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OLD POINT FINANCIAL CORP - Quarter Report: 2014 June (Form 10-Q)

 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-Q

(Mark One)
x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2014

or

o TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from____________ to___________

Commission File Number: 000-12896

OLD POINT FINANCIAL CORPORATION
(Exact name of registrant as specified in its charter)

VIRGINIA
54-1265373
(State or other jurisdiction of incorporation or organization)
(I.R.S. Employer Identification No.)

1 West Mellen Street, Hampton, Virginia 23663
(Address of principal executive offices) (Zip Code)

(757) 728-1200
(Registrant's telephone number, including area code)

Not Applicable
(Former name, former address and former fiscal year, if changed since last report)

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      o No

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

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

Large accelerated filer o
Accelerated filer o
 
 
Non-accelerated filer o
Smaller reporting company ■
(Do not check if a smaller reporting company)
 

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

Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date.

4,959,009 shares of common stock ($5.00 par value) outstanding as of July 31, 2014



OLD POINT FINANCIAL CORPORATION

FORM 10-Q

INDEX

PART I - FINANCIAL INFORMATION

 
 
Page
 
 
 
Item 1
1
 
 
 
 
1
 
 
 
 
2
 
 
 
 
3
 
 
 
 
4
 
 
 
 
5
 
 
 
 
6
 
 
 
Item 2.
34
 
 
 
Item 3.
46
 
 
 
Item 4.
46
 
 
 
 
PART II - OTHER INFORMATION
 
 
 
 
Item 1.
47
 
 
 
Item 1A.
47
 
 
 
Item 2.
47
 
 
 
Item 3.
47
 
 
 
Item 4.
47
 
 
 
Item 5.
47
 
 
 
Item 6.
48
 
 
 
 
48
i




PART I – FINANCIAL INFORMATION

Item 1.  Financial Statements.

Old Point Financial Corporation and Subsidiaries
Consolidated Balance Sheets

 
 
June 30, 2014
   
December 31, 2013
 
 
 
(dollars in thousands except per share data)
 
 
 
(unaudited)
   
 
Assets
 
   
 
 
 
   
 
Cash and due from banks
 
$
20,383
   
$
11,802
 
Interest-bearing due from banks
   
507
     
18,045
 
Federal funds sold
   
1,643
     
1,478
 
Cash and cash equivalents
   
22,533
     
31,325
 
Securities available-for-sale, at fair value
   
144,040
     
155,639
 
Securities held-to-maturity (fair value approximates $97,091 and $97,453)
   
93,990
     
96,847
 
Restricted securities
   
2,293
     
2,378
 
Loans, net of allowance for loan losses of $6,976 and $6,831
   
512,686
     
493,868
 
Premises and equipment, net
   
42,599
     
40,546
 
Bank-owned life insurance
   
23,107
     
22,673
 
Other real estate owned, net of valuation allowance of $2,700 and $2,775
   
6,549
     
6,415
 
Other assets
   
13,104
     
14,597
 
Total assets
 
$
860,901
   
$
864,288
 
 
               
Liabilities & Stockholders' Equity
               
 
               
Deposits:
               
Noninterest-bearing deposits
 
$
185,277
   
$
182,513
 
Savings deposits
   
292,481
     
286,085
 
Time deposits
   
238,770
     
256,807
 
Total deposits
   
716,528
     
725,405
 
Overnight repurchase agreements
   
25,677
     
31,175
 
Term repurchase agreements
   
412
     
411
 
Federal Home Loan Bank advances
   
30,000
     
25,000
 
Accrued expenses and other liabilities
   
2,297
     
1,536
 
Total liabilities
   
774,914
     
783,527
 
 
               
Commitments and contingencies
   
0
     
0
 
 
               
Stockholders' equity:
               
Common stock, $5/share par value, 10,000,000 shares authorized;4,959,009 shares issued and outstanding
   
24,795
     
24,795
 
Additional paid-in capital
   
16,392
     
16,392
 
Retained earnings
   
51,859
     
50,376
 
Accumulated other comprehensive loss, net
   
(7,059
)
   
(10,802
)
Total stockholders' equity
   
85,987
     
80,761
 
Total liabilities and stockholders' equity
 
$
860,901
   
$
864,288
 

See Notes to Consolidated Financial Statements.
- 1 -


Old Point Financial Corporation and Subsidiaries
Consolidated Statements of Income
 
 
Three Months Ended June 30,
   
Six Months Ended June 30,
 
 
 
2014
   
2013
   
2014
   
2013
 
 
 
(unaudited, dollars in thousands except per share data)
 
Interest and Dividend Income:
 
   
   
   
 
Interest and fees on loans
 
$
6,122
   
$
5,891
   
$
12,115
   
$
11,899
 
Interest on due from banks
   
0
     
19
     
3
     
33
 
Interest on federal funds sold
   
0
     
1
     
5
     
1
 
Interest on securities:
                               
Taxable
   
962
     
1,252
     
1,967
     
2,576
 
Tax-exempt
   
426
     
287
     
855
     
552
 
Dividends and interest on all other securities
   
26
     
26
     
57
     
44
 
Total interest and dividend income
   
7,536
     
7,476
     
15,002
     
15,105
 
 
                               
Interest Expense:
                               
Interest on savings deposits
   
52
     
69
     
123
     
156
 
Interest on time deposits
   
595
     
796
     
1,244
     
1,650
 
Interest on federal funds purchased, securities sold under agreements to repurchase and other borrowings
   
8
     
7
     
17
     
19
 
Interest on Federal Home Loan Bank advances
   
307
     
305
     
609
     
607
 
Total interest expense
   
962
     
1,177
     
1,993
     
2,432
 
Net interest income
   
6,574
     
6,299
     
13,009
     
12,673
 
Provision for loan losses
   
100
     
300
     
350
     
500
 
Net interest income, after provision for loan losses
   
6,474
     
5,999
     
12,659
     
12,173
 
 
                               
Noninterest Income:
                               
Income from fiduciary activities
   
793
     
866
     
1,748
     
1,766
 
Service charges on deposit accounts
   
1,056
     
1,036
     
2,030
     
2,033
 
Other service charges, commissions and fees
   
1,041
     
912
     
1,993
     
1,771
 
Income from bank-owned life insurance
   
217
     
217
     
433
     
432
 
Income from Old Point Mortgage
   
6
     
218
     
31
     
304
 
Loss on sale of available-for-sale securities, net
   
(7
)
   
(21
)
   
(7
)
   
(21
)
Other operating income
   
47
     
57
     
87
     
113
 
Total noninterest income
   
3,153
     
3,285
     
6,315
     
6,398
 
 
                               
Noninterest Expense:
                               
Salaries and employee benefits
   
4,981
     
4,805
     
9,834
     
9,726
 
Occupancy and equipment
   
1,205
     
1,079
     
2,319
     
2,191
 
Data processing
   
433
     
413
     
856
     
835
 
FDIC insurance
   
183
     
174
     
367
     
357
 
Customer development
   
207
     
205
     
399
     
411
 
Legal and audit expense
   
153
     
124
     
277
     
235
 
Other outside service fees
   
152
     
113
     
271
     
209
 
Employee professional development
   
220
     
182
     
388
     
313
 
Marketing and advertising
   
127
     
124
     
251
     
247
 
Postage and courier
   
113
     
120
     
234
     
243
 
Loan expenses
   
118
     
87
     
216
     
177
 
Stationery and supplies
   
118
     
96
     
237
     
216
 
Capital stock tax
   
127
     
105
     
261
     
192
 
Loss (gain) on write-down/sale of other real estate owned
   
(26
)
   
78
     
57
     
204
 
Other operating expense
   
356
     
345
     
763
     
719
 
Total noninterest expense
   
8,467
     
8,050
     
16,730
     
16,275
 
Income before income taxes
   
1,160
     
1,234
     
2,244
     
2,296
 
Income tax expense
   
59
     
219
     
166
     
380
 
Net income
 
$
1,101
   
$
1,015
   
$
2,078
   
$
1,916
 
 
                               
Basic Earnings per Share:
                               
Average shares outstanding
   
4,959,009
     
4,959,009
     
4,959,009
     
4,959,009
 
Net income per share of common stock
 
$
0.22
   
$
0.21
   
$
0.42
   
$
0.39
 
 
                               
Diluted Earnings per Share:
                               
Average shares outstanding
   
4,959,009
     
4,959,009
     
4,959,009
     
4,959,009
 
Net income per share of common stock
 
$
0.22
   
$
0.21
   
$
0.42
   
$
0.39
 

See Notes to Consolidated Financial Statements.

- 2 -


Old Point Financial Corporation and Subsidiaries
Consolidated Statements of Comprehensive Income (Loss)

 
 
Three Months Ended
June 30,
   
Six Months Ended
June 30,
 
 
 
2014
   
2013
   
2014
   
2013
 
 
 
(unaudited, dollars in thousands)
 
Net income
 
$
1,101
   
$
1,015
   
$
2,078
   
$
1,916
 
Other comprehensive income (loss), net of tax
                               
Unrealized gains (losses) on available-for-sale securities
   
1,932
     
(6,497
)
   
3,484
     
(8,223
)
Amortization of unrealized losses on securities transferred to held-to-maturity
   
133
     
0
     
259
     
0
 
Other comprehensive income (loss)
   
2,065
     
(6,497
)
   
3,743
     
(8,223
)
Comprehensive income (loss)
 
$
3,166
   
$
(5,482
)
 
$
5,821
   
$
(6,307
)

See Notes to Consolidated Financial Statements.

- 3 -


Old Point Financial Corporation and Subsidiaries
Consolidated Statements of Changes in Stockholders' Equity

(unaudited, dollars in thousands except per share data)
 
Shares of
Common
Stock
   
Common
Stock
   
Additional
Paid-in
Capital
   
Retained
Earnings
   
Accumulated
Other
Comprehensive
Income (Loss)
   
Total
 
SIX MONTHS ENDED JUNE 30, 2014
 
   
   
   
   
   
 
 
 
   
   
   
   
   
 
Balance at beginning of period
   
4,959,009
   
$
24,795
   
$
16,392
   
$
50,376
   
$
(10,802
)
 
$
80,761
 
Net income
   
0
     
0
     
0
     
2,078
     
0
     
2,078
 
Other comprehensive income, net of tax
   
0
     
0
     
0
     
0
     
3,743
     
3,743
 
Cash dividends ($0.12 per share)
   
0
     
0
     
0
     
(595
)
   
0
     
(595
)
 
                                               
Balance at end of period
   
4,959,009
   
$
24,795
   
$
16,392
   
$
51,859
   
$
(7,059
)
 
$
85,987
 
                                 
                                 
SIX MONTHS ENDED JUNE 30, 2013
                                 
 
                                               
Balance at beginning of period
   
4,959,009
   
$
24,795
   
$
16,392
   
$
48,305
   
$
(192
)
 
$
89,300
 
Net income
   
0
     
0
     
0
     
1,916
     
0
     
1,916
 
Other comprehensive loss, net of tax
   
0
     
0
     
0
     
0
     
(8,223
)
   
(8,223
)
Cash dividends ($0.10 per share)
   
0
     
0
     
0
     
(496
)
   
0
     
(496
)
 
                                               
Balance at end of period
   
4,959,009
   
$
24,795
   
$
16,392
   
$
49,725
   
$
(8,415
)
 
$
82,497
 

See Notes to Consolidated Financial Statements.

- 4 -


Old Point Financial Corporation and Subsidiaries
Consolidated Statements of Cash Flows

Six Months Ended June 30,
 
2014
   
2013
 
 
 
(unaudited, in thousands)
 
CASH FLOWS FROM OPERATING ACTIVITIES
 
   
 
Net income
 
$
2,078
   
$
1,916
 
Adjustments to reconcile net income to net cash provided by operating activities:
               
Depreciation and amortization
   
1,030
     
980
 
Provision for loan losses
   
350
     
500
 
Net loss on sale of available-for-sale securities
   
7
     
21
 
Net amortization of securities
   
1,125
     
1,318
 
Net loss on disposal of premises and equipment
   
0
     
16
 
Net loss on write-down/sale of other real estate owned
   
57
     
204
 
Income from bank owned life insurance
   
(433
)
   
(432
)
Deferred tax (benefit) expense
   
130
     
(117
)
Increase in other assets
   
(675
)
   
(522
)
Increase in other liabilities
   
761
     
807
 
Net cash provided by operating activities
   
4,430
     
4,691
 
 
               
CASH FLOWS FROM INVESTING ACTIVITIES
               
Purchases of available-for-sale securities
   
(2,275
)
   
(11,377
)
Purchases of held-to-maturity securities
   
0
     
(10,854
)
Proceeds from sales of restricted securities
   
85
     
184
 
Proceeds from maturities and calls of available-for-sale securities
   
170
     
10,490
 
Proceeds from sales of available-for-sale securities
   
13,702
     
39,301
 
Paydowns on available-for-sale securities
   
4,796
     
18,672
 
Paydowns on held-to-maturity securities
   
2,701
     
0
 
(Increase) decrease in loans made to customers
   
(20,060
)
   
230
 
Proceeds from sales of other real estate owned
   
711
     
1,117
 
Purchases of premises and equipment
   
(3,083
)
   
(4,483
)
Net cash provided by (used in) investing activities
   
(3,253
)
   
43,280
 
 
               
CASH FLOWS FROM FINANCING ACTIVITIES
               
Increase in noninterest-bearing deposits
   
2,764
     
1,099
 
Increase in savings deposits
   
6,396
     
2,568
 
Decrease in time deposits
   
(18,037
)
   
(27,115
)
Decrease in federal funds purchased, repurchase agreements and other borrowings, net
   
(5,497
)
   
(11,173
)
Increase in Federal Home Loan Bank advances
   
10,000
     
0
 
Repayment of Federal Home Loan Bank advances
   
(5,000
)
   
0
 
Cash dividends paid on common stock
   
(595
)
   
(496
)
Net cash used in financing activities
   
(9,969
)
   
(35,117
)
 
               
Net increase (decrease) in cash and cash equivalents
   
(8,792
)
   
12,854
 
Cash and cash equivalents at beginning of period
   
31,325
     
42,317
 
Cash and cash equivalents at end of period
 
$
22,533
   
$
55,171
 
 
               
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION
               
Cash payments for:
               
Interest
 
$
2,054
   
$
2,505
 
Income tax
 
$
360
   
$
450
 
 
               
SUPPLEMENTAL SCHEDULE OF NONCASH TRANSACTIONS
               
Unrealized gain (loss) on securities available-for-sale
 
$
5,278
   
(12,459
)
Loans transferred to other real estate owned
 
$
892
   
$
866
 
Former branch site transferred from fixed assets to foreclosed properties
 
$
0
   
$
506
 
Book value of equity securities transferred from other assets to available-for-sale
 
$
100
   
$
0
 
Amortization of unrealized loss on securities transferred to held-to-maturity
 
$
392
   
$
0
 

See Notes to Consolidated Financial Statements.
- 5 -



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)


Note 1. General
The accompanying unaudited consolidated financial statements of Old Point Financial Corporation (the Company) and its subsidiaries have been prepared in accordance with U.S. generally accepted accounting principles (GAAP) for interim financial information. All significant intercompany balances and transactions have been eliminated. In the opinion of management, the accompanying unaudited consolidated financial statements contain all adjustments and reclassifications of a normal and recurring nature considered necessary to present fairly the financial position at June 30, 2014, the statements of income and comprehensive income (loss) for the three and six months ended June 30, 2014 and 2013, and the statements of changes in stockholders' equity and cash flows for the six months ended June 30, 2014 and 2013. The results of operations for the interim periods are not necessarily indicative of the results that may be expected for the full year.

These financial statements should be read in conjunction with the consolidated financial statements and notes thereto included in the Company's 2013 annual report on Form 10-K. Certain previously reported amounts have been reclassified to conform to current period presentation, none of which were material in nature.


Note 2. Securities

Amortized costs and fair values of securities held-to-maturity as of the dates indicated are as follows:

 
 
Amortized
Cost
   
Gross
Unrealized
Gains
   
Gross
Unrealized
Losses
   
Fair
Value
 
 
 
(in thousands)
 
June 30, 2014
 
 
Obligations of  U.S. Government agencies
 
$
400
   
$
0
   
$
(3
)
 
$
397
 
Obligations of state and political subdivisions
   
29,826
     
326
     
(78
)
   
30,074
 
Mortgage-backed securities
   
63,764
     
2,856
     
0
     
66,620
 
Total
 
$
93,990
   
$
3,182
   
$
(81
)
 
$
97,091
 
 
                               
December 31, 2013
                               
Obligations of  U.S. Government agencies
 
$
400
   
$
1
   
$
(5
)
 
$
396
 
Obligations of state and political subdivisions
   
30,120
     
29
     
(715
)
   
29,434
 
Mortgage-backed securities
   
66,327
     
1,296
     
0
     
67,623
 
Total
 
$
96,847
   
$
1,326
   
$
(720
)
 
$
97,453
 
- 6 -



Amortized costs and fair values of securities available-for-sale as of the dates indicated are as follows:

 
 
Amortized
Cost
   
Gross
Unrealized
Gains
   
Gross
Unrealized
Losses
   
Fair
Value
 
 
 
(in thousands)
 
June 30, 2014
 
   
   
   
 
Obligations of  U.S. Government agencies
 
$
14,956
   
$
260
   
$
(285
)
 
$
14,931
 
Obligations of state and political subdivisions
   
50,601
     
291
     
(1,397
)
   
49,495
 
Mortgage-backed securities
   
78,249
     
3
     
(1,627
)
   
76,625
 
Money market investments
   
614
     
0
     
0
     
614
 
Corporate bonds
   
2,298
     
4
     
(11
)
   
2,291
 
Other marketable equity securities
   
100
     
0
     
(16
)
   
84
 
Total
 
$
146,818
   
$
558
   
$
(3,336
)
 
$
144,040
 
 
                               
December 31, 2013
                               
Obligations of  U.S. Government agencies
 
$
15,189
   
$
263
   
$
(428
)
 
$
15,024
 
Obligations of state and political subdivisions
   
51,032
     
86
     
(4,018
)
   
47,100
 
Mortgage-backed securities
   
94,685
     
0
     
(3,935
)
   
90,750
 
Money market investments
   
691
     
0
     
0
     
691
 
Corporate bonds
   
2,098
     
1
     
(25
)
   
2,074
 
Total
 
$
163,695
   
$
350
   
$
(8,406
)
 
$
155,639
 


OTHER-THAN-TEMPORARILY IMPAIRED SECURITIES
Management assesses whether the Company intends to sell or it is more-likely-than-not that the Company will be required to sell a security before recovery of its amortized cost basis less any current-period credit losses. For debt securities that are considered other-than-temporarily impaired and that the Company does not intend to sell and will not be required to sell prior to recovery of the amortized cost basis, the Company separates the amount of the impairment into the amount that is credit related (credit loss component) and the amount due to all other factors. The credit loss component is recognized in earnings and is the difference between the security's amortized cost basis and the present value of its expected future cash flows. The remaining difference between the security's fair value and the present value of expected future cash flows is due to factors that are not credit related, which are recognized in other comprehensive income.

