Item 1A. Risk Factors
RISK FACTORS
In addition to the other information included in this Annual Report on Form 10-K, the following risk factors should be carefully considered in connection with evaluating our business and any forward-looking statements contained herein. Our business, financial condition, results of operations and cash flows could be harmed by any of the risk factors described below, or other risks that have not been identified or which we believe are immaterial or unlikely. If one or more of these or other risks or uncertainties materialize, or if our underlying assumptions prove to be incorrect, our business, financial condition, operating results and cash flows could be materially adversely affected.
RISKS RELATED TO OUR BUSINESS
Our profitability depends significantly on local economic conditions.
Our success depends primarily on the general economic conditions of the primary markets in Virginia in which we operate and where our loans are concentrated. Unlike nationwide banks that are more geographically diversified, the Company provides banking and financial services to customers primarily in the Lynchburg metropolitan statistical area (“MSA”). Lynchburg’s MSA, which is often referred to as Region 2000, consists of approximately 2,122 square miles, and includes the City of Lynchburg and the Counties of Bedford, Campbell, Amherst and Appomattox. To a lesser extent, our lending market includes the Roanoke, Charlottesville and Harrisonburg MSAs. Our branches in localities outside of Region 2000 have a short operating history. As of December 2021, the Lynchburg MSA had an unemployment rate (seasonally adjusted) of 2.7%, as compared to a statewide average unemployment rate of 3.3%.
The local economic conditions in these areas have a significant impact on the Company’s commercial and industrial, real estate and construction loans, the ability of its borrowers to repay their loans and the value of
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the collateral securing these loans. In addition, if the population or income growth in the Company’s market areas is slower than projected, income levels, deposits and housing starts could be adversely affected and could result in a reduction of the Company’s expansion, growth and profitability. If the Company’s market areas experience a downturn or a recession for a prolonged period of time, the Company could experience significant increases in nonperforming loans, which could lead to operating losses, impaired liquidity and eroding capital. A significant decline in general economic conditions, caused by inflation, recession, acts of terrorism, outbreaks of hostilities or other international or domestic calamities, unemployment, monetary and fiscal policies of the federal government or other factors could impact these local economic conditions and could negatively affect the Company’s financial condition, results of operations and cash flows.
The Company’s business, financial condition, liquidity and results of operations have been, and may continue to be, adversely affected by the COVID-19 pandemic.
The COVID-19 pandemic negatively impacted the local, state, national, and world economies. The pandemic created economic and financial disruptions that have adversely affected, and have the potential to continue to adversely affect, the Company's business, financial condition, liquidity and results of operations. The extent to which the COVID-19 pandemic will continue to negatively affect our business, financial condition, liquidity and results of operations will depend on future developments, which are highly uncertain and cannot be predicted, including the scope and duration of the pandemic, the continued effectiveness of the Company's business continuity plan, the direct and indirect impact of the pandemic on the Company's employees, customers, clients, and service providers, as well as other market participants, and actions taken by governmental authorities and other third parties in response to the pandemic.
The COVID-19 pandemic has contributed to or resulted in:
Employment shortages and decreased consumer confidence and business generally.
Temporary closures of many businesses and the institution of social distancing or other measurements.
Ratings downgrades, credit deterioration and some defaults in several industries, including natural resources, hospitality, transportation and commercial real estate.
Volatility in the rates and yields on U.S. Treasury securities.
Unpredictable demands on capital and liquidity.
Heightened cybersecurity, information security and operational risks as a result of work-from-home arrangements.
As a result:
The demand for our products and services could be significantly impacted, which could decrease our net interest income and adversely affect our revenue and net income.
We could have an increase in customer delinquencies and loan defaults, including defaults on unsecured loans, and further increases in our allowance for loan losses and foreclosures.
The decline in rates and yields has had a negative effect on our yields on assets which has compressed our net interest margin.
Governmental authorities took unprecedented measures to provide economic assistance to individual households and businesses, stabilize the markets and support economic growth. The consequences of these measures may not be sufficient to fully mitigate the negative impact of the COVID-19 pandemic. The Company also faces an increase in governmental and regulatory scrutiny as a result of the effects of COVID-19 on market and economic conditions and actions governmental authorities take in response to those conditions.
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The extent to which the COVID-19 pandemic continues to impact our business, results of operation, and financial condition, as well as our regulatory capital and liquidity ratios, will depend on future developments, which are highly uncertain and cannot be predicted, including the scope and duration of the pandemic and the actions taken by governmental authorities and other third parties in response to the pandemic.
The length of the pandemic and the long term consequences of the extraordinary measures being put in place to address it are unknown. Even after the pandemic subsides, the U.S. economy may experience a recession, and the Company anticipates the Company's businesses would be materially and adversely affected by a prolonged recession. To the extent the pandemic adversely affects the Company's business, financial condition, liquidity or results of operations, it may also have the effect of heightening many of the other risks described in the section.
A significant portion of our loan portfolio is secured by real estate, and events that negatively impact the real estate market could hurt our business.
A substantial majority of our loans have real estate as a primary or secondary component of collateral. The real estate collateral in each case provides an alternate source of repayment in the event of default by the borrower and may deteriorate in value during the time the credit is extended. Because most of our loans are concentrated in the Region 2000 area in and surrounding the City of Lynchburg, a decline in local economic conditions may have a greater effect on our earnings and capital than on the earnings and capital of larger financial institutions whose real estate loan portfolios are more geographically diverse. A weakening of the real estate market in our primary market areas could result in an increase in the number of borrowers who default on their loans and a reduction in the value of the collateral securing their loans, which in turn could have an adverse effect on our profitability and asset quality. If we are required to liquidate the collateral securing a loan to satisfy the debt during a period of reduced real estate values, our earnings and capital could be adversely affected. Additionally, acts of nature, including hurricanes, tornados, earthquakes, fires and floods, which may cause uninsured damage and other loss of value to real estate that secures these loans, may also negatively impact our financial condition.
Our loan portfolio contains a number of real estate loans with relatively large balances.
A significant portion of our total loan portfolio contains real estate loans with balances in excess of $1,000,000. The deterioration of one or a few of these loans could cause a significant increase in nonperforming loans, which could result in a net loss of earnings, an increase in the provision for loan losses and an increase in loan charge-offs, all of which could have a material adverse effect on our financial condition and results of operations.
Commercial real estate loans increase our exposure to credit risk.
A majority of our loan portfolio is secured by commercial real estate. Loans secured by commercial real estate are generally viewed as having more risk of default than loans secured by residential real estate or consumer loans because repayment of the loans often depends on the successful operation of the property, the income stream of the borrowers, the accuracy of the estimate of the property’s value at completion of construction and the estimated cost of construction. An adverse development with respect to one lending relationship can expose us to a significantly greater risk of loss as compared with a single-family residential mortgage loan because we typically have more than one loan with such borrowers. Additionally, these loans typically involve larger loan balances to single borrowers or groups of related borrowers compared with single-family residential mortgage loans. Therefore, the deterioration of one or a few of these loans could cause a significant decline in the related asset quality. These loans represent higher risk and could result in a sharp increase in loans charged-off and could require us to significantly increase our allowance for loan losses, which could have a material adverse impact on our business, financial condition, results of operations and cash flows.
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A percentage of the loans in our portfolio currently include exceptions to our loan policies and supervisory guidelines.
All of the loans that we make are subject to written loan policies adopted by our board of directors and to supervisory guidelines imposed by our regulators. Our loan policies are designed to reduce the risks associated with the loans that we make by requiring our loan officers to take certain steps that vary depending on the type and amount of the loan, prior to closing a loan. These steps include, among other things, making sure the proper liens are documented and perfected on property securing a loan, and requiring proof of adequate insurance coverage on property securing loans. Loans that do not fully comply with our loan policies are known as “exceptions.” We categorize exceptions as policy exceptions, financial statement exceptions and document exceptions. As a result of these exceptions, such loans may have a higher risk of loan loss than the other loans in our portfolio that fully comply with our loan policies. In addition, we may be subject to regulatory action by federal or state banking authorities if they believe the number of exceptions in our loan portfolio represents an unsafe banking practice.
As a community bank, we have different lending risks than larger banks. We provide services to individuals and small to medium-sized businesses in our local markets who may have fewer financial resources to weather a downturn in the economy.
Our ability to diversify our economic risks is limited by our own local markets and economies. We lend primarily to small to medium-sized businesses, professionals and individuals, which may expose us to greater lending risks than those of banks lending to larger, better-capitalized businesses with longer operating histories. For instance, small to medium-sized businesses frequently have smaller market share than their competition, may be more vulnerable to economic downturns, have fewer financial resources in terms of capital or borrowing capacity than larger entities, often need substantial additional capital to expand or compete and may experience significant volatility in operating results. Any one or more of these factors may impair the borrower’s ability to repay a loan. In addition, the success of a small to medium-sized business often depends on the management talents and efforts of one or two persons or a small group of persons, and the death, disability or resignation of one or more of these persons could have a material adverse impact on the business and its ability to repay a loan. Economic downturns and other events that negatively impact the Company’s market areas could cause the Company to incur substantial credit losses that could negatively affect the Company’s results of operations and financial condition.
We depend on the accuracy and completeness of information about clients and counterparties, and our financial condition could be adversely affected if we rely on misleading information.
In deciding whether to extend credit or to enter into other transactions with clients and counterparties, we may rely on information furnished to us by or on behalf of clients and counterparties, including financial statements and other financial information, which we do not independently verify as a matter of course. We also may rely on representations of clients and counterparties as to the accuracy and completeness of that information and, with respect to financial statements, on reports of independent auditors. For example, in deciding whether to extend credit to customers, we may assume that a customer’s audited financial statements conform with U.S. Generally Accepted Accounting Principles (“GAAP”) and present fairly, in all material respects, the financial condition, results of operations and cash flows of the customer. Our financial condition and results of operations could be negatively impacted to the extent we rely on financial statements that do not comply with GAAP or are materially misleading.
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If we suffer loan losses from a decline in credit quality, our earnings will decrease.
We could sustain losses if borrowers, guarantors or related parties fail to perform in accordance with the terms of their loans. We have adopted underwriting and credit monitoring procedures and policies, including the establishment and review of the allowance for loan losses, that we believe are appropriate to minimize this risk by assessing the likelihood of nonperformance, tracking loan performance and diversifying our credit portfolio. These policies and procedures, however, may not prevent unexpected losses that could materially adversely affect our results of operations.
These policies and procedures necessarily rely on our making various assumptions and judgments about the collectability of our loan portfolio, including the creditworthiness of our borrowers and the value of the real estate and other assets serving as collateral for the repayment of many of our loans. In determining the amount of the allowance for loan losses, we review our loans and our loss and delinquency experience, and we evaluate economic conditions. If our assumptions are incorrect, our allowance for loan losses may not be sufficient to cover probable incurred losses in our loan portfolio, resulting in additions to our allowance. Any future additions to our allowance could materially decrease our net income.
In addition, the Federal Reserve Bank of Richmond and the Virginia Bureau of Financial Institutions (the “BFI”) periodically review our allowance for loan losses and may require us to increase our provision for loan losses or recognize further loan charge-offs. Any increase in our allowance for loan losses or loan charge-offs as required by regulatory authorities might have a material adverse effect on our financial condition and results of operations.
Our allowance may not be adequate to cover actual loan losses.
A significant source of risk arises from the possibility that we could sustain losses due to loan defaults and nonperformance on loans. We maintain an allowance in accordance with GAAP to provide for such defaults and other nonperformance. As of December 31, 2021, our allowance as a percentage of total loans was 1.19% and our allowance as a percentage of nonperforming loans was 724.84%. The determination of the appropriate level of allowance is an inherently difficult process and is based on numerous assumptions. The amount of future losses is susceptible to changes in economic, operating and other conditions, including changes in interest rates, many of which are beyond our control. In addition, our underwriting policies, adherence to credit monitoring processes and risk management systems and controls may not prevent unexpected losses. Our allowance may not be adequate to cover actual loan losses. Moreover, any increase in our allowance will adversely affect our earnings by decreasing our net income.
In June 2016, the Financial Accounting Standards Board decided to change how banks estimate losses in the allowance calculation, and it issued ASU 2016-13, Financial Instruments-Credit Losses. Currently, the impairment model is based on incurred losses, and loans are recognized as impaired when there is no longer an assumption that future cash flows will be collected in full under the originally contracted terms. This model will be replaced by the new Current Expected Credit Losses (“CECL”) model that will become effective for us, as a smaller reporting company, for the first interim and annual reporting periods beginning after December 15, 2022. Under the new CECL model, we will be required to use historical information, current conditions and reasonable and supportable forecasts to estimate the expected loss over the life of the loan. The transition to the CECL model will bring with it significantly greater data requirements and changes to methodologies to accurately account for expected losses under the new parameters.
Management is currently evaluating the impact of these changes to our financial position and results of operations. The allowance is a material estimate of ours, and given the change from an incurred loss model to a methodology that considers the credit loss over the life of the loan, there is the potential for an increase in the allowance at adoption date. We anticipate a significant change in the processes and procedures to calculate the
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allowance, including changes in assumptions and estimates to consider expected credit losses over the life of the loan versus the current accounting practice that utilizes the incurred loss model. We expect to continue developing and implementing processes and procedures to ensure we are fully compliant with the CECL requirements at its adoption date.
The markets for our deposit and lending products and services are highly competitive, and we face substantial competition.
