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BANK OF THE JAMES FINANCIAL GROUP INC – 10-K – Management’s Discussion and Analysis of Financial Condition and Results of Operations
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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. Because Bank of theJames Financial Group, Inc. ("Financial") has no material operations and conducts no business other than the ownership of its operating subsidiary,Bank of the James (and its divisions and subsidiary), 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. The comparison of operating results for Financial between the years endedDecember 31, 2011 and 2010 should be read in the context of both the size and the relatively short operating history of the Bank. 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. The words "believe," "estimate," "expect," "intend," "anticipate," "plan" and similar expressions and variations thereof identify certain of such forward-looking statements which speak only as of the dates on which they were made. We undertake no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events, or otherwise. Readers are cautioned that any such forward-looking statements are not guarantees of future performance and involve risks and uncertainties, and that actual results may differ materially from those indicated in the forward-looking statements as a result of various factors. Factors that could cause actual results to differ from the results discussed in the forward-looking statements include, but are not limited to: economic conditions (both generally and more specifically in the markets in which we operate); 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 the value of real estate securing loans made by the Bank; changes in interest rates; and material unforeseen changes in the liquidity, results of operations, or financial condition of our customers. Other risks, uncertainties and factors could cause our actual results to differ materially from those projected in any forward-looking statements we make.
Overview
Financial is a bank holding company headquartered inLynchburg, VirginiaBank of the James (which we refer to as the "Bank"). We conduct three 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"), and insurance activities through BOTJ Insurance, Inc. , a subsidiary of the Bank, (which we refer to as "Insurance"). 25
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The Bank is aVirginia banking corporation headquartered inLynchburg, Virginia . The Bank was incorporated under the laws of the Commonwealth ofVirginia as a state chartered bank in 1998 and began banking operations inJuly 1999 . We began providing securities brokerage services to the public inApril 2006 through Financial'sBOTJ Investment Group, Inc. subsidiary. Following a restructuring, we now provide the securities brokerage services through Investment. Investment conducts its business primarily from one office located in theCity of Lynchburg . We began offering insurance and annuity products inSeptember 2008 . Insurance currently operates out of the same location as Investment. 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 loan fees and service charges, and its noninterest expenses, including salaries and employee benefits, occupancy expense, data processing expenses, miscellaneous other expenses, franchise taxes, and income taxes.
As discussed in more detail below,
• For the year endedDecember 31, 2011 , Financial had net income of$600,000 , a decrease of$1,220,000 from net income of$1,820,000 , from the year endedDecember 31, 2010 ; • For the year endedDecember 31, 2011 , the income per basic and diluted share was$0.18 , as compared income of$0.55 per basic and diluted share for the year endedDecember 31, 2010 ; • Net interest income increased to$15,327,000 for the current year from$15,201,000 for the year endedDecember 31, 2010 ; • Noninterest income (exclusive of gains and losses on sales of securities) decreased to$2,498,000 for the year endedDecember 31, 2011 from$3,160,000 for the year endedDecember 31, 2010 ; • Total assets as ofDecember 31, 2011 were$427,436,000 compared to$418,928,000 at the end of 2010, an increase of$8,508,000 or 2.03%; • Loans, net of unearned income and loan loss provision, decreased to$319,188,000 as ofDecember 31, 2011 from$320,715,000 as of the end ofDecember 31, 2010 , a decrease of 0.48%; and • The net interest margin decreased 5 basis points to 3.89% for 2012, compared to 3.94% for 2009.