The present value of expected future cash flows is determined using the best-estimate cash flows discounted at the effective interest rate implicit to the security at the date of purchase or the current yield to accrete an asset-backed or floating rate security. The methodology and assumptions for establishing the best-estimate cash flows vary depending on the type of security. The asset-backed securities cash flow estimates are based on bond specific facts and circumstances that may include collateral characteristics, expectations of delinquency and default rates, loss severity and prepayment speeds, and structural support, including subordination and guarantees.

The Company has a process in place to identify debt securities that could potentially have a credit or interest-rate related impairment that is other-than-temporary. This process involves monitoring late payments, pricing levels, downgrades by rating agencies, key financial ratios, financial statements, revenue forecasts, and cash flow projections as indicators of credit issues. On a quarterly basis, management reviews all securities to determine whether an other-than-temporary decline in value exists and whether losses should be recognized. Management considers relevant facts and circumstances in evaluating whether a credit or interest rate-related impairment of a security is other-than-temporary. Relevant facts and circumstances considered include: (a) the extent and length of time the fair value has been below cost; (b) the reasons for the decline in value; (c) the financial position and access to capital of the issuer, including the current and future impact of any specific events; and (d) for fixed maturity securities, the Company's intent to sell a security or whether it is more-likely-than-not the Company will be required to sell the security before the recovery of its amortized cost which, in some cases, may extend to maturity, and for equity securities, the Company's ability and intent to hold the security for a period of time that allows for the recovery in value.
- 7 -

The Company has not recorded impairment charges through income on securities for the three or six months ended June 30, 2014 or the year ended December 31, 2013.

TEMPORARILY IMPAIRED SECURITIES

The following table shows the number of securities with unrealized losses, and the gross unrealized losses and fair value of the Company's investments with unrealized losses that are deemed to be temporarily impaired, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position as of the dates indicated.

 
 
June 30, 2014
 
 
 
Less Than Twelve Months
   
More Than Twelve Months
   
Total
 
 
 
Gross
Unrealized
Losses
   
Fair
Value
   
Gross
Unrealized
Losses
   
Fair
Value
   
Gross
Unrealized
Losses
   
Fair
Value
   
Number
of
Securities
 
 
 
(dollars in thousands)
 
Securities Available-for-Sale
 
   
   
   
   
   
   
 
Debt securities:
 
   
   
   
   
   
   
 
Obligations of U.S. Government agencies
 
$
0
   
$
0
   
$
285
   
$
4,320
   
$
285
   
$
4,320
     
1
 
Obligations of state and political subdivisions
   
29
     
4,983
     
1,368
     
27,004
     
1,397
     
31,987
     
55
 
Mortgage-backed securities
   
0
     
0
     
1,627
     
63,446
     
1,627
     
63,446
     
8
 
Corporate bonds
   
2
     
398
     
9
     
791
     
11
     
1,189
     
10
 
Total debt securities
   
31
     
5,381
     
3,289
     
95,561
     
3,320
     
100,942
     
74
 
Other marketable equity securities
   
16
     
84
     
0
     
0
     
16
     
84
     
1
 
Total securities available-for-sale
 
$
47
   
$
5,465
   
$
3,289
   
$
95,561
   
$
3,336
   
$
101,026
     
75
 
 
                                                       
Securities Held-to-Maturity
                                                       
Obligations of U.S. Government agencies
 
$
0
   
$
0
   
$
3
   
$
97
   
$
3
   
$
97
     
1
 
Obligations of state and political subdivisions
   
14
     
3,625
     
64
     
3,213
     
78
     
6,838
     
14
 
Total securities held-to-maturity
 
$
14
   
$
3,625
   
$
67
   
$
3,310
   
$
81
   
$
6,935
     
15
 
 
                                                       
Total securities
 
$
61
   
$
9,090
   
$
3,356
   
$
98,871
   
$
3,417
   
$
107,961
     
90
 

- 8 -


 
 
December 31, 2013
 
 
 
Less Than Twelve Months
   
More Than Twelve Months
   
Total
 
 
 
Gross
Unrealized
Losses
   
Fair
Value
   
Gross
Unrealized
Losses
   
Fair
Value
   
Gross
Unrealized
Losses
   
Fair
Value
   
Number
of
Securities
 
 
 
(dollars in thousands)
 
Securities Available-for-Sale
 
   
   
   
   
   
   
 
Debt securities:
 
   
   
   
   
   
   
 
Obligations of U.S. Government agencies
 
$
0
   
$
0
   
$
428
   
$
4,403
   
$
428
   
$
4,403
     
1
 
Obligations of state and political subdivisions
   
3,246
     
36,235
     
772
     
6,450
     
4,018
     
42,685
     
82
 
Mortgage-backed securities
   
3,321
     
81,664
     
614
     
9,086
     
3,935
     
90,750
     
12
 
Corporate bonds
   
19
     
1,279
     
6
     
295
     
25
     
1,574
     
12
 
Total securities available-for-sale
 
$
6,586
   
$
119,178
   
$
1,820
   
$
20,234
   
$
8,406
   
$
139,412
     
107
 
 
                                                       
Securities Held-to-Maturity
                                                       
Obligations of U.S. Government agencies
 
$
0
   
$
0
   
$
5
   
$
95
   
$
5
   
$
95
     
1
 
Obligations of state and political subdivisions
   
715
     
23,765
     
0
     
0
     
715
     
23,765
     
50
 
Total securities held-to-maturity
 
$
715
   
$
23,765
   
$
5
   
$
95
   
$
720
   
$
23,860
     
51
 
 
                                                       
Total securities
 
$
7,301
   
$
142,943
   
$
1,825
   
$
20,329
   
$
9,126
   
$
163,272
     
158
 


Certain investments within the Company's portfolio had unrealized losses at June 30, 2014 and December 31, 2013, as shown in the tables above. The unrealized losses were caused by increases in market interest rates. Because the Company does not intend to sell the investments and management believes it is unlikely that the Company will be required to sell the investments before recovery of their amortized cost basis, which may be maturity, the Company does not consider the investments to be other-than-temporarily impaired at June 30, 2014 or December 31, 2013.

Restricted Securities
The restricted security category is comprised of stock in the Federal Home Loan Bank of Atlanta (FHLB) and the Federal Reserve Bank (FRB). These stocks are classified as restricted securities because their ownership is restricted to certain types of entities and the securities lack a market. Therefore, FHLB and FRB stock is carried at cost and evaluated for impairment. When evaluating these stocks for impairment, their value is determined based on the ultimate recoverability of the par value rather than by recognizing temporary declines in value. Restricted stock is viewed as a long-term investment and management believes that the Company has the ability and the intent to hold this stock until its value is recovered.

- 9 -


Note 3. Loans and the Allowance for Loan Losses

The following is a summary of the balances in each class of the Company's loan portfolio as of the dates indicated:

 
 
June 30, 2014
   
December 31, 2013
 
 
 
(in thousands)
 
Mortgage loans on real estate:
 
   
 
Residential 1-4 family
 
$
85,206
   
$
84,500
 
Commercial
   
294,298
     
287,071
 
Construction
   
14,100
     
14,505
 
Second mortgages
   
12,756
     
13,232
 
Equity lines of credit
   
38,255
     
32,163
 
Total mortgage loans on real estate
   
444,615
     
431,471
 
Commercial loans
   
34,973
     
30,702
 
Consumer loans
   
18,625
     
19,791
 
Other
   
21,449
     
18,735
 
Total loans
   
519,662
     
500,699
 
Less: Allowance for loan losses
   
(6,976
)
   
(6,831
)
Loans, net of allowance and deferred fees
 
$
512,686
   
$
493,868
 


Overdrawn deposit accounts are reclassified as loans and included in the Other category in the table above. Overdrawn deposit accounts totaled $781 thousand and $641 thousand at June 30, 2014 and December 31, 2013, respectively.

CREDIT QUALITY INFORMATION
The Company uses internally-assigned risk grades to estimate the capability of borrowers to repay the contractual obligations of their loan agreements as scheduled or at all. The Company's internal risk grade system is based on experiences with similarly graded loans. Credit risk grades are updated at least quarterly as additional information becomes available, at which time management analyzes the resulting scores to track loan performance.

The Company's internally assigned risk grades are as follows:
· Pass: Loans are of acceptable risk.
· Other Assets Especially Mentioned (OAEM): Loans have potential weaknesses that deserve management's close attention.
· Substandard: Loans reflect significant deficiencies due to several adverse trends of a financial, economic or managerial nature.
· Doubtful: Loans have all the weaknesses inherent in a substandard loan with added characteristics that make collection or liquidation in full based on currently existing facts, conditions and values highly questionable or improbable.
· Loss: Loans have been charged off because they are considered uncollectible and of such little value that their continuance as bankable assets is not warranted.
- 10 -



The following table presents credit quality exposures by internally assigned risk ratings as of the dates indicated:

Credit Quality Information
As of June 30, 2014
 
(in thousands)
 
 
 
Pass
   
OAEM
   
Substandard
   
Total
 
 
 
   
   
   
 
Mortgage loans on real estate:
 
   
   
   
 
Residential 1-4 family
 
$
80,378
   
$
0
   
$
4,828
   
$
85,206
 
Commercial
   
285,386
     
4,266
     
4,646
     
294,298
 
Construction
   
11,196
     
456
     
2,448
     
14,100
 
Second mortgages
   
12,517
     
0
     
239
     
12,756
 
Equity lines of credit
   
37,547
     
0
     
708
     
38,255
 
Total mortgage loans on real estate
   
427,024
     
4,722
     
12,869
     
444,615
 
Commercial loans
   
34,817
     
85
     
71
     
34,973
 
Consumer loans
   
18,557
     
0
     
68
     
18,625
 
Other
   
21,449
     
0
     
0
     
21,449
 
Total
 
$
501,847
   
$
4,807
   
$
13,008
   
$
519,662
 

Credit Quality Information
As of December 31, 2013
 
(in thousands)
 
 
 
Pass
   
OAEM
   
Substandard
   
Total
 
 
 
   
   
   
 
Mortgage loans on real estate:
 
   
   
   
 
Residential 1-4 family
 
$
78,612
   
$
1,167
   
$
4,721
   
$
84,500
 
Commercial
   
274,749
     
5,693
     
6,629
     
287,071
 
Construction
   
10,319
     
640
     
3,546
     
14,505
 
Second mortgages
   
12,994
     
0
     
238
     
13,232
 
Equity lines of credit
   
31,690
     
0
     
473
     
32,163
 
Total mortgage loans on real estate
   
408,364
     
7,500
     
15,607
     
431,471
 
Commercial loans
   
30,164
     
319
     
219
     
30,702
 
Consumer loans
   
19,723
     
0
     
68
     
19,791
 
Other
   
18,735
     
0
     
0
     
18,735
 
Total
 
$
476,986
   
$
7,819
   
$
15,894
   
$
500,699
 


As of June 30, 2014 and December 31, 2013 the Company did not have any loans internally classified as Loss or Doubtful.
- 11 -


AGE ANALYSIS OF PAST DUE LOANS BY CLASS

All classes of loans are considered past due if the required principal and interest payments have not been received as of the date such payments were due. Interest and fees continue to accrue on past due loans until the date the loan is placed in nonaccrual status, if applicable. The following table includes an aging analysis of the recorded investment in past due loans as of the dates indicated. Also included in the table below are loans that are 90 days or more past due as to interest and principal and still accruing interest, because they are well-secured and in the process of collection. Loans in nonaccrual status that are also past due are included in the aging categories in the table below.

Age Analysis of Past Due Loans as of June 30, 2014
 
 
 
30 - 59
Days Past
Due
   
60 - 89
Days Past
Due
   
90 or More
Days Past
Due
   
Total Past
Due
   
Total
Current
Loans (1)
   
Total
Loans
   
Recorded
Investment
> 90 Days
Past Due
and
Accruing
 
 
 
(in thousands)
 
Mortgage loans on real estate:
   
   
   
   
   
 
Residential 1-4 family
 
$
534
   
$
61
   
$
3,460
   
$
4,055
   
$
81,151
   
$
85,206
   
$
0
 
Commercial
   
365
     
781
     
53
     
1,199
     
293,099
     
294,298
     
0
 
Construction
   
456
     
0
     
2,448
     
2,904
     
11,196
     
14,100
     
67
 
Second mortgages
   
3
     
5
     
33
     
41
     
12,715
     
12,756
     
33
 
Equity lines of credit
   
0
     
0
     
20
     
20
     
38,235
     
38,255
     
20
 
Total mortgage loans on real estate
   
1,358
     
847
     
6,014
     
8,219
     
436,396
     
444,615
     
120
 
Commercial loans
   
18
     
0
     
10
     
28
     
34,945
     
34,973
     
10
 
Consumer loans
   
461
     
582
     
905
     
1,948
     
16,677
     
18,625
     
861
 
Other
   
41
     
11
     
5
     
57
     
21,392
     
21,449
     
5
 
Total
 
$
1,878
   
$
1,440
   
$
6,934
   
$
10,252
   
$
509,410
   
$
519,662
   
$
996
 
(1) For purposes of this table, Total Current Loans includes loans that are 1 - 29 days past due.

In the table above, the consumer category includes student loans with principal amounts that are 97 - 98% guaranteed by the government.  The past due portion of these guaranteed loans totaled $1.9 million at June 30, 2014.

Age Analysis of Past Due Loans as of December 31, 2013
 
 
 
30 - 59
Days Past
Due
   
60 - 89
Days Past
Due
   
90 or More
Days Past
Due
   
Total Past
Due
   
Total
Current
Loans (1)
   
Total
Loans
   
Recorded
Investment
> 90 Days
Past Due
and
Accruing
 
 
 
(in thousands)
 
Mortgage loans on real estate:
 
   
   
   
   
   
   
 
Residential 1-4 family
 
$
324
   
$
82
   
$
4,304
   
$
4,710
   
$
79,790
   
$
84,500
   
$
493
 
Commercial
   
120
     
704
     
53
     
877
     
286,194
     
287,071
     
0
 
Construction
   
0
     
0
     
2,545
     
2,545
     
11,960
     
14,505
     
0
 
Second mortgages
   
0
     
10
     
34
     
44
     
13,188
     
13,232
     
34
 
Equity lines of credit
   
139
     
0
     
0
     
139
     
32,024
     
32,163
     
0
 
Total mortgage loans on real estate
   
583
     
796
     
6,936
     
8,315
     
423,156
     
431,471
     
527
 
Commercial loans
   
15
     
80
     
0
     
95
     
30,607
     
30,702
     
0
 
Consumer loans
   
929
     
5
     
5
     
939
     
18,852
     
19,791
     
5
 
Other
   
51
     
15
     
14
     
80
     
18,655
     
18,735
     
14
 
Total
 
$
1,578
   
$
896
   
$
6,955
   
$
9,429
   
$
491,270
   
$
500,699
   
$
546
 
(1) For purposes of this table, Total Current Loans includes loans that are 1 - 29 days past due.

In the table above, the consumer category includes student loans with principal amounts that are 97 - 98% guaranteed by the government.  The past due portion of these guaranteed loans totaled $744 thousand at December 31, 2013.
- 12 -



NONACCRUAL LOANS
The Company generally places non-consumer loans in nonaccrual status when the full and timely collection of interest or principal becomes uncertain, part of the principal balance has been charged off and no restructuring has occurred or the loan reaches 90 days past due, unless the credit is well-secured and in the process of collection. Under regulatory rules, consumer loans, which are loans to individuals for household, family and other personal expenditures, and loans secured by 1-4 family residential properties are not required to be placed in nonaccrual status. Although consumer loans and loans secured by 1-4 family residential property are not required to be placed in nonaccrual status, the Company may place a consumer loan or loan secured by 1-4 family residential property in nonaccrual status, if necessary to avoid a material overstatement of interest income.

Generally, consumer loans not secured by real estate are placed in nonaccrual status only when part of the principal has been charged off. These loans are charged off or written down to the net realizable value of the collateral when deemed uncollectible, due to bankruptcy or other factors, or when they are past due based on loan product, industry practice, terms and other factors.

When management places a loan in nonaccrual status, the accrued unpaid interest receivable is reversed against interest income and the loan is accounted for by the cash or cost recovery method, until it qualifies for return to accrual status or is charged off. Generally, management returns a loan to accrual status if (a) all delinquent interest and principal payments become current under the terms of the loan agreement or (b) the loan is both well-secured and in the process of collection and collectability is no longer doubtful.