The banking and financial services industry is highly competitive. We compete as a financial intermediary with other commercial banks, savings banks, credit unions, finance companies, mutual funds, insurance companies and brokerage and investment banking firms soliciting business from residents of and businesses located in the Virginia localities where the Bank has a presence, surrounding areas and elsewhere. Many of these competing institutions have nationwide or regional operations and have greater resources than we have. We also face competition from local community institutions. Many of our competitors enjoy competitive advantages, including greater name recognition, financial resources, a wider geographic presence or more accessible branch office locations, the ability to offer additional services, greater marketing resources, more favorable pricing alternatives for loans and deposits and lower origination and operating costs. We are also subject to lower lending limits than our larger competitors. Our profitability depends upon our continued ability to successfully compete in our market areas. Increased deposit competition could increase our cost of funds and could adversely affect our ability to generate the funds necessary for our lending operations. If we must raise interest rates paid on deposits or lower interest rates charged on our loans, our net interest margin and profitability could be adversely affected. Competition could result in a decrease in loans we originate and could negatively affect our ability to grow and our results of operations.
Technology has lowered barriers to entry and made it possible for non-banks to offer products and services traditionally provided by banks, such as automatic transfer and automatic payment systems. Many of our competitors have fewer regulatory constraints and may have lower cost structures. Additionally, due to their size, many competitors may be able to achieve economies of scale and, as a result, may offer a broader range of products and services as well as better pricing for those products and services.
We have increased and plan to continue to increase our levels of commercial and industrial loans. We may not be successful in continuing to penetrate this market segment, which has helped to drive some of our recent earnings.
A significant percentage of our loans are commercial and industrial loans. Our portfolio of commercial and industrial loans has increased during the past year.
While we intend to originate these types of loans in a manner that is consistent with safety and soundness, these non-residential loans generally expose us to greater risk of loss than one- to four-family residential mortgage loans, as repayment of such commercial and industrial loans generally depends, in large part, on the borrower’s business to cover operating expenses and debt service. In addition, these types of loans typically involve larger loan balances to single borrowers or groups of related borrowers, as compared to one- to four-family residential mortgage loans. Changes in economic conditions that are beyond our or the borrower’s control could adversely affect the value of the security for the loan, including the future cash flow of the affected business. As we increase our portfolio of these loans, we may experience higher levels of non-performing assets or loan losses, or both.
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Our plans for future expansion depend, in some instances, on factors beyond our control, and an unsuccessful attempt to achieve growth could have a material adverse effect on our business, financial condition, results of operations and future prospects.
We expect to continue to engage in new branch expansion in the future. We may also seek to acquire other financial institutions, or parts of those institutions, though we have no present plans in that regard. Expansion involves a number of risks, including, without limitation:
the time and costs of evaluating new markets, hiring experienced local management and opening new offices;
the time lags between these activities and the generation of sufficient assets and deposits to support the costs of the expansion;
our entrance into new markets where we lack experience;
the introduction of new products and services with which we have no prior experience into our business;
failure to culturally integrate an acquisition target or new branches or failing to identify and select the optimal candidate for integration or expansion; and
failure to identify and retain experienced key management members with local expertise and relationships in new markets.
We may acquire and hold other real estate owned (OREO) properties, which could lead to increased operating expenses and vulnerability to declines in the market value of real estate in our areas of operations.
From time-to-time, we foreclose upon and take title to the real estate serving as collateral for our loans as part of our business. If our OREO balance increases, management expects that our earnings will be negatively affected by various expenses associated with OREO, including personnel costs, insurance and taxes, completion and repair costs, valuation adjustments and other expenses associated with property ownership. Also, at the time that we foreclose upon a loan and take possession of a property, we estimate the value of that property using third-party appraisals and opinions and internal judgments. OREO property is valued on our books at the estimated market value of the property, less the estimated costs to sell (or “fair value”). Upon foreclosure, a charge-off to the allowance for loan losses is recorded for any excess between the value of the asset on our books over its fair value. Thereafter, we periodically reassess our judgment of fair value based on updated appraisals or other factors, including, at times, at the request of our regulators. Any declines in our estimate of fair value for OREO will result in valuation adjustments, with a corresponding expense in our consolidated statements of income that is recorded under the line item for “Other real estate expenses.” As a result, our results of operations are vulnerable to declines in the market for residential and commercial real estate in the areas in which we operate. The expenses associated with OREO and property write downs could have a material adverse effect on our results of operations and financial condition. Any increase in non-accrual loans may lead to increases in our OREO balance in the future.
Additional growth and regulatory requirements may require us to raise additional capital in the future, and capital may not be available when it is needed or may have unfavorable terms, which could adversely affect our financial condition and results of operations.
We are required by federal and state regulatory authorities to maintain adequate levels of capital to support our operations. While the boards of the Company and the Bank intend to take steps to ensure that the capital plan aligns with the Bank’s strategic plan, that all material risks to the Bank are identified and measured and that capital limits are appropriate for the institution’s risk profile, failure to successfully implement such steps could have a material adverse effect on our financial condition and results of operations. We may at some point need to raise additional capital to support our continued growth. Our ability to raise additional capital, if needed, will depend on conditions in the capital markets at that time, which are outside of our control, and on
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our financial performance. Accordingly, we can make no assurances of our ability to raise additional capital, if needed, on terms acceptable to us. If we cannot raise additional capital when needed, our ability to further expand our operations could be materially impaired.
Our corporate culture has contributed to our success, and if we cannot maintain this culture as we grow, we could lose the teamwork and increased productivity fostered by our culture, which could harm our business.
We believe that a critical contributor to our success has been our corporate culture, which we believe fosters teamwork and increased productivity. As our organization grows and we are required to implement more complex organizational management structures, we may find it increasingly difficult to maintain the beneficial aspects of our corporate culture. This could negatively impact our future success.
If we fail to retain our key employees, our growth and profitability could be adversely affected.
Our success is, and is expected to remain, highly dependent on our executive management team. We are especially dependent on these executives as well as other key personnel because, as a community bank, we depend on our management team’s ties to the community to generate business for us, and our executives have key expertise needed to implement our business strategy. Our executive management and other key personnel have not signed non-competition covenants.
Competition for personnel is intense, and we may not be successful in attracting or retaining qualified personnel. Our failure to compete for these personnel, or the loss of the services of several of such key personnel, could adversely affect our growth strategy and seriously harm our business, results of operations and financial condition.
Severe weather, natural disasters, widespread disease or pandemics (including the COVID-19 pandemic), acts of war or terrorism or other adverse external events could significantly impact our business.
Severe weather, natural disasters, widespread disease or pandemics (including the COVID-19 pandemic), acts of war or terrorism or other adverse external events could have a significant impact on our ability to conduct business. In addition, such events could affect the stability of our deposit base, impair the ability of borrowers to repay outstanding loans, impair the value of collateral securing loans, cause significant property damage, result in loss of revenue or cause us to incur additional expenses. The occurrence of any of these events in the future could have a material adverse effect on our business, financial condition, results of operations and growth prospects.
As a community bank, our ability to maintain our reputation is critical to the success of our business, and our failure to do so may materially adversely affect our performance.
As a community bank, our reputation is one of the most valuable components of our business. As such, we strive to conduct our business in a manner that enhances our reputation. This is done, in part, by recruiting, hiring and retaining employees who share our core values of being an integral part of the communities we serve, delivering superior service to our customers and caring about our customers and associates. Negative publicity can result from our actual or alleged conduct in any number of activities, including lending practices, corporate governance, acquisitions and actions taken or threatened by government regulators and community organizations in response to those activities. If our reputation is negatively affected by the actions of our employees or otherwise, there may be an adverse effect on our ability to keep and attract customers, and we might be exposed to litigation and regulatory action. Any of such events could harm our business, and, therefore, our operating results may be materially adversely affected. As a financial services company with a high profile in our market area, we are inherently exposed to this risk. While we take steps to minimize reputation risk in dealing with customers and other constituencies, we will continue to face additional
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challenges maintaining our reputation with respect to customers of the Bank in our current primary market area in Region 2000 and in establishing our reputation in new market areas.
Our decisions regarding how we manage our credit exposure may materially and adversely affect our business.
We manage our credit exposure through careful monitoring of lending relationships and loan concentrations in particular industries, and through loan approval and review procedures.
We have established an evaluation process designed to determine the adequacy of our allowance for loan losses. While this evaluation process uses historical and other objective information, the classification of loans and the establishment of loan losses is an estimate based on experience, judgment and expectations regarding our borrowers and the economies in which we and our borrowers operate, as well as the judgment of our regulators. While our board and senior management are continuing to improve the Bank’s risk management framework and align the Bank’s risk philosophy with its capital and strategic plans, failure to continue to improve such risk management framework could have a material adverse effect on our financial condition and results of operations. We can make no assurances that our loan loss reserves will be sufficient to absorb future loan losses or prevent a material adverse effect on our business, financial condition or results of operations.
Our profitability is vulnerable to interest rate fluctuations and changes in monetary policies.
Our profitability depends substantially upon our net interest income. Net interest income is the difference between the interest earned on interest-earning assets, such as loans and investment securities, and the interest expense paid on interest-bearing liabilities, such as NOW accounts, savings accounts, time deposits and other borrowings. Market interest rates for loans, investments and deposits are highly sensitive to many factors beyond our control. Interest rate spreads have seen a sustained period of narrowness due to many factors, such as market conditions, policies of various government and regulatory authorities and competitive pricing pressures, and we cannot predict whether these rate spreads will narrow further. This narrowing of interest rate spreads could adversely affect our financial condition and results of operations. In addition, we cannot predict whether interest rates will continue to remain at present levels. Changes in interest rates may cause significant changes, up or down, in our net interest income. Depending on our portfolio of loans and investments, our results of operations may be adversely affected by changes in interest rates.
Our financial condition and results of operations are affected by credit policies of monetary authorities, particularly the Federal Reserve Board. Actions by monetary and fiscal authorities, including the Federal Reserve Board, could have an adverse effect on our deposit levels, loan demand or business and earnings.
A failure in or breach of our operational or security systems or infrastructure, or those of our third party vendors and other service providers, including as a result of cyber-attacks, could disrupt our business, result in the disclosure or misuse of confidential or proprietary information, damage our reputation, increase our costs and cause losses.
We rely heavily on communications and information systems to conduct our business. Any failure, interruption or breach in security of these systems could result in failures or disruptions in our customer-relationship management, general ledger, deposit, loan and other systems. While we have policies and procedures designed to prevent or limit the effect of the failure, interruption or security breach of our information systems, there can be no assurance that any such failures, interruptions or security breaches will not occur; or, if they do occur, that they will be adequately addressed. The occurrence of any failures, interruptions or security breaches of our information systems could disrupt our business, increase our costs, result in the disclosure of confidential client information, damage our reputation, result in a loss of customer business,
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subject us to additional regulatory scrutiny or expose us to civil litigation and possible financial liability; any of which could have a material adverse effect on our financial condition and results of operations.
Our computer systems, software and networks have been and will continue to be vulnerable to unauthorized access, loss or destruction of data (including confidential client information), account takeovers, unavailability of service, computer viruses or other malicious code, cyber-attacks and other events. These threats may derive from human error, fraud or malice on the part of employees or third parties, or may result from accidental technological failure. Information security risks for financial institutions such as ours have generally increased in recent years in part because of the proliferation of new technologies, the use of the Internet and digital technologies to conduct financial transactions, and the increased sophistication and activities of organized crime, hackers, terrorists, activists and other external parties. Some of our operations rely on the secure processing, transmission and storage of confidential information in our computer systems and networks. Our business relies on our digital technologies, computer and email systems, software and networks to conduct its operations. In addition, to access our products and services, our customers may use personal smartphones, tablets, personal computers and other mobile devices that are beyond our control systems. Although we have information security procedures and controls in place, our technologies, systems, networks and our customers’ devices may become the target of cyber-attacks or information security breaches that could result in the unauthorized release, gathering, monitoring, misuse, loss or destruction of our or our customers’ confidential, proprietary and other information, or otherwise disrupt our or our customers’ or other third parties’ business operations.
Although we maintain safeguards to protect against these risks, there can be no assurance that we will not suffer losses in the future that may be material in amount or nature.
Changes in consumers’ use of banks and changes in consumers’ spending and saving habits could adversely affect our financial results.
Technology and other changes now allow many consumers to complete financial transactions without using banks. For example, consumers can pay bills and transfer funds directly without going through a bank. This disintermediation could result in the loss of fee income, as well as the loss of customer deposits and income generated from those deposits. In addition, changes in consumer spending and saving habits could adversely affect our operations, and we may be unable to timely develop competitive new products and services in response to these changes that are accepted by new and existing customers.
Failure to implement new technologies in our operations may adversely affect our growth or profits.
The market for financial services, including banking services and consumer finance services, is increasingly affected by advances in technology, including developments in telecommunications, data processing, computers, automation, Internet-based banking and telebanking. Our ability to compete successfully in our markets may depend on the extent to which we are able to exploit such technological changes. However, we can provide no assurance that we will be able to properly or timely anticipate or implement such technologies or properly train our staff to use such technologies. Any failure to adapt to new technologies could adversely affect our business, financial condition or operating results.