The following table sets forth selected financial ratios:
For the Year Ended December 31, 2011 2010 2009 Return on average equity 2.25 % 7.27 %
-0.16 %
Return on average assets 0.14 % 0.44 %
-2.60 %
Dividend payout % 0.00 % 0.00 %
0.00 %
Average equity to total average assets 6.24 % 6.01 % 6.17 %
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Effect of Economic Trends
The twelve months endedDecember 31, 2011 continue to reflect the turbulent economic conditions and continued weakness in the financial markets which have negatively impacted the liquidity and credit quality of financial institutions inthe United States . Concerns regarding increased credit losses from the weakening economy have negatively affected capital and earnings of most financial institutions. Nationally, financial institutions have experienced significant declines in the value of collateral for real estate loans and heightened credit losses, which have resulted in record levels of nonperforming assets, charge-offs and foreclosures. Although management cannot be certain, it expects weak economic conditions to persist in 2012. Financial institutions likely will continue to experience heightened credit losses and higher levels of nonperforming assets, charge-offs and foreclosures. In light of these conditions, financial institutions also face heightened levels of scrutiny from federal and state regulators. Financial institutions experienced, and are expected to continue to experience, pressure on credit costs, loan yields, deposit and other borrowing costs, liquidity, and capital. 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 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. The downward trend in short term interest rates beginning in the last quarter of 2007 was due to the actions of the Federal Open Market Committee ("FOMC") resulting from a weakening economy. The federal funds target rate set by the Federal Reserve has remained at 0.00% to 0.25% sinceDecember 2008 , following a decline from 4.25% inDecember 2007 through a series of rate reductions. As liquidity increased as a result of open market operations and other government actions, longer-term interest rates decreased and the yield curve remains positively sloped. Although it cannot be certain, management believes that short term interest rates will remain stable for at least the first two quarters of 2012. An increase in long-term interest rates likely would have an adverse impact on the Mortgage Division, primarily due to reduced refinancing opportunities.The Treasury Department , theFDIC and other governmental agencies continue to enact rules and regulations to implement the EESA, TARP, the Financial Stability Plan, the Recovery Act and related economic recovery programs, many of which contain limitations on the ability of financial institutions to take certain actions or to engage in certain activities if the financial institution is a participant in the TARP capital purchase program or related programs. Future regulations, or enforcement of the terms of programs already in place, may require financial institutions to raise additional capital and result in the conversion of preferred equity issued under TARP or other programs to common equity. Although the Company did not participate in TARP and therefore should not be directly impacted by the foregoing, there can be no assurance as to the actual impact of these programs or any other governmental program on the financial markets.
Stock Dividends
OnMay 19, 2010 , Financial declared a 10% stock dividend, which was paid onJuly 23, 2010 to shareholders of record onJune 21, 2010 . Except as otherwise described in this report, all share amounts and dollar amounts per share in this report with regard to the common stock have been adjusted to reflect these and all prior stock dividends. 27
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Critical Accounting Policies
Financial's financial statements are prepared in accordance with accounting principles generally accepted inthe 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 losses that may be sustained in our loan portfolio. The allowance is based on two basic principles of accounting: (i) ASC 450, Contingencies, which requires that losses be accrued when they are probable of occurring and are reasonably estimable and (ii) ASC 310, Impairment of a Loan, 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 theSEC Staff Accounting Bulletin No. 102 - "Selected Loan Loss Allowance Methodology and Documentation Issues" and theFederal Financial Institutions Examination Council's interagency guidance, "Interagency Policy Statement on the Allowance for Loan and Lease Losses" (the "FFIEC Policy Statement"). See "Management Discussion and Analysis Results of Operations - Allowance for Loan Losses and Loan Loss Reserve" below for further discussion of the allowance for loan losses. Because Financial has a relatively short operating history, historical trends alone do not provide sufficient information to judge the adequacy of the allowance for loan losses. Therefore, management considers industry trends, peer comparisons, as well as individual classified impaired loans, in addition to historical experience to evaluate the allowance for loan losses. Our method for determining the allowance for loan losses is discussed more fully under "Provision and Allowance for Loan Losses for the Bank" below.
RESULTS OF OPERATIONS
Net Income
The net income for Financial for the year endedDecember 31, 2011 was$600,000 or$0.18 per basic and diluted share compared with net income of$1,820,000 or$0.55 per basic and diluted share for the year endedDecember 31, 2010 . Note 12 of the Audited Financial Statements provides additional information with respect to the calculation of Financial's earnings per share. The decrease of$1,220,000 in 2011 net income compared to 2010 was due in large part the following: i) a significant increase in provisions for loan losses in 2011 as compared to 2010; ii) a slight increase in net interest income; iii) an increase in the loss on sale of other real estate owned; and iv) a slight decrease (exclusive of OREO losses and expenses) in noninterest expense that was generally offset by a slight increase in noninterest income. As discussed in more detail below, we charged off$4,716,000 in nonperforming loans during the year endedDecember 31, 2011 as compared with$1,899,000 in 2010. The amount of the provision to the loan loss reserve was$4,807,000 in the year endedDecember 31, 2011 as compared to$2,783,000 in 2010. 28
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These operating results represent a return on average shareholders' equity of 2.25% for the year endedDecember 31, 2011 compared to 7.27% for the year endedDecember 31, 2010 . The return on average assets for the year endedDecember 31, 2011 was 0.14% compared to 0.44% in 2010.