The following table presents loans in nonaccrual status by class of loan as of the dates indicated:

Nonaccrual Loans by Class
 
 
 
June 30, 2014
   
December 31, 2013
 
 
 
(in thousands)
 
 
 
 
Mortgage loans on real estate
 
   
 
Residential 1-4 family
 
$
3,717
   
$
4,024
 
Commercial
   
4,442
     
4,606
 
Construction
   
2,382
     
2,545
 
Total mortgage loans on real estate
   
10,541
     
11,175
 
Commercial loans
   
0
     
149
 
Consumer loans
   
44
     
0
 
Total
 
$
10,585
   
$
11,324
 


The following table presents the interest income that the Company would have earned under the original terms of its nonaccrual loans and the actual interest recorded by the Company on nonaccrual loans for the periods presented:

 
Six Months Ended June 30,
 
 
2014
   
2013
 
 
(in thousands)
 
Interest income that would have been recorded under original loan terms
 
$
369
   
$
275
 
Actual interest income recorded for the period
   
170
     
51
 
Reduction in interest income on nonaccrual loans
 
$
199
   
$
224
 

- 13 -



TROUBLED DEBT RESTRUCTURINGS
The Company's loan portfolio includes certain loans that have been modified in a troubled debt restructuring (TDR), where economic concessions have been granted to borrowers who are experiencing financial difficulties. These concessions typically result from the Company's loss mitigation activities and could include reduction in the interest rate below current market rates for borrowers with similar risk profiles, payment extensions, forgiveness of principal, forbearance or other actions intended to maximize collection. The Company defines a TDR as nonperforming if the TDR is in nonaccrual status or is 90 days or more past due and still accruing interest at the report date.

When the Company modifies a loan, management evaluates any possible impairment as stated in the impaired loan section below.


The following table presents TDRs during the period indicated, by class of loan.  The Company did not restructure any loans in the second quarter of 2014.

Troubled Debt Restructurings by Class
For the Three Months Ended June 30, 2013
 
(dollars in thousands)
 
 
Number of
Modifications
 
Recorded
Investment
Prior to
Modification
 
Recorded
Investment
After
Modification
 
Current Investment on June 30, 2013
 
Mortgage loans on real estate:
 
 
 
 
Residential 1-4 family
   
2
   
$
$285
   
$
$285
   
$
$284
 

Troubled Debt Restructurings by Class
For the Six Months Ended June 30, 2014
 
(dollars in thousands)
 
 
Number of
Modifications
 
Recorded
Investment
Prior to
Modification
 
Recorded
Investment
After
Modification
 
Current
Investment on
June 30, 2014
 
Mortgage loans on real estate:
 
 
 
 
Residential 1-4 family
   
1
   
$
276
   
$
276
   
$
272
 
Construction
   
1
     
103
     
103
     
103
 
Second mortgages
   
1
     
89
     
89
     
88
 
Total
   
3
   
$
468
   
$
468
   
$
463
 

Troubled Debt Restructurings by Class
For the Six Months Ended June 30, 2013
 
(dollars in thousands)
 
 
Number of
Modifications
 
Recorded
Investment
Prior to
Modification
 
Recorded
Investment
After
Modification
 
Current Investment on June 30, 2013
 
Mortgage loans on real estate:
 
 
 
 
Residential 1-4 family
   
3
   
$
676
   
$
676
   
$
673
 
Commercial
   
1
     
207
     
207
     
203
 
Total
   
4
   
$
883
   
$
883
   
$
876
 



All loans restructured in the first six months of 2014 and 2013 were given below-market rates for debt with similar risk characteristics.  At June 30, 2014 and December 31, 2013, the Company had no outstanding commitments to disburse additional funds on any TDR.
- 14 -



The following tables presents TDRs for the periods indicated for which there was a payment default where the default occurred within twelve months of restructuring. The Company considers a TDR in default when any of the following occurs: the loan, as restructured, becomes 90 days or more past due; the loan is moved to non-accrual status following the restructure; the loan is restructured again under terms that would qualify it as a TDR if it were not already so classified; or any portion of the loan is charged off.  For the three months ended June 30, 2014, there were no TDRs for which there was a payment default where the default occurred within twelve months of restructuring.

Restructurings that Subsequently Defaulted
 
For the Three Months Ended June 30, 2013
 
(in thousands)
 
 
 
Recorded Investment in Defaulting Loans as of June 30, 2013
 
Mortgage loans on real estate:
 
 
Residential 1-4 family
 
$
210
 

Restructurings that Subsequently Defaulted
 
For the Six Months Ended June 30, 2014
 
(in thousands)
 
 
 
Recorded Investment in Defaulting Loans as of June 30, 2014
 
Mortgage loans on real estate:
 
 
Residential 1-4 family
 
$
94
 

Restructurings that Subsequently Defaulted
 
For the Six Months Ended June 30, 2013
 
(in thousands)
 
 
 
Recorded Investment in Defaulting Loans as of June 30, 2013
 
Mortgage loans on real estate:
 
 
Residential 1-4 family
 
$
210
 
Commercial
   
1,843
 
Total
 
$
2,053
 


The TDRs in the tables above are factored into the determination of the allowance for loan losses as of the periods indicated. These loans are included in the impaired loan analysis, as discussed below.

IMPAIRED LOANS
A loan is considered impaired when, based on current information and events, it is probable that the Company will be unable to collect all amounts due from the borrower in accordance with the contractual terms of the loan. Impaired loans include nonperforming commercial loans and loans modified in a TDR. When management identifies a loan as impaired, the impairment is measured based on the present value of expected future cash flows, discounted at the loan's effective interest rate, except when the sole or remaining source of repayment for the loan is the operation or liquidation of the collateral. In these cases, management uses the current fair value of the collateral, less selling costs, when foreclosure is probable, instead of the discounted cash flows. If management determines that the value of the impaired loan is less than the recorded investment in the loan (net of previous charge-offs, deferred loan fees or costs and unamortized premium or discount), impairment is recognized through an allowance estimate or a charge-off to the allowance.

When the ultimate collectability of the total principal of an impaired loan is in doubt and the loan is in nonaccrual status, all payments are applied to principal under the cost-recovery method. For financial statement purposes, the recorded investment in the loan is the actual principal balance reduced by payments that would otherwise have been applied to interest. When reporting information on these loans to the applicable customers, the unpaid principal balance is reported as if payments were applied to principal and interest under the original terms of the loan agreements. Therefore, the unpaid principal balance reported to the customer would be higher than the recorded investment in the loan for financial statement purposes. When the ultimate collectability of the total principal of the impaired loan is not in doubt and the loan is in nonaccrual status, contractual interest is credited to interest income when received under the cash-basis method.
- 15 -



The following table includes the recorded investment and unpaid principal balances (a portion of which may have been charged off) for impaired loans with the associated allowance amount, if applicable, as of the dates presented. Also presented are the average recorded investments in the impaired loans and the related amount of interest recognized for the periods presented. The average balances are calculated based on daily average balances.

Impaired Loans by Class
(in thousands)
 
 
 
As of June 30, 2014
 
For the six months ended June 30, 2014
 
 
 
 
Recorded Investment
 
 
 
 
 
 
Unpaid
Principal
Balance
 
Without
Valuation
Allowance
 
With
Valuation
Allowance
 
Associated
Allowance
 
Average
Recorded
Investment
 
Interest
Income
Recognized
 
Mortgage loans on real estate:
 
 
 
 
 
 
 
Residential 1-4 family
 
$
5,680
   
$
4,464
   
$
1,038
   
$
137
   
$
5,503
   
$
60
 
Commercial
   
12,650
     
7,561
     
3,373
     
186
     
10,817
     
215
 
Construction
   
3,706
     
0
     
2,941
     
380
     
2,778
     
21
 
Second mortgages
   
455
     
271
     
153
     
117
     
460
     
11
 
Total mortgage loans on real estate
 
$
22,491
   
$
12,296
   
$
7,505
   
$
820
   
$
19,558
   
$
307
 
Commercial loans
   
0
     
0
     
0
     
0
     
74
     
0
 
Consumer loans
   
59
     
59
     
0
     
0
     
37
     
1
 
Total
 
$
22,550
   
$
12,355
   
$
7,505
   
$
820
   
$
19,669
   
$
308
 

Impaired Loans by Class
(in thousands)
 
 
 
As of December 31, 2013
 
For the year ended
December 31, 2013
 
 
 
 
Recorded Investment
 
 
 
 
 
 
Unpaid
Principal
Balance
 
Without
Valuation
Allowance
 
With
Valuation
Allowance
 
Associated
Allowance
 
Average
Recorded
Investment
 
Interest
Income
Recognized
 
Mortgage loans on real estate:
 
 
 
 
 
 
 
Residential 1-4 family
 
$
5,713
   
$
1,542
   
$
4,009
   
$
1,383
   
$
5,152
   
$
102
 
Commercial
   
12,905
     
6,882
     
4,300
     
307
     
10,631
     
591
 
Construction
   
3,309
     
2,545
     
0
     
0
     
2,798
     
0
 
Second mortgages
   
374
     
296
     
47
     
3
     
462
     
(19
)
Equity lines of credit
   
0
     
0
     
0
     
0
     
97
     
0
 
Total mortgage loans on real estate
 
$
22,301
   
$
11,265
   
$
8,356
   
$
1,693
   
$
19,140
   
$
674
 
Commercial loans
   
150
     
149
     
0
     
0
     
44
     
6
 
Consumer loans
   
15
     
0
     
15
     
0
     
17
     
1
 
Total
 
$
22,466
   
$
11,414
   
$
8,371
   
$
1,693
   
$
19,201
   
$
681
 
- 16 -



MONITORING OF LOANS AND EFFECT OF MONITORING FOR THE ALLOWANCE FOR LOAN LOSSES
Loan officers are responsible for continual portfolio analysis and prompt identification and reporting of problem loans, which includes assigning a risk grade to each applicable loan at its origination and revising such grade as the situation dictates. Loan officers maintain frequent contact with borrowers, which should enable the loan officer to identify potential problems before other personnel. In addition, meetings with loan officers and upper management are held to discuss problem loans and review risk grades. Nonetheless, in order to avoid over-reliance upon loan officers for problem loan identification, the Company's loan review system provides for review of loans and risk grades by individuals who are independent of the loan approval process. Risk grades and historical loss rates (determined by migration analysis) by risk grades are used as a component of the calculation of the allowance for loan losses.

ALLOWANCE FOR LOAN LOSSES
Management has an established methodology to determine the adequacy of the allowance for loan losses that assesses the risks and losses inherent in the loan portfolio. The Company segments the loan portfolio into categories as defined by Schedule RC-C of the Federal Financial Institutions Examination Council Consolidated Reports of Condition and Income Form 041 (Call Report).  Management believes that using the Call Report categories to segment loans for this purpose results in increased efficiency and accuracy in the determination of the adequacy of the allowance for loan losses.  For purposes of calculating the allowance for loan losses, loans are segmented into the following pools: commercial, real estate-construction, real estate-mortgage, consumer and other loans. The Company also sub-segments the real estate-mortgage segment into four classes: residential 1-4 family, commercial, second mortgages and equity lines of credit. The Company uses an internally developed risk evaluation model in the estimation of the credit risk process. The model and assumptions used to determine the allowance are independently validated and reviewed to ensure that the theoretical foundation, assumptions, data integrity, computational processes and reporting practices are appropriate and properly documented.

Each portfolio segment has risk characteristics as follows:
· Commercial: Commercial loans carry risks associated with the successful operation of a business or project, in addition to other risks associated with the ownership of a business. The repayment of these loans may be dependent upon the profitability and cash flows of the business. In addition, there is risk associated with the value of collateral other than real estate which may depreciate over time and cannot be appraised with as much precision.
· Real estate-construction: Construction loans carry risks that the project will not be finished according to schedule, the project will not be finished according to budget and the value of the collateral may at any point in time be less than the principal amount of the loan. Construction loans also bear the risk that the general contractor, who may or may not be the loan customer, may be unable to finish the construction project as planned because of financial pressure unrelated to the project.
· Real estate-mortgage: Residential mortgage loans and equity lines of credit carry risks associated with the continued credit-worthiness of the borrower and changes in the value of the collateral. Commercial real estate loans carry risks associated with the successful operation of a business if owner occupied. If non-owner occupied, the repayment of these loans may be dependent upon the profitability and cash flow from rent receipts.
· Consumer loans: Consumer loans carry risks associated with the continued credit-worthiness of the borrowers and the value of the collateral. Consumer loans are more likely than real estate loans to be immediately adversely affected by job loss, divorce, illness or personal bankruptcy.
· Other loans: Other loans are loans to mortgage companies, loans for purchasing or carrying securities, and loans to insurance, investment and finance companies. These loans carry risks associated with the successful operation of a business. In addition, there is risk associated with the value of collateral other than real estate which may depreciate over time, depend on interest rates or fluctuate in active trading markets.

- 17 -

To assess the adequacy of the allowance for loan losses, the Company uses a software program that performs migration analysis on pooled segments by risk grade or by days past due.  Loans not secured by real estate and made to individuals for household, family and other personal expenditures are segmented into pools based on days past due, while all other loans, including loans to consumers that are secured by real estate, are segmented by risk grades.  The migration analysis applied to all pools is able to track the risk grading and historical performance of individual loans throughout a number of periods set by management, which provides management with more information regarding trends (or migrations) in a particular loan segment. Loans collectively evaluated for impairment are pooled, with a historical loss rate applied to each pool. For the December 31, 2013, March 31, 2014 and June 30, 2014 calculations, the historical loss was based on migration analysis of the past nine, ten and eleven quarters, respectively.

Management also provides an allocated component of the allowance for loans that are specifically identified that may be impaired, and are individually analyzed for impairment. An allocated allowance is established when the discounted value of expected future cash flows from the impaired loan (or the collateral value or observable market price of the impaired loan) is lower than the carrying value of that loan.

Based on credit risk assessments and management's analysis of qualitative factors, additional loss factors are applied to loan balances. These additional qualitative factors include: economic conditions, trends in growth, loan concentrations, changes in certain loans, changes in underwriting, changes in management and changes in the legal and regulatory environment.

ALLOWANCE FOR LOAN LOSSES BY SEGMENT
The total allowance reflects management's estimate of loan losses inherent in the loan portfolio at the balance sheet date. The Company considers the allowance for loan losses of $7.0 million adequate to cover loan losses inherent in the loan portfolio at June 30, 2014.


The following table presents, by portfolio segment, the changes in the allowance for loan losses and the recorded investment in loans for the periods presented. Allocation of a portion of the allowance to one category of loans does not preclude its availability to absorb losses in other categories.

ALLOWANCE FOR LOAN LOSSES AND RECORDED INVESTMENT IN LOANS
 
(in thousands)
 
For the Six Months Ended
June 30, 2014
 
Commercial
   
Real Estate -
Construction
   
Real Estate -
Mortgage
   
Consumer
   
Other
   
Total
 
Allowance for Loan Losses:
 
   
   
   
   
   
 
Balance at the beginning of period
 
$
350
   
$
662
   
$
5,357
   
$
294
   
$
168
   
$
6,831
 
Charge-offs
   
(139
)
   
0
     
(249
)
   
(93
)
   
(77
)
   
(558
)
Recoveries
   
28
     
5
     
253
     
35
     
32
     
353
 
Provision for loan losses
   
260
     
483
     
(502
)
   
(1
)
   
110
     
350
 
Ending balance
 
$
499
   
$
1,150
   
$
4,859
   
$
235
   
$
233
   
$
6,976
 
Ending balance individually evaluated for impairment
 
$
0
   
$
380
   
$
440
   
$
0
   
$
0
   
$
820
 
Ending balance collectively evaluated for impairment
   
499
     
770
     
4,419
     
235
     
233
     
6,156
 
Ending balance
 
$
499
   
$
1,150
   
$
4,859
   
$
235
   
$
233
   
$
6,976
 
Loan Balances:
                                               
Ending balance individually evaluated for impairment
 
$
0
   
$
2,941
   
$
16,860
   
$
59
   
$
0
   
$
19,860
 
Ending balance collectively evaluated for impairment
   
34,973
     
11,159
     
413,655
     
18,566
     
21,449
     
499,802
 
Ending balance
 
$
34,973
   
$
14,100
   
$
430,515
   
$
18,625
   
$
21,449
   
$
519,662
 
- 18 -


For the Year Ended
December 31, 2013
 
Commercial
   
Real Estate -
Construction
   
Real Estate -
Mortgage
   
Consumer
   
Other
   
Total
 
Allowance for Loan Losses:
 
   
   
   
   
   
 
Balance at the beginning of period
 
$
677
   
$
187
   
$
6,179
   
$
204
   
$
77
   
$
7,324
 
Charge-offs
   
(200
)
   
(501
)
   
(1,548
)
   
(141
)
   
(316
)
   
(2,706
)
Recoveries
   
76
     
6
     
513
     
111
     
207
     
913
 
Provision for loan losses
   
(203
)
   
970
     
213
     
120
     
200
     
1,300
 
Ending balance
 
$
350
   
$
662
   
$
5,357
   
$
294
   
$
168
   
$
6,831
 
Ending balance individually evaluated for impairment
 
$
0
   
$
0
   
$
1,693
   
$
0
   
$
0
   
$
1,693
 
Ending balance collectively evaluated for impairment
   
350
     
662
     
3,664
     
294
     
168
     
5,138
 
Ending balance
 
$
350
   
$
662
   
$
5,357
   
$
294
   
$
168
   
$
6,831
 
Loan Balances:
                                               
Ending balance individually evaluated for impairment
 
$
149
   
$
2,545
   
$
17,076
   
$
15
   
$
0
   
$
19,785
 
Ending balance collectively evaluated for impairment
   
30,553
     
11,960
     
399,890
     
19,776
     
18,735
     
480,914
 
Ending balance
 
$
30,702
   
$
14,505
   
$
416,966
   
$
19,791
   
$
18,735
   
$
500,699
 


Note 4. Share-Based Compensation
Share-based compensation arrangements include stock options, restricted stock awards, performance-based awards, stock appreciation rights and employee stock purchase plans. Accounting standards require all share-based payments to employees to be valued using a fair value method on the date of grant and to be expensed based on that fair value over the applicable vesting period.