In addition, the financial services industry is undergoing rapid technological changes, with new technology-driven products and services being frequently introduced. The changes could cause our customers to use these new services and products rather than the Bank. For example, financial technology (or “fintech”) companies that rely on technology to provide financial services such as peer-to-peer platforms, blockchain and other distributed ledger technologies have the potential to disrupt the financial services industry and change the way banks do business. Fintech companies are subject to limited regulation. We may not be able to effectively
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implement new technology-driven products and services or be successful in competing against products, which could impair our growth and profitability.
We are subject to operational risks.
The Company may also be subject to disruptions of its systems arising from events that are wholly or partially beyond our control (including, for example, computer viruses or electrical or telecommunications outages), which may give rise to losses in service to customers and to financial loss or liability. The Company is further exposed to the risk that its external vendors may be unable to fulfill their contractual obligations (or will be subject to the same risk of fraud or operational errors by their respective employees as is the Company) and to the risk that the Company’s (or its vendors’) business continuity and data security systems prove to be inadequate.
We are subject to liquidity risk.
Liquidity risk is the potential that we will be unable to meet our obligations as they become due, capitalize on growth opportunities as they arise or pay regular cash dividends because of an inability to liquidate assets or obtain adequate funding in a timely basis, at a reasonable cost and within acceptable risk tolerances. A failure to adequately manage our liquidity risk could adversely affect our business, financial condition or operating results, especially in the event of another financial crisis. Further, the Federal Reserve could impose additional requirements on the Company if the agency determines that our enhanced liquidity risk management practices do not adequately manage our liquidity risk.
We may lose lower-cost funding sources.
Checking, savings and money market deposit account balances and other forms of customer deposits can decrease when customers perceive alternative investments, such as the stock market, as providing a better risk/return tradeoff. If customers move money out of bank deposits and into other investments, the Bank could lose a relatively low-cost source of funds, thereby increasing its funding costs and reducing the Bank’s net interest income and net income.
If we fail to maintain an effective system of internal and disclosure controls, we may not be able to accurately report our financial results or prevent or detect fraud.
Effective internal control over financial reporting and disclosure controls and procedures are necessary for us to provide reliable financial reports and effectively prevent or detect fraud and to operate successfully as a public company.
The Company faces the risk that the design of its controls and procedures, including those to mitigate the risk of fraud by employees or outsiders, may prove to be inadequate or are circumvented, thereby causing delays in detection of errors or inaccuracies in data and information. We regularly review and update the Company’s internal controls, disclosure controls and procedures and corporate governance policies and procedures. Any system of controls, however well designed and operated, is based in part on certain assumptions and can provide only reasonable, not absolute, assurances that the objectives of the system are met. Any failure or circumvention of the Company’s controls and procedures or failure to comply with regulations related to controls and procedures could have a material adverse effect on the Company’s business, results of operations and financial condition.
Any failure to maintain effective controls or timely effect any necessary improvement of our internal and disclosure controls could hinder our ability to accurately report our operating results or cause us to fail to meet our reporting obligations, which could affect our ability to remain listed with The NASDAQ Capital
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Market. Ineffective internal and disclosure controls could also harm our reputation, negatively impact our operating results or cause investors to lose confidence in our reported financial information, which likely would have a negative effect on the trading price of our securities.
Changes in the financial markets could impair the value of our investment portfolio.
Our investment securities portfolio is a significant component of our total earning assets. Turmoil in the financial markets could impair the market value of our investment portfolio, which could adversely affect our net income and possibly our capital.
From time to time, we hold as investments certain securities that have unrealized losses. While we currently maintain substantial liquidity which supports our intent and ability to hold these investments until they mature, or until there is a market price recovery, if we were to cease to have the ability and intent to hold these investments until maturity or if the market prices do not recover, and we were to sell these securities at a loss, it could adversely affect our net income and possibly our capital.
Our deposit insurance premiums could be substantially higher in the future, which could have a material adverse effect on our future earnings.
The FDIC insures deposits at FDIC-insured depository institutions, such as the Bank, up to applicable limits. The amount of a particular institution’s deposit insurance assessment is based on that institution’s risk classification under an FDIC risk-based assessment system. An institution’s risk classification is assigned based on its capital levels and the level of supervisory concern the institution poses to its regulators. Bank failures significantly depleted the FDIC’s Deposit Insurance Fund and reduced the ratio of reserves to insured deposits. As a result of recent economic conditions and the enactment of the Dodd-Frank Reform Act, banks are now assessed deposit insurance premiums based on the bank’s average consolidated total assets, and the FDIC has modified certain risk-based adjustments, which increase or decrease a bank’s overall assessment rate. This has resulted in increases to the deposit insurance assessment rates, and thus raised deposit premiums for many insured depository institutions. If these increases are insufficient for the Deposit Insurance Fund to meet its funding requirements, further special assessments or increases in deposit insurance premiums may be required. We are generally unable to control the amount of premiums that we are required to pay for FDIC insurance. If there are additional bank or financial institution failures, we may be required to pay even higher FDIC premiums than the recently increased levels. Any future additional assessments, increases or required prepayments in FDIC insurance premiums could reduce our profitability, may limit our ability to pursue certain business opportunities or otherwise negatively impact our operations.
Revenues and profitability from our investment advisory business may be adversely affected by any reduction in assets under management, which could reduce fees earned.
PWW, our investment advisory business derives the majority of its revenue from non-interest income, which primarily consists of investment advisory fees. Substantially all of PWW’s revenues are generated from investment management contracts with clients. Under these contracts, the investment advisory fees paid to us are typically based on the market value of assets under management. Assets under management may decline for various reasons including declines in the market value of the assets, which could be caused by price declines in the securities markets. Assets under management may also decrease due to redemptions and other withdrawals by clients or termination of contracts. This could be in response to adverse market conditions or in pursuit of other investment opportunities. If the assets under management we supervise decline and there is a related decrease in fees, it will negatively affect our results of operations.
We may not be able to attract and retain investment advisory clients.
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Due to strong competition, our investment advisory business may not be able to attract and retain clients. Competition is strong because there are numerous well-established and successful investment management and wealth advisory firms including commercial banks and trust companies, investment advisory firms, mutual fund companies, stock brokerage firms, and other financial companies. Many of our competitors have greater resources than we have. Our ability to successfully attract and retain investment advisory clients is dependent upon our ability to compete with competitors' investment products, level of investment performance, client services and marketing and distribution capabilities. If we are not successful, our results of operations and financial condition may be negatively impacted.
The investment advisory industry is subject to extensive regulation, supervision and examination by regulators, and any enforcement action or adverse changes in the laws or regulations governing our business could decrease our revenues and profitability.
As an investment advisor registered with the Securities and Exchange Commission, PWW is subject to regulation by a number of regulatory agencies that are charged with safeguarding the integrity of the securities and other financial markets and with protecting the interests of customers participating in those markets. In the event of non-compliance with regulation, governmental regulators, including the SEC, and the Financial Industry Regulatory Authority, may institute administrative or judicial proceedings that may result in censure, fines, civil penalties, the issuance of cease-and-desist orders or the deregistration or suspension of the non-compliant broker-dealer or investment adviser or other adverse consequences. The imposition of any such penalties or orders could have a material adverse effect on the wealth management segment's operating results and financial condition. We may be adversely affected as a result of new or revised legislation or regulations. Regulatory changes have imposed and may continue to impose additional costs, which could adversely impact our profitability.
If we fail to retain PWW’s key employees, the growth and profitability of our investment advisory business could be adversely affected.
PWW’s success is, and is expected to remain, highly dependent on its executive management team as well as other key personnel because of their role in, among other things, making investment decisions for PWW clients and managing client relations. Although each of the foregoing are subject to non-compete agreements, there are no assurances that these key personnel will remain employees of PWW.
Competition for investment advisory personnel is intense, and we may not be successful in attracting or retaining qualified personnel. Our failure to compete for these personnel, or the loss of the services of several of such key personnel, could adversely affect our growth strategy and seriously harm our business, results of operations and financial condition.
REGULATORY AND LEGAL RISKS
We are subject to extensive regulation that could limit or restrict our activities and impose financial requirements or limitations on the conduct of our business, which limitations or restrictions could adversely affect our profitability.
As a bank holding company, we are primarily regulated by the Federal Reserve. The Bank is primarily regulated by the BFI and the Federal Reserve. These regulatory authorities have extensive discretion in connection with their supervisory and enforcement activities, including the imposition of restrictions on the operation of a financial institution, the classification of assets by a financial institution and the adequacy of a financial institution’s allowance for loan losses. The Company periodically reviews its policies, procedures and limits, and undertakes reporting, to ensure all guidance is appropriate for the Bank’s current and planned operations and aligns with regulatory expectations. In this regard, regulatory authorities may impose particular
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requirements on the Bank, which could have a material adverse effect on our results of operations. Any change in such regulation and regulatory oversight, whether in the form of regulatory policy, regulations or legislation, could have a material impact on us and our operations. Further, our compliance with Federal Reserve and the BFI regulations is costly. Because our business is highly regulated, the applicable laws, rules and regulations are subject to regular modification and change. Laws, rules and regulations may be adopted in the future that could make compliance more difficult or expensive or otherwise adversely affect our business, financial condition or prospects. For instance, such changes may limit our growth and restrict certain of our activities, including payment of dividends, mergers and acquisitions, investments, loans and interest rates charged, interest rates paid on deposits and locations of offices. We are also subject to capital requirements by our regulators.
The laws and regulations, including the Dodd-Frank Reform Act, applicable to the banking industry could change at any time, and these changes may adversely affect our business and profitability.
We are subject to extensive federal and state regulation. Because government regulation greatly affects the business and financial results of all commercial banks and bank holding companies, our cost of compliance could adversely affect our ability to operate profitably. The increased scope, complexity, and cost of corporate governance, reporting, and disclosure practices are proportionately higher for a company of our size and will affect our profitability more than that of some of our larger competitors. We expect to experience increasing compliance costs related to this supervision and regulation.
Also, the 2020 national election results and new administration have introduced additional uncertainty into future implementation and enforcement of the Dodd-Frank Reform Act and other financial sector regulatory requirements. Such additional regulation and supervision may increase our costs and limit our ability to pursue business opportunities. The effects of any such recently enacted, or proposed, legislation and regulatory programs on us cannot reliably be determined at this time.
The Consumer Financial Protection Bureau’s (the “CFPB”) “ability-to-repay” and “qualified mortgage” rules may have a negative impact on our loan origination process and foreclosure proceedings, which could adversely affect our business, operating results and financial condition.
On January 10, 2013, the CFPB issued a final rule to implement the “qualified mortgage” provisions of the Dodd-Frank Reform Act requiring mortgage lenders to consider consumers’ ability to repay home loans before extending them credit. The CFPB’s “qualified mortgage” rule, which became effective on January 10, 2014, describes certain minimum requirements for lenders making ability-to-repay determinations, but does not dictate that they follow particular underwriting models. Lenders will be presumed to have complied with the ability-to-repay rule if they issue “qualified mortgages,” which are generally defined as mortgage loans prohibiting or limiting certain risky features. Loans that do not meet the ability-to-repay standard can be challenged in court by borrowers who default, and the absence of ability-to-repay status can be used against a lender in foreclosure proceedings. Any loans that we make outside of the “qualified mortgage” criteria could expose us to an increased risk of liability and reduce or delay our ability to foreclose upon the underlying property. Any decreases in loan origination volume or increases in compliance and foreclosure costs caused by the rule could negatively affect our business, operating results and financial condition. The CFPB also has adopted a number of additional requirements and issued additional guidance, including with respect to appraisals, escrow accounts and servicing, each of which entails increased compliance costs. In addition, the CFPB likely will continue to make rules relating to consumer protection, and it is difficult to predict which of our products and services will be subject to these rules or how these rules will be implemented.
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Compliance with the Dodd-Frank Reform Act will increase our regulatory compliance burdens, and may increase our operating costs and may adversely impact our earnings or capital ratios, or both.
Signed into law on July 21, 2010, the Dodd-Frank Reform Act has represented a significant overhaul of many aspects of the regulation of the financial services industry. Among other things, the Dodd-Frank Reform Act created the CFPB, tightened capital standards, imposed clearing and margining requirements on many derivatives activities and generally increased oversight and regulation of financial institutions and financial activities.
In addition to the self-implementing provisions of the statute, the Dodd-Frank Reform Act calls for over 200 administrative rulemakings by numerous federal agencies to implement various parts of the legislation. While many rules have been finalized or issued in proposed form, additional rules have yet to be proposed. It is not possible at this time to predict when all such additional rules will be issued or finalized, and what the content of such rules will be. We will have to apply resources to ensure that we are in compliance with all applicable provisions of the Dodd-Frank Reform Act and any implementing rules, which may increase our costs of operations and adversely impact our earnings or capital, or both.
The Dodd-Frank Reform Act and any implementing rules that are ultimately issued could have adverse implications on the financial industry, the competitive environment and our ability to conduct business.
The short-term and long-term impact of regulatory capital requirements and capital rules is uncertain.
Under the capital standards, in order to be well-capitalized, the Bank is required to have a common equity to Tier 1 capital ratio of 6.5% and a Tier 1 capital ratio of 8.0%. The application of more stringent capital requirements for the Bank could, among other things, result in lower returns on invested capital, require the raising of additional capital and result in regulatory actions if we were to be unable to comply with such requirements. Furthermore, the imposition of liquidity requirements in connection with the implementation of Basel III could result in our having to lengthen the term of our funding, restructure our business models or increase our holdings of liquid assets, or all or any combination of the foregoing. Implementation of changes to asset risk weightings for risk based capital calculations, items included or deducted in calculating regulatory capital or additional capital conservation buffers, or both, could result in management modifying its business strategy, and could limit our ability to make distributions, including paying out dividends or buying back shares.
Pursuant to the Regulatory Relief Act, on September 17, 2019, the federal banking agencies adopted a final rule regarding a community bank leverage ratio. Under the final rule, which was effective on January 1, 2021, depository institutions and depository institution holding companies that have less than $10 billion in total consolidated assets and meet other qualifying criteria, including a leverage ratio (equal to tier 1 capital divided by average total consolidated assets) of greater than 9 percent, will be eligible to opt into the community bank leverage ratio framework (qualifying community banking organizations). Qualifying community banking organizations that elect to use the community bank leverage ratio framework and that maintain a leverage ratio of greater than 9 percent will be considered to have satisfied the generally applicable risk-based and leverage capital requirements in the agencies’ capital rules (generally applicable rule) and, if applicable, will be considered to have met the well-capitalized ratio requirements for purposes of section 38 of the Federal Deposit Insurance Act. At this point the Bank has chosen not to opt in to the community bank leverage ratio framework.
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RISKS RELATED TO OUR STOCK
Our ability to pay cash dividends is limited, and we may be unable to pay future dividends even if we desire to do so.
The Company is a legal entity, separate and distinct from the Bank. The Company currently does not have any significant sources of revenue other than cash dividends paid to it by the Bank. Both the Company and the Bank are subject to laws and regulations that limit the payment of cash dividends, including requirements to maintain capital at or above regulatory minimums. As a bank that is a member of the Federal Reserve System, the Bank must obtain prior written approval for any cash dividend if the total of all dividends declared in any calendar year would exceed the total of its net profits for that year combined with its retained net profits for the preceding two years.
Banking regulators have indicated that Virginia banking organizations should generally pay dividends only (1) from net undivided profits of the bank, after providing for all expenses, losses, interest and taxes accrued or due by the bank and (2) if the prospective rate of earnings retention appears consistent with the organization’s capital needs, asset quality and overall financial condition. In addition, the FDIA prohibits insured depository institutions such as the Bank from making capital distributions, including the payment of dividends, if, after making such distribution, the institution would become undercapitalized as defined in the statute. Moreover, the Federal Reserve is authorized to determine under certain circumstances relating to the financial condition of a bank that the payment of dividends would be an unsafe and unsound practice and to prohibit payment thereof. The payment of dividends that deplete a bank’s capital base could be deemed to constitute such an unsafe and unsound banking practice. The Federal Reserve has indicated that banking organizations generally pay dividends only out of current operating earnings. The Bank may be prohibited under Virginia law from the payment of dividends, including in the event the BFI determines that a limitation of dividends is in the public interest and is necessary to ensure the Bank’s financial soundness.
In addition, the Bank’s ability to pay dividends will be limited if the Bank does not have the capital conservation buffer required by the capital rules, which may limit the Company’s ability to pay dividends to stockholders.
If the Bank is not permitted to pay cash dividends to the Company, it is unlikely that the Company would be able to pay cash dividends on our common stock. Moreover, holders of our common stock are entitled to receive dividends only when and if declared by our board of directors. Although we currently pay cash dividends on our common stock, we are not required to do so and our board of directors could reduce or eliminate the amount of our common stock dividends in the future.
A limited market exists for our common stock.
Our common stock commenced trading on The NASDAQ Capital Market on January 25, 2012, and trading volumes since that time have been relatively low as compared to other larger financial services companies. The limited trading market for our common stock may cause fluctuations in the market value of our common stock to be exaggerated, leading to price volatility in excess of that which would occur in a more active trading market. Accordingly, holders of our common stock may have difficulty selling our common stock at prices which holders find acceptable or which accurately reflect the value of the Company.
Future offerings of debt or other securities may adversely affect the market price of our stock.
In the future, we may attempt to increase our capital resources or, if our or the Bank’s capital ratios fall below the required minimums, we or the Bank could be forced to raise additional capital by making additional offerings of debt or preferred equity securities, including medium-term notes, trust preferred securities, senior
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or subordinated notes and preferred stock. Upon liquidation, holders of any debt securities and shares of preferred stock and lenders with respect to other borrowings will receive distributions of our available assets prior to the holders of our common stock.
Our stockholders may experience dilution due to our issuance(s) of additional securities in the future.
We may in the future issue additional shares of our common stock to raise cash for operations or to fund acquisitions, to provide equity-based incentives to our management and employees, to permit our stockholders to invest cash dividends and optional cash payments in shares of our common stock or as consideration in acquisition transactions. Additional equity offerings and issuance(s) of additional shares of our common stock may dilute the holdings of our existing stockholders or reduce the market price of our common stock, or both. No assurances can be given that the Company will not issue additional securities that will have the effect of diluting the equity interest of our stockholders. Holders of our common stock are not entitled to preemptive rights or other protections against dilution.
Virginia law and the provisions of our articles of incorporation and bylaws could deter or prevent takeover attempts by a potential purchaser of our common stock that would be willing to pay holders a premium for their shares of our common stock.
Our articles of incorporation and bylaws contain provisions that may be deemed to have the effect of discouraging or delaying uninvited attempts by third parties to gain control of us. These provisions include the division of our board of directors into classes with staggered terms, the ability of our board of directors to set the price, terms and rights of, and to issue, one or more series of our preferred stock and the ability of our board of directors, in evaluating a proposed business combination or other fundamental change transaction, to consider the effect of the business combination on us and our stockholders, employees, customers and the communities which we serve. Similarly, the Virginia Stock Corporation Act contains provisions designed to protect Virginia corporations and employees from the adverse effects of hostile corporate takeovers. These provisions reduce the possibility that a third party could effect a change in control without the support of our incumbent directors. These provisions may also strengthen the position of current management by restricting the ability of stockholders to change the composition of the board of directors, to affect its policies generally and to benefit from actions which are opposed by the current board of directors.
Item 1B.Unresolved Staff Comments
None.
Item 2.Properties
Current Locations and Property
Depending on such factors as cost, availability, and location, we may either lease or purchase our operating facilities. The existing facilities that we have purchased typically have been former branches of other financial institutions. As of March 29, 2022, the Bank conducts its operations from 19 locations, of which we own 11 and lease 8. The following table describes the location and general character of our operating facilities:
Address Type of Facility Year Opened Owned/Leased
5204 Fort Avenue Full-service branch with drive thru and ATM 2000 Owned
Lynchburg, Virginia
Madison Heights, Virginia
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17000 Forest Road Full-service branch with drive thru and ATM 2005 Owned
Forest, Virginia Headquarters for Mortgage Division
164 South Main Street Full-service branch with drive thru and ATM 2007 Owned
Amherst, Virginia
1405 Ole Dominion Blvd Full-service branch with drive thru and ATM 2008 Owned
Bedford, Virginia
1110 Main Street Full-service branch with drive thru and ATM 2009 Owned
Altavista, Virginia
Lynchburg, Virginia
Lynchburg, Virginia
501 VES Road Limited service branch 2010 Leased (3)
Lynchburg, Virginia
250 Pantops Mountain Road Limited service branch 2015 Leased (4)
Charlottesville, Virginia
1391 South High Street Full-service branch with drive thru and ATM 2015 Owned
Harrisonburg, Virginia
1745 Confederate Blvd Full-service branch with drive thru and ATM 2017 Owned
Appomattox, Virginia
Charlottesville, Virginia
3562 Electric Road Full-service branch with ATM 2017 Leased (6)
Roanoke, Virginia
2001 South Main Street #107 Mortgage origination office 2018 Leased (7)
Blacksburg, Virginia
550 East Water Street Full-service branch with ATM 2019 Owned
Charlottesville, Virginia
2101 Electric Road Full-service branch with drive thru and ATM 2019 Leased (8)
Roanoke, Virginia
45 South Main Street Full-service branch with ATM 2019 Owned
Lexington, Virginia
(1)The current term of the amended and restated lease expires in four years and the Bank has three five-year renewal options (subject to the terms and conditions outlined in the lease). The Bank leases this property from Jamesview Investment, LLC, which is wholly-owned by William C. Bryant III, a member of the Board of Directors of both Financial and the Bank.
(2)The previous term expired on December 31, 2021. The Bank currently leases on a month-to-month basis.
(3)Base lease expires May 31, 2025. We have one or more renewal options that we may exercise at our discretion subject to the terms and conditions outlined in the lease.
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(4) Base lease expires April 30, 2025. We have one or more renewal options that we may exercise at our discretion subject to the terms and conditions outlined in the lease.
(5)Base lease expires October 31, 2026. We have one or more renewal options that we may exercise at our discretion subject to the terms and conditions outlined in the lease.
(6)Base lease expires January 31, 2022. The Bank is currently leasing the property on a month-to-month basis and anticipates that it will extend the lease until at least January 31, 2025.
(7)Base lease expired February 28, 2021. The Bank currently leases on a month-to-month basis.
(8)Base lease expires February 28, 2024. We have one or more renewal options that we may exercise at our discretion subject to the terms and conditions outlined in the lease.
We believe that each of these operating facilities is maintained in good operating condition and is suitable for our operational needs.
Interest in Additional Properties
As discussed in “Management’s Discussion and Analysis—Expansion Plans” in addition to the facilities set forth above, the Bank owns the following properties which are being held for possible expansion:
real property located in the Timberlake Road area of Campbell County (Lynchburg), Virginia. The existing structure located on the property is not suitable for its intended use as a branch bank. Management anticipates that it will be necessary to raze the current structures and replace them with appropriate new construction.
real property located at 4501 Boonsboro Road, Lynchburg, Virginia. The Bank purchased this property in 2021. This property was previously used by another institution as a branch bank. While the Bank does not anticipate opening a branch at this location until the fall of 2022, the Bank believes the investment needed to upfit this property will be minimal and primarily related to aesthetics due to the fact this location was a former bank branch.
real property located at 1925 Atherholt Rd, Lynchburg, Virginia. The Bank purchased this property in 2021. The building currently houses all personnel of the Company’s wholly-owned subsidiary, PWW. PWW is currently leasing the space from the Bank on a month-to-month basis. While the Bank currently does not have a timeline for a branch at this location, the space is attractive for a branch due to its close proximity to Centra’s Lynchburg General Hospital. The investment needed to upfit the property will be minimal.
Management of the Bank continues to look for and evaluate additional locations for future branch growth and will consider opening an additional branch in the next 18 months if a suitable location is available on acceptable terms. The opening of all additional branches is contingent upon the receipt of regulatory approval.
We will use the internet, consistent with applicable regulatory guidelines, to augment our growth plans. We currently offer online account access, bill payment, and account management functions through our website. The Bank recently released an application that enables customers to transact banking business on smartphones and other mobile devices.
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Item 3.Legal Proceedings
There are no material pending legal proceedings to which the Company is a party or to which the property of the Company is subject.
Item 4.Mine Safety Disclosures -- Not applicable.
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PART II
Item 5.Market For Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
Market Prices and Dividends
As of January 25, 2012, the Common Stock of Financial is traded on the NASDAQ Capital Market LLC (NASDAQ) under the symbol “BOTJ.” Prior to this time, the Common Stock of Financial was quoted on the Over the Counter Bulletin Board (OTCBB) under the symbol “BOJF (“BOJF.OB” on some systems) and transactions generally involved a small number of shares.
As of March 29, 2022, there were approximately 4,740,657 shares of Common Stock outstanding, which shares are held by approximately 1,500 active shareholders of record.
Dividend Policy
The Company’s future dividend policy is subject to the discretion of its Board of Directors and will depend upon a number of factors, including future earnings, financial condition, liquidity and capital requirements of both the Company and the Bank, applicable governmental regulations and policies and other factors deemed relevant by its Board of Directors.
The Company is organized under the Virginia Stock Corporation Act, which prohibits the payment of a dividend if, after giving it effect, the corporation would not be able to pay its debts as they become due in the normal course of business or if the corporation’s total assets would be less than the sum of its total liabilities plus the amount that would be needed, if the corporation were to be dissolved, to satisfy the preferential rights upon dissolution of any preferred shareholders.
The Company is a legal entity separate and distinct from its subsidiaries. Its ability to distribute cash dividends will depend primarily on the ability of the Bank to pay dividends to it, and the Bank is subject to laws and regulations that limit the amount of dividends that it can pay. As a state member bank, the Bank is subject to certain restrictions imposed by the reserve and capital requirements of federal and Virginia banking statutes and regulations. For a discussion of these restrictions, see “Supervision and Regulation of Financial – Limits on the Payment of Dividends” in Item 1 of this Report on Form 10-K.
On January 18, 2022 Financial declared a cash dividend for the fourth quarter of 2021 of $0.07 per common share. The dividend was paid on March 18, 2022 to shareholders of record at the close of business on March 4, 2022. Financial will evaluate the factors set forth above when making a determination of whether to continue to pay a cash dividend in 2022.
Share Repurchases
On January 21, 2020, Financial’s board of directors adopted a stock repurchase plan that authorized the Company to repurchase up to an aggregate of 65,000 shares of its common stock. Although this plan expired in January of 2021, on January 19, 2021, the Company’s board of directors approved a share repurchase program under which the Company was authorized to repurchase, from time to time as the Company deems appropriate, up to a total of 47,000 shares of the Company’s common stock. Repurchases could have been made in the open market, through block trades, or otherwise, and in privately negotiated transactions.
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During the quarter ended December 31, 2021, Financial repurchased no shares of common stock. The plan expired on January 19, 2022, with the Company having purchased a total of 28,900 out of 47,000 shares authorized for repurchase.
Item 6.[Reserved]
Item 7.Management’s Discussion and Analysis of Financial Condition and Results of Operations
The following discussion is intended to assist readers in understanding and evaluating our financial condition and results of operations. You should read this discussion in conjunction with our financial statements and accompanying notes included elsewhere in this report. Bank of the James Financial Group, Inc. (“Financial”) has no material operations and conducts no business other than the ownership of its operating subsidiaries, Bank of the James (and its divisions and subsidiary), and Pettyjohn, Wood & White, Inc. Because Pettyjohn, Wood & White, Inc. was acquired on December 31, 2021, Pettyjohn, Wood & White, Inc. did not impact our operating results in 2021, the discussion primarily concerns the business of the Bank. However, for ease of reading and because our financial statements are presented on a consolidated basis, references to “we,” “us,” or “our” refer to Financial, Bank of the James, and their divisions and subsidiaries as appropriate.
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Cautionary Statement Regarding Forward-Looking Statements
This report contains statements that constitute “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended, and the Private Securities Litigation Reform Act of 1995. Statements made in this document and in any documents that are incorporated by reference which are not purely historical are forward-looking statements, including any statements regarding descriptions of management’s plans, objectives, or goals for future operations, products or services, and forecasts of its revenues, earnings, or other measures of performance. Forward-looking statements are based on current management expectations and, by their nature, are subject to risks and uncertainties. These statements generally may be identified by the use of words such as “believe,” “expect,” “anticipate,” “plan,” “estimate,” “should,” “will,” “intend,” or similar expressions. Shareholders should note that many factors, some of which are discussed elsewhere in this document, could affect the future financial results of Financial and could cause those results to differ materially from those expressed in forward-looking statements contained in this document. These factors, many of which are beyond Financial’s control, include, but are not necessarily limited to the following:
the effects of the COVID-19 pandemic on the business, customers, employees and third-party service providers of Financial or any of its acquisition targets;
operating, legal and regulatory risks, including the effects of legislative or regulatory developments affecting the financial industry generally or Financial specifically;
government legislation and policies (including the impact of the Dodd-Frank Wall Street Reform and the Consumer Protection Act and its related regulations);
changes to statutes, regulations, or regulatory policies or practices, including changes to address the impact of COVID-19;
economic, market, political and competitive forces affecting Financial’s banking and other businesses;
competition for our customers from other providers of financial services; government legislation and regulation relating to the banking industry (which changes from time to time and over which we have no control) including but not limited to the Dodd-Frank Wall Street Reform and Consumer Protection Act;
changes in interest rates, monetary policy and general economic conditions, which may impact Financial’s net interest income;
changes in the value of real estate securing loans made by the Bank;
diversion of management time on pandemic-related issues;
adoption of new accounting standards or changes in existing standards;
compliance or operational risks related to new products, services, ventures, or lines of business, if any, that Financial may pursue or implement;
the risk that Financial’s analysis of these risks and forces could be incorrect and/or that the strategies developed to address them could be unsuccessful;
a potential resurgence of economic and political tensions with China, the ongoing war between Russia and Ukraine and potential expansion of combatants, and the sanctions imposed on Russia by numerous countries and private companies, all of which may have a destabilizing effect on financial markets and economic activity; and
other risks and uncertainties set forth in this Annual Report on Form 10-K and, from time to time, in our other filing with the Securities and Exchanges Commission (“SEC”).
Other risks, uncertainties and factors could cause our actual results to differ materially from those projected in any forward-looking statements we make.
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These factors should be considered in evaluating the forward-looking statements, and you should not place undue reliance on such statements. Financial specifically disclaims any obligation to update factors or to publicly announce the results of revisions to any of the forward-looking statements or comments included herein to reflect future events or developments.
IMPACT OF COVID-19
The progression of the COVID-19 pandemic in the United States has had an adverse impact on our financial condition and results of operations as of and for the year ended December 31, 2020 and to a lesser extent for the year ended December 31, 2021. Management anticipates that impact of the pandemic will continue to have potentially adverse effect on the economy, the banking industry and our Company in future periods.
Effects on Market Areas
The broad suspension of business activities in the Commonwealth initially led to an increase in the Commonwealth’s and our market areas’ unemployment rate. While these developments commenced late in the first quarter of 2020, the nation, the Commonwealth, and our market areas have experienced a number of COVID-19 surges, we believe the economic consequences of the pandemic are difficult to predict.
Policy and Regulatory Developments
Federal, state and local governments and regulatory authorities have enacted and issued a range of policy responses to the COVID-19 pandemic, including the following:
The Federal Reserve decreased the range for the Federal Funds Target Rate by 0.50% on March 3, 2020, and by another 1.0% on March 16, 2020, reaching a range of 0.0 - 0.25%, where the range stayed until the Federal Reserve raised the rate on March 16, 2022.
On March 27, 2020, President Trump signed the Coronavirus Aid, Relief and Economic Security Act, or CARES Act, which established a $2.0 trillion economic stimulus package, including cash payments to individuals, supplemental unemployment insurance benefits and a $349 billion loan program administered through the U.S. Small Business Administration (SBA), referred to as the Paycheck Protection Program, or PPP Program, which was subsequently increased by $320 billion on April 24, 2020. Under the PPP program, small businesses, sole proprietorships, independent contractors and self-employed individuals may apply for loans from existing SBA lenders and other approved regulated lenders that enroll in the program, subject to numerous limitations and eligibility criteria. The Bank participated as a lender in the PPP program. Effective August 8, 2020, banks ceased taking applications under the PPP program. In addition, the CARES Act provided financial institutions the option to temporarily suspend certain requirements under GAAP related to loan modifications and classification as troubled debt restructurings (“TDRs”) for a limited period of time to account for the effects of COVID-19.
On April 7, 2020, federal banking regulators issued a revised Interagency Statement on Loan Modifications and Reporting for Financial Institutions, which, among other things, encouraged financial institutions to work prudently with borrowers who were unable to meet their contractual payment obligations because of the effects of COVID-19, and stated that institutions generally did not need to categorize COVID-19-related modifications as TDRs, and that the agencies would not direct supervised institutions to automatically categorize all COVID-19 related loan modifications as TDRs. In addition, upon expiration of the initial loan modification period, the Bank, pursuant to the “Joint Statement on Additional Loan Accommodations Related to COVID-19” published August 3, 2020, was encouraged to continue to work with effected borrowers on additional loan modifications.
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On December 27, 2020, President Trump signed the Economic Aid to Hard-Hit Small Businesses, Nonprofits, and Venues Act (the “Economic Aid Act”) into law to provide continued assistance to individuals and businesses that have been financially impacted by the ongoing coronavirus pandemic. Section 311 of the Economic Aid Act added a new temporary provision that authorized the SBA to guarantee Paycheck Protection Program Second Draw Loans (the “PPP Second Draw Program”), under generally the same terms and conditions available under the PPP Under section 311, SBA was authorized to guarantee loans under the PPP Second Draw Program through May 31, 2021 (‘‘Second Draw PPP Loans’’) to borrowers that previously received an initial PPP loan and have used or will use the full amount of the initial PPP loan for authorized purposes on or before the expected date of disbursement of the Second Draw PPP Loan. In addition, the Economic Aid Act permitted individuals and business that did not receive an initial PPP loan to apply under the PPP Program.
In accordance with the relief provisions of the CARES Act and the March 22, 2020 (revised April 2020) Joint Interagency Regulatory Guidance, the above modifications were not considered to be troubled debt restructurings and were excluded from the TDR discussion above. The TDR relief provisions provided for by the CARES Act were extended in December 2020 by the Consolidated Appropriations Act through the earlier of January 1, 2022 or 60 days after the national COVID-19 emergency terminates.
Effects on Our Business
The COVID-19 pandemic and the specific developments referred to above have had an impact on our business. Initially, we anticipated that the COVID-19 pandemic could have a negative impact on our financial condition, capital levels and results of operations could be significantly adversely affected. Mitigation efforts, as described in further detail below, helped offset the effects of the pandemic.
COVID-19 Crisis Management
As an essential service provider, Bank of the James has continued to provide uninterrupted service to its clients throughout the COVID-19 crisis. On March 2, 2020 the Company's Management Committee initiated plans in response to the emerging risk related to the pandemic.
From the beginning, our management of the crisis has focused on protecting the health and well-being of our employees and clients while continuing to provide our clients with full access to banking services. As the operational risk related to the COVID-19 crisis evolved, the Company took proactive measures to manage operational risk, including the following:
The Company has implemented its Business Continuity Plan.
All branches remained open, with routine banking services offered through online banking, drive-thru, ATMs, and limited lobby access. All branches now provide full lobby access.
Implemented a number of actions to support a healthy workforce, including:
oFlexible work practices such as work-from-home options, working in shifts and placing greater distances between employees;
oDiscontinuation of non-essential business travel and meetings; and
oUse of online meeting platforms, including successfully conducting the 2021 and 2021 Annual Meeting of Shareholders in a virtual format.
We anticipate that the Company will continue to maintain these policies as long as necessary.
Overview
Financial is a bank holding company headquartered in Lynchburg, Virginia. Our primary business is retail banking which we conduct through our wholly-owned subsidiary, Bank of the James (which we refer to as
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the “Bank”). We conduct four other business activities: mortgage banking through the Bank’s Mortgage Division (which we refer to as “Mortgage”), investment services through the Bank’s Investment division (which we refer to as “Investment Division”), insurance activities through BOTJ Insurance, Inc., a subsidiary of the Bank, (which we refer to as “Insurance”), and as of December 31, 2021, investment advisory services through the Company’s wholly-owned subsidiary, Pettyjohn, Wood & White, Inc., which we refer to as “PWW.”
Although we intend to increase other sources of revenue, our operating results depend primarily upon the Bank’s net interest income, which is determined by the difference between (i) interest and dividend income on earning assets, which consist primarily of loans, investment securities and other investments, and (ii) interest expense on interest-bearing liabilities, which consist principally of deposits and other borrowings. The Bank’s net income also is affected by its provision for loan losses, as well as the level of its noninterest income, including deposit fees and service charges, gains on sales of mortgage loans, and its noninterest expenses, including salaries and employee benefits, occupancy expense, data processing expenses, miscellaneous other expenses, franchise taxes, and income taxes. We anticipate that going forward, PWW will enhance our operating results by providing additional noninterest income (generally investment advisory fees less operating expenses).
As discussed in more detail below,
For the year ended December 31, 2021, Financial had net income of $7,589,000, an increase of $2,609,000 from net income of $4,980,000, for the year ended December 31, 2020;
For the year ended December 31, 2021, earnings per basic and diluted common share were $1.60, as compared to earnings of $1.04 per basic and diluted common share for the year ended December 31, 2020;
Net interest income increased to $27,079,000 for the current year from $25,146,000 for the year ended December 31, 2021;
Noninterest income (exclusive of net gains on sales and calls of securities) increased to $11,209,000 for the year ended December 31, 2021 from $10,331,000 for the year ended December 31, 2020;
Total assets as of December 31, 2021 were $987,634,000 compared to $851,386,000 at the end of 2020, an increase of $136,248,000 or 16.00%;
Net loans (excluding loans held for sale), net of unearned income and the allowance for loan losses, decreased to $576,469,000 as of December 31, 2021 from $601,934,000 as of the end of December 31, 2020, a decrease of 4.23%; and
The net interest margin decreased 18 basis points to 3.14% for 2021, compared to 3.32% for 2020.
The following table sets forth selected financial ratios:
For the Year Ended
December 31,
Return on average equity 11.34% 8.01%
Return on average assets 0.82% 0.62%
Average equity to total average assets 7.27% 7.72%
Effect of Economic Trends
A variety and wide scope of economic factors affect Financial’s success and earnings. Although interest rate trends are one of the most important of these factors, Financial believes that interest rates cannot be predicted with a reasonable level of confidence and therefore does not attempt to do so with complicated
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economic models. Management believes that the best defense against wide swings in interest rate levels is to minimize vulnerability at all potential interest rate levels. Rather than concentrate on any one interest rate scenario, Financial prepares for the opposite as well, in order to safeguard margins against the unexpected.
Between January 2018 and December 2018, the FOMC raised rates by 25 basis points four times, at which point the target rate for federal funds (“fed funds”) peaked at 2.25% to 2.50%. Beginning in July 2019, the FOMC began to decrease rates. Between July 2019 and October 2019, the FOMC decreased the target rate three times by 25 basis points.
In its December 11, 2019 statement, the FOMC stated it continues to seek to foster maximum employment and price stability. The FOMC judged that the current stance of monetary policy was appropriate to support sustained expansion of economic activity, strong labor market conditions, and inflation near the FOMC's two percent objective. However, on March 3, 2020, the FOMC lowered the target range of the fed funds rate by 50 basis points in response to concerns related to risks the coronavirus poses to economic activity. Further, in response to concerns that the coronavirus could push the U.S. economy towards a recession, on March 15, 2020, the FOMC, at an emergency meeting lowered the target range of the federal funds rate by an additional 100 basis points. At that meeting, the Federal Reserve also announced that it would buy $700 billion in Treasury and mortgage-backed securities.
As of March 20, 2020, the FOMC had set a current target rate range of 0% to 0.25%. The target rate remained unchanged for the remainder of 2020. Long term interest rates decreased in 2019 and remained relatively flat in 2021. However, as a result of COVID-19 stimulus, long term rates began to trend slightly upward in the first quarter of 2021.
In response to higher inflation and supply chain issues exacerbated by the war in Ukraine, on March 16, 2022, the FOMC increased the target rate to a range of 0.25% to 0.50%. The FOMC further indicated that it is likely to increase the target rate multiple times in 2022.
Critical Accounting Policies
Financial’s financial statements are prepared in accordance with accounting principles generally accepted in the United States (GAAP). The financial information contained within our statements is, to a significant extent, based on measures of the financial effects of transactions and events that have already occurred. A variety of factors could affect the ultimate value that is obtained either when earning income, recognizing an expense, recovering an asset or relieving a liability. The Bank uses historical loss factors as one factor in determining the inherent loss that may be present in the loan portfolio. Actual losses could differ significantly from the historical factors that the Bank uses in estimating risk. In addition, GAAP itself may change from one previously acceptable method to another method. Although the economics of Financial’s transactions would be the same, the timing of events that would impact the transactions could change.
The allowance for loan losses is management’s estimate of the probable losses inherent in our loan portfolio. Management considers impaired loans, historical loss experience, and various qualitative factors (both internal and external) in the Company’s determination of the allowances. Historical and industry trends, as well as peer comparisons are also considered in the Company’s ongoing evaluation of the allowance for loan losses. The allowance is based on two basic principles of accounting: (i) ASC 450, Contingencies, which requires that losses be accrued when they are probable of occurring and are reasonably estimable and (ii) ASC 310, Receivables, which requires that losses on impaired loans be accrued based on the differences between the value of collateral, present value of future cash flows or values that are observable in the secondary market and the loan balance. Guidelines for determining allowances for loan losses are also provided in the SEC Staff Accounting Bulletin No. 102 – “Selected Loan Loss Allowance Methodology and Documentation Issues” and the Federal Financial Institutions Examination Council’s interagency guidance, “Interagency Policy Statement
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on the Allowance for Loan and Lease Losses” (the “FFIEC Policy Statement”). See “Management Discussion and Analysis Results of Operations – Asset Quality” below and Note 2 of the Notes to Consolidated Financial Statements for further discussion of the allowance for loan losses.
Other real estate owned (“OREO”) consists of properties acquired through foreclosure or deed in lieu of foreclosure. These properties are carried at fair value less estimated costs to sell at the date of foreclosure establishing a new cost basis. These properties are subsequently accounted for at the lower of cost or fair value less estimated costs to sell. Losses from the acquisition of property in full or partial satisfaction of loans are charged against the allowance for loan losses. Subsequent write-downs, if any, are charged against expense. Gains and losses on the sales of foreclosed properties are included in determining net income in the year of the sale. Operating costs after acquisition are expensed. The Bank had OREO totaling $761,000 and $1,105,000 as of December 31, 2021 and 2020, respectively.
Goodwill arises from business combinations and is generally determined as the excess of fair value of the consideration transferred, plus the fair value of any noncontrolling interests in the acquired entity, over the fair value of the nets assets acquired and liabilities assumed as of the acquisition date. Goodwill and intangible assets acquired in a purchase business combination and determined to have an indefinite useful life are not amortized, but tested for impairment at least annually or more frequently in events and circumstances exists that indicate that a goodwill impairment test should be performed. The initial goodwill impairment test will occur in 2022 as goodwill was the result of a transaction on December 31, 2021. The Company has selected September 1 of each year as the date to perform the annual impairment test. Intangible assets with definite useful lives are amortized over their estimated useful lives to their estimated residual values. Goodwill is the only intangible asset with an indefinite life on our consolidated balance sheet.
RESULTS OF OPERATIONS
Year Ended December 31, 2021 compared to year ended December 31, 2020
Net Income
The net income for Financial for the year ended December 31, 2021 was $7,589,000 or $1.60 per basic and diluted share compared with net income of $4,980,000 or $1.04 per basic and diluted share for the year ended December 31, 2020. All earnings per share figures have been adjusted to reflect the 10% stock dividend paid in 2021. Note 13 of the consolidated financial statements provides additional information with respect to the calculation of Financial’s earnings per share.
The increase of $2,609,000 in 2021 net income compared to 2020 was due in large part to an increase in net interest income of $1,933,000 or 7.69% and a decrease in the provision for loan losses of $3,048,000, or a decrease of 119.62%. These changes were partially offset by an increase in noninterest expense of $1,943,000, or 7.09%.
These operating results represent a return on average stockholders’ equity of 11.34% for the year ended December 31, 2021 compared to 8.01% for the year ended December 31, 2020. Our return on average stockholder’s equity increased because of an increase in net income and a decrease in the market value of the available-for-sale securities portfolio. The return on average assets for the year ended December 31, 2021 was 0.82% compared to 0.62% in 2020 primarily due to the increase in net income, which was offset in part by an increase in our total assets.
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Net Interest Income
The fundamental source of Financial’s earnings, net interest income, is defined as the difference between income on earning assets and the cost of funds supporting those assets. The significant categories of earning assets are loans, federal funds sold, interest-bearing balances at other banks, and investment securities, while deposits, fed funds purchased, and other borrowings represent interest-bearing liabilities. The level of net interest income is impacted primarily by variations in the volume and mix of these assets and liabilities, as well as changes in interest rates when compared to previous periods of operation.
Interest income decreased to $29,181,000 for the year ended December 31, 2021 from $29,686,000 for the year ended December 31, 2020. This decrease was due to a decrease in the yields on average earning assets which primarily consist of loans and investment securities, as discussed below.
Net interest income for 2021 increased $1,933,000, or 7.69%, to $27,079,000 from $25,146,000 in 2020. The growth in net interest income was due primarily to a decrease in interest expense. Our interest expense decreased by $2,438,000 to $2,102,000 in 2021 from $4,540,000 in 2020. Our interest expense decreased primarily because of a decrease in the rates paid on interest bearing liabilities but was partially offset by an increase in the balance of interest-bearing liabilities. The average balance of interest bearing liabilities increased 10.73% from $615,989,000 for the year ended December 31, 2020 to $682,089,000 for the year ended December 31, 2021. The average interest rate paid on interest bearing liabilities decreased by 43 basis points from 0.74% in 2021 to 0.31% in 2020.
The net interest margin decreased to 3.14% in 2021 from 3.32% in 2020. The average rate on earning assets decreased 53 basis points from 3.91% in 2020 to 3.38% in 2021 and the average rate on interest-bearing deposits decreased from 0.69% in 2020 to 0.25% in 2021. The decreases were primarily caused by the impact of lower-yielding PPP loans. One of the results of the spread of COVID-19 has been a sustained low interest rate environment, which negatively impacted our net interest margin. Because of Financial’s asset interest rate sensitivity, we anticipate that an increase in interest rates would have a positive impact on our results of operations.
The following table shows the average balances of total interest earning assets and total interest bearing liabilities for the periods indicated, showing the average distribution of assets, liabilities, stockholders’ equity and related revenue, expense and corresponding weighted average yields and rates. The average balances used in this table and other statistical data were calculated using average daily balances.
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Net Interst Margin Analysis
Average Balance Sheets
(dollars in thousands)
Average Average
Average Interest Rates Average Interest Rates
Balance Income/ Earned/ Balance Income/ Earned
Sheet Expense Paid Sheet Expense /Paid
ASSETS
Allowance for loan losses (7,223) (5,913)
LIABILITIES AND STOCKHOLDERS’ EQUITY
Deposits
Other borrowed funds
Total liabilities and
Net interest margin 3.14% 3.32%
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(1)Net deferred loan fees and costs are included in interest income.
(2)Nonperforming loans are included in the average balances. However, interest income and yields calculated do not reflect any accrued interest associated with non-accrual loans.
(3)The interest income and yields calculated on securities have been tax affected to reflect any tax-exempt interest on municipal securities using the Company’s applicable federal tax rate of 21% for each year.
Interest income and expenses are affected by fluctuations in interest rates, by changes in the volume of earning assets and interest-bearing liabilities, and by the interaction of rate and volume factors. The following table shows the direct causes of the year-to-year changes in components of net interest income on a taxable equivalent basis.
Volume and Rate
(dollars in thousands)
Years Ending December 31,
Change in Change in
Volume Rate Income/ Volume Rate Income/
Effect Effect Expense Effect Effect Expense
Liabilities:
Financing leases (9) — (9) 52 (8) 44
Repurchase agreements and other borrowings — — — — — —
Noninterest Income of Financial
Noninterest income has been and will continue to be an important factor for increasing our profitability. Our management continues to review and consider areas where noninterest income can be increased. Noninterest income (excluding securities gains and losses) consists of income from mortgage originations and sales, service fees, income from life insurance, income from credit and debit card transactions, fees generated by the investment services of Investment, and going forward, income from PWW. Service fees consist primarily of monthly service and minimum account balance fees and charges on transactional deposit accounts, treasury management fees, overdraft charges, and ATM service fees.
The Bank, through the Mortgage Division originates both conforming, non-conforming consumer residential mortgage, and reverse mortgage loans primarily in the Region 2000 area as well as in Charlottesville, Harrisonburg, Roanoke, Lexington, and Blacksburg. As part of the Bank’s overall risk management strategy, all of the loans originated and closed by the Mortgage Division are presold to mortgage banking or other financial institutions. The Mortgage Division assumes no credit or interest rate risk on these mortgages.
The Mortgage Division originated 1,335 mortgage loans, totaling approximately $331,235,000 during the year ended December 31, 2021 as compared with 1,304 mortgage loans, totaling $298,154,000 in 2020. Income improved with the increased origination volume, which is attributable in part to an improving residential real estate market throughout our footprint as well as consistently low long-term interest rates. Beginning in 2013 we began operating the Mortgage Division with hybrid correspondent relationships that
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allow the Bank to close loans in its name before an investor purchases the loan. By using the Bank’s funds to close the loan (as compared to a broker relationship in which loans are funded by the purchaser of the mortgage), the Bank is able to obtain better pricing due to the slight increase in risk. In 2021 and 2020, the Mortgage Division continued to operate in an environment in which real estate values continued to improve some of which may be attributed to a decrease in overall home inventory for sale. Loans for new home purchases comprised 54% of the total volume in 2021 as compared to 59% in 2020. The Mortgage Division’s revenue is derived from gains on sales of loans held-for-sale to the secondary market. For the year ended December 31, 2021, the Mortgage Division accounted for 20.46% of Financial’s total revenue as compared with 19.44% of Financial’s total revenue for the year ended December 31, 2020. Mortgage contributed $2,360,000 and $2,693,000 to Financial’s pre-tax net income in 2021 and 2020, respectively. Because of the uncertainty surrounding current and near-term economic conditions and potential continuing effects from the COVID-19 pandemic, management cannot predict future mortgage rates. Management also anticipates that if rates continue to trend higher, the majority of the loan mix will continue to lean towards new home purchases and away from refinancing.
The Mortgage Division continues to increase its market share in its service areas. We opened a new mortgage origination office in Roanoke in October, 2013 and began originating mortgages in Charlottesville in March, 2014. In addition, in 2016, we hired a new mortgage loan origination officer for the Harrisonburg Market and in 2018 we opened a mortgage origination office in Blacksburg, Virginia with one producer. In 2018, we added one additional mortgage producer in Roanoke and in 2019, a second producer was also added in Blacksburg. In early 2020, a mortgage producer was added at the Bank’s branch location in Lexington. Management expects that continued historically low rates coupled with the Mortgage Division’s reputation in its markets and our recently-added offices and producers present an opportunity for us to continue to grow the Mortgage Division’s revenue.
Service charges and fees and commissions increased to $2,496,000 for the year ended December 31, 2021 from $2,033,000 for the year ended December 31, 2020 primarily due to increases related to commissions on the sales of securities, debit card fees, and treasury management fees.
Investment provides brokerage services through an agreement with a third-party broker-dealer. Pursuant to this arrangement, the third party broker-dealer operates a service center adjacent to one of the branches of the Bank. The center is staffed by dual employees of the Bank and the broker-dealer. Investment receives commissions on transactions generated and in some cases ongoing management fees such as mutual fund 12b-1 fees. Investment’s financial impact on our consolidated revenue has been minimal. Although management cannot predict the financial impact of Investment with certainty, management anticipates it will continue to be a relatively small component of revenue in 2022.
Although dependent on overall market performance and other economic factors, we anticipate that PWW will begin to contribute noninterest income to the Company in 2022.
In the third quarter of 2008, we began providing insurance and annuity products to Bank customers and others, through the Bank’s Insurance subsidiary. The Bank has one full-time and one part-time employee that are dedicated to selling insurance products through Insurance. Insurance generates minimal revenue and its financial impact on our consolidated revenue has been immaterial. Management anticipates that Insurance’s impact on noninterest income will remain immaterial in 2022.
Noninterest income, exclusive of gains and losses on the sale and call of securities, increased to $11,209,000 in 2021 from $10,331,000 in 2020. Inclusive of gains and losses on the sale and call of securities, noninterest income increased to $11,209,000 in 2021 from $10,975,000 in 2020. The following table summarizes our noninterest income for the periods indicated.
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Noninterest Income
(dollars in thousands)
December 31,
Gains on sale of loans held for sale $ 8,265 $ 7,812
Service charges, fees and commissions 2,496 2,033
Gain on sales and calls of securities, net — 644
The increase in noninterest income for 2021 as compared to 2020 was due to an increase in income from gains on sale of loans held for sale and service charges and was partially offset by a decrease in gains on sales of securities.
Noninterest Expense of Financial
Noninterest expenses increased from $27,934,000 for the year ended December 31, 2020 to $29,337,000 for the year ended December 31, 2021. The following table summarizes our noninterest expense for the periods indicated.
Noninterest Expense
(dollars in thousands)
December 31,
Professional, data processing and other outside expenses 4,094 3,691
Other real estate expenses 102 443
The increase in noninterest expense was due in large part to an increase in compensation and benefits, which has a variable component related to mortgage origination. In 2020, compensation expense was impacted by the Bank’s early retirement plan, pursuant to which the Bank incurred approximately $700,000 in salary and benefit expense. To a lesser degree professional, data processing, and other outside expenses, marketing, equipment, and FDIC Insurance, driven by the year-over-year increase in deposits, contributed to the overall increase. Professional, data processing, and other outside expense increased primarily due increased charges by our core service provider relating to the additional deposit business generated in 2021. The increase in equipment expense was related to the replacement of certain computer equipment and software in order to continue to make progress toward cloud-based computing and a fully electronic signature system. The increase in marketing expenses was due primarily to expenses incurred in resuming normal operations in light of easing COVID-19 restrictions and increased charitable contributions.
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The efficiency ratio, that is the cost of producing each dollar of revenue, is determined by dividing noninterest expense by the sum of net interest income plus noninterest income. Financial’s efficiency ratio increased from 75.84% in 2020 to 76.62% in 2021. Our efficiency ratio increased because of the increase in noninterest expense was greater than the increases in net interest income and noninterest income. This is a non-GAAP financial measure that the Company believes provides investors with important information regarding operational efficiency. No non-recurring adjustments were made to the calculation of the efficiency ratio.
Income Tax Expense
For the year ended December 31, 2020, Financial had federal income tax expense of $1,199,000, as compared to a federal income tax expense of $1,862,000 in 2021, which equates to effective tax rates of 19.40% and 19.70%, respectively. Our effective tax rate was lower than the statutory corporate tax rate in 2020 and 2021 because of federal income tax benefits resulting from the tax treatment of earnings on bank owned life insurance, and certain tax-free municipal securities. Note 12 of the consolidated financial statements provides additional information with respect to our 2020 and 2021 federal income tax expense and deferred tax accounts.
ANALYSIS OF FINANCIAL CONDITION
As of December 31, 2021 and December 31, 2020
General
Our total assets were $987,634,000 at December 31, 2021, an increase of $136,248,000 or 16.00% from $851,386,000 at December 31, 2020, primarily due to securities available-for-sale and cash equivalents, both of which were primarily funded by an increase in deposits. As explained in more detail below, deposits increased from $764,967,000 on December 31, 2020 to $887,056,000 on December 31, 2021. Loans, net of unearned income and the allowance, decreased to $576,469,000 on December 31, 2021 from $601,934,000 on December 31, 2020.
Loans
Our loan portfolio is the largest and most profitable component of our earning assets. The Bank has comprehensive policies and procedures which cover both commercial and consumer loan origination and management of credit risk. Loans are underwritten in a manner that focuses on the borrower’s ability to repay. Management’s goal is not to avoid risk, but to manage it and to include credit risk as part of the pricing decision for each product.
The Bank’s loan portfolio consists of commercial short-term lines of credit, term loans, mortgage financing and construction loans that are used by the borrower to build or develop real estate properties, and consumer loans. The consumer portfolio includes residential real estate mortgages, home equity lines and installment loans.
Loans, net of unearned income and the allowance, decreased to $576,469,000 on December 31, 2021 from $601,934,000 on December 31, 2020. Total loans, including loans held for sale decreased to $585,012,000 on December 31, 2021 from $616,192,000 on December 31, 2020. The decrease in total loans was in large part due to PPP loan payoffs and normal amortization of non-PPP loans. This decrease was offset in part by growth in the non-PPP loan portfolio, which is attributed to increased calling and sales efforts by our lenders. Competition for qualified borrowers remains strong.
As of December 31, 2021, the Bank had $954,000, or 0.16% of its total loans, in non-accrual status compared with $2,063,000, or 0.34% of its total loans, at December 31, 2020. Management is continuing its
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efforts to reduce non-performing assets through enhanced collection efforts and the liquidation of underlying collateral. The Bank attempts to work with borrowers on a case-by-case basis to attempt to protect the Bank’s interests. However, despite our commitment, a reduction of non-accrual loans can be dependent on a number of factors, including improvements in employment, housing, and overall economic conditions at the local, regional and national levels. See “Asset Quality” below.
The following table summarizes net charge-offs, average loan balance and the percentage of charge-offs to average loan balance for each of the Company’s loan segments at the end of the period:
Loan Portfolio
(dollars in thousands)
December 31,
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The following table sets forth the maturities of the loan portfolio at December 31, 2021:
Remaining Maturities of Selected Loans
(dollars in thousands)
Loans with fixed interest rates:
Loans with variable interest rates:
Deposits
We experienced an increase in deposits from $764,967,000 at December 31, 2020 to $887,056,000 at December 31, 2021, for an increase of 15.96%. Noninterest-bearing deposits increased $18,941,000 or 13.21% from $143,345,000 at December 31, 2020 to $162,286,000 at December 31, 2021. The increase in noninterest-bearing deposits was due to increased market share, customers maintaining higher balances due to COVID-19 uncertainty, along with government stimulus. To a lesser extent, the recent expansion into Charlottesville, Harrisonburg, Roanoke, and most recently, Appomattox and Rustburg, as well as increased and continued efforts to procure the primary checking accounts of our commercial loan customers through offering treasury services contributed to the increase in deposits. Interest-bearing deposits including certificates of deposit increased $103,148,000, or 16.59%, from $621,622,000 at December 31, 2020 to $724,770,000 at December 31, 2021.
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The following table sets forth the average deposit balances and the rates paid on deposits for the years indicated:
Average Deposits and Rates Paid
(dollars in thousands)
Year Ended December 31,
Amount Rate Amount Rate
Interest-bearing deposits
Time deposits
The following table includes a summary of maturities of CDs greater than $250,000:
Maturities of CD’s Greater than $ 250,000
(dollars in thousands)
The total amount of all deposit categories in excess of the FDIC $250,000 insurance limit was $118,315,000 and $171,875,000 as of December 31, 2021 and 2020, respectively.
Cash and Cash Equivalents
Cash and cash equivalents increased from $100,886,000 on December 31, 2020 to $183,153,000 on December 31, 2021. Federal funds sold amounted to $153,816,000 on December 31, 2021 compared to $69,203,000 on December 31, 2020. The increase in the balance of federal funds sold is due in part to the Bank’s decision not to invest a large amount of cash in low-yielding, long term securities. In addition, fluctuations in federal funds sold generally are related to fluctuations in transactional accounts and professional settlement accounts, and the use of cash and cash equivalents to fund loan growth. The large increase in cash and cash equivalents in 2021 can be directly attributed to the growth in deposits as a result of organic growth and PPP loan payoffs received throughout 2021.
Investment Securities
The investment securities portfolio of the Bank is used as a source of income and liquidity.
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The following table summarizes the fair value of the Bank’s securities portfolio for the periods indicated:
Securities Portfolio
(dollars in thousands)
December 31,
Held-to-maturity
Available-for-sale
Deposited funds are generally invested in overnight vehicles, including federal funds sold, until approved loans are funded. The decision to purchase investment securities is based on several factors or a combination thereof, including:
a) The fact that yields on acceptably rated investment securities (S&P “A” rated or better) are significantly better than the overnight federal funds rate;
b) Whether demand for loan funding exceeds the rate at which deposits are growing, which leads to higher or lower levels of surplus cash;
c) Management’s target of maintaining a minimum of 6% of the Bank’s total assets in a combination of federal funds sold and investment securities (aggregate of available-for-sale and held-to-maturity portfolios); and
d) Whether the maturity or call schedule meets management’s asset/liability plan.
Available-for-sale securities (as opposed to held-to-maturity securities) may be liquidated at any time as funds are needed to fund loans. Liquidation of securities may result in a net loss or net gain depending on current bond yields available in the primary and secondary markets and the shape of the U.S. Treasury yield curve. Management is cognizant of its credit standards policy and does not feel pressure to maintain loan growth at the same levels as deposit growth and thus sacrifice credit quality in order to avoid security purchases.
Management has made the decision to maintain a significant portion of its available funds in liquid assets so that funds are available to fund future growth of the loan portfolio and in anticipation of rising rates. Management believes that this strategy will allow us to maximize interest margins while maintaining appropriate levels of liquidity.
Securities held-to-maturity at carrying cost decreased from $3,671,000 as of December 31, 2020 to $3,655,000 as of December 31, 2021. This decrease resulted from the amortization of premiums within the held-to-maturity portfolio. The decision to invest in securities held-to-maturity is based on the same factors as the decision to invest in securities available-for-sale except that management invests surplus funds in securities held-to-maturity only after concluding that such funds will not be necessary for liquidity purposes during the term of such security. However, the held-to-maturity securities may be pledged for such purposes as short term borrowings and as collateral for public deposits.
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The portfolio of securities available-for-sale increased to $161,267,000 as of December 31, 2021 from $90,185,000 as of December 31, 2020. The increase was due to the use of excess cash from our increased deposit balances to purchase securities available-for-sale. The increase was offset in part by a decrease in the fair value of available-for-sale securities caused by rising interest rates. Out of an abundance of caution, during the first six months of 2020, the Bank sold available-for-sale securities to increase cash and cash equivalents in light of the uncertainties surrounding the COVID-19 pandemic. Because the need for additional liquidity did not materialize, the Bank reinvested some of the proceeds. The Bank realized $7,860,000 from pay-downs related to the normal amortization of principal related to the Bank’s mortgage backed securities, calls, and maturities. During 2021, the Bank did not sell any available-for-sale securities. During 2021, the Bank purchased $83,964,000 of available-for-sale securities.
The following table shows the maturities of held-to-maturity and available-for-sale securities at fair value at December 31, 2021 and 2020 and approximate weighted average yields of such securities. Weighted average yields on all securities including state and political subdivision securities are shown on a pre-tax basis. Financial attempts to maintain diversity in its portfolio and maintain credit quality and repricing terms that are consistent with its asset/liability management and investment practices and policies. For further information on Financial’s securities, see Note 4 to the consolidated financial statements included in Item 8 of this Form 10-K.
Securities Portfolio Maturity Distribution / Yield Analysis
(dollars in thousands)
Held-to-maturity
U.S. Agency
Weighted average yield 2.88% 3.23%
Available-for-sale securities
U.S Treasury
Weighted average yield 1.37%
U.S. Agency
Mortgage Backed Securities
Municipals
Corporates
Total portfolio
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Securities Portfolio Maturity Distribution / Yield Analysis
(dollars in thousands)
Held-to-maturity
U.S. Agency
Weighted average yield 2.99% 2.99%
Available-for-sale securities
U.S Treasury
Weighted average yield 1.38%
U.S. Agency
Mortgage Backed Securities
Municipals
Corporates
Weighted average yield 2.22% 4.40%
Total portfolio
Cash surrender value of bank-owned life insurance
The Company has funded bank-owned life insurance (BOLI) for a small group of its officers. The Company is the owner and sole beneficiary of the BOLI policies. As of December 31, 2021, the BOLI had a cash surrender value of $18,785,000, an increase of $2,430,000 from the cash surrender value of $16,355,000 as of December 31, 2020. The Company purchased an additional $2,000,000 in BOLI during 2021. With the exception of purchases, the value of BOLI increases from the cash surrender values of the pool of insurance. The increase in cash surrender value is recorded as a component of noninterest income; however, the Company does not pay tax on the increase in cash value. This profitability is used to offset a portion of current and future employee benefit costs. BOLI can be liquidated if necessary with associated tax costs. However, the Company intends to hold this pool of insurance, because it provides income that enhances the Company’s capital position. Therefore, the Company has not provided for deferred income taxes on the earnings from the increase in cash surrender value.
Goodwill and Other Intangible Assets
Goodwill arises from business combinations and is generally determined as the excess of fair value of the consideration transferred, plus the fair value of any noncontrolling interests in the acquired entity, over the fair value of the nets assets acquired and liabilities assumed as of the acquisition date. Goodwill and intangible assets acquired in a purchase business combination and determined to have an indefinite useful life are not amortized, but tested for impairment at least annually or more frequently in events and circumstances exists that indicate that a goodwill impairment test should be performed. The Company has selected September 1 of each year as the date to perform the annual impairment test. Intangible assets with definite useful lives are amortized over their estimated useful lives to their estimated residual values. Goodwill is the only intangible asset with an
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indefinite life on our balance sheet.
On December 31, 2021, Financial completed its acquisition of Pettyjohn, Wood & White, Inc. (“PWW”), a Lynchburg, Virginia-based investment advisory firm with approximately $650 million in assets under management and advisement at the time of the acquisition. PWW operates as a subsidiary of Financial. The acquisition date fair value of consideration transferred totaled $10.5 million, which was paid in cash.
In connection with this transaction, the Company recorded $3.0 million in goodwill and $8.4 million of amortizable intangible assets, which primarily relate to the value of customer relationships. The goodwill is not deductible for tax purposes. The Company is amortizing these intangible assets over a 15-year period using the straight line method. The transaction was accounted for using the acquisition method of accounting, and accordingly, assets acquired, liabilities assumed, and consideration exchanged were recorded at estimated fair values on the acquisition date. The fair values are subject to refinement for up to one year after the closing date of the acquisition, in accordance with ASC 350, Intangibles-Goodwill and Other.
Liquidity
Liquidity represents the ability of a company to convert assets into cash or cash equivalents without significant loss, and the ability to raise additional funds by increasing liabilities.
The liquidity of Financial depends primarily on Financial’s current assets, available credit, and the dividends paid to it by the Bank. Payment of cash dividends by the Bank is limited by regulations of the Federal Reserve Board and is tied to the regulatory capital requirements. Management believes that Financial has sufficient liquidity to meet its current obligations. See “Capital Resources,” below.
The objective of liquidity management for the Bank is to ensure the continuous availability of funds to meet the demands of depositors, investors and borrowers. Liquidity management involves monitoring the Bank’s sources and uses of funds in order to meet the day-to-day cash flow requirements while maximizing profits. Stable core deposits and a strong capital position are the components of a solid foundation for the Bank’s liquidity position. Liquidity management is made more complicated because different balance sheet components are subject to varying degrees of management control. For example, the timing of maturities of securities held-to-maturity is fairly predictable and subject to a high degree of control at the time investment decisions are made. However, net non-maturity deposit inflows and outflows are far less predictable and are not subject to the same degree of control.
Funding sources for the Bank primarily include paid-in capital and customer-based deposits but also include borrowed funds and cash flow from operations. The Bank has in place several agreements that will provide alternative sources of funding, including, but not limited to, lines of credit, sale of investment securities, purchase of federal funds, advances through the Federal Home Loan Bank of Atlanta (“FHLBA”) and correspondents, and brokered certificate of deposit arrangements. Management believes that the Bank has the ability to meet its liquidity needs.
At December 31, 2021, liquid assets, which include cash, interest-bearing and noninterest-bearing deposits with banks, federal funds sold, and securities available-for-sale totaled $344,420,000 as compared to $191,071,000 at December 31, 2020. Management deems liquidity to be sufficient. Investment securities traditionally provide a secondary source of liquidity since they can be converted into cash in a timely manner. However, approximately $24,055,000 (current market value) of these securities are pledged to secure public deposits and $8,104,000 (current market value) are pledged to secure unfunded lines of credit. In the event any secured line of credit is drawn upon, the related debt would need to be repaid before the securities could be sold and converted to cash.
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While we have not experienced any unusual pressure on our deposit balances or our liquidity position as a result of the COVID-19 pandemic, management continues to monitor our sources and uses of funds in order to meet our cash flow requirements while maximizing profits. Based in part on recent loan activity including loans made pursuant to the PPP as discussed below under “ASSET QUALITY,” the Bank is monitoring liquidity to ensure it is able to fund future loans and withdrawals related to the use of PPP funds.
The following table sets forth non-deposit sources of funding:
Funding Sources
(dollars in thousands)
Source Capacity Outstanding Available
Federal funds purchased lines (unsecured) $ 33,000 $ — $ 33,000
Federal funds purchased lines (secured) 7,294 — 7,294
Reverse repurchase agreements 5,000 — 5,000
Source Capacity Outstanding Available
Federal funds purchased lines (unsecured) $ 33,000 $ — $ 33,000
Federal funds purchased lines (secured) 8,055 — 8,055
Reverse repurchase agreements 5,000 — 5,000
(1)Currently the Bank has in place pledged collateral in the form of 1-4 family residential mortgages in the amount of approximately $28,187,000 against which $0 was drawn and outstanding on December 31, 2021. Additional collateral would be required to be pledged in order for the full $235,788,000 to be available.
At the end of 2021, approximately 34.76%, or $202,812,000 of the loan portfolio could mature or could reprice within a one-year period. At December 31, 2021, non-deposit sources of available funds totaled $281,082,000, which included $235,788,000 available from the FHLBA.
Capital Resources
Capital adequacy is an important measure of financial stability and performance. Management’s objectives are to maintain a level of capitalization that is sufficient to sustain asset growth and promote depositor and investor confidence.
Regulatory agencies measure capital adequacy utilizing a formula that takes into account the individual risk profiles of financial institutions. The guidelines define capital as Tier 1 (primarily common stockholders’ equity, defined to include certain debt obligations) and Tier 2 (remaining capital generally consisting of a limited amount of subordinated debt, certain hybrid capital instruments and other debt securities, preferred stock and a limited amount of the general valuation allowance for loan losses).
On June 7, 2012, the Federal Reserve issued a series of proposed rules that would revise and strengthen its risk-based and leverage capital requirements and its method for calculating risk-weighted assets. The rules were proposed to implement the Basel III regulatory capital reforms from the Basel Committee on Banking Supervision and certain provisions of the Dodd-Frank Act. On July 2, 2013, the Federal Reserve approved certain revisions to the proposals and finalized new capital requirements for banking organizations.
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Effective January 1, 2015, the final rules require the Bank to comply with the following minimum capital ratios: (i) a common equity Tier 1 capital ratio of 4.5% of risk-weighted assets; (ii) a Tier 1 capital ratio of 6.0% of risk-weighted assets; (iii) a total capital ratio of 8.0% of risk-weighted assets (unchanged from the previous requirement); and (iv) a leverage ratio of 4.0% of total assets. These initial capital requirements were phased in over a five-year period. The phase was completed, as of January 1, 2019 and the rules require the Bank to maintain (i) a minimum ratio of common equity Tier 1 to risk-weighted assets of at least 4.5%, plus a 2.5% “capital conservation buffer” (which is added to the 4.5% common equity Tier 1 ratio, effectively resulting in a minimum ratio of common equity Tier 1 to risk-weighted assets of at least 7.0% upon full implementation), (ii) a minimum ratio of Tier 1 capital to risk-weighted assets of at least 6.0%, plus the capital conservation buffer (which is added to the 6.0% Tier 1 capital ratio, effectively resulting in a minimum Tier 1 capital ratio of 8.5% upon full implementation), (iii) a minimum ratio of total capital to risk-weighted assets of at least 8.0%, plus the capital conservation buffer (which is added to the 8.0% total capital ratio, effectively resulting in a minimum total capital ratio of 10.5% upon full implementation), and (iv) a minimum leverage ratio of 4.0%, calculated as the ratio of Tier 1 capital to average assets.
The capital conservation buffer requirement was phased in beginning January 1, 2016, at 0.625% of risk-weighted assets, increasing each year until fully implemented at 2.5% on January 1, 2019. The capital conservation buffer is designed to absorb losses during periods of economic stress. Banking institutions with a ratio of common equity Tier 1 to risk-weighted assets above the minimum but below the conservation buffer will face constraints on dividends, equity repurchases, and compensation based on the amount of the shortfall.
With respect to the Bank, the rules also revised the “prompt corrective action” regulations pursuant to Section 38 of the FDIA by (i) introducing a common equity Tier 1 capital ratio requirement at each level (other than critically undercapitalized), with the required ratio being 6.5% for well-capitalized status; (ii) increasing the minimum Tier 1 capital ratio requirement for each category, with the minimum ratio for well-capitalized status being 8.0% (as compared to the previous 6.0%); and (iii) eliminating the current provision that provides that a bank with a composite supervisory rating of 1 may have a 3.0% Tier 1 leverage ratio and still be well-capitalized.
The capital requirements also include changes in the risk weights of assets to better reflect credit risk and other risk exposures. These include a 150% risk weight (up from 100%) for certain high volatility commercial real estate acquisition, development and construction loans and nonresidential mortgage loans that are 90 days past due or otherwise on non-accrual status, a 20% (up from 0%) credit conversion factor for the unused portion of a commitment with an original maturity of one year or less that is not unconditionally cancellable, a 250% risk weight (up from 100%) for mortgage servicing rights and deferred tax assets that are not deducted from capital, and increased risk-weights (from 0% to up to 600%) for equity exposures.
Pursuant to the Regulatory Relief Act, on September 17, 2019, the federal banking agencies adopted a final rule regarding a community bank leverage ratio. Under the final rule, which was effective on January 1, 2020, depository institutions and depository institution holding companies that have less than $10 billion in total consolidated assets and meet other qualifying criteria, including a leverage ratio (equal to tier 1 capital divided by average total consolidated assets) of greater than 9 percent, will be eligible to opt into the community bank leverage ratio framework (qualifying community banking organizations). Qualifying community banking organizations that elect to use the community bank leverage ratio framework and that maintain a leverage ratio of greater than 9 percent will be considered to have satisfied the generally applicable risk-based and leverage capital requirements in the agencies’ capital rules (generally applicable rule) and, if applicable, will be considered to have met the well-capitalized ratio requirements for purposes of section 38 of the Federal Deposit Insurance Act.
The Bank’s regulatory capital levels exceed those established for well-capitalized institutions.
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The following table (along with Note 18 of the consolidated financial statements) shows the minimum capital requirements and the Bank’s capital position as of December 31, 2021 and 2020.
Analysis of Capital for Bank of the James (Bank only)
(dollars in thousands)
December 31, December 31,
Tier 1 capital
Tier 2 capital
Allowance for loan losses $ 6,915 $ 7,156
Actual Regulatory Benchmarks
For Capital For Well
December 31, December 31, Adequacy Capitalized
Capital Ratios:
(1)Includes capital conservation buffer of 2.5%, where applicable.
During the first quarter of 2017, Financial closed a private placement of unregistered debt securities (the “2017 Offering”) pursuant to which Financial issued $5,000,000 in principal of notes (the “2017 Notes”). The 2017 Notes were scheduled to mature on January 24, 2022, but were subject to prepayment in whole or in part on or after January 24, 2018 at Financial’s sole discretion on 30 days written notice to the holders. The Company contributed $3,000,000 of the proceeds from the 2017 Offering to the Bank as additional paid in capital. The remainder of the proceeds were retained at the parent level to service the debt and pay dividends.
On April 13, 2020, the Company commenced a private placement of unregistered debt securities (the “2020 Offering”). In the 2020 Offering, the Company sold and closed $10,050,000 in principal of notes (the “2020 Notes”) during the 2nd and 3rd quarters of 2020. The 2020 Offering officially ended on July 8, 2020. The 2020 Notes will bear interest at the rate of 3.25% per year with interest payable quarterly in arrears. The 2020 Notes will mature on June 30, 2025 and are subject to full or partial repayment on or after June 30, 2021. The
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balance of the 2020 Notes as presented on the December 31, 2021 consolidated balance sheet is net of unamortized issuance costs.
On September 24, 2020 the Bank used $5,000,000 of the proceeds for the payment of principal of the 2017 Notes. The Company intends to use the balance of the proceeds from the 2020 Offering for general corporate purposes in the discretion of Company’s management such as payment of interest on the 2020 Notes and as a contribution of additional capital to the Bank.
The capital ratios set forth in the above tables state the capital position and analysis for the Bank only. Because total assets on a consolidated basis are less than $3 billion, Financial is not subject to the consolidated capital requirements imposed by the Bank Holding Company Act. Consequently, Financial does not calculate its financial ratios on a consolidated basis. If calculated, the capital ratios for the Company on a consolidated basis would be slightly lower than the capital ratios of the Bank because the of the Company’s decision to contribute $3,000,000 in proceeds from the 2017 Offering to the Bank.
Stockholders’ Equity
Stockholders’ equity increased by $2,697,000 from $66,732,000 on December 31, 2021 to $69,429,000 on December 31, 2020 because of net income of $7,589,000, less cash dividends paid, less a comprehensive loss of $3,178,000 resulting from a decrease in the market value (mark to market) of available-for-sale securities.
ASSET QUALITY
We perform monthly reviews of all delinquent loans and loan officers are charged with working with customers to resolve potential payment issues. We generally classify a loan as non-accrual when interest is deemed uncollectible or when the borrower is 90 days or more past due. We generally restore a loan if i) a borrower is no longer 90 days past due on the loan and the borrower has demonstrated the capacity to repay the loan for six consecutive months or ii) the loan committee of the Board of Directors determines that a borrower has the capacity to repay the loan.
Non-accrual loans decreased to $954,000 on December 31, 2021 from $2,063,000 on December 31, 2020. As set forth in tabular form below, total charge-offs during 2021 were $91,000 compared to $448,000 in 2020. In 2021, the Bank recovered $350,000 in loans previously charged-off as compared with recoveries of $227,000 in 2020.
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We also classify other real estate owned (OREO) as a nonperforming asset. OREO is the value of real property acquired by the Bank following default by the borrower. During the twelve months ended December 31, 2021 the Bank acquired two (2) OREO properties and disposed of three (3) OREO properties and as of December 31, 2021 is carrying two (2) OREO properties at a value of $761,000, as compared to three (3) properties with a value of $1,105,000 as of December 31, 2020. The OREO properties are available for sale and are being actively marketed on the Bank’s website and through other means. The following table represents the changes in OREO balance in 2021 and 2020.
OREO Changes
(dollars in thousands)
Year Ended December 31,
Balance at the beginning of the year (net) $ 1,105 $ 2,339
Transfers from Loans 111 18
Capitalized costs — —
Valuation Adjustment — (437)