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, 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$19,519,000 for the year endedDecember 31, 2011 from$21,589,000 for the year endedDecember 31, 2010 . This decrease was due to a decrease in the yields on average earning assets which primarily consist of loans and investment securities. Interest expense decreased to$4,192,000 for the year endedDecember 31, 2011 from$6,388,000 primarily as a result of the decrease in rates paid on deposit accounts, as discussed more fully below. Net interest income for 2011 increased$126,000 to$15,327,000 or 0.83% from net interest income of$15,201,000 in 2010. The growth in net interest income was due in large part to a decrease in our interest expense of$2,196,000 from$6,388,000 for the year endedDecember 31, 2010 to$4,192,000 for the year endedDecember 31, 2011 . This decrease in interest expense was primarily due to reductions in the interest rate paid on time deposits and savings accounts, specifically savings accounts. OnDecember 31, 2011 , 51.7% of the interest bearing deposits were held in a product known as the "Peaks Savings Account." During 2011, the Bank reduced the rate paid on this account from 1.00% APY to 0.25% to APY. The average interest rate paid on time deposits decreased by 60 basis points during 2011 as compared to 2010. The net interest margin decreased to 3.89% in 2011 from 3.94% in 2010. The average rate on earning assets decreased 65 basis points from 5.60% in 2010 to 4.95% in 2011 and the average rate on interest-bearing liabilities decreased from 1.85% in 2010 to 1.20% in 2011. Although management cannot predict with certainty future interest rate decisions by the FOMC, statements from theFederal Reserve Board indicate that interest rates will remain low through the end of 2014. A continued low interest rate environment could make it difficult to maintain an acceptable spread between the average rate the Bank receives on assets and the average rate that the Bank pays on liabilities. 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. 29
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Table of Contents Net Interest Margin Analysis Average Balance Sheets
For the Twelve Months Ended
(dollars in thousands) 2011 2010 Average Average Average Interest Rates Average Interest Rates Balance Income/ Earned/ Balance Income/ Earned/ Sheet Expense Paid Sheet Expense Paid ASSETS Loans, including fees (1) (2) $ 324,456 $ 17,572 5.42 % $ 326,442 $ 19,710 6.04 % Federal funds sold 9,310 23 0.25 % 9,707 24 0.25 % Securities (3) 58,516 1,872 3.20 % 47,091 1,808 3.84 % Federal agency equities 1,976 52 2.63 % 2,174 47 2.16 % CBB equity 116 - 0.00 % 116 - 0.00 % Total earning assets 394,374 19,519 4.95 % 385,530 21,589 5.60 % Allowance for loan losses (5,169 ) (4,683 ) Non-earning assets 38,308 35,482 Total assets $ 427,513 $ 416,329 LIABILITIES AND STOCKHOLDERS' EQUITY Deposits Demand interest bearing $ 63,666 $ 346 0.54 % $ 54,517 $ 554 1.01 % Savings 175,866 1,329 0.76 % 179,998 2,751 1.53 % Time deposits 84,822 1,725 2.03 % 84,319 2,221 2.63 % Total interest bearing deposits 324,354 3,400 1.05 % 318,834 5,526 1.73 % Other borrowed funds Fed funds purchased 10 - 0.00 % 236 2 0.85 % Repurchase agreements 8,383 75 0.89 % 8,756 116 1.32 % Other borrowings 10,000 297 2.97 % 10,959 324 2.96 % Capital notes 7,000 420 6.00 % 7,000 420 6.00 %
Total interest-bearing liabilities 349,747 4,192 1.20 % 345,785 6,388 1.85 %
Noninterest bearing deposits 50,784 45,293 Other liabilities 325 214 Total liabilities 400,856 391,292 Stockholders' equity 26,657 25,037 Total liabilities and Stockholders' equity $ 427,513 $ 416,329 Net interest earnings $ 15,327 $ 15,201 Net interest margin 3.89 % 3.94 % Interest spread 3.75 % 3.75 % 30
-------------------------------------------------------------------------------- Table of Contents (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 nonaccrual loans.
(3) The interest income and yields calculated on securities have been tax
affected to reflect any tax exempt interest on municipal securities.