Historically, the Company has only granted share-based compensation in the form of stock options. There were no options granted in the first six months of 2014.

On March 9, 2008, the Company's 1998 Stock Option Plan expired. Options to purchase 150,085 shares of common stock were outstanding under the Company's 1998 Stock Option Plan at June 30, 2014. The exercise price of each option equals the market price of the Company's common stock on the date of the grant and each option's maximum term is ten years.


Stock option activity for the six months ended June 30, 2014 is summarized below:

 
 
Shares
   
Weighted
Average
Exercise
Price
 
Weighted
Average
Remaining
Contractual
Life
(in years)
 
Aggregate
Intrinsic
Value
(in thousands)
 
Options outstanding, January 1, 2014
   
151,335
   
$
21.66
 
 
 
Granted
   
0
     
0
 
 
 
Exercised
   
0
     
0
 
 
 
Canceled or expired
   
(1,250
)
   
20.05
 
 
 
Options outstanding, June 30, 2014
   
150,085
   
$
21.68
     
1.93
   
$
0
 
Options exercisable, June 30, 2014
   
150,085
   
$
21.68
     
1.93
   
$
0
 
- 19 -



The aggregate intrinsic value of a stock option in the table above represents the total pre-tax intrinsic value (the amount by which the current market value of the underlying stock exceeds the exercise price of the option) that would have been received by the option holders had all option holders exercised their options on June 30, 2014. This amount changes based on changes in the market value of the Company's common stock. As of June 30, 2014, the outstanding options had no intrinsic value because the exercise prices of all outstanding options were above the market value of a share of the Company's common stock.

No options were exercised during the six months ended June 30, 2014.

As of June 30, 2014, all outstanding stock options were fully vested and there was no unrecognized stock-based compensation expense.


Note 5. Pension Plan

The Company provides pension benefits for eligible participants through a non-contributory defined benefit pension plan. The plan was frozen effective September 30, 2006; therefore, no additional participants will be added to the plan. The components of net periodic pension plan cost are as follows for the periods indicated:

Three months ended June 30,
 
2014
   
2013
 
 
 
(in thousands)
 
Interest cost
 
$
69
   
$
63
 
Expected return on plan assets
   
(91
)
   
(89
)
Amortization of net loss
   
55
     
75
 
Net periodic pension plan cost
 
$
33
   
$
49
 

Six months ended June 30,
 
2014
   
2013
 
 
 
(in thousands)
 
Interest cost
 
$
137
   
$
126
 
Expected return on plan assets
   
(182
)
   
(177
)
Amortization of net loss
   
110
     
149
 
Net periodic pension plan cost
 
$
65
   
$
98
 


At June 30, 2014, management had not yet determined the amount, if any, that the Company will contribute to the plan in the year ending December 31, 2014.


Note 6. Stockholders' Equity and Earnings per Share

STOCKHOLDERS' EQUITY – ACCUMULATED OTHER COMPREHENSIVE LOSS

The following table presents information on amounts reclassified out of accumulated other comprehensive loss, by category, during the periods indicated:

 
Three Months Ended
June 30,
 
Six Months Ended
June 30,
 
Affected Line Item on
 
2014
 
2013
 
2014
 
2013
 
Consolidated Statements of Income
 
(in thousands)
 
 
Available-for-sale securities
 
 
 
 
        
Realized losses on sales of securities
 
$
(7
)
 
$
(21
)
 
$
(7
)
 
$
(21
)
Loss on sale of available-for-sale securities, net
Tax benefit
   
(2
)
   
(7
)
   
(2
)
   
(7
)
Income tax benefit
 
 
$
(5
)
 
$
(14
)
 
$
(5
)
 
$
(14
)
Net of tax
- 20 -



The following table presents the changes in accumulated other comprehensive loss, by category, net of tax, for the periods indicated:

 
 
Unrealized Gains (Losses) on Securities
   
Unrealized Losses on Securities Transferred to Held-to-Maturity
   
Defined Benefit Pension Plans
   
Accumulated Other Comprehensive Loss
 
 
 
(in thousands)
 
 
 
   
   
   
 
Six Months Ended June 30, 2014
 
   
   
   
 
 
 
   
   
   
 
Balance at beginning of period
 
$
(5,317
)
 
$
(3,937
)
 
$
(1,548
)
 
$
(10,802
)
Net change for the period
   
3,484
     
259
     
0
     
3,743
 
Balance at end of period
 
$
(1,833
)
 
$
(3,678
)
 
$
(1,548
)
 
$
(7,059
)
 
                               
 
                               
Six Months Ended June 30, 2013
                               
 
                               
Balance at beginning of period
 
$
1,992
   
$
0
   
$
(2,184
)
 
$
(192
)
Net change for the period
   
(8,223
)
   
0
     
0
     
(8,223
)
Balance at end of period
 
$
(6,231
)
 
$
0
   
$
(2,184
)
 
$
(8,415
)


The following table presents the change in each component of accumulated other comprehensive loss on a pre-tax and after-tax basis for the periods indicated.

 
 
Six Months Ended June 30, 2014
 
 
 
Pretax
   
Tax Expense (Benefit)
   
Net-of-Tax
 
 
 
(in thousands)
 
Unrealized gains on available-for-sale securities
 
   
   
 
Unrealized holding gains arising during the period
 
$
5,271
   
$
1,792
   
$
3,479
 
Less reclassification adjustment for losses recognized in income
   
(7
)
   
(2
)
   
(5
)
Net unrealized gains on securities
   
5,278
     
1,794
     
3,484
 
 
                       
Market adjustment on securities transferred to held-to-maturity
                       
Amortization
   
392
     
133
     
259
 
 
                       
Total change in accumulated other comprehensive loss
 
$
5,670
   
$
1,927
   
$
3,743
 

 
Six Months Ended June 30, 2013
 
 
Pretax
 
Tax Expense
(Benefit)
 
Net-of-Tax
 
 
(in thousands)
 
Unrealized losses on available-for-sale securities
 
 
 
Unrealized holding losses arising during the period
 
$
(12,480
)
 
$
(4,243
)
 
$
(8,237
)
Less reclassification adjustment for losses recognized in income
   
(21
)
   
(7
)
   
(14
)
Net unrealized losses on securities
   
(12,459
)
   
(4,236
)
   
(8,223
)
 
                       
Total change in accumulated other comprehensive loss
 
$
(12,459
)
 
$
(4,236
)
 
$
(8,223
)
- 21 -



EARNINGS PER COMMON SHARE
Basic earnings per share is computed by dividing net income by the weighted average number of common shares outstanding during the period. Diluted earnings per share is computed using the weighted average number of common shares outstanding during the period, including the effect of dilutive potential common shares attributable to outstanding stock options.  The Company did not include an average of 151 thousand and 156 thousand potential common shares attributable to outstanding stock options in the diluted earnings per share calculation for the first six months of 2014 and 2013, respectively, because they were antidilutive.


Note 7. Recent Accounting Pronouncements
In January 2014, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) 2014-01, "Investments—Equity Method and Joint Ventures (Topic 323): Accounting for Investments in Qualified Affordable Housing Projects (a consensus of the FASB Emerging Issues Task Force)."  The amendments in this ASU permit reporting entities to make an accounting policy election to account for their investments in qualified affordable housing projects using the proportional amortization method if certain conditions are met.  Under the proportional amortization method, an entity amortizes the initial cost of the investment in proportion to the tax credits and other tax benefits received and recognizes the net investment performance in the income statement as a component of income tax expense (benefit).  The amendments in this ASU should be applied retrospectively to all periods presented. A reporting entity that uses the effective yield method to account for its investments in qualified affordable housing projects before the date of adoption may continue to apply the effective yield method for those preexisting investments. The amendments in this ASU are effective for public business entities for annual periods and interim reporting periods within those annual periods, beginning after December 15, 2014. Early adoption is permitted.  The Company is currently assessing the impact that ASU 2014-01 will have on its consolidated financial statements.

In January 2014, the FASB issued ASU 2014-04, "Receivables—Troubled Debt Restructurings by Creditors (Subtopic 310-40): Reclassification of Residential Real Estate Collateralized Consumer Mortgage Loans upon Foreclosure (a consensus of the FASB Emerging Issues Task Force)."  The amendments in this ASU clarify that an in substance repossession or foreclosure occurs, and a creditor is considered to have received physical possession of residential real estate property collateralizing a consumer mortgage loan, upon either (1) the creditor obtaining legal title to the residential real estate property upon completion of a foreclosure or (2) the borrower conveying all interest in the residential real estate property to the creditor to satisfy that loan through completion of a deed in lieu of foreclosure or through a similar legal agreement. Additionally, the amendments require interim and annual disclosure of both (1) the amount of foreclosed residential real estate property held by the creditor and (2) the recorded investment in consumer mortgage loans collateralized by residential real estate property that are in the process of foreclosure according to local requirements of the applicable jurisdiction.  The amendments in this ASU are effective for public business entities for annual periods, and interim periods within those annual periods, beginning after December 15, 2014. The Company is currently assessing the impact that ASU 2014-04 will have on its consolidated financial statements.

In April 2014, the FASB issued ASU 2014-08, "Presentation of Financial Statements (Topic 205) and Property, Plant, and Equipment (Topic 360): Reporting Discontinued Operations and Disclosures of Disposals of Components of an Entity." The amendments in this ASU change the criteria for reporting discontinued operations while enhancing disclosures in this area. Under the new guidance, only disposals representing a strategic shift in operations should be presented as discontinued operations. Those strategic shifts should have a major effect on the organization's operations and financial results and include disposals of a major geographic area, a major line of business, or a major equity method investment. The new guidance requires expanded disclosures about discontinued operations that will provide financial statement users with more information about the assets, liabilities, income, and expenses of discontinued operations. Additionally, the new guidance requires disclosure of the pre-tax income attributable to a disposal of a significant part of an organization that does not qualify for discontinued operations reporting. The amendments in the ASU are effective for public business entities for annual periods, and interim periods within those annual periods, beginning after December 15, 2014. Early adoption is permitted.  The Company does not expect the adoption of ASU 2014-08 to have a material impact on its consolidated financial statements.

- 22 -

In June 2014, the FASB issued ASU No. 2014-09, "Revenue from Contracts with Customers: Topic 606". This ASU applies to any entity using U.S. GAAP that either enters into contracts with customers to transfer goods or services or enters into contracts for the transfer of nonfinancial assets unless those contracts are within the scope of other standards. The guidance supersedes the revenue recognition requirements in Topic 605, "Revenue Recognition", most industry-specific guidance, and some cost guidance included in Subtopic 605-35, "Revenue Recognition—Construction-Type and Production-Type Contracts". The core principle of the guidance is that an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. To be in alignment with the core principle, an entity must apply a five step process including: identification of the contract(s) with a customer, identification of performance obligations in the contract(s), determination of the transaction price, allocation of the transaction price to the performance obligations, and recognition of revenue when (or as) the entity satisfies a performance obligation.  Additionally, the existing requirements for the recognition of a gain or loss on the transfer of nonfinancial assets that are not in a contract with a customer have also been amended to be consistent with the guidance on recognition and measurement.  The amendments in this ASU are effective for annual reporting periods beginning after December 15, 2016, including interim periods within that reporting period. Early adoption is not permitted. The Company is currently assessing the impact that ASU 2014-09 will have on its consolidated financial statements.

In June 2014, the FASB issued ASU No. 2014-11, "Transfers and Servicing (Topic 860): Repurchase-to-Maturity Transactions, Repurchase Financings, and Disclosures".  This ASU aligns the accounting for repurchase-to-maturity transactions and repurchase agreements executed as a repurchase financing with the accounting for other typical repurchase agreements. The new guidance eliminates sale accounting for repurchase-to-maturity transactions and supersedes the guidance under which a transfer of a financial asset and a contemporaneous repurchase financing could be accounted for on a combined basis as a forward agreement. The amendments in the ASU also require a new disclosure for transactions economically similar to repurchase agreements in which the transferor retains substantially all of the exposure to the economic return on the transferred financial assets throughout the term of the transaction. Additional disclosures will be required for the nature of collateral pledged in repurchase agreements and similar transactions accounted for as secured borrowings.  The amendments in this ASU are effective for the first interim or annual period beginning after December 15, 2014; however, the disclosure for transactions accounted for as secured borrowings is required to be presented for annual periods beginning after December 15, 2014, and interim periods beginning after March 15, 2015. Early adoption is not permitted.  The Company is currently assessing the impact that ASU 2014-11 will have on its consolidated financial statements.

In June 2014, the FASB issued ASU No. 2014-12, "Compensation – Stock Compensation (Topic 718): Accounting for Share-Based Payments When the Terms of an Award Provide That a Performance Target Could Be Achieved after the Requisite Service Period". The new guidance applies to reporting entities that grant employees share-based payments in which the terms of the award allow a performance target to be achieved after the requisite service period. The amendments in the ASU require that a performance target that affects vesting and that could be achieved after the requisite service period be treated as a performance condition.  Existing guidance in "Compensation – Stock Compensation (Topic 718)", should be applied to account for these types of awards. The amendments in this ASU are effective for annual periods and interim periods within those annual periods beginning after December 15, 2015. Early adoption is permitted and reporting entities may choose to apply the amendments in the ASU either on a prospective or retrospective basis.  The Company is currently assessing the impact that ASU 2014-12 will have on its consolidated financial statements.
- 23 -



Note 8. Fair Value Measurements
The Company uses fair value measurements to record fair value adjustments to certain assets and liabilities and to determine fair value disclosures. In accordance with the "Fair Value Measurements and Disclosures" topics of FASB ASU 2010-06 and FASB ASU 2011-04, the fair value of a financial instrument is the price that would be received in the sale of an asset or transfer of a liability in an orderly transaction between market participants at the measurement date. Fair value is best determined based upon quoted market prices. However, in many instances, there are no quoted market prices for the Company's various financial instruments. In cases where quoted market prices are not available, fair values are based on estimates using present value or other valuation techniques. Those techniques are significantly affected by the assumptions used, including the discount rate and estimate of future cash flows. Accordingly, the fair value estimates may not be realized in an immediate settlement of the instrument.

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

In estimating the fair value of assets and liabilities, the Company relies mainly on two models. The first model, used by the Company's bond accounting service provider, determines the fair value of securities. Securities are priced based on an evaluation of observable market data, including benchmark yield curves, reported trades, broker/dealer quotes, and issuer spreads. Pricing is also impacted by credit information about the issuer, perceived market movements, and current news events impacting the individual sectors. For assets other than securities and for all liabilities, fair value is determined using the Company's asset/liability modeling software. The software uses current yields, anticipated yield changes, and estimated duration of assets and liabilities to calculate fair value.

In accordance with ASC 820, "Fair Value Measurements and Disclosures," the Company groups its financial assets and financial liabilities generally measured at fair value into three levels, based on the markets in which the assets and liabilities are traded and the reliability of the assumptions used to determine fair value.

Level 1 – Valuation is based on quoted prices in active markets for identical assets or liabilities that the reporting entity has the ability to access at the measurement date. Level 1 assets and liabilities generally include debt and equity securities that are traded in an active exchange market. Valuations are obtained from readily available pricing sources for market transactions involving identical assets or liabilities.

Level 2 – Valuation is based on inputs other than quoted prices included within Level 1 that are observable for the asset or liability, either directly or indirectly. The valuation may be based on quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the asset or liability.

Level 3 – Valuation is based on unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities. Level 3 assets and liabilities include financial instruments whose value is determined using pricing models, discounted cash flow methodologies, or similar techniques, as well as instruments for which determination of fair value requires significant management judgment or estimation.

An instrument's categorization within the valuation hierarchy is based upon the lowest level of input that is significant to the fair value measurement.
- 24 -

ASSETS MEASURED AT FAIR VALUE ON A RECURRING BASIS
Debt and equity securities with readily determinable fair values that are classified as "available-for-sale" are recorded at fair value, with unrealized gains and losses excluded from earnings and reported in other comprehensive income. Securities available-for-sale are recorded at fair value on a recurring basis. Fair value measurement is based upon quoted market prices, when available (Level 1). If quoted market prices are not available, fair values are measured utilizing independent valuation techniques of identical or similar securities for which significant assumptions are derived primarily from or corroborated by observable market data. Third party vendors compile prices from various sources and may determine the fair value of identical or similar securities by using pricing models that consider observable market data (Level 2). In certain cases where there is limited activity or less transparency around inputs to the valuation, securities are classified within Level 3 of the valuation hierarchy. Currently, all of the Company's available-for-sale securities are considered to be Level 2 securities.


The following table presents the balances of certain assets measured at fair value on a recurring basis as of the dates indicated:

 
 
Fair Value Measurements at June 30, 2014 Using
 
 
 
(in thousands)
 
Description
Balance
 
Quoted Prices in
Active Markets
for Identical
Assets
(Level 1)
 
Significant
Other
Observable
Inputs
(Level 2)
 
Significant
Unobservable
Inputs
(Level 3)
 
Available-for-sale securities
 
 
 
 
Obligations of  U.S. Government agencies
 
$
14,931
   
$
0
   
$
14,931
   
$
0
 
Obligations of state and political subdivisions
   
49,495
     
0
     
49,495
     
0
 
Mortgage-backed securities
   
76,625
     
0
     
76,625
     
0
 
Money market investments
   
614
     
0
     
614
     
0
 
Corporate bonds
   
2,291
     
0
     
2,291
     
0
 
Other marketable equity securities
   
84
     
0
     
84
     
0
 
Total available-for-sale securities
 
$
144,040
   
$
0
   
$
144,040
   
$
0
 

 
 
Fair Value Measurements at December 31, 2013 Using
 
 
 
(in thousands)
 
Description
Balance
 
Quoted Prices in
Active Markets
for Identical
Assets
(Level 1)
 
Significant
Other
Observable
Inputs
(Level 2)
 
Significant
Unobservable
Inputs
(Level 3)
 
Available-for-sale securities
 
 
 
 
Obligations of  U.S. Government agencies
 
$
15,024
   
$
0
   
$
15,024
   
$
0
 
Obligations of state and political subdivisions
   
47,100
     
0
     
47,100
     
0
 
Mortgage-backed securities
   
90,750
     
0
     
90,750
     
0
 
Money market investments
   
691
     
0
     
691
     
0
 
Corporate bonds
   
2,074
     
0
     
2,074
     
0
 
Total available-for-sale securities
 
$
155,639
   
$
0
   
$
155,639
   
$
0
 
- 25 -



ASSETS MEASURED AT FAIR VALUE ON A NONRECURRING BASIS
Under certain circumstances, adjustments are made to the fair value for assets and liabilities although they are not measured at fair value on an ongoing basis.

Impaired loans
Loans are designated as impaired when, in the judgment of management based on current information and events, it is probable that all amounts due according to the contractual terms of the loan agreement will not be collected. The measurement of fair value and loss associated with impaired loans can be based on the observable market price of the loan, the fair value of the collateral securing the loan, or the present value of the loan's expected future cash flows. Collateral may be in the form of real estate or business assets including equipment, inventory, and accounts receivable, with the vast majority of the collateral in real estate.

The value of real estate collateral is determined utilizing an income, market, or cost valuation approach based on an appraisal conducted by an independent, licensed appraiser outside of the Company. In the case of loans with lower balances, the Company may obtain a real estate evaluation instead of an appraisal. Evaluations utilize many of the same techniques as appraisals, and are typically performed by independent appraisers. Once received, appraisals and evaluations are reviewed by trained staff independent of the lending function to verify consistency and reasonability. Appraisals and evaluations are based on significant unobservable inputs, including but not limited to: adjustments made to comparable properties, judgments about the condition of the subject property, the availability and suitability of comparable properties, capitalization rates, projected income of the subject or comparable properties, vacancy rates, projected depreciation rates, and the state of the local and regional economy. The Company may also elect to make additional reductions in the collateral value based on management's best judgment, which represents another source of unobservable inputs. Because of the subjective nature of collateral valuation, impaired loans are considered Level 3.

Impaired loans may be secured by collateral other than real estate. The value of business equipment is based upon an outside appraisal if deemed significant, or the net book value on the applicable business' financial statements if not considered significant using observable market data. Likewise, values for inventory and accounts receivable collateral are based on financial statement balances or aging reports (Level 3). If a loan is not collateral-dependent, its impairment may be measured based on the present value of expected future cash flows, discounted at the loan's effective interest rate. Because the loan is discounted at its effective rate of interest, rather than at a market rate, the loan is not considered to be held at fair value and is not included in the tables below. Collateral-dependent impaired loans allocated to the allowance for loan losses are measured at fair value on a nonrecurring basis. Any fair value adjustments are recorded in the period incurred as part of the provision for loan losses on the Consolidated Statements of Income.

Other Real Estate Owned (OREO)
Loans are transferred to OREO when the collateral securing them is foreclosed on. The measurement of loss associated with OREOs is based on the fair value of the collateral compared to the unpaid loan balance and anticipated costs to sell the property. If there is a contract for the sale of a property, and management reasonably believes the transaction will be consummated in accordance with the terms of the contract, fair value is based on the sale price in that contract (Level 1). If management has recent information about the sale of identical properties, such as when selling multiple condominium units on the same property, the remaining units would be valued based on the observed market data (Level 2). Lacking either a contract or such recent data, management would obtain an appraisal or evaluation of the value of the collateral as discussed above under Impaired Loans (Level 3). After the asset has been booked, a new appraisal or evaluation is obtained when management has reason to believe the fair value of the property may have changed and no later than two years after the last appraisal or evaluation was received. Any fair value adjustments to OREOs below the original book value are recorded in the period incurred and expensed against current earnings.
- 26 -



The following table presents the assets carried on the consolidated balance sheets for which a nonrecurring change in fair value has been recorded. Assets are shown by class of loan and by level in the fair value hierarchy, as of the dates indicated. Certain impaired loans are valued by the present value of the loan's expected future cash flows, discounted at the interest rate of the loan rather than at a market rate. These loans are not carried on the consolidated balance sheets at fair value and, as such, are not included in the table below.

 
 
   
Carrying Value at June 30, 2014 Using
 
 
 
   
(in thousands)
 
 
 
Fair Value
   
Quoted Prices in
Active Markets
for Identical
Assets
(Level 1)
   
Significant
Other
Observable
Inputs
(Level 2)
   
Significant
Unobservable
Inputs
(Level 3)
 
Impaired loans
 
   
   
   
 
Mortgage loans on real estate:
 
   
   
   
 
Residential 1-4 family
 
$
744
   
$
0
   
$
0
   
$
744
 
Construction
   
2,561
     
0
     
0
     
2,561
 
Second mortgages
   
37
     
0
     
0
     
37
 
Total
 
$
3,342
   
$
0
   
$
0
   
$
3,342
 
 
                               
Other real estate owned
                               
Residential 1-4 family
 
$
1,261
   
$
0
   
$
0
   
$
1,261
 
Commercial
   
1,735
     
0
     
0
     
1,735
 
Construction
   
2,670
     
0
     
0
     
2,670
 
Total
 
$
5,666
   
$
0
   
$
0
   
$
5,666
 

 
 
   
Carrying Value at December 31, 2013 Using
 
 
 
   
(in thousands)
 
 
 
Fair Value
   
Quoted Prices in
Active Markets for
Identical
Assets
(Level 1)
   
Significant
Other
Observable
Inputs
(Level 2)
   
Significant
Unobservable
Inputs
(Level 3)
 
Impaired loans
 
   
   
   
 
Mortgage loans on real estate:
 
   
   
   
 
Residential 1-4 family
 
$
2,455
   
$
0
   
$
0
   
$
2,455
 
Commercial
   
800
     
0
     
0
     
800
 
Second mortgages
   
44
     
0
     
0
     
44
 
Total
 
$
3,299
   
$
0
   
$
0
   
$
3,299
 
 
                               
Other real estate owned
                               
Residential 1-4 family
 
$
457
   
$
0
   
$
0
   
$
457
 
Commercial
   
2,290
     
0
     
0
     
2,290
 
Construction
   
2,783
     
0
     
0
     
2,783
 
Total
 
$
5,530
   
$
0
   
$
0
   
$
5,530
 
- 27 -



The following table displays quantitative information about Level 3 Fair Value Measurements as of the dates indicated:

 
 
 
Quantitative Information About Level 3 Fair Value Measurements
 
Description
 
Fair Value at June 30, 2014 (dollars in thousands)
 
Valuation Techniques
Unobservable Input
 
Range (Average)
 
Impaired loans
 
 
 
 
 
 
Residential 1-4 family real estate
 
$
744
 
Market comparables
Selling costs
   
0.00% - 7.25% (1.81
%)
 
       
     
Liquidation discount
   
0.00% - 10.00% (3.75
%)
Construction
 
$
2,561
 
Market comparables
Selling costs
   
0.00% - 11.25% (3.75
%)
Second mortgages
 
$
37
 
Market comparables
Selling costs
   
0.00
%
 
       
 
 
       
Other real estate owned
       
 
 
       
Residential 1-4 family
 
$
1,261
 
Market comparables
Selling costs
   
6.00% - 10.00% (6.00
%)
Commercial
 
$
1,735
 
Market comparables
Selling costs
   
6.00% - 10.00% (6.00
%)
Construction
 
$
2,670
 
Market comparables
Selling costs
   
6.00% - 10.00% (6.00
%)

 
 
 
Quantitative Information About Level 3 Fair Value Measurements
 
Description
 
Fair Value at December 31, 2013 (dollars in thousands)
 
Valuation Techniques
Unobservable Input
 
Range (Average)
 
Impaired loans
 
 
 
 
 
 
Residential 1-4 family real estate
 
$
2,455
 
Market comparables
Selling costs
   
3.00% - 7.25% (6.39
%)
 
       
   
Liquidation discount
   
0.00% - 90.00% (15.56
%)
Commercial real estate
 
$
800
 
Market comparables
Selling costs
   
7.25
%
Second mortgages
 
$
44
 
Market comparables
Selling costs
   
7.25
%
 
       
 
 
       
Other real estate owned
       
 
 
       
Residential 1-4 family
 
$
457
 
Market comparables
Selling costs
   
6.00% - 10.00% (6.00
%)
Commercial
 
$
2,290
 
Market comparables
Selling costs
   
6.00% - 10.00% (6.00
%)
Construction
 
$
2,783
 
Market comparables
Selling costs
   
6.00% - 10.00% (6.00
%)


ASC 825, "Financial Instruments," requires disclosure about fair value of financial instruments for interim periods and excludes certain financial instruments and all non-financial instruments from its disclosure requirements. Accordingly, the aggregate fair value amounts presented may not necessarily represent the underlying fair value of the Company's assets.

The following methods and assumptions were used by the Company in estimating fair value disclosures for financial instruments:
- 28 -

CASH AND CASH EQUIVALENTS
The carrying amounts of cash and short-term instruments, including interest-bearing due from banks, approximate fair values.

RESTRICTED SECURITIES
The restricted security category is comprised of FHLB and FRB stock. These stocks are classified as restricted securities because their ownership is restricted to certain types of entities and they lack a market. When the FHLB or FRB repurchases stock, they repurchase at the stock's book value. Therefore, the carrying amounts of restricted securities approximate fair value.

LOANS RECEIVABLE
The fair value of a loan is based on its interest rate in relation to its risk profile, in comparison to what an investor could earn on a different investment with a similar risk profile. Variations in risk tolerance between lenders, and thus in risk pricing, can result in the same loan being priced differently at different institutions. A bank's experience with the type of lending (such as commercial real estate) can also impact its assessment of the riskiness of a loan. A comprehensive picture of competitors' rates in relation to borrower risk profiles is not available. Since the rate and risk profile are the primary factors in determining the fair value of a loan, both of which are unobservable in the market, the Company classifies loans as Level 3 in the fair value hierarchy. Instead, the Company uses a model which estimates market value based on the loan's interest rate (regardless of its risk level) and rates for debt of similar maturities where market data is available. Fair values for non-performing loans are estimated as described above.

BANK-OWNED LIFE INSURANCE
Bank-owned life insurance represents insurance policies on certain current and former officers of the Company. The cash value of the policies is estimated using information provided by the insurance carrier. The insurance carrier uses actuarial data to estimate the value of each policy, based on the age and health of the insured relative to other individuals about whom the carrier has information. Health information can be broken down into quantitative, observable inputs, such as smoking habits, blood pressure, and weight, which, along with the insured's age, can be compared to observable data the insurance carrier has available. The carrier can then estimate the cash value of each policy. Since the cash value represents the amount of cash the Company would receive when the policies are paid, the cash value closely approximates the fair value of the policies. Accordingly, bank-owned life insurance is classified as Level 2.

DEPOSIT LIABILITIES
The fair value of demand deposits, savings and certain money market deposits is the amount payable on demand at the reporting date. The fair value of certificates of deposits is estimated by discounting the future cash flows using the rates currently offered for deposits of similar remaining maturities. Information about the rates paid by other institutions for deposits of similar terms is readily available, and rates are mainly influenced by the term of the deposit itself. As a result, fair value calculations are based on observable inputs, and are classified as Level 2.

SHORT-TERM BORROWINGS
The carrying amounts of federal funds purchased, overnight repurchase agreements, and other short-term borrowings maturing within 90 days approximate their fair values. Since the contractual terms of these borrowings provide all information necessary to calculate the amounts that will be due at maturity, these liabilities are classified as Level 2.

LONG-TERM BORROWINGS
The fair values of the Company's long-term borrowings are estimated based on the current cost to repay the debt in full, discounted to current values and including any prepayment penalties that may apply. As the contractual terms of the borrowing provide all the necessary inputs for this calculation, long-term borrowings are classified as Level 2.

ACCRUED INTEREST
The calculation of accrued interest is based on readily observable information, such as the rate and term of the underlying asset or liability. Since these amounts are expected to be realized quickly (generally within 30 to 90 days), the carrying value approximates fair value and is classified as Level 2.
- 29 -

COMMITMENTS TO EXTEND CREDIT AND IRREVOCABLE LETTERS OF CREDIT
The fair value of commitments is estimated using the fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the present credit-worthiness of the counterparties. For fixed-rate loan commitments, fair value also considers the difference between current levels of interest rates and the committed rates. The fair value of letters of credit is based on fees currently charged for similar agreements or on the estimated cost to terminate them or otherwise settle the obligations with the counterparties at the reporting date. At June 30, 2014 and December 31, 2013, the fair value of fees charged for loan commitments and irrevocable letters of credit was immaterial.


- 30 -

The estimated fair values, and related carrying or notional amounts, of the Company's financial instruments as of the dates indicated are as follows:

 
 
   
Fair Value Measurements at June 30, 2014 Using (in thousands)
 
 
 
Carrying Value
   
Quoted Prices in Active Markets for Identical Assets
(Level 1)
   
Significant Other Observable Inputs
(Level 2)
   
Significant Unobservable Inputs
(Level 3)
 
Assets
 
   
   
   
 
Cash and cash equivalents
 
$
22,533
   
$
22,533
   
$
0
   
$
0
 
Securities available-for-sale
   
144,040
     
0
     
144,040
     
0
 
Securities held-to-maturity
   
93,990
     
0
     
97,091
     
0
 
Restricted securities
   
2,293
     
0
     
2,293
     
0
 
Loans, net of allowances for loan losses
   
512,686
     
0
     
0
     
512,268
 
Bank owned life insurance
   
23,107
     
0
     
23,107
     
0
 
Accrued interest receivable
   
2,768
     
0
     
2,768
     
0
 
 
                               
Liabilities
                               
Deposits
 
$
716,528
   
$
0
   
$
717,631
   
$
0
 
Overnight repurchase agreements
   
25,677
     
0
     
25,677
     
0
 
Term repurchase agreements
   
412
     
0
     
411
     
0
 
Federal Home Loan Bank advances
   
30,000
     
0
     
32,092
     
0
 
Accrued interest payable
   
266
     
0
     
266
     
0
 

 
 
   
Fair Value Measurements at December 31, 2013 Using
(in thousands)
 
 
 
Carrying
Value
   
Quoted Prices in
Active Markets
for Identical
Assets
(Level 1)
   
Significant
Other
Observable
Inputs
(Level 2)
   
Significant
Unobservable
Inputs
(Level 3)
 
Assets
 
   
   
   
 
Cash and cash equivalents
 
$
31,325
   
$
31,325
   
$
0
   
$
0
 
Securities available-for-sale
   
155,639
     
0
     
155,639
     
0
 
Securities held-to-maturity
   
96,847
     
0
     
97,453
     
0
 
Restricted securities
   
2,378
     
0
     
2,378
     
0
 
Loans, net of allowances for loan losses
   
493,868
     
0
     
0
     
494,714
 
Bank owned life insurance
   
22,673
     
0
     
22,673
     
0
 
Accrued interest receivable
   
2,754
     
0
     
2,754
     
0
 
 
                               
Liabilities
                               
Deposits
 
$
725,405
   
$
0
   
$
728,011
   
$
0
 
Overnight repurchase agreements
   
31,175
     
0
     
31,175
     
0
 
Term repurchase agreements
   
411
     
0
     
410
     
0
 
Federal Home Loan Bank advances
   
25,000
     
0
     
27,567
     
0
 
Accrued interest payable
   
327
     
0
     
327
     
0
 




- 31 -

Note 9. Segment Reporting
The Company operates in a decentralized fashion in three principal business segments: The Old Point National Bank of Phoebus (the Bank), Old Point Trust & Financial Services, N. A. (Trust), and the Company as a separate segment (for purposes of this Note, the Parent). Revenues from the Bank's operations consist primarily of interest earned on loans and investment securities and service charges on deposit accounts. Trust's operating revenues consist principally of income from fiduciary activities. The Parent's revenues are mainly interest and dividends received from the Bank and Trust companies. The Company has no other segments.

The Company's reportable segments are strategic business units that offer different products and services. They are managed separately because each segment appeals to different markets and, accordingly, requires different technologies and marketing strategies.


Information about reportable segments, and reconciliation of such information to the consolidated financial statements as of and for the three and six months ended June 30, 2014 and 2013 follows:

 
 
Three Months Ended June 30, 2014
 
 
 
Bank
   
Trust
   
Unconsolidated
Parent
   
Eliminations
   
Consolidated
 
Revenues
 
   
   
   
   
 
Interest and dividend income
 
$
7,523
   
$
13
   
$
1,100
   
$
(1,100
)
 
$
7,536
 
Income from fiduciary activities
   
0
     
793
     
0
     
0
     
793
 
Other income
   
2,126
     
250
     
50
     
(66
)
   
2,360
 
Total operating income
   
9,649
     
1,056
     
1,150
     
(1,166
)
   
10,689
 
 
                                       
Expenses
                                       
Interest expense
   
962
     
0
     
0
     
0
     
962
 
Provision for loan losses
   
100
     
0
     
0
     
0
     
100
 
Salaries and employee benefits
   
4,192
     
680
     
109
     
0
     
4,981
 
Other expenses
   
3,347
     
265
     
(60
)
   
(66
)
   
3,486
 
Total operating expenses
   
8,601
     
945
     
49
     
(66
)
   
9,529
 
 
                                       
Income before taxes
   
1,048
     
111
     
1,101
     
(1,100
)
   
1,160
 
 
                                       
Income tax expense (benefit)
   
20
     
39
     
0
     
0
     
59
 
 
                                       
Net income
 
$
1,028
   
$
72
   
$
1,101
   
$
(1,100
)
 
$
1,101
 
 
                                       
Total assets
 
$
855,989
   
$
5,740
   
$
85,989
   
$
(86,817
)
 
$
860,901
 

 
 
Three Months Ended June 30, 2013
 
 
 
Bank
   
Trust
   
Unconsolidated
Parent
   
Eliminations
   
Consolidated
 
Revenues
 
   
   
   
   
 
Interest and dividend income
 
$
7,467
   
$
10
   
$
1,095
   
$
(1,096
)
 
$
7,476
 
Income from fiduciary activities
   
0
     
866
     
0
     
0
     
866
 
Other income
   
2,300
     
134
     
50
     
(65
)
   
2,419
 
Total operating income
   
9,767
     
1,010
     
1,145
     
(1,161
)
   
10,761
 
 
                                       
Expenses
                                       
Interest expense
   
1,177
     
0
     
0
     
0
     
1,177
 
Provision for loan losses
   
300
     
0
     
0
     
0
     
300
 
Salaries and employee benefits
   
4,144
     
553
     
108
     
0
     
4,805
 
Other expenses
   
3,021
     
226
     
64
     
(66
)
   
3,245
 
Total operating expenses
   
8,642
     
779
     
172
     
(66
)
   
9,527
 
 
                                       
Income before taxes
   
1,125
     
231
     
973
     
(1,095
)
   
1,234
 
 
                                       
Income tax expense (benefit)
   
182
     
79
     
(42
)
   
0
     
219
 
 
                                       
Net income
 
$
943
   
$
152
   
$
1,015
   
$
(1,095
)
 
$
1,015
 
 
                                       
Total assets
 
$
862,066
   
$
5,502
   
$
82,500
   
$
(83,187
)
 
$
866,881
 

- 32 -


 
 
Six Months Ended June 30, 2014
 
 
 
Bank
   
Trust
   
Unconsolidated
Parent
   
Eliminations
   
Consolidated
 
Revenues
 
   
   
   
   
 
Interest and dividend income
 
$
14,977
   
$
25
   
$
2,152
   
$
(2,152
)
 
$
15,002
 
Income from fiduciary activities
   
0
     
1,748
     
0
     
0
     
1,748
 
Other income
   
4,112
     
486
     
100
     
(131
)
   
4,567
 
Total operating income
   
19,089
     
2,259
     
2,252
     
(2,283
)
   
21,317
 
 
                                       
Expenses
                                       
Interest expense
   
1,993
     
0
     
0
     
0
     
1,993
 
Provision for loan losses
   
350
     
0
     
0
     
0
     
350
 
Salaries and employee benefits
   
8,290
     
1,325
     
219
     
0
     
9,834
 
Other expenses
   
6,512
     
522
     
(7
)
   
(131
)
   
6,896
 
Total operating expenses
   
17,145
     
1,847
     
212
     
(131
)
   
19,073
 
 
                                       
Income before taxes
   
1,944
     
412
     
2,040
     
(2,152
)
   
2,244
 
 
                                       
Income tax expense (benefit)
   
63
     
141
     
(38
)
   
0
     
166
 
 
                                       
Net income
 
$
1,881
   
$
271
   
$
2,078
   
$
(2,152
)
 
$
2,078
 
 
                                       
Total assets
 
$
855,989
   
$
5,740
   
$
85,989
   
$
(86,817
)
 
$
860,901
 

 
 
Six Months Ended June 30, 2013
 
 
 
Bank
   
Trust
   
Unconsolidated
Parent
   
Eliminations
   
Consolidated
 
Revenues
 
   
   
   
   
 
Interest and dividend income
 
$
15,087
   
$
19
   
$
2,057
   
$
(2,058
)
 
$
15,105
 
Income from fiduciary activities
   
0
     
1,766
     
0
     
0
     
1,766
 
Other income
   
4,418
     
245
     
100
     
(131
)
   
4,632
 
Total operating income
   
19,505
     
2,030
     
2,157
     
(2,189
)
   
21,503
 
 
                                       
Expenses
                                       
Interest expense
   
2,433
     
0
     
0
     
(1
)
   
2,432
 
Provision for loan losses
   
500
     
0
     
0
     
0
     
500
 
Salaries and employee benefits
   
8,438
     
1,069
     
219
     
0
     
9,726
 
Other expenses
   
6,142
     
444
     
94
     
(131
)
   
6,549
 
Total operating expenses
   
17,513
     
1,513
     
313
     
(132
)
   
19,207
 
 
                                       
Income before taxes
   
1,992
     
517
     
1,844
     
(2,057
)
   
2,296
 
 
                                       
Income tax expense (benefit)
   
277
     
175
     
(72
)
   
0
     
380
 
 
                                       
Net income
 
$
1,715
   
$
342
   
$
1,916
   
$
(2,057
)
 
$
1,916
 
 
                                       
Total assets
 
$
862,066
   
$
5,502
   
$
82,500
   
$
(83,187
)
 
$
866,881
 

The accounting policies of the segments are the same as those described in the summary of significant accounting policies reported in the Company's 2013 annual report on Form 10-K. The Company evaluates performance based on profit or loss from operations before income taxes, not including nonrecurring gains or losses.

Both the Parent and the Trust companies maintain deposit accounts with the Bank, on terms substantially similar to those available to other customers. These transactions are eliminated to reach consolidated totals.
- 33 -



Note 10. Commitments and Contingencies
There have been no material changes in the Company's commitments and contingencies from those disclosed in the Company's 2013 annual report on Form 10-K.  During the second quarter of 2014 the Company completed construction on expanding a branch office into the Company's new corporate headquarters.

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

Available Information
The Company maintains a website on the Internet at www.oldpoint.com. The Company makes available free of charge, on or through its website, its proxy statements, annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and any amendments to those reports as soon as reasonably practicable after such material is electronically filed with the Securities and Exchange Commission (SEC). The information available on the Company's Internet website is not part of this Form 10-Q or any other report filed by the Company with the SEC. The public may read and copy any documents the Company files with or furnishes to the SEC at the SEC's Public Reference Room at 100 F Street, N.E., Washington, D.C. 20549. The public may obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. The Company's SEC filings can also be obtained on the SEC's website on the Internet at www.sec.gov.

The following discussion is intended to assist readers in understanding and evaluating the financial condition, changes in financial condition and the results of operations of the Company. The Company consists of the parent company and its wholly-owned subsidiaries, The Old Point National Bank of Phoebus (the Bank) and Old Point Trust & Financial Services, N. A. (Trust), collectively referred to as the Company. This discussion should be read in conjunction with the consolidated financial statements and other financial information contained elsewhere in this report.

Caution About Forward-Looking Statements
In addition to historical information, this report may contain forward-looking statements. For this purpose, any statement that is not a statement of historical fact may be deemed to be a forward-looking statement. These forward-looking statements may include, but are not limited to, statements regarding profitability including the focus on reducing time deposits, the net interest margin, strategies for managing the net interest margin and the expected impact of such efforts, liquidity, levels of cash and cash equivalents, the loan portfolio and expected trends in the quality of the loan portfolio, the allowance and provision for loan losses, the securities portfolio, interest rate sensitivity, asset quality, levels of net loan charge-offs and nonperforming assets, noninterest expense (and components of noninterest expense), the impact of fee refunds to customers, noninterest income (and components of noninterest income), income taxes, expected impact of efforts to restructure the balance sheet, expected yields on the loan and securities portfolios, expected rates on interest-bearing liabilities, market risk, expected effects of the federal government's automatic spending cuts (commonly known as sequestration), business and growth strategies, investment strategy and financial and other goals. Forward-looking statements often use words such as "believes," "expects," "plans," "may," "will," "should," "projects," "contemplates," "anticipates," "forecasts," "intends" or other words of similar meaning. These statements can also be identified by the fact that they do not relate strictly to historical or current facts. Forward-looking statements are subject to numerous assumptions, risks and uncertainties, and actual results could differ materially from historical results or those anticipated by such statements.

There are many factors that could have a material adverse effect on the operations and future prospects of the Company including, but not limited to, changes in interest rates and yields; national and local economic conditions; the effects of the sequestration or other federal budget cuts, particularly to the Department of Defense, on economic conditions in the Company's market areas; the quality or composition of the loan or investment portfolios; changes in the volume and mix of interest-earning assets and interest-bearing liabilities; the effects of management's investment strategy and strategy to manage the net interest margin; the adequacy of the Company's credit quality review processes; the level of nonperforming assets and charge-offs; the ability of the Company to diversify its sources of noninterest income; the effect of the Company's sales training efforts for branch staff; the local real estate market; volatility and disruption in national and international financial markets; government intervention in the U.S. financial system; FDIC premiums and/or assessments; penalties paid if the Company were to prepay its FHLB advance; demand for loan and other banking products; levels of noninterest income and expense; deposit flows; competition; adequacy of the allowance for loan losses; and changes in accounting principles, policies and guidelines. The Company could also be adversely affected by monetary and fiscal policies of the U.S. Government, as well as any regulations or programs implemented pursuant to the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act) or other legislation and policies of the Office of the Comptroller of the Currency, U.S. Treasury and the Federal Reserve Board.
- 34 -

These risks and uncertainties, in addition to the risks and uncertainties identified in the Company's 2013 annual report on Form 10-K, should be considered in evaluating the forward-looking statements contained herein, and readers are cautioned not to place undue reliance on such statements. Any forward-looking statement speaks only as of the date on which it is made, and the Company undertakes no obligation to update any forward-looking statement to reflect events or circumstances after the date on which it is made. In addition, past results of operations are not necessarily indicative of future results.

General
The Company is the parent company of the Bank and Trust. The Bank is a locally managed community bank serving the Hampton Roads localities of Chesapeake, Hampton, Isle of Wight County, Newport News, Norfolk, Virginia Beach, Williamsburg/James City County and York County. The Bank currently has 18 branch offices. Trust is a wealth management services provider.

Critical Accounting Policies and Estimates
As of June 30, 2014, there have been no significant changes with regard to the critical accounting policies and estimates disclosed in the Company's 2013 annual report on Form 10-K. The accounting policy that required management's most difficult, subjective or complex judgments is the Company's allowance for loan losses.  The Company's policies for calculating the allowance for loan losses are discussed in this Item 2 and in Note 3 of the Notes to the Consolidated Financial Statements included in this quarterly report on Form 10-Q, and are discussed in further detail in the Company's 2013 annual report on Form 10-K.

Earnings Summary
Net income for the first half of 2014 was $2.1 million, or $0.42 per diluted share, compared to net income of $1.9 million, or $0.39 per diluted share, for the first half of 2013. This 8.46% increase is primarily attributable to lower interest expense and a reduced provision for loan losses, partially offset by higher noninterest expenses. Net income was also increased by a shift in the investment portfolio toward tax-exempt securities, which reduced income tax expense when comparing the first two quarters of 2014 and 2013. Old Point also took advantage of several tax credits during the first half of 2014; together, the tax credits and shift in the securities portfolio reduced income tax expense by 56.32% compared to the first half of 2013.

In the second quarter of 2014, net income was $1.1 million or $0.22 per diluted share, compared to $1.0 million or $0.21 per diluted share in the second quarter of 2013.  As in the six month period discussed above, lower interest expense, a reduced provision for loan losses and lower income tax expense were the main drivers of improved profitability.  A small increase in interest income, due to growth in the loan portfolio, also improved income when comparing the second quarter of 2014 to the same period in 2013.

Net Interest Income
The principal source of earnings for the Company is net interest income. Net interest income is the difference between interest and fees generated by earning assets and interest expense paid to fund them. Changes in the volume and mix of interest-earning assets and interest-bearing liabilities, as well as their respective yields and rates, have a significant impact on the level of net interest income. The net interest margin is calculated by dividing tax-equivalent net interest income by average earning assets. To fund the loan growth experienced in 2013 and the first half of 2014, the Company reduced its securities portfolio by deciding not to reinvest proceeds from paydowns on and sales of mortgage-backed securities. This change in the mix of earning assets, from lower-yielding securities to higher-yielding loans, resulted in an increase in the net interest margin to 3.48% in the first six months of 2014, compared to 3.19% in the same period of 2013.

Net interest income, on a fully tax-equivalent basis, was $6.8 million in the second quarter of 2014, an increase of $345 thousand from the second quarter of 2013, due to an increase in tax-equivalent interest income of $130 thousand and a decrease in interest expense of $215 thousand. For the six months ended June 30, 2014, tax-equivalent net interest income was $13.5 million, compared to $13.0 million for the six months ended June 30, 2013. Similar to trends seen when comparing the three months ended June 30, 2014 and 2013, the increase in net interest income during the first six months of 2014 as compared to the same period in 2013 was the result of both increases in tax-equivalent interest income and decreases in interest expense.

During the three and six months ended June 30, 2014, the yield on average earning assets increased by 25 and 20 basis points respectively, over the comparable periods in 2013.  These increases were due to the reallocation of earning assets from securities to loans, as discussed above. In addition, yields on securities increased by 37 and 40 basis points in the three and six months ended June 30, 2014 when compared to the same periods in 2013.  Yields on securities increased as prepayment speeds slowed over the second half of 2013 and the first half of 2014.

At the same time that the average yields on earning assets were increasing, the average cost of funding liabilities decreased, lowering interest expense.  To manage the net interest margin in the current low rate environment, the Company focused on building customer relationships to attract low-cost deposit accounts. Over the past year, higher-cost funds such as time deposits were allowed to mature without being renewed, and the Company implemented below-market pricing strategies with regard to rates paid on higher-cost time deposits accounts. The Company also took out two short-term FHLB advances during the second quarter, both of which had rates below 30 basis points, which further reduced the cost of funds.
- 35 -

Average earning assets decreased $36.5 million during the second quarter of 2014 and $38.8 million during the first half of 2014, when compared to the same periods of 2013. Although average loans grew significantly over these periods, the investment portfolio declined at a faster rate as costlier liabilities were allowed to mature, which resulted in less excess liquidity for the Company to deploy through the investment portfolio..

The yield on average loans and cost of average interest-bearing liabilities both decreased due to persistent low rates set by the Federal Open Market Committee (FOMC) lowering the Federal Funds Target Rate during 2008 from 4.25% to a range of 0.00% to 0.25%. The FOMC has kept the Federal Funds Target Rate unchanged through June 30, 2014. As higher-yielding loans and higher-cost interest-bearing liabilities that were opened prior to 2008 mature, they are being replaced with lower-yielding loans and lower-cost interest-bearing liabilities. Assuming that the FOMC keeps interest rates at current levels, management believes that the decrease of the average rate on interest-bearing liabilities will continue to slow as a high percentage of the Company's interest-bearing liabilities have already re-priced. Management also believes that the average yield on loans will continue to decline due to increased competition for loans in the Company's markets, and as loans are renewed or refinanced at lower current market rates.
- 36 -

The following table shows an analysis of average earning assets, interest-bearing liabilities and rates and yields for the periods indicated. Nonaccrual loans are included in loans outstanding.

AVERAGE BALANCE SHEETS, NET INTEREST INCOME* AND RATES*
 
 
 
For the three months ended June 30,
 
 
 
2014
   
2013
 
 
 
   
Interest
   
   
   
Interest
   
 
 
 
Average
   
Income/
   
Yield/
   
Average
   
Income/
   
Yield/
 
 
 
Balance
   
Expense
   
Rate**
   
Balance
   
Expense
   
Rate**
 
 
 
   
   
(dollars in thousands)
   
   
   
 
ASSETS
 
   
   
   
   
   
 
Loans*
 
$
512,702
   
$
6,130
     
4.78
%
 
$
462,256
   
$
5,899
     
5.10
%
Investment securities:
                                               
Taxable
   
178,479
     
962
     
2.16
%
   
265,181
     
1,253
     
1.89
%
Tax-exempt*
   
74,258
     
645
     
3.47
%
   
45,720
     
435
     
3.81
%
Total investment securities
   
252,737
     
1,607
     
2.54
%
   
310,901
     
1,688
     
2.17
%
Interest-bearing due from banks
   
1,119
     
0
     
0.00
%
   
28,995
     
19
     
0.26
%
Federal funds sold
   
1,296
     
0
     
0.00
%
   
1,784
     
1
     
0.22
%
Other investments
   
2,977
     
26
     
3.49
%
   
3,411
     
26
     
3.05
%
Total earning assets
   
770,831
   
$
7,763
     
4.03
%
   
807,347
   
$
7,633
     
3.78
%
Allowance for loan losses
   
(6,935
)
                   
(7,417
)
               
Other nonearning assets
   
102,709
                     
85,479
                 
Total assets
 
$
866,605
                   
$
885,409
                 
 
                                               
LIABILITIES AND STOCKHOLDERS' EQUITY
                                               
Time and savings deposits:
                                               
Interest-bearing transaction accounts
 
$
12,270
   
$
2
     
0.07
%
 
$
11,700
   
$
1
     
0.03
%
Money market deposit accounts
   
213,141
     
41
     
0.08
%
   
194,811
     
53
     
0.11
%
Savings accounts
   
71,788
     
9
     
0.05
%
   
61,731
     
15
     
0.10
%
Time deposits, $100,000 or more
   
108,862
     
274
     
1.01
%
   
128,465
     
369
     
1.15
%
Other time deposits
   
130,023
     
321
     
0.99
%
   
160,595
     
427
     
1.06
%
Total time and savings deposits
   
536,084
     
647
     
0.48
%
   
557,302
     
865
     
0.62
%
Federal funds purchased, repurchase
                                               
agreements and other borrowings
   
31,036
     
8
     
0.10
%
   
30,860
     
7
     
0.09
%
Federal Home Loan Bank advances
   
28,956
     
307
     
4.24
%
   
25,000
     
305
     
4.88
%
Total interest-bearing liabilities
   
596,076
     
962
     
0.65
%
   
613,162
     
1,177
     
0.77
%
Demand deposits
   
183,227
                     
180,838
                 
Other liabilities
   
2,437
                     
3,095
                 
Stockholders' equity
   
84,865
                     
88,314
                 
Total liabilities and stockholders' equity
 
$
866,605
                   
$
885,409
                 
Net interest margin
         
$
6,801
     
3.53
%
         
$
6,456
     
3.20
%
 
                                               
*Computed on a fully tax-equivalent basis using a 34% rate
                                 
**Annualized
                                 
- 37 -


 
 
For the six months ended June 30,
 
 
 
2014
   
2013
 
 
 
   
Interest
   
   
   
Interest
   
 
 
 
Average
   
Income/
   
Yield/
   
Average
   
Income/
   
Yield/
 
 
 
Balance
   
Expense
   
Rate**
   
Balance
   
Expense
   
Rate**
 
 
 
   
   
(dollars in thousands)
   
   
   
 
ASSETS
 
   
   
   
   
   
 
Loans*
 
$
506,997
   
$
12,130
     
4.79
%
 
$
462,759
   
$
11,916
     
5.15
%
Investment securities:
                                               
Taxable
   
181,255
     
1,967
     
2.17
%
   
275,152
     
2,577
     
1.87
%
Tax-exempt*
   
74,440
     
1,295
     
3.48
%
   
42,919
     
836
     
3.90
%
Total investment securities
   
255,695
     
3,262
     
2.55
%
   
318,071
     
3,413
     
2.15
%
Interest-bearing due from banks
   
2,859
     
3
     
0.21
%
   
26,467
     
33
     
0.25
%
Federal funds sold
   
5,283
     
5
     
0.19
%
   
1,857
     
1
     
0.11
%
Other investments
   
3,022
     
57
     
3.77
%
   
3,492
     
44
     
2.52
%
Total earning assets
   
773,856
   
$
15,457
     
3.99
%
   
812,646
   
$
15,407
     
3.79
%
Allowance for loan losses
   
(6,966
)
                   
(7,414
)
               
Other nonearning assets
   
101,324
                     
84,136
                 
Total assets
 
$
868,214
                   
$
889,368
                 
 
                                               
LIABILITIES AND STOCKHOLDERS' EQUITY
                                               
Time and savings deposits:
                                               
Interest-bearing transaction accounts
 
$
12,053
   
$
3
     
0.05
%
 
$
11,370
   
$
3
     
0.05
%
Money market deposit accounts
   
211,931
     
95
     
0.09
%
   
194,956
     
124
     
0.13
%
Savings accounts
   
69,760
     
25
     
0.07
%
   
59,885
     
29
     
0.10
%
Time deposits, $100,000 or more
   
110,802
     
595
     
1.07
%
   
131,712
     
765
     
1.16
%
Other time deposits
   
134,044
     
649
     
0.97
%
   
164,847
     
885
     
1.07
%
Total time and savings deposits
   
538,590
     
1,367
     
0.51
%
   
562,770
     
1,806
     
0.64
%
Federal funds purchased, repurchase
                                               
agreements and other borrowings
   
33,806
     
17
     
0.10
%
   
31,628
     
19
     
0.12
%
Federal Home Loan Bank advances
   
26,989
     
609
     
4.51
%
   
25,000
     
607
     
4.86
%
Total interest-bearing liabilities
   
599,385
     
1,993
     
0.67
%
   
619,398
     
2,432
     
0.79
%
Demand deposits
   
183,048
                     
178,556
                 
Other liabilities
   
2,297
                     
2,993
                 
Stockholders' equity
   
83,484
                     
88,421
                 
Total liabilities and stockholders' equity
 
$
868,214
                   
$
889,368
                 
Net interest margin
         
$
13,464
     
3.48
%
         
$
12,975
     
3.19
%
 
                                               
*Computed on a fully tax-equivalent basis using a 34% rate
                                 
**Annualized
                                 

- 38 -

Provision for Loan Losses
The provision for loan losses is a charge against earnings necessary to maintain the allowance for loan losses at a level consistent with management's evaluation of the portfolio. This expense is based on management's estimate of credit losses that may be sustained in the loan portfolio. Management's evaluation included credit quality trends, collateral values, the findings of internal credit quality assessments and results from external bank regulatory examinations. These factors, as well as identified impaired loans, historical losses and current economic and business conditions, were used in developing estimated loss factors for determining the loan loss provision.

The provision for loan losses was $350 thousand in the first six months of 2014, as compared to $500 thousand in the first six months of 2013. Management concluded that the provision was appropriate based on its analysis of the adequacy of the allowance for loan losses.  The lower provision in the first half of 2014, as compared to the provision for the first half of 2013, was mainly due to a large recovery in the second quarter of 2014 on a real estate mortgage loan that was charged off in 2004.

Net loans charged off were $205 thousand for the first six months of 2014 as compared to $528 thousand for the first six months of 2013. On an annualized basis, net loans charged off were 0.08% of total loans for the first half of 2014 compared with 0.22% for the same period in 2013.  Management believes that net loan charge-offs in future quarters will be higher than what was experienced in the first half of 2014, due to the unusually large recovery received in the second quarter of 2014.  At the same time, management does not expect that net charge-offs in future periods will be as high as those experienced during the recession of 2008 and 2009 and its aftermath. Net charge-offs in future periods are expected to be closer to long-term historical averages unless national and local economic conditions do not continue to improve. Sequestration did have in 2013, and could have in 2014 and beyond, an impact on federal military and defense spending and could have a dramatic negative effect on the local economy. Possible future reductions in military and defense spending could cause higher local unemployment, which would likely cause an increase in nonperforming assets as individuals struggle to make loan payments.  Increased nonperforming assets could cause increased charge-offs and lower earnings due to larger contributions to the loan loss provision and reductions in interest-accruing loans.

Nonperforming assets consist of nonaccrual loans, loans past due 90 days or more and accruing interest, restructured loans that are accruing interest and not performing according to their modified terms, and OREO. See Note 3 of the Notes to the Consolidated Financial Statements included in this quarterly report on Form 10-Q for an explanation of these categories. OREO includes foreclosed assets, which consist of real estate from foreclosures on loan collateral, and former branch sites that are no longer in use by the Bank. The majority of the loans 90 days or more past due but still accruing interest are student loans with principal amounts that are 97 - 98% guaranteed by the government. Most of the remaining loans that are 90 days or more past due and still accruing interest are classified as substandard. Substandard loans are a component of the allowance for loan losses. When a loan changes from "past due 90 days or more and accruing interest" status to "nonaccrual" status, the loan is reviewed for impairment. In most cases, if the loan is considered impaired, then the difference between the value of the collateral and the principal amount outstanding on the loan is charged off. If the Company is waiting on an appraisal to determine the collateral's value or is in negotiations with the borrower or other parties that may affect the value of the collateral, management allocates funds to cover the deficiency to the allowance for loan losses based on information available to management at that time. In the case of TDRs, the restructuring may be to modify to an unsecured loan (e.g., a short sale) that the borrower can afford to repay. In these circumstances, the entire balance of the loan would be specifically allocated for, unless the present value of expected future cash flows was more than the current balance on the loan. It would not be charged off if the loan documentation supports the borrower's ability to repay the modified loan.
- 39 -

The following table presents information on nonperforming assets, as of the dates indicated:

NONPERFORMING ASSETS
 
 
 
June 30,
   
December 31,
   
Increase
 
 
 
2014
   
2013
   
(Decrease)
 
 
 
(in thousands)
 
Nonaccrual loans
 
   
   
 
Commercial
 
$
0
   
$
149
   
$
(149
)
Real estate-construction
   
2,382
     
2,545
     
(163
)
Real estate-mortgage (1)
   
8,159
     
8,630
     
(471
)
Consumer loans
   
44
     
0
     
44
 
Total nonaccrual loans
 
$
10,585
   
$
11,324
   
$
(739
)
 
                       
Loans past due 90 days or more and accruing interest 
                       
Commercial
 
$
10
   
$
0
   
$
10
 
Real estate-construction
   
67
     
0
     
67
 
Real estate-mortgage (1)
   
53
     
527
     
(474
)
Consumer loans
   
861
     
5
     
856
 
Other
   
5
     
14
     
(9
)
Total loans past due 90 days or more and accruing interest
 
$
996
   
$
546
   
$
450
 
 
                       
Restructured loans 
                       
Real estate-construction
   
103
     
0
     
103
 
Real estate-mortgage (1)
 
$
12,328
   
$
12,076
   
$
252
 
Consumer loans
   
14
     
15
     
(1
)
Total restructured loans 
 
$
12,445
   
$
12,091
   
$
354
 
Less nonaccrual restructured loans (included above)
   
3,628
     
3,630
     
(2
)
Less restructured loans currently in compliance (2)
   
8,817
     
8,461
     
356
 
      Net nonperforming, accruing restructured loans
 
$
0
   
$
0
   
$
0
 
 
                       
Other real estate owned
                       
Construction, land development, and other land
 
$
2,670
     
2,783
   
$
(113
)
1-4 family residential properties
   
1,259
     
457
     
802
 
Nonfarm nonresidential properties
   
1,734
     
2,289
     
(555
)
Former branch sites
   
886
     
886
     
-
 
 
 
$
6,549
   
$
6,415
   
$
134
 
 
                       
Total nonperforming assets
 
$
18,130
   
$
18,285
   
$
(155
)
 
                       
(1) The real estate-mortgage segment includes residential 1 – 4 family, commercial real estate, second mortgages and equity lines of credit.
 
(2) As of June 30, 2014 and December 31, 2013, all of the Company's restructured accruing loans were performing in compliance with their modified terms.
 

Nonperforming assets as of June 30, 2014 were $18.1 million, $155 thousand lower than nonperforming assets as of December 31, 2013. Nonaccrual loans decreased $739 thousand when comparing the balances as of June 30, 2014 to December 31, 2013, due primarily to improvements in asset quality. Loans past due 90 days or more and accruing interest increased $450 thousand.  However, as of June 30, 2014, $861 thousand of the $996 thousand of loans past due 90 days or more and accruing interested were student loans on which the Company expects to experience minimal losses. Because the government has provided guarantees of repayment of these student loans in an amount ranging from 97% to 98% of the total principal balance of the loans, management does not expect even significant increases in past due student loans to have a material effect on the Company.

Total restructured loans increased by $354 thousand as the Company continued to work with troubled borrowers.  All accruing TDRs are performing in accordance with their modified terms.  OREO increased by $134 thousand during the first half of 2014, primarily due to additional foreclosures on 1 – 4 family residential property.  The decreases in nonfarm, nonresidential properties and in construction, land development, and other land were mainly due to sales of these types of properties. The former branch sites included in OREO are also listed for sale.
- 40 -

The majority of the balance of nonaccrual loans at June 30, 2014 was related to a few large credit relationships. Of the $10.6 million of nonaccrual loans at June 30, 2014, $8.6 million or approximately 81.25% was comprised of three credit relationships: $3.4 million, $2.8 million, and $2.4 million.  On July 11, 2014, the $2.8 million credit relationship was paid in full.

The loans that make up the nonaccrual balance have been written down to their net realizable value.  If the Company is waiting on an appraisal to determine the collateral's value, management allocates funds to cover the deficiency to the allowance for loan losses based on information available to management at the time. As shown in the table above, the majority of the nonaccrual loans were collateralized by real estate at June 30, 2014 and December 31, 2013. The increase in TDRs between December 31, 2013 and June 30, 2014 was due to the Company's efforts to modify problem credits to assist borrowers and return the loans to performing status.

Management believes the Company has excellent credit quality review processes in place to identify problem loans quickly. The quality of the Company's loan portfolio has continued to improve over the past few years, with nonperforming assets generally stabilizing as troubled borrowers' finances have improved and troubled loans have been charged off or sold. Management remains cautious about the future and is well aware that if the economy does not continue to improve, or if the sequestration continues to negatively impact federal military and defense spending in the Company's service area, nonperforming assets could increase in future periods. As was seen in prior years, the effect of a sustained increase in nonperforming assets would be lower earnings caused by larger contributions to the loan loss provision, and lower levels of accruing loans, which in turn would be driven by larger impairments in the loan portfolio and higher levels of loan charge-offs.

As of June 30, 2014, the allowance for loan losses was 38.48% of nonperforming assets and 60.24% of nonperforming loans, compared to 37.36% and 57.55% as of December 31, 2013. The asset quality of the loan portfolio as detailed in Note 3 of the Notes to the Consolidated Financial Statements included in this quarterly report on Form 10-Q reflects the broad improvement during the first half of 2014 of the Company's loan portfolio asset quality across all internally assigned risk grades. However, the possible negative consequences of sequestration on local economic conditions continue to concern management. The allowance for loan losses was 1.34% and 1.36% of total loans on June 30, 2014 and December 31, 2013, respectively.

Allowance for Loan Losses
The allowance for loan losses is based on several components. The first component of the allowance for loan losses is determined based on specifically identified loans that may become impaired. These loans are individually analyzed for impairment and include nonperforming loans and both performing and nonperforming TDRs. This component may also include loans considered impaired for other reasons, such as outdated financial information on the borrower or guarantors or financial problems of the borrower, including operating losses, marginal working capital, inadequate cash flow, or business interruptions. Changes in TDRs and nonperforming loans affect the dollar amount of the allowance. Increases in the impairment allowance for TDRs and nonperforming loans are reflected as an increase in the allowance for loan losses except in situations where the TDR or nonperforming loan does not require a specific allocation (i.e. the present value of expected future cash flows or the collateral value is considered sufficient).

The majority of the Company's TDRs and nonperforming loans are collateralized by real estate. When reviewing loans for impairment, the Company obtains current appraisals when applicable. If the Company has not yet received a current appraisal on loans being reviewed for impairment, any loan balance that is in excess of the estimated appraised value is allocated in the allowance. As of June 30, 2014 and December 31, 2013, the impaired loan component of the allowance for loan losses amounted to $820 thousand and $1.7 million, respectively. The drop in this component was due to the resolution of one loan during the first quarter of 2014 that had a large impairment before the resolution.

Historical loss is the second component of the allowance for loan losses. The calculation of the historical loss component is conducted on loans evaluated collectively for impairment and uses migration analysis on pooled segments based on the loan classification pursuant to FDIC call report instructions applicable to the Bank.  Loans not secured by real estate and made to individuals for household, family and other personal expenditures are segmented into pools based on whether the loan's payments are current (including loans 1 – 29 days past due), or are 30 – 59 days past due, 60 – 89 days past due, or 90 days or more past due.  All other loans, including loans to consumers that are secured by real estate, are segmented by the Company's internally assigned risk grades: substandard, other assets especially mentioned (rated just above substandard), and pass (all other loans). The Company may also assign loans to the risk grades of doubtful or loss, but as of June 30, 2014 and December 31, 2013, the Company had no loans in these categories.
- 41 -

Prior to 2011, the historical loss component was generally based on loan losses experienced during the previous four years. Beginning in 2011 through September 30, 2013, the historical loss was based on the past eight quarters, which management believed better reflected the risk related to each segment of the loan portfolio in the economic environment at that time. With the December 31, 2013 and June 30, 2014 calculations, the historical loss was based on the past nine quarters and the past eleven quarters, respectively. Each quarter, management evaluates the historical period used to ensure that it provides the most appropriate reflection of risk related to the current loan portfolio.

The final component of the allowance consists of qualitative factors and includes items such as economic conditions, growth trends, loan concentrations, changes in certain loans, changes in underwriting, changes in management and legal and regulatory changes. On a combined basis, the historical loss and qualitative factor components amounted to $6.2 million and $5.1 million as of June 30, 2014 and December 31, 2013, respectively. The major reasons for the increase in this component when comparing the allowance calculation as of June 30, 2014 to the allowance calculation as of December 31, 2013 are growth in the loan portfolio and higher historical loss rates due to the expanded migration period.

Migration analysis follows a loan over a set number of quarters to monitor its performance and provide more accurate information about the probability of default for loans that are currently performing.  Adding additional quarters to the migration analysis extends the period over which the loan could cease to perform, increasing the number of loans that default and thus also increasing the historical loss rates.  When first converting to migration analysis, management elected to use an eight-quarter migration period to match the eight-quarter loss history that was used previously.

As a result of management's analysis, the Company added, through the provision, $350 thousand to the allowance for loan losses for the six months ended June 30, 2014. Management believes that the allowance has been appropriately funded for additional losses on existing loans, based on currently available information. If the sequestration results in increased historical loss rates, increases in impairment analyses or changes in certain qualitative factors related to the economic conditions, the current level of the allowance for loan losses may be insufficient and increases in the allowance may be needed.

Noninterest Income
Noninterest income was $3.2 million and $6.3 million in the three and six months ended June 30, 2014, down 4.02% and 1.30% respectively when compared to the same periods in 2013. In both the quarterly and year-to-date periods, significant reductions in income from Old Point Mortgage and smaller decreases in income from fiduciary activities offset increases in income from other service charges, commissions and fees.

Other service charges, commissions and fees increased 14.14% and 12.54% in the three and six months ended June 30, 2014, to $1.0 million and $2.0 million respectively, as compared the the same periods in 2013. This increase was mainly due to income from securities brokerage sales and income generated by Penact Associates, Incorporated (Penact), a company that provides administrative and valuation services for retirement plans.  Trust acquired Penact in the fourth quarter of 2013.

Income from Old Point Mortgage (OPM), a joint venture of the Company, decreased $212 thousand and $273 thousand in the three and six months ended June 30, 2014 when compared to the three and six months ended June 30, 2013.  OPM income was elevated in the second quarter of 2013 by the recognition of fair value accounting.  In addition, income has been elevated in recent years by a large number of refinancings driven by low interest rates.  By the end of 2013, most eligible borrowers in OPM's market areas who were interested in refinancing their mortgage loans had completed a refinancing in the low rate environment, and subsequent rate increases have suppressed refinancing activity during 2014.

Income from fiduciary activities decreased $73 thousand in the second quarter and $18 thousand in the first six months of 2014, when compared to the same periods in 2013, due to Trust's determination that certain customer fees had been inadvertently charged. The Company recognized an adjustment in the financial statements for the second quarter of 2014. The adjustment reduced noninterest income by $135 thousand in the second quarter of 2014. The affected customers were credited in the third quarter of 2014.  Other than the impact of the inadvertent fee charges, other income from fiduciary activities has increased during the three and six months ended June 30, 2014 as compared to the same periods in 2013, and management expects this positive trend to continue through the remainder of 2014.

Noninterest Expense
Noninterest expense increased $417 thousand and $455 thousand when comparing the three and six months ended June 30, 2014 to the same periods in 2013.  The largest increases were in salaries and employee benefits and occupancy and equipment expenses.  Salaries and employee benefits increased $176 thousand and $108 thousand for the second quarter and first half of 2014, compared to the same periods in 2013. This increase was partially due to an increase in the cost of employer-provided medical insurance.  This expense was also increased by the addition of four employees when Trust acquired Penact in the fourth quarter of 2013.

Occupancy and equipment expenses increased 11.68% and 5.84% in the three and six months ended June 30, 2014, when compared to the same periods in 2013.  In the second quarter of 2014, the Company finished its expansion of a branch office into its new corporate headquarters, and the building was recorded on the Company's balance sheet with a book value of $14.1 million.  The completion of this building increased depreciation, utilities and real estate taxes.
- 42 -

While many categories of noninterest expense increased, loss (gain) on write-down/sale of other real estate owned decreased for both the three and six months ended June 30, 2014 when compared to the same periods in 2013, by $104 thousand and $147 thousand respectively. In the second quarter of 2014, the Company recorded a large gain on the sale of a property that had been written down in 2008.

For both the three and six months ended June 30, 2014, compared to the same periods in 2013, nearly all other categories of noninterest expense increased, although no increase individually was significant beyond those previously discussed. Moderate increases were seen in other outside service fees, employee professional development and capital stock tax.  Outside service fees increased due to fees paid for the servicing of the Company's purchased student loan portfolio and due to additional fees paid for information technology support.  Employee professional development increased as the Company provided sales training for all branch staff, to improve future revenues.

Capital stock tax is paid to the state of Virginia instead of state income tax, and is based on the subsidiaries' capital less certain allowances.  One such allowance is based on holdings of U.S. Government agency securities.  As the composition of the Bank's securities portfolio has changed between 2012, 2013, and 2014, the level of U.S. Government agency securities decreased significantly and provided a smaller deduction for the purposes of calculating the capital stock tax. The increase in capital stock tax expense was more than offset by the benefit to the interest margin and the reduction in income tax expense, as the Company rebalanced its securities portfolio by acquiring additional tax-exempt municipal securities.

Balance Sheet Review
Assets as of June 30, 2014 were $860.9 million, a decrease of $3.4 million or 0.39% when compared to assets as of December 31, 2013.  Loan demand continued to improve in the second quarter of 2014, with net loans increasing $18.8 million or 3.81% between December 31, 2013 and June 30, 2014. Loan demand showed the most significant improvement during the first half of 2014 in the commercial and equity lines of credit sub-segments of the Company's mortgage loans on real estate portfolio, due to increased sales efforts and the Bank's equity-line campaign. This loan growth was funded by reductions in the investment securities portfolio and cash and cash equivalents, and an additional Federal Home Loan Bank (FHLB) advance. As loans generally bear higher rates of interest than investment securities, the shift in the mix of earning assets should provide additional increases to the net interest margin in subsequent quarters.

To manage its net interest margin, the Company continued to focus on reducing higher-cost time deposits by generally lowering deposit rates and allowing most time deposit categories to shrink through attrition.  Rates on certain time products were set at or above current average rates in the Company's market in order to manage interest rate risk.  At the same time, rates paid on most of the Company's other deposit products remain low.  The Company's loan-to-deposit ratio is still well below regulatory limits, and rates on short-term FHLB advances continue to be more favorable than rates on time deposits.  As a result, time deposits decreased $18.0 million from $256.8 million on December 31, 2013 to $238.8 million at June 30, 2014. Over the same period, FHLB advances increased by $5.0 million, as the Company took out two short-term advances totaling $10.0 million during the second quarter of 2014, repaying one $5.0 million advance during the same quarter. Noninterest-bearing deposits and lower cost savings deposits continue to grow. Noninterest-bearing deposits increased $2.8 million or 1.51% in the first half of 2014 and savings deposits grew $6.4 million or 2.24% in the same period.

The Company's holdings of "Alt-A" type mortgage loans such as adjustable rate and nontraditional type loans were inconsequential, amounting to less than 1.00% of the Company's loan portfolio as of June 30, 2014.

The Company does not have a formal program for subprime lending. The Company is required by law to comply with the requirements of the Community Reinvestment Act (the CRA), which imposes on financial institutions an affirmative and ongoing obligation to meet the credit needs of their local communities, including low- and moderate-income borrowers. In order to comply with the CRA and meet the credit needs of its local communities, the Company finds it necessary to make certain loans with subprime characteristics.
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For the purposes of this discussion, a "subprime loan" is defined as a loan to a borrower having a credit score of 660 or below. The majority of the Company's subprime loans are to customers in the Company's local market area. The following table details the Company's loans with subprime characteristics that were secured by 1-4 family first mortgages, 1-4 family open-end loans and 1-4 family junior lien loans for which the Company has recorded a credit score in its system.

Loans Secured by 1 - 4 Family First Mortgages,
 
1 - 4 Family Open-end and 1 - 4 Family Junior Liens
 
As of June 30, 2014
 
(dollars in thousands)
 
 
 
   
 
 
 
Amount
   
Percent
 
Subprime
 
$
20,366
     
17.14
%
Non-subprime
   
98,477
     
82.86
%
 
 
$
118,843
     
100.00
%
 
               
Total loans
 
$
519,662
         
 
               
Percentage of Real Estate-Secured Subprime Loans to Total Loans
         
   
3.92
%

In addition to the subprime loans secured by real estate discussed above, as of June 30, 2014, the Company had an additional $1.3 million in subprime consumer loans that were either not government guaranteed, were unsecured or were secured by collateral other than real estate. Together with the subprime loans secured by real estate, the Company's total subprime loans as of June 30, 2014 were $21.7 million, amounting to 4.17% of the Company's total loans at June 30, 2014.

Additionally, the Company has no investments secured by "Alt-A" type mortgage loans such as adjustable rate and nontraditional type mortgages or subprime loans.

Average assets for the first six months of 2014 were $868.2 million compared to $889.4 million for the first six months of 2013, a decrease of $21.2 million or 2.38%. Average investment securities decreased by $62.4 million for the six months ended June 30, 2014 as compared to the six months ended June 30, 2013, due to actions taken in 2013 by management to reduce the available-for-sale securities portfolio's exposure to interest rate risk, as well as due to normal principal payments on the mortgage-backed securities portfolio.  The Company elected not to reinvest the prepayments on the mortgage-backed securities portfolio, instead using these payments to fund loan portfolio growth. Comparing the first half of 2013 to the first half of 2014, lower yielding balances held in investment securities and interest-bearing due from banks moved to higher yielding loans.  Average loans increased $44.2 million when comparing average loans for the first six months of 2014 to the same period in 2013. Similar changes were seen when comparing the second quarter of 2014 to the second quarter of 2013, with average investment securities decreasing $58.2 million and average loans increasing $50.4 million.

Capital Resources
Total stockholders' equity as of June 30, 2014 was $86.0 million, an increase of $5.2 million or 6.47% from $80.8 million at December 31, 2013. The decrease in the 10-year Treasury rate during the first half of 2014 had a positive effect on the accumulated other comprehensive loss component of stockholders' equity, as unrealized losses on available-for-sale securities, net of tax, are reported in this section of the balance sheet. At June 30, 2014, the unrealized loss on available-for-sale securities component of stockholders' equity was an unrealized loss of $1.8 million, compared to an unrealized loss of $5.3 million as of December 31, 2013. Because the Company does not intend to sell, and management believes it is unlikely that the Company will be required to sell, the investments before recovery of their amortized cost, the Company does not consider the investments to be other-than-temporarily impaired.
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Under currently applicable banking regulations, total capital is comprised of core capital (Tier 1) and supplemental capital (Tier 2). Tier 1 capital consists of common stockholders' equity and retained earnings less goodwill. Tier 2 capital consists of certain qualifying debt and a qualifying portion of the allowance for loan losses. The following is a summary of the Company's capital ratios at June 30, 2014. As shown below, these ratios were all well above the regulatory minimum levels, and demonstrate that the Company's capital position remains strong.

 
2014
 
 
Regulatory
June 30, 2014
 
Minimums
 
Tier 1 Leverage
4.00%
10.69%
Tier 1
4.00%
14.27%
Total Capital
8.00%
15.34%

Book value per share was $17.34 at June 30, 2014 as compared to $16.64 at June 30, 2013. Cash dividends were $595 thousand or $0.12 per share in the first half of 2014 and $496 thousand or $0.10 per share in the first half of 2013.

Liquidity
Liquidity is the ability of the Company 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 in securities and loans maturing within one year.

A major source of the Company's liquidity is its large, stable deposit base. In addition, secondary liquidity sources are available through the use of borrowed funds if the need should arise, including secured advances from the FHLB. As of the end of the second quarter of 2014, the Company had $226.8 million in FHLB borrowing availability. The Company has available short-term, unsecured borrowed funds in the form of federal funds lines of credit with correspondent banks. As of the end of the second quarter of 2014, the Company had $50.0 million available in federal funds lines to handle any short-term borrowing needs.

Management is not aware of any market or institutional trends, events or uncertainties that are expected to have a material effect on the liquidity, capital resources or operations of the Company. Nor is management aware of any current recommendations by regulatory authorities that would have a material effect on liquidity, capital resources or operations. The Company's internal sources of such liquidity are deposits, loan and investment repayments and securities available-for-sale. As of June 30, 2014, the Bank's unpledged, available-for-sale securities totaled $111.6 million. The Company's primary external source of liquidity is advances from the FHLB.

As a result of the Company's management of liquid assets, the availability of borrowed funds and the ability to generate liquidity through liability funding, management believes that the Company maintains overall liquidity sufficient to satisfy its depositors' requirements and to meet its customers' future borrowing needs.

Contractual Obligations
In the normal course of business there are various outstanding contractual obligations of the Company that will require future cash outflows. In addition, there are commitments and contingent liabilities, such as commitments to extend credit that may or may not require cash outflows.

As of June 30, 2014, there have been no material changes outside the ordinary course of business in the Company's contractual obligations disclosed in the Company's 2013 annual report on Form 10-K. During the second quarter of 2014 the Company completed construction on expanding a branch office into the Company's new corporate headquarters.

Off-Balance Sheet Arrangements
As of June 30, 2014, there were no material changes in the Company's off-balance sheet arrangements disclosed in the Company's 2013 annual report on Form 10-K.
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Item 3.  Quantitative and Qualitative Disclosures About Market Risk.

An important element of earnings performance and the maintenance of sufficient liquidity is proper management of the interest sensitivity gap. The interest sensitivity gap is the difference between interest sensitive assets and interest sensitive liabilities in a specific time interval. This gap can be managed by re-pricing assets or liabilities, which are variable rate instruments, by replacing an asset or liability at maturity or by adjusting the interest rate during the life of the asset or liability. Matching the amounts of assets and liabilities maturing in the same time interval helps to offset interest rate risk and to minimize the impact of rising or falling interest rates on net interest income.

The Company determines the overall magnitude of interest sensitivity risk and then formulates policies governing asset generation and pricing, funding sources and pricing, and off-balance sheet commitments. These decisions are based on management's expectations regarding future interest rate movements, the state of the national and regional economy, and other financial and business risk factors. The Company uses computer simulations to measure the effect of various interest rate scenarios on net interest income. This modeling reflects interest rate changes and the related impact on net interest income and net income over specified time horizons.

Based on scheduled maturities only, the Company was liability sensitive as of June 30, 2014. It should be noted, however, that non-maturing deposit liabilities, which consist of money market, savings and interest-bearing and noninterest-bearing checking accounts, are less interest sensitive than other market driven deposits. At June 30, 2014, non-maturing deposit liabilities totaled $477.8 million or 66.68% of total deposit liabilities.

In a rising rate environment, changes in these deposit rates have historically lagged behind the changes in earning asset rates, thus mitigating the impact from the liability sensitivity position. The asset/liability model allows the Company to reflect the fact that non-maturing deposits are less rate sensitive than other deposits by using a decay rate. The decay rate is a type of artificial maturity that simulates maturities for non-maturing deposits over the number of months that more closely reflects historic data. Using the decay rate, the model reveals that the Company is only slightly liability sensitive at the one-year time frame as of June 30, 2014.

When the Company is liability sensitive, net interest income should improve if interest rates fall since liabilities will reprice faster than assets (depending on the optionality or prepayment speeds of the assets).  Conversely, if interest rates rise, net interest income should decline.  When the Company is asset sensitive, net interest income should improve if interest rates rise and fall if rates fall.

The most likely scenario represents the rate environment as management forecasts it to occur. Management uses a "static" test to measure the effects of changes in interest rates on net interest income. This test assumes that management takes no steps to adjust the balance sheet to respond to the rate change by re-pricing assets/liabilities, as discussed in the first paragraph of this section.

Under the rate environment forecasted by management, rate changes in 50 to 100 basis point increments are applied to assess the impact on the Company's earnings at June 30, 2014. The rate change model assumes that these changes will occur gradually over the course of a year. The model reveals that a 50 basis point ramped decrease in rates would cause an approximate 0.30% annual decrease in net interest income. The model reveals that a 50 basis point ramped rise in rates would cause an approximate 0.43% annual increase in net interest income and that a 100 basis point ramped rise in rates would cause an approximate 0.41% increase in net interest income. Despite its slightly liability-sensitive position, the optionality in the Company's balance sheet forecasts an increase in net interest income if rates rise.

Item 4. Controls and Procedures.

Disclosure Controls and Procedures. Management evaluated, with the participation of the Company's Chief Executive Officer and Chief Financial Officer, the effectiveness of the Company's disclosure controls and procedures (as defined in Rule 13a-15(e) under the Securities Exchange Act of 1934, as amended (the Exchange Act)) as of the end of the period covered by this report. Based on that evaluation, the Company's Chief Executive Officer and Chief Financial Officer concluded that the Company's disclosure controls and procedures are effective as of the end of the period covered by this report to ensure that information required to be disclosed in the reports that the Company files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC's rules and forms and that such information is accumulated and communicated to management, including the Company's Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure.
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In designing and evaluating its disclosure controls and procedures, management recognized that disclosure controls and procedures, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the disclosure controls and procedures are met. The design of any disclosure controls and procedures also is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions.

Internal Control over Financial Reporting. Management is responsible for establishing and maintaining adequate internal control over financial reporting (as defined in Rule 13a-15(f) under the Exchange Act). No changes in the Company's internal control over financial reporting occurred during the fiscal quarter ended June 30, 2014 that have materially affected, or are reasonably likely to materially affect, the Company's internal control over financial reporting. Because of its inherent limitations, a system of internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

PART II - OTHER INFORMATION

Item 1.  Legal Proceedings.

There are no pending legal proceedings to which the Company, or any of its subsidiaries, is a party or to which the property of the Company or any of its subsidiaries is subject that, in the opinion of management, may materially impact the financial condition of the Company.

Item 1A.  Risk Factors.

There have been no material changes in the risk factors faced by the Company from those disclosed in the Company's 2013 annual report on Form 10-K.

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

Pursuant to the Company's stock option plans, participants may exercise stock options by surrendering shares of the Company's common stock that the participants already own. Shares surrendered by participants of these plans are repurchased at current market value pursuant to the terms of the applicable stock options. During the quarter ended June 30, 2014, the Company did not repurchase any shares related to the exercise of stock options.

During the quarter ended June 30, 2014, the Company did not repurchase any shares pursuant to the Company's stock repurchase program.

Item 3.  Defaults Upon Senior Securities.

None.

Item 4.  Mine Safety Disclosures.

None.

Item 5.  Other Information.

The Company has made no changes to the procedures by which security holders may recommend nominees to its board of directors.


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Item 6.  Exhibits

Exhibit No.
 
Description
3.1
 
Articles of Incorporation of Old Point Financial Corporation, as amended effective June 22, 2000 (incorporated by reference to Exhibit 3.1 to Form 10-K filed March 12, 2009)
 
 
 
3.2
 
Bylaws of Old Point Financial Corporation, as amended and restated March 8, 2011 (incorporated by reference to Exhibit 3.2 to Form 8-K filed March 10, 2011)
 
 
 
 
 
 
31.1
 
Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
 
 
 
31.2
 
Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
 
 
 
32.1
 
Certification of Chief Executive Officer and Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
 
 
 
101
 
The following materials from Old Point Financial Corporation's quarterly report on Form 10-Q for the quarter ended June 30, 2014, formatted in XBRL (Extensible Business Reporting Language), filed herewith: (i) Consolidated Balance Sheets (unaudited for June 30, 2014), (ii) Consolidated Statements of Income (unaudited), (iii) Consolidated Statements of Comprehensive Income (Loss) (unaudited), (iv) Consolidated Statements of Changes in Stockholders' Equity (unaudited), (v) Consolidated Statements of Cash Flows (unaudited), and (vi) Notes to Consolidated Financial Statements (unaudited)




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.

 
 
OLD POINT FINANCIAL CORPORATION
 
 
 
 
August 12, 2014
 
/s/Robert F. Shuford, Sr.
 
 
 
Robert F. Shuford, Sr.
 
 
 
Chairman, President & Chief Executive Officer
 
 
 
(Principal Executive Officer)
 
 
 
 
 
August 12, 2014
 
/s/Laurie D. Grabow
 
 
 
Laurie D. Grabow
 
 
 
Chief Financial Officer & Senior Vice President/Finance
 
 
 
(Principal Financial & Accounting Officer)
 

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