item 1. Business, continued

 

Regulation and Supervision

 

General. The operations of the Company and the Bank are subject to federal and state statutes, which apply to bank holding companies, financial holding companies and state member banks of the Federal Reserve System. The common stock of the Company is registered pursuant to and subject to the periodic reporting requirements of the Securities Exchange Act of 1934 (the “Exchange Act”). These include, but are not limited to, the filing of annual, quarterly, and other current reports with the SEC. As an Exchange Act reporting company, the Company is directly affected by the Sarbanes-Oxley Act of 2002 (“Sarbanes-Oxley”).  The Company believes it is in compliance with SEC and other rules and regulations implemented pursuant to Sarbanes-Oxley and intends to comply with any applicable rules and regulations implemented in the future.

 

The Company, as a bank holding company and a financial holding company, is subject to the provisions of the Bank Holding Company Act of 1956, as amended (the "Act") and is supervised by the Board of Governors of the Federal Reserve System (the “Federal Reserve Board”). The Act requires the Company to secure the prior approval of the Federal Reserve Board before the Company acquires ownership or control of more than 5% of the voting shares or substantially all of the assets of any institution, including another bank.

 

As a financial holding company, the Company is required to file with the Federal Reserve Board an annual report and such additional information as it may require pursuant to the Act. The Federal Reserve Board may also conduct examinations of F & M Bank Corp. and any or all of its subsidiaries. Under the Act and the regulations of the Federal Reserve Board, a bank holding company and its subsidiaries are prohibited from engaging in certain tie-in arrangements in connection with an extension of credit, pro-vision of credit, sale or lease of property or furnishing of services.

 

The permitted activities of a bank holding company are limited to managing or controlling banks, furnishing services to or performing services for its subsidiaries, and engaging in other activities that the Federal Reserve Board determines by regulation or order to be so closely related to banking or managing or controlling banks as to be a proper incident thereto. In addition, bank holding companies that qualify and elect to be financial holding companies, such as the Company, may engage in any activity, or acquire and retain the shares of a company engaged in any activity, that is either (i) financial in nature or incidental to such financial activity (as determined by the Federal Reserve Board in consultation with the Secretary of the Treasury) or (ii) complementary to a financial activity and does not pose a substantial risk to the safety and soundness of depository institutions or the financial system generally (as solely determined by the Federal Reserve Board). Activities that are financial in nature include but are not limited to securities underwriting and dealing, insurance underwriting, and making merchant banking investments. Since 1994, the Company has entered into agreements with the Virginia Community Development Corporation to purchase equity positions in several Low-Income Housing Funds; these funds provide housing for low-income individuals throughout Virginia. Approval of the Federal Reserve Board is necessary to engage in certain of the activities described above or to acquire interests engaging in these activities.

 

The Bank as a state member bank is supervised and regularly examined by the Virginia Bureau of Financial Institutions and the Federal Reserve Board; such supervision and examination by the Virginia Bureau of Financial Institutions and the Federal Reserve Board is intended primarily for the protection of depositors and not the stockholders of the Company.

 

Payment of Dividends. The Company is a legal entity, separate and distinct from its subsidiaries. A significant portion of the revenues of the Company result from dividends paid to it by the Bank. There are various legal limitations applicable to the payment of dividends by the Bank to the Company. Under the current regulatory guidelines, prior approval from the Federal Reserve Board is required if cash dividends declared in any given year exceed net income for that year, plus retained net profits of the two preceding years. A bank also may not declare a dividend out of or in excess of its net undivided profits without regulatory approval. The payment of dividends by the Bank or the Company may also be limited by other factors, such as requirements to maintain capital above regulatory guidelines.

 

Bank regulatory agencies have the authority to prohibit the Bank or the Company from engaging in an unsafe or unsound practice in conducting their businesses. The payment of dividends, depending on the financial condition of the Bank, or the Company, could be deemed to constitute such an unsafe or unsound practice. Based on the Bank’s current financial condition, the Company does not expect that any of these laws will have any impact on its ability to obtain dividends from the Bank.

 

PART I, continued

 

Item 1. Business, continued

 

Regulation and Supervision, continued

 

The Company also is subject to regulatory restrictions on payment of dividends to its shareholders. Regulators have indicated that bank holding companies should generally pay dividends only if the organization’s net income available to common shareholders over the past year has been sufficient to fully fund the dividends and the prospective rate of earnings retention appears consistent with the organization’s capital needs, asset quality, and overall financial condition. Further, a bank holding company should inform and consult with the Federal Reserve Board prior to declaring a dividend that exceeds earnings for the period (e.g., quarter) for which the dividend is being paid or that could result in a material adverse change to the organization’s capital structure.

 

Capital Requirements. Effective January 1, 2015, the Federal Reserve, the Federal Deposit Insurance Company (“FDIC”) and the Office of the Comptroller of the Currency (“OCC”) adopted a new rule that substantially amended the regulatory risk-based capital rules applicable to us. The final rule implemented the "Basel III" regulatory capital reforms and changes required by the Dodd-Frank Act (see definition below). The final rule includes new minimum risk-based capital and leverage ratios and refines the definition of what constitutes "capital" for purposes of calculating these ratios. The minimum capital requirements currently applicable to the Bank are: (i) a new common equity Tier 1 ("CET1") capital ratio of 4.5%; (ii) a Tier 1 to risk-based assets capital ratio of 6%; (iii) a total capital ratio of 8%; and (iv) a Tier 1 leverage ratio of 4%. The final rule established a "capital conservation buffer" of 2.5% above the new regulatory minimum capital ratios, and when fully effective on January 1, 2019, results in the following minimum ratios: (a) a common equity Tier 1 capital ratio of 7.0%; (b) a Tier 1 to risk-based assets capital ratio of 8.5%; and (c) a total capital ratio of 10.5%. An institution will be subject to limitations on paying dividends, engaging in share repurchases, and paying discretionary bonuses if its capital level falls below the buffer amount. These limitations will establish a maximum percentage of eligible retained income that can be utilized for such activities.

 

The CETI and Tier 1 leverage ratio of the Bank as of December 31, 2019, were 13.30% and 10.89%, respectively, which are significantly above the minimum requirements. The guidelines also provide that banking organizations experiencing internal growth or making acquisitions will be expected to maintain strong capital positions substantially above the minimum supervisory levels, without significant reliance on intangible assets.

 

In December 2017, the Basel Committee published standards that it described as the finalization of the Basel III post-crisis regulatory reforms (the standards are commonly referred to as “Basel IV”). Among other things, these standards revise the Basel Committee’s standardized approach for credit risk (including by recalibrating risk weights and introducing new capital requirements for certain “unconditionally cancellable commitments,” such as unused credit card lines of credit) and provide a new standardized approach for operational risk capital. Under the proposed framework, these standards will generally be effective on January 1, 2022, with an aggregate output floor phasing-in through January 1, 2027. Under the current capital rules, operational risk capital requirements and a capital floor apply only to advanced approaches institutions, and not to the Company. The impact of Basel IV on the Company and the Bank will depend on the manner in which it is implemented by the federal bank regulatory agencies.

 

As directed by the Economic Growth, Regulatory Relief and Consumer Protection Act (the “Economic Growth Act”), the federal banking regulators in 2019 jointly issued a final rule that permits qualifying banks that have less than $10 billion in total consolidated assets to elect to be subject to a 9% “community bank leverage ratio.” A qualifying bank that has chosen the proposed framework would not be required to calculate the existing risk-based and leverage capital requirements and would be considered to have met the capital ratio requirements to be “well capitalized” under prompt corrective action rules, provided it has a community bank leverage ratio greater than 9%.

 

Pursuant to the Federal Reserve’s Small Bank Holding Company and Savings and Loan Holding Company Policy Statement, qualifying bank holding companies with total consolidated assets of less than $3 billion, such as the Company, are not subject to consolidated regulatory capital requirements

 

 

PART I, continued

 

Item 1. Business, continued

 

Regulation and Supervision, continued

 

Source of Strength. Federal Reserve policy has historically required bank holding companies to act as a source of financial and managerial strength to their subsidiary banks. The Dodd-Frank Act codified this policy as a statutory requirement. Under this requirement, the Company is expected to commit resources to support the Bank, including at times when the Company may not be in a financial position to provide such resources. Any capital loans by a bank holding company to any of its subsidiary banks are subordinate in right of payment to depositors and to certain other indebtedness of such subsidiary banks. In the event of a bank holding company's bankruptcy, any commitment by the bank holding company to a federal bank regulatory agency to maintain the capital of a subsidiary bank will be assumed by the bankruptcy trustee and entitled to priority of payment.

 

Safety and Soundness. There are a number of obligations and restrictions imposed on bank holding companies and their subsidiary banks by law and regulatory policy that are designed to minimize potential loss to the depositors of such depository institutions and the FDIC insurance fund in the event of a depository institution default. For example, under the Federal Deposit Insurance Corporation Improvement Act of 1991, to avoid receivership of an insured depository institution subsidiary, a bank holding company is required to guarantee the compliance of any subsidiary bank that may become "undercapitalized" with the terms of any capital restoration plan filed by such subsidiary with its appropriate federal bank regulatory agency up to the lesser of (i) an amount equal to 5% of the institution's total assets at the time the institution became undercapitalized or (ii) the amount that is necessary (or would have been necessary) to bring the institution into compliance with all applicable capital standards as of the time the institution fails to comply with such capital restoration plan. Under the Federal Deposit Insurance Act, the federal bank regulatory agencies have adopted guidelines prescribing safety and soundness standards. These guidelines establish general standards relating to internal controls and information systems, internal audit systems, loan documentation, credit underwriting, interest rate exposure, asset growth and compensation, fees and benefits. In general, the guidelines require, among other things, appropriate systems and practices to identify and manage the risk and exposures specified in the guidelines.

 

The Gramm-Leach-Bliley Act. The Gramm-Leach-Bliley Act (the “GLB Act”) allows a bank holding company or other company to certify status as a financial holding company, which will allow such company to engage in activities that are financial in nature, that are incidental to such activities, or are complementary to such activities. The GLB Act enumerates certain activities that are deemed financial in nature, such as underwriting insurance or acting as an insurance principal, agent or broker; dealing in or making markets in securities; and engaging in merchant banking under certain restrictions. It also authorizes the Federal Reserve to determine by regulation what other activities are financial in nature, or incidental or complementary thereto.

 

USA Patriot Act of 2001. In October 2001, the USA Patriot Act of 2001 was enacted in response to the terrorist attacks in New York, Pennsylvania and Northern Virginia which occurred on September 11, 2001. The Patriot Act is intended to strengthen U.S. law enforcements’ and the intelligence communities’ abilities to work cohesively to combat terrorism on a variety of fronts. The continuing and potential impact of the Patriot Act and related regulations and policies on financial institutions of all kinds is significant and wide ranging. The Patriot Act contains sweeping anti-money laundering and financial transparency laws, and imposes various regulations, including standards for verifying client identification at account opening, and rules to promote cooperation among financial institutions, regulators and law enforcement entities in identifying parties that may be involved in terrorism or money laundering.

 

Community Reinvestment Act.   The requirements of the Community Reinvestment Act are also applicable to the Bank. The act imposes on financial institutions an affirmative and ongoing obligation to meet the credit needs of their local communities, including low and moderate income neighborhoods, consistent with the safe and sound operation of those institutions. A financial institution’s efforts in meeting community needs currently are evaluated as part of the examination process pursuant to twelve assessment factors. These factors are also considered in evaluating mergers, acquisitions and applications to open a branch or facility.

 

PART I, continued

 

Item 1. Business, continued

 

Regulation and Supervision, continued

 

Dodd-Frank Wall Street Reform and Consumer Protection Act. The Dodd-Frank Act was signed into law on July 21, 2010. Its wide-ranging provisions affect all federal financial regulatory agencies and nearly every aspect of the American financial services industry. Among the provisions of the Dodd-Frank Act that directly impact the Company is the creation of an independent Consumer Financial Protection Bureau (“CFPB”), which has the ability to implement, examine and enforce complaints with federal consumer protection laws, which govern all financial institutions. For smaller financial institutions, such as the Company and the Bank, their primary regulators will continue to conduct its examination activities.

 

The Dodd-Frank Act contains provisions designed to reform mortgage lending, which includes the requirement of additional disclosures for consumer mortgages. In addition, the Federal Reserve has issued new rules that have the effect of limiting the fees charged to merchants for debit card transactions. The result of these rules will be to limit the amount of interchange fee income available explicitly to larger banks and indirectly to us. The Dodd-Frank Act also contains provisions that affect corporate governance and executive compensation.

 

In May 2018, the Economic Growth Act was enacted to modify or remove certain regulatory financial reform rules and regulations, including some of those implemented under the Dodd-Frank Act. While the Economic Growth Act maintains most of the regulatory structure established by the Dodd-Frank Act, it amends certain aspects of the regulatory framework for small depository institutions with assets of less than $10 billion, such as the Bank, and for large banks with assets of more than $50 billion.

 

Among other matters, the Economic Growth Act expands the definition of qualified mortgages which may be held by a financial institution with total consolidated assets of less than $10 billion, exempts community banks from the Volcker Rule, and includes additional regulatory relief regarding regulatory examination cycles, call reports, mortgage disclosures and risk weights for certain high-risk commercial real estate loans.

 

Consumer Financial Protection. The Bank is subject to a number of federal and state consumer protection laws that extensively govern its relationship with its customers. These laws include the Equal Credit Opportunity Act, the Fair Credit Reporting Act, the Truth in Lending Act, the Truth in Savings Act, the Electronic Fund Transfer Act, the Expedited Funds Availability Act, the Home Mortgage Disclosure Act, the Fair Housing Act, the Real Estate Settlement Procedures Act, the Fair Debt Collection Practices Act, the Service Members Civil Relief Act, laws governing flood insurance, federal and state laws prohibiting unfair and deceptive business practices, foreclosure laws, and various regulations that implement some or all of the foregoing. These laws and regulations mandate certain disclosure requirements and regulate the manner in which financial institutions must deal with customers when taking deposits, making loans,collecting loans and providing other services. If the Bank fails to comply with these laws and regulations, it may be subject to various penalties. Failure to comply with consumer protection requirements may also result in failure to obtain any required bank regulatory approval for merger or acquisition transactions the Company may wish to pursue or being prohibited from engaging in such transactions even if approval is not required.

 

Cybersecurity. The federal banking agencies have adopted guidelines for establishing information security standards and cybersecurity programs for implementing safeguards under the supervision of a financial institution’s board of directors. These guidelines, along with related regulatory materials, increasingly focus on risk management and processes related to information technology and the use of third parties in the provision of financial products and services. The federal banking agencies expect financial institutions to establish lines of defense and ensure that their riskmanagement processes also address the risk posed by compromised customer credentials, and also expect financial institutions to maintain sufficient business continuity planning processes to ensure rapid recovery, resumption and maintenance of the institution’s operations after a cyber-attack. If the Bank fails to meet the expectations set forth in this regulatory guidance, it could be subject to various regulatory actions and any remediation efforts may require significant resources of the Bank. In addition, all federal and state bank regulatory agencies continue to increase focus on cybersecurity programs and risks as part of regular supervisory exams.

 

 

PART I, continued

 

Item 1. Business, continued

 

Regulation and Supervision, continued

 

Future Legislation and Regulation. Congress may enact legislation from time to time that affects the regulation of the financial services industry, and state legislatures may enact legislation from time to time affecting the regulation of financial institutions chartered by or operating in those states. Federal and state regulatory agencies also periodically propose and adopt changes to their regulations or change the manner in which existing regulations are applied. The substance or impact of pending or future legislation or regulation, or the application thereof, cannot be predicted, although enactment of the proposed legislation could impact the regulatory structure under which the Company and the Bank operate and may significantly increase costs, impede the efficiency of internal business processes, require an increase in regulatory capital, require modifications to business strategy, and limit the ability to pursue business opportunities in an efficient manner. A change in statutes, regulations or regulatory policies applicable to the Company or the Bank could have a material adverse effect on the business, financial condition and results of operations of the Company and the Bank.

 

Forward-Looking Statements

 

Certain information contained in this report may include “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Exchange Act. These forward-looking statements are generally identified by phrases such as “we expect,” “we believe” or words of similar import. Such forward-looking statements are subject to known and unknown risks including, but not limited to:

 

Although we believe that our expectations with respect to the forward-looking statements are based upon reliable assumptions within the bounds of our knowledge of our business and operations, there can be no assurance that our actual results, performance or achievements will not differ materially from any future results, performance or achievements expressed or implied by such forward-looking statements.

 

Operating Revenue

 

The following table displays components that contributed 15% or more of the Company’s total operating revenue for the years ended December 31, 2019 and 2018:

 

Period	Class of Service	Percentage of Total Revenues
December 31, 2019	Interest and fees on loans held for investment	73.75%
December 31, 2018	Interest and fees on loans held for investment	78.26%

 

 

PART I, continued

 

Item 1. Business, continued

 

Executive Officers of the Company

 

Mark C. Hanna, 51, has served as President/CEO of the Bank since July 1, 2018. Prior to that he served as President since December 2017. Prior to joining the Company, he served as Executive Vice President and Tidewater Regional President of EVB and its successor, Sonabank from November 2014 through October 2017. Previously, he served as President and Chief Executive Officer of Virginia Company Bank from November 2006 through November 2014.

 

Carrie A. Comer, 50, has served as Executive Vice President and Chief Financial Officer of the Bank and the Company since March 1, 2018. Prior to that she served as Senior Vice President/Chief Financial Officer of the Company and Bank since June 2013. Ms. Comer served as Vice President/Controller of the Bank from March 2009 to June 2013. From December 2005 to March 2009, Ms. Comer served as Assistant Vice President/Controller of F&M Bank.

 

Stephanie E. Shillingburg, 58, has served as Executive Vice President/Chief Banking Officer of the Bank and the Company since July 2016, Executive Vice President/Chief Retail Officer from June 2013 until July 2016 and Senior Vice President/Branch Administrator from February 2005 until June 2013. She also served as Vice President/Branch Administrator from March 2003 until February 2005 and as Branch Manager of the Edinburg Branch from February 2001 until March 2003.

 

Edward Strunk, 63, has served as Executive Vice President and Chief Credit Officer of the Bank and the Company since March 1, 2018. Prior to that he served as Senior Vice President/Senior Lending Officer since July 2006, Senior Vice President/Commercial Loan Administrator from May 2011 until July 2016, Vice President/Commercial Loan Administrator from February 2011 until May 2011 and Vice Present/Business Development Officer III from May 2007 until February 2011.

 

Barton E. Black, 49, has served as Executive Vice President and Chief Strategy & Risk Officer of the Bank and the Company since March 1, 2019. Prior to joining the company, he served as Managing Director at Strategic Risk Associates, a financial services consulting company based in Virginia from August 2012 through February 2019.

 

Item 1A. Risk Factors

 

Not required.

PART I, continued

 

Item 1B. Unresolved Staff Comments

 

None

 

Item 2. Properties

 

The locations of F & M Bank Corp. and its subsidiaries are shown below.

Corporate Offices	205 South Main Street	Timberville, VA 22853
Timberville Branch	165 New Market Road	Timberville, VA 22853
Elkton Branch	127 West Rockingham Street	Elkton, VA 22827
Broadway Branch	126 Timberway	Broadway, VA 22815
Bridgewater Branch	100 Plaza Drive	Bridgewater, VA 22812
Edinburg Branch	300 Stoney Creek Blvd.	Edinburg, VA 22824
Woodstock Branch	161 South Main Street	Woodstock, VA 22664
Crossroads Branch	80 Cross Keys Road	Harrisonburg, VA 22801
Coffman’s Corner Branch	2030 Legacy Lane	Harrisonburg, VA 22801
Luray Branch	700 East Main Street	Luray, VA 22835
Myers Corner Branch	30 Gosnell Crossing	Staunton, VA 24401
North Augusta Branch	2813 North Augusta Street	Staunton, VA 22401
Craigsville Branch	125 W. Craig Street	Craigsville, VA 24430
Grottoes Branch	200 Augusta Avenue	Grottoes, VA 24441
Stuarts Draft	2782 Stuarts Draft Highway	Stuarts Draft, VA 24477
Dealer Finance Division	4759 Spotswood Trail	Penn Laird, VA 22846
F&M Mortgage offices are located at:
Harrisonburg Office	2040 Deyerle Avenue, Suite 107	Harrisonburg, VA 22801
Fishersville Office	19 Myers Corner Drive, Suite 105	Staunton, VA 24401
Woodstock Office	161 South Main Street	Woodstock, VA 22664
VSTitle offices are located at:
Harrisonburg Office	410 Neff Avenue	Harrisonburg, VA 22801
Fishersville Office	1707 Jefferson Highway	Fishersville, VA 22939
Charlottesville Office	154 Hansen Rd., Suite 202-C	Charlottesville, VA 22911

With the exception of the Luray Branch, Dealer Finance Division, and the North Augusta Branch, the remaining facilities are owned by Farmers & Merchants Bank. ATMs are available at all branch locations. The Woodstock office of F&M Mortgage is leased from F&M Bank. All offices of VST are leased.

 

Through an agreement with FCTI, Inc., the Bank also operates cash only ATMs at three Food Lion grocery stores, one in Mt. Jackson, Virginia and two in Harrisonburg, Virginia.

 

Item 3. Legal Proceedings

 

In the normal course of business, the Company may become involved in litigation arising from banking, financial, or other activities of the Company. Management after consultation with legal counsel, does not anticipate that the ultimate liability, if any, arising out of these matters will have a material effect on the Company’s financial condition, operating results or liquidity.

 

Item 4. Mine Safety Disclosures

 

None.

 

PART II

 

Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

 

Stock Listing

The Company’s Common Stock is quoted under the symbol “FMBM” on the OTCQX Market. The bid and ask price is quoted at www.OTCMARKETS.com/Stock/FMBM/quote. Any over-the-counter market quotations reflect iner-dealer prices, without retail mark-up, mark-down or commission and may not necessarily represent actual transactions. With its inclusion on the OTCQX Markets, there are now several active market makers for FMBM stock.

 

Transfer Agent and Registrar

Broadridge Corporate Issuer Solutions

PO Box 1342

Brentwood, NY 11717

 

Stock Performance

The following graph compares the cumulative total return to the shareholders of the Company for the last five fiscal years with the total return of the Russell 2000 Index and the SNL Bank Index, as reported by SNL Financial, assuming an investment of $100 in the Company’s common stock on December 31, 2014, and the reinvestment of dividends.

 

	Period Ending
Index	12/31/14	12/31/15	12/31/16	12/31/17	12/31/18	12/31/19
F & M Bank Corp.	100.00	120.47	142.79	187.16	175.50	175.67
Russell 2000 Index	100.00	95.59	115.95	132.94	118.30	148.49
SNL Bank Index	100.00	101.71	128.51	151.75	126.12	170.79

 

PART II, continued

 

Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities, continued

 

Dividends

 

Dividends to common shareholders totaled $3,272 and $3,890 in 2019 and 2018, respectively. In addition to regular dividends totaling $1.00 per share, a special dividend of $0.20 per share was paid in 2018 to mark the Bank’s 110th anniversary. Preferred stock dividends were $315 and $413 in 2019 and 2018, respectively. Regular quarterly dividends have been declared for at least 26 years. The payment of dividends depends on the earnings of the Company and its subsidiaries, the financial condition of the Company and other factors including capital adequacy, regulatory requirements, general economic conditions and shareholder returns. The ratio of dividends per common share to net income per common share was 77.27% in 2019 compared to 46.15% (including special dividend) in 2018.

 

Refer to Payment of Dividends in Item 1. Business, Regulation and Supervision section above for a summary of applicable restrictions on the Company’s ability to pay dividends.

 

Stock Repurchases and Holders

 

On October 20, 2016, the Company’s Board of Directors approved a plan to repurchase up to 150,000 shares of common stock. Shares repurchased through the end of 2019 totaled 131,528 shares; of this amount, 60,104 were repurchased in 2019 at an average price of $29.90 per share. During the fourth quarter of 2019, 14,200 shares were repurchased on 11/8/19.

 

The number of common shareholders was approximately 2,142 as of March 6, 2020. This amount includes all shareholders, whether titled individually or held by a brokerage firm or custodian in street name.

 

 

 

 

 

PART II, continued

 

Item 6. Selected Financial Data

 

Five Year Summary of Selected Financial Data

 

(Dollars and shares in thousands, except per share data)	2019	20187	20177	20166	20156
Income Statement Data:
Interest and Dividend Income	$38,210	$36,377	$33,719	$32,150	29,404
Interest Expense	6,818	4,832	3,897	3,599	2,876
Net Interest Income	31,392	31,545	29,822	28,551	26,528
Provision for Loan Losses	7,405	2,930	-	-	300
Net Interest Income After Provision for Loan Losses	23,987	28,615	29,822	29,822	26,228
Noninterest Income6	10,759	8,770	8,517	6,313	5,412
Low income housing partnership losses	(839)	(767)	(625)	(731)	(619)
Noninterest Expenses6	29,518	26,744	24,719	21,272	19,554
Income before income taxes	4,389	9,874	12,995	12,861	11,467
Income Tax Expense (Benefit)	(250)	1,041	4,202	3,099	2,886
Net income attributable to noncontrolling interest	(130)	(10)	(31)	(194)	(164)
Net Income attributable to F & M Bank Corp.	$4,509	$8,823	$8,762	$9,568	$8,417
Per Common Share Data:
Net Income – basic	$1.32	$2.60	$2.68	$2.77	$2.40
Net Income - diluted	1.30	2.45	2.41	2.57	2.25
Dividends Declared	1.02	1.20	.94	.80	.73
Book Value per Common Share	27.11	26.68	25.65	24.18	22.38
Balance Sheet Data:
Assets	$813,999	$779,743	$752,894	$744,889	$665,357
Loans Held for Investment	603,425	638,799	616,974	591,636	544,053
Loans Held for Sale	66,798	55,910	39,775	62,735	57,806
Securities	18,015	21,844	41,243	39,475	25,329
Deposits	641,709	591,325	569,177	537,085	494,670
Short-Term Debt	10,000	40,116	25,296	40,000	24,954
Long-Term Debt	53,201	40,218	49,733	64,237	48,161
Stockholders’ Equity	91,575	91,401	91,027	86,682	82,950
Average Common Shares Outstanding – basic	3,189	3,238	3,270	3,282	3,291
Average Common Shares Outstanding – diluted	3,460	3,596	3,632	3,717	3,735
Financial Ratios:
Return on Average Assets1	0.57%	1.15%	1.17%	1.34%	1.31%
Return on Average Equity1	4.93%	9.67%	9.89%	11.18%	10.46%
Net Interest Margin	4.33%	4.65%	4.48%	4.34%	4.43%
Efficiency Ratio 2	69.03%	66.04%	64.27%	60.78%	60.97%
Dividend Payout Ratio - Common	77.27%	46.15%	35.07%	28.88%	30.42%
Capital and Credit Quality Ratios:
Average Equity to Average Assets1	11.48%	11.90%	12.10%	11.97%	12.49%
Allowance for Loan Losses to Loans3	1.39%	0.82%	0.98%	1.27%	1.61%
Nonperforming Loans to Total Assets4	0.70%	1.31%	0.94%	0.65%	0.98%
Nonperforming Assets to Total Assets5	0.89%	1.62%	1.21%	0.94%	1.34%
Net Charge-offs to Total Loans3	0.71%	0.58%	0.24%	0.21%	0.04%

 

  

PART II, continued

 

Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations (dollars in thousands)

 

The following discussion provides information about the major components of the results of operations and financial condition, liquidity and capital resources of F & M Bank Corp. and its subsidiaries. This discussion and analysis should be read in conjunction with the Consolidated Financial Statements and the Notes to the Consolidated Financial Statements presented in Item 8, Financial Statements and Supplementary Information, of this Form 10-K.

 

Lending Activities

 

Credit Policies

The principal risk associated with each of the categories of loans in our portfolio is the creditworthiness of our borrowers. Within each category, such risk is increased or decreased, depending on prevailing economic conditions. In an effort to manage the risk, our loan policy gives loan amount approval limits to individual loan officers based on their position and level of experience and to our loan committees based on the size of the lending relationship. The risk associated with real estate and construction loans, commercial loans and consumer loans varies, based on market employment levels, consumer confidence, fluctuations in the value of real estate and other conditions that affect the ability of borrowers to repay indebtedness. The risk associated with real estate construction loans varies, based on the supply and demand for the type of real estate under construction.

 

We have written policies and procedures to help manage credit risk. We have a loan review policy that includes regular portfolio reviews to establish loss exposure and to ascertain compliance with our loan policy.

 

We use a management loan committee and a directors’ loan committee to approve loans. The management loan committee is comprised of members of senior management, and the directors’ loan committee is comprised of any six directors. Both committees approve new, renewed and or modified loans that exceed officer loan authorities. The directors’ loan committee also reviews any changes to our lending policies, which are then approved by our board of directors.

 

Construction and Development Lending

 

We make construction loans, primarily residential, and land acquisition and development loans. The construction loans are secured by residential houses under construction and the underlying land for which the loan was obtained. The average life of a construction loan is approximately 12 months, and it is typically re-priced as the prime rate of interest changes. Construction lending entails significant additional risks, compared with residential mortgage lending. Construction loans often involve larger loan balances concentrated with single borrowers or groups of related borrowers. Another risk involved in construction lending is attributable to the fact that loan funds are advanced upon the security of the land or home under construction, which value is estimated prior to the completion of construction. Thus, it is more difficult to evaluate accurately the total loan funds required to complete a project and related loan-to-value ratios. To mitigate the risks associated with construction lending, we generally limit loan amounts to 75% to 90% of appraised value, in addition to analyzing the creditworthiness of our borrowers. We also obtain a first lien on the property as security for our construction loans and typically require personal guarantees from the borrower’s principal owners.

 

 

PART II, continued

 

Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations (dollars in thousands), Continued

 

Commercial Real Estate Lending

 

Commercial real estate loans are secured by various types of commercial real estate in our market area, including multi-family residential buildings, commercial buildings and offices, shopping centers and churches. Commercial real estate lending entails significant additional risks, compared with residential mortgage lending. Commercial real estate loans typically involve larger loan balances concentrated with single borrowers or groups of related borrowers. Additionally, the payment experience on loans secured by income producing properties is typically dependent on the successful operation of a business or a real estate project and thus may be subject, to a greater extent, to adverse conditions in the real estate market or in the economy in general. Our commercial real estate loan underwriting criteria require an examination of debt service coverage ratios and the borrower’s creditworthiness, prior credit history and reputation. We also evaluate the location of the property securing the loan and typically require personal guarantees or endorsements of the borrower’s principal owners.

 

Business Lending

 

Business loans generally have a higher degree of risk than residential mortgage loans but have higher yields. To manage these risks, we generally obtain appropriate collateral and personal guarantees from the borrower’s principal owners and monitor the financial condition of our business borrowers. Residential mortgage loans generally are made on the basis of the borrower’s ability to make repayment from employment and other income and are secured by real estate whose value tends to be readily ascertainable. In contrast, business loans typically are made on the basis of the borrower’s ability to make repayment from cash flow from its business and are secured by business assets, such as real estate, accounts receivable, equipment and inventory. As a result, the availability of funds for the repayment of business loans is substantially dependent on the success of the business itself. Furthermore, the collateral for business loans may depreciate over time and generally cannot be appraised with as much precision as residential real estate.

 

Consumer Lending

 

We offer various consumer loans, including personal loans and lines of credit, automobile loans, deposit account loans, installment and demand loans, and home equity loans and lines of credit. Such loans are generally made to clients with whom we have a pre-existing relationship. We currently originate all of our consumer loans in our geographic market area.

 

The underwriting standards employed by us for consumer loans include a determination of the applicant’s payment history on other debts and an assessment of their ability to meet existing obligations and payments on the proposed loan. The stability of the applicant’s monthly income may be determined by verification of gross monthly income from primary employment and additionally from any verifiable secondary income. Although creditworthiness of the applicant is of primary consideration, the underwriting process also includes an analysis of the value of the security in relation to the proposed loan amount. For home equity lines of credit and loans we require title insurance, hazard insurance and, if required, flood insurance.

 

Residential Mortgage Lending

 

The Bank makes residential mortgage loans for the purchase or refinance of existing loans with loan to value limits ranging between 80 and 90% depending on the age of the property, borrower’s income and credit worthiness. Loans that are retained in our portfolio generally carry adjustable rates that can change every three to five years, based on amortization periods of twenty to thirty years.

 

 

PART II, continued

 

Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations (dollars in thousands), Continued

 

Loans Held for Sale

 

The Bank makes fixed rate mortgage loans with terms of typically fifteen or thirty years through its subsidiary F&M Mortgage. These loans are funded by F&M Mortgage utilizing a line of credit at the Bank until sold to investors in the secondary market. Similarly, the Bank also has a relationship with Northpointe Bank in Grand Rapids, MI whereby it purchases fixed rate conforming 1-4 family mortgage loans for short periods of time pending those loans being sold to investors in the secondary market. These loans have an average duration of ten days to two weeks, but occasionally remain on the Bank’s books for up to 60 days. The Bank began its relationship with Northpointe Bank in 2014 and had a similar program with a prior bank since 2003. This relationship allows the Bank to achieve a higher rate of return than is available on other short term investment opportunities.

 

Dealer Finance Division

 

In September 2012, the Bank started a loan production office in Penn Laird, VA which specializes in providing automobile financing through a network of automobile dealers. The Dealer Finance Division was originally staffed with three officers that have extensive experience in Dealer Finance. Based on the strong growth of this division the staff has been increased to six employees. This office is serving the automobile finance needs for customers of dealers throughout the existing geographic footprint of the Bank. Approximately fifty dealers have signed contracts to originate loans on behalf of the Bank. As of year end 2019, the division had total loans outstanding of $78,976.

 

Critical Accounting Policies

 

General

 

The Company’s financial statements are prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”). The financial information contained within the statements is, to a significant extent, financial information that is based on measures of the financial effects of transactions and events that have already occurred. The Company’s financial position and results of operations are affected by management’s application of accounting policies, including estimates, assumptions and judgments made to arrive at the carrying value of assets and liabilities and amounts reported for revenues, expenses and related disclosures. Different assumptions in the application of these policies could result in material changes in the Company’s consolidated financial position and/or results of operations.

 

In addition, GAAP itself may change from one previously acceptable method to another method. Although the economics of these transactions would be the same, the timing of events that would impact these transactions could change. Following is a summary of the Company’s significant accounting policies that are highly dependent on estimates, assumptions and judgments.

 

Allowance for Loan Losses

 

The allowance for loan losses is an estimate of the losses that may be sustained in the loan portfolio. The allowance is based on two basic principles of accounting: (i) ASC 450 “Contingencies”, which requires that losses be accrued when they are probable of occurring and estimable and (ii) ASC 310, “Receivables”, which requires that losses be accrued based on the differences between the value of collateral, present value of future cash flows or values that are observable in the secondary market and the loan balance. The Company’s allowance for loan losses is the accumulation of various components that are calculated based on independent methodologies. All components of the allowance represent an estimation performed pursuant to either ASC 450 or ASC 310. Management’s estimate of each ASC 450 component is based on certain observable data that management believes are most reflective of the underlying credit losses being estimated. This evaluation includes credit quality trends; collateral values; loan volumes; geographic, borrower and industry concentrations; seasoning of the dealer loan portfolio; the findings of internal credit quality assessments, results from external bank regulatory examinations and third-party loan reviewer. These factors, as well as historical losses and current economic and business conditions, are used in developing estimated loss factors used in the calculations.

 

PART II, continued

 

Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations (dollars in thousands), continued

 

Allowance for Loan Losses, continued

 

Allowances for loan losses are determined by applying estimated loss factors to the portfolio based on management’s evaluation and “risk grading” of the loan portfolio. Specific allowances, if required are typically provided on all impaired loans in excess of a defined loan size threshold that are classified in the Substandard, Watch or Doubtful risk grades and on all troubled debt restructurings. 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.

 

 

PART II, continued

 

Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations (dollars in thousands), continued

 

Fair Value

 

The estimate of fair value involves the use of (1) quoted prices for identical instruments traded in active markets, (2) quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active, and model-based valuation techniques using significant assumptions that are observable in the market or (3) model-based techniques that use significant assumptions not observable in the market. When observable market prices and parameters are not fully available, management’s judgment is necessary to arrive at fair value including estimates of current market participant expectations of future cash flows, risk premiums, among other things. Additionally, significant judgment may be required to determine whether certain assets measured at fair value are classified within the fair value hierarchy as Level 2 or Level 3. The estimation process and the potential materiality of the amounts involved result in this item being identified as critical.

 

Pension Plan Accounting

 

The accounting guidance for the measurement and recognition of obligations and expense related to pension plans generally applies the concept that the cost of benefits provided during retirement should be recognized over the employees’ active working life. Inherent in this concept is the requirement to use various actuarial assumptions to predict and measure costs and obligations many years prior to the settlement date. Major actuarial assumptions that require significant management judgment and have a material impact on the measurement of benefits expense and accumulated benefit obligation include discount rates, expected return on assets, mortality rates, and projected salary increases, among others. Changes in assumptions or judgments related to any of these variables could result in significant volatility in the Company’s financial condition and results of operations. As a result, accounting for the Company’s pension expense and obligation is considered a significant estimate. The estimation process and the potential materiality of the amounts involved result in this item being identified as critical.

 

Other Real Estate Owned (OREO)

 

OREO is held for sale and represents real estate acquired through or in lieu of foreclosure. OREO is initially recorded at fair value less costs to sell when acquired, establishing a new cost basis. Physical possession of residential real estate property collateralizing a consumer mortgage loan occurs when legal title is obtained upon completion of foreclosure or when the borrower conveys all interest in the property to satisfy the loan through completion of a deed in lieu of foreclosure or through a similar legal agreement. The Company’s policy is to carry OREO on its balance sheet at the lower of cost or fair value less estimated costs to sell. If fair value declines subsequent to foreclosure, a valuation allowance is recorded through expense. Operating costs after acquisition are expensed.

 

PART II, continued

 

Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations (dollars in thousands), continued

 

Overview

 

The Company’s net income for 2019 totaled $4,509 or $1.32 per common share basic, a decrease of 49% from $8,823 or $2.60 a share in 2018. Return on average equity decreased in 2019 to 4.93% versus 9.67% in 2018, and the return on average assets decreased from 1.15% in 2018 to .57% in 2019. The Company’s net income per share (dilutive) totaled $1.30 in 2019, a decrease from $2.45 in 2018.

  

Changes in Net Income per Common Share (Basic)

 

	2019	2018
	to 2018	to 2017
Prior Year Net Income Per Common Share (Basic)	$2.60	$2.68
Change from differences in:
Net interest income	(0.05)	.37
Provision for loan losses	(1.40)	(0.90)
Noninterest income, excluding securities gains	0.56	0 .03
Security gains (losses), net		0 .01
Noninterest expenses	(.87)	(0.63)
Income taxes	0.40	1.02
Effect of preferred stock dividend	0.03	-
Change in average shares outstanding	0 .05	0 .02
Total Change	(1.28)	(0.08)
Net Income Per Common Share (Basic)	$1.32	$2.60

 

Net Interest Income

 

The largest source of operating revenue for the Company is net interest income, which is calculated as the difference between the interest earned on earning assets and the interest expense paid on interest bearing liabilities. Net interest income decreased 0.49% from 2018 to 2019 following an increase of 5.78% from 2017 to 2018. The net interest margin is the net interest income expressed as a percentage of interest earning assets. Changes in the volume and mix of interest earning assets and interest bearing liabilities, along with their yields and rates, have a significant impact on the level of net interest income. Tax equivalent net interest income for 2019 was $31,466 representing a decrease of $160 or 0.51% over the prior year. A 3.24% increase in 2018 versus 2017 resulted in total tax equivalent net interest income of $31,626.

 

In this discussion and in the tabular analysis of net interest income performance, entitled “Consolidated Average Balances, Yields and Rates,” the interest earned on tax exempt loans and investment securities has been adjusted to reflect the amount that would have been earned had these investments been subject to normal income taxation. This is referred to as tax equivalent net interest income. For a reconciliation of tax equivalent net interest income to GAAP measures, see the following table.

 

Tax equivalent income on earning assets increased $1,826 in 2019 compared to 2018. Loans held for investment, expressed as a percentage of total earning assets, decreased in 2019 to 87.41% as compared to 92.72% in 2018. During 2019, yields on earning assets decreased 3 basis points (BP), primarily due to changes in the earning asset categories, specifically an increase in loans held for sale, federal funds sold and interest bearing deposits, while loans held for investment decreased. The average cost of interest bearing liabilities increased 28BP in 2019, following an increase of 19BP in 2018. The increase in 2019 is due to increased cost of deposits and growth in interest bearing deposits, as well as increased cost of borrowings from FHLB.

 

PART II, Continued

 

 

The following table provides detail on the components of tax equivalent net interest income:

 

GAAP Financial Measurements: (Dollars in thousands).	2019	2018
Interest Income – Loans	$37,348	$35,798
Interest Income - Securities and Other Interest-Earnings Assets	862	579
Interest Expense – Deposits	5,170	3,425
Interest Expense - Other Borrowings	1,648	1,407
Total Net Interest Income	31,392	31,545
Non-GAAP Financial Measurements:
Add: Tax Benefit on Tax-Exempt Interest Income – Loans	74	81
Total Tax Benefit on Tax-Exempt Interest Income	74	81
Tax-Equivalent Net Interest Income	$31,466	$31,626

 

Interest Income

 

Tax equivalent interest income decreased $160 or 0.51% in 2019, after increasing 4.23% or $1,284 in 2018. Overall, the yield on earning assets decreased 0.03%, from 5.30% to 5.27%. Average loans held for investment declined during 2019, with average loans outstanding decreasing $2,318 to $635,110. Average real estate loans decreased 4.17%, commercial loans decreased 1.62% and consumer installment loans increased 14.28% on average. The increase in average consumer loans is a result of the growth in our Dealer Finance Division despite the fourth quarter sale of a portion of the dealer portfolio. The decrease in tax equivalent net interest income is due primarily to the increase in deposit cost related to the 8.30% growth in average interest bearing deposits.

 

Interest Expense

 

Interest expense increased $1,986 or 41.10% during 2019. The average cost of funds of 1.30% increased 28BP compared to 2018, which followed an increase of 19BP in 2018. Average interest bearing liabilities increased $47,683 or 10.02% in 2019. Changes in the cost of funds attributable to rate and volume variances are in a following table.

 

The analysis on the next page reveals a decrease in the net interest margin to 4.33% in 2019 from 4.60% in 2018, primarily due to changes in balance sheet mix during the year and rising costs of interest bearing deposits and borrowings.

 

PART II, Continued

 

Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations (dollars in thousands), Continued

 

Consolidated Average Balances, Yields and Rates1

 

	2019			2018
	Balance	Interest	Rate	Balance	Interest	Rate
ASSETS
Loans2
Commercial	$184,954	$10,145	5.49%	$187,999	$9,754	5.19%
Real estate	329,825	17,810	5.40%	344,191	17,946	5.21%
Consumer	120,321	7,614	6.33%	105,288	_ 7,115	6.77%
Loans held for investment4	635,110	35,569	5.60%	637,478	34,815	5.46%
Loans held for sale	58,307	1,853	3.18%	29,971	1,064	3.48%
Investment securities3
Fully taxable	13,290	492	3.70%	13,702	457	3.34%
Partially taxable	124	3	2.42%	124	2	1.61%-
Total investment securities	13,414	495	3.69%	13,826	459	3.32%
Interest bearing deposits in banks	1,610	33	2.05%	924	15	1.62%
Federal funds sold	18,145	334	1.84%	5,364	105	1.96%
Total Earning Assets	726,586	38,284	5.27%	687,563	36,458	5.30%
Allowance for loan losses	(6,815)			(6,416)
Nonearning assets	77,100			85,172
Total Assets	$796,871			$766,319
LIABILITIES AND STOCKHOLDERS’ EQUITY
Deposits
Demand –interest bearing	$89,823	$212	.24%	$87,079	$149	.17%
Savings	208,551	2,539	1.22%	162,718	1,209	.74%
Time deposits	147,107	2,418	1.64%	161,635	2,067	1.28%
Total interest bearing deposits	445,581	5,170	1.16%	411,432	3,425	.83%
Short-term debt	27,684	688	2.49%	24,336	456	1.87%
Long-term debt	50,496	960	1.90%	40,210	951	2.37%
Total interest bearing liabilities	523,661	6,818	1.30%	475,978	4,832	1.02%
Noninterest bearing deposits	165,731			161,860
Other liabilities	15,991			37,267
Total liabilities	705,383			675,105
Stockholders’ equity	91,488			91,214
Total liabilities and stockholders’ equity	$796,871			$766,319
Net interest earnings		$31,466			$31,626
Net yield on interest earning assets (NIM)			4.33%			4.60%

 

PART II, Continued

 

Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations (dollars in thousands), Continued

 

The following table illustrates the effect of changes in volumes and rates.

 

	2019 Compared to 2018
	Increase (Decrease)
	Due to Change		Increase
	in Average:		Or
	Volume	Rate	(Decrease)
Interest income
Loans held for investment	$(129)	$883	$754
Loans held for sale	1,006	(217)	789
Investment securities
Fully taxable	(14)	49	35
Partially taxable	-	1	1
Interest bearing deposits in banks	11	7	18
Federal funds sold	251	(22)	229
Total Interest Income	1,125	701	1,826
Interest expense
Deposits
Demand                       - interest bearing	3	60	63
Savings	454	876	1,330
Time deposits	485	(134)	351
Short-term debt	63	169	232
Long-term debt	244	(234)	10
Total Interest Expense	1,249	737	1,986
Net Interest Income	$(124)	$(36)	$(160)

 

Note: Volume changes have been determined by multiplying the prior years’ average rate by the change in average balances outstanding. The rate change is determined by multiplying the current year average balance outstanding by the change in rate from the prior year to the current year.

 

Noninterest Income

 

Noninterest income continues to be an increasingly important factor in maintaining and growing profitability. Management is conscious of the need to constantly review fee income and develop additional sources of complementary revenue.

 

Noninterest income increased 23.95% or $1,917, in 2019. Included in 2019 was a onetime gain on the sale of a portion of the dealer portfolio of $618. The 2019 increase, net of the gain on the dealer portfolio, is due to growth in the gross revenue of VST Title, F & M Financial services and F&M Mortgage and service charges on deposit accounts. The losses on low income housing projects increased 9.39% in 2019 which is consistent with growth in the underlying investments.

 

PART II, Continued

 

Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations (dollars in thousands), Continued

 

Noninterest Expense

 

Noninterest expenses increased from $26,744 in 2018 to $29,518 in 2019, a 10.37% increase. Salary and benefits increased 4.99% to $17,151 in 2019. This increase was the result of normal salary increases, pension settlement costs and severance packages expensed during the year. Other real estate owned, net increased $548 due to an increased effort to dispose of properties. Other areas of increase include data processing, legal and professional and other operating expenses. Total noninterest expense as a percentage of average assets totaled 3.70% and 3.49% in 2019 and 2018, respectively. Peer group averages (as reported in the most recent Uniform Bank Performance Report) were 2.81% for 2019 and 2018.

 

Provision for Loan Losses

 

Management evaluates the loan portfolio in light of national and local economic trends, changes in the nature and volume of the portfolio and industry standards. Specific factors considered by management in determining the adequacy of the level of the allowance for loan losses include internally generated and third-party loan review reports, past due reports and historical loan loss experience. This review also considers concentrations of loans in terms of geography, business type and level of risk. Management evaluates nonperforming loans relative to their collateral value, when deemed collateral dependent, and makes the appropriate adjustments to the allowance for loan losses when needed. Based on the factors outlined above, the current year provision for loan losses totaled $7,405 compared to $2,930 for 2018. The current levels of the allowance for loan losses reflect increased net charge-off activity and other credit risk factors that the Company considers in assessing the adequacy of the allowance for loan losses. During 2019, management has made a tremendous effort to lower nonperforming loans, including through charge-off of loan balances after disposal. As a result nonperforming loans decreased from 1.60% of loans held for investment at December 31, 2018 to 0.94% at December 31, 2019. There has been an increase in substandard loans during 2019 and that along with loan review results have increased the allowance for loan losses despite the improvements in nonperforming loans. Management will continue to monitor nonperforming, adversely classified and past due loans and will make necessary adjustments to specific reserves and provision for loan losses should conditions change regarding collateral values or cash flow expectations.

 

Net loan charge-offs were $4,255 in 2019 and $3,734 in 2018. The increase reflects management’s efforts or reduce nonperforming loans throughout 2019. Net charge-offs as a percentage of loans held for investment totaled 0.71% and 0.58% in 2019 and 2018, respectively. The construction and development charge-off percentage is the largest category at 0.38% of loans held for investment and dealer finance was 0.16%. As stated in the most recently available Uniform Bank Performance Report (UPBR), peer group loss averages were 0.09% in 2019 and 0.08% in 2018. The Bank anticipates losses will remain above peer due to the Dealer Finance Division, however losses in this segment have been in line with expectations and are closely monitored.

 

Balance Sheet

 

Total assets increased 4.39% during the year to $813,999, an increase of $34,256 from $779,743 in 2018. Cash and cash equivalents increased $64,892, Net loans held for investment declined $38,524, Loans held for sale increased $10,888, and other asset categories experienced modest fluctuations. Average earning assets increased 5.68% to $726,586 at December 31, 2019. The increase in earning assets is due largely to the growth in the loans held for sale, which is the short-term loan participation program with Northpointe Bank and the growth in federal funds sold as a result of deposit growth. Deposits grew $50,384 and other liabilities decreased $16,302 in 2019. Average interest bearing deposits increased $34,149 for 2019 or 8.30%, with increases in interest-bearing demand accounts and savings while time deposits declined. The Company continues to utilize 34,149 of its assets well, with 8.30% of average assets consisting of earning assets.

 

 

PART II, Continued

 

Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations (dollars in thousands), Continued

 

Investment Securities

 

Total securities decreased $3,829 or 17.53% in 2019 to $18,015 at December 31, 2019 from $21,844 at December 31, 2018. Average balances in investment securities decreased 2.98% in 2019 to $13,414. At year end, 1.85% of average earning assets of the Company were held as investment securities, all of which are unpledged. Management strives to match the types and maturities of securities owned to balance projected liquidity needs, interest rate sensitivity and to maximize earnings through a portfolio bearing low credit risk. Portfolio yields averaged 3.69% for 2019, up from 3.32% in 2018.

 

There were no Other Than Temporary Impairments (OTTI) write-downs in 2019 or 2018. There were no security gains or losses in 2019 or 2018.

 

The composition of securities at December 31 was:

 

(Dollars in thousands)	2019	2018
Available for Sale1
U.S. Treasury and Agency	$1,989	$7,886
Mortgage-backed obligations of federal agencies2	319	403
Other debt securities	2,058	-
Total	4,366	8,289
Held to Maturity
U.S. Treasury and Agency	124	123
Total	124	123
Other Equity Investments	13,525	13,432
Total Securities	$18,015	$21,844

 

 

Maturities and weighted average yields of securities at December 31, 2019 are presented in the table below. Amounts are shown by contractual maturity; expected maturities will differ as issuers may have the right to call or prepay obligations. Maturities of other investments are not readily determinable due to the nature of the investment; see Note 5 to the Consolidated Financial Statements for a description of these investments.

 

	Less		One to		Five to		Over
	Than one Year		Five Years		Ten Years		Ten Years
(Dollars in thousands)	Amount	Yield	Amount	Yield	Amount	Yield	AmountYield	Total	Yield
Debt Securities Available for Sale
U.S. Treasury & Agency	$-		$1,989	3.00%	$-		$-	$1,989	3.00%
Mortgage-backed obligations of federal agencies	-		-		319	2.49%	-	319	2.49%
Other debt securities	-		2,058	1.07%	-		-	2,058	1.07%
Total	$-		$4,047	2.66%	$319	2.49%	$-	$4,366	2.65%
Debt Securities Held to Maturity
U.S. Treasury & Agency	$124	2.42%	$3		$-		$-	$124	2.42%
Total	$124	2.42%	$3		$-		$-	$124	2.42%