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, 2011 2010 Change in Change in Volume Rate Income/ Volume Rate Income/ Effect Effect Expense Effect Effect Expense Loans $ (1,180 ) $ (958 ) $ (2,138 ) $ 1,366 $ (90 ) $ 1,276 Federal funds sold - (1 ) (1 ) (16 ) 8 (8 ) Securities 91 (27 ) 64 (119 ) (146 ) (265 ) Restricted stock (13 ) 18 5 1 4 5 Total earning assets (1,101 ) (969 ) (2,070 ) 1,232 (224 ) 1,008 Liabilities: Demand interest bearing (566 ) 358 (208 ) 86 (45 ) 41 Savings (67 ) (1,355 ) (1,422 ) 1,027 (2,609 ) (1,582 ) Time deposits 13 (509 ) (496 ) (393 ) (706 ) (1,099 ) Fed funds purchased 1 (3 ) (2 ) 2 - 2 Capital notes - - - 107 - 107 FHLB borrowings (48 ) 21 (27 ) (277 ) 23 (254 ) Repurchase agreements (9 ) (32 ) (41 ) (54 ) (25 ) (79 )
Total interest-bearing liabilities $ (678 ) $ (1,518 ) $ (2,196 )
Change in net interest income $ (424 )
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Noninterest Income of Financial
Noninterest income has been and will continue to be an important factor for increasing our profitability. We recognize this and our management continues to review and consider areas where noninterest income can be increased. Noninterest income (excluding securities gains and losses) consists mortgage loan origination fees, service fees, distributions from a title insurance agency in which we have an ownership interest, and fees generated by the investment services of Investment. Service fees consist primarily of monthly service and minimum account balance fees and charges on transactional deposit accounts, overdraft charges, and ATM service fees. The Bank, through the Mortgage division originates both conforming and non-conforming consumer residential mortgage loans primarily in the Region 2000 area. 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. Because the overall mortgage loan market was suppressed, during 2011 as a result of continued declines in real estate values and a difficult credit market, mortgage loan origination decreased. The Mortgage Division originated 290 mortgage loans, totaling$49,481,000 in 2011 as compared with 374 mortgage loans, totaling$75,582,000 during the year endedDecember 31, 2010 . In 2011, the Mortgage Division faced a declining real estate market and loans for new home purchase comprised 37% of the total volume. Refinancing increased significantly in response to continued historical low interest rates. For the year endedDecember 31, 2011 , the Mortgage Division accounted for 4.49% of Financial's total revenue as compared with 6.03% of Financial's total revenue for the year endedDecember 31, 2010 . Mortgage contributed$158,653 and$263,000 to Financial's pre-tax net income in 2011 and 2010, respectively. Management anticipates that residential mortgage rates will remain low by historical standards throughout 2012. Despite this decrease, the Mortgage Division continues to improve its market share in Region 2000. Management expects that low rates coupled with the Mortgage Division's reputation in Region 2000 will allow us to continue to grow revenue at the Mortgage Division. Service charges and fees and commissions decreased to$1,149,000 for the year endedDecember 31, 2011 from$1,344,000 for the year endedDecember 31, 2010 . This decrease was due in large part to a decrease in commissions earned on the sale of securities to$69,000 for the year endedDecember 31, 2011 from$276,000 for the year endedDecember 31, 2010 . The decrease was offset in part an increase in debit card fees which increased to$505,000 for the year endedDecember 31, 2011 from$403,000 for the year endedDecember 31, 2010 . Our Investment division 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. The Investment division's financial impact on our consolidated revenue has been immaterial. Although management cannot predict the financial impact of Investment with certainty, management anticipates it will continue to be an immaterial component of revenue in 2012. 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 2011. 32
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Noninterest income, exclusive of gains and losses on sale of securities, decreased to$2,498,000 in 2011 from$3,160,000 in 2010. Inclusive of gains and losses on sale of securities, noninterest income increased to$3,680,000 in 2011 from$3,518,000 in 2010. The following table summarizes our noninterest income for the periods indicated. Noninterest Income (dollars in thousands) December 31, 2011 2010 Mortgage fee income $ 1,042 $ 1,515
Service charges, fees and commissions 1,149
1,344
Increase in cash value of life insurance 249 234 Other 58 67 Gain on sale of available-for-sale securities 1,182 358 Total noninterest income $ 3,680 $ 3,518 The increase in noninterest income for 2011 as compared to 2010 was due to an increase in gains on sales of available-for-sale securities. These gains were largely offset by decreases in the other categories of non-interest income, particularly mortgage fee income. Mortgage fee income decreased due to the factors discussed previously.
Noninterest Expense of Financial
Noninterest expenses increased from$13,502,000 for the year endedDecember 31, 2010 to$13,693,000 for the year endedDecember 31, 2011 . The following table summarizes our noninterest expense for the periods indicated. Noninterest Expense (dollars in thousands) December 31, 2011 2010 Salaries and employee benefits $ 5,668 $ 6,686 Occupancy 1,091 1,022 Equipment 1,038 1,100 Supplies 365 373 Professional, data processing and other outside expenses 2,139 1,690 Marketing 333 274 Credit expense 257 323 Loss on sale and/or writedown of other real estate owned 1,021 185 Amortization of tax credit investment 247 196 FDIC insurance expense 661 902 Other 873 751 Total noninterest expense $ 13,693 $ 13,502 The slight increase in noninterest expense was due in large part to an increase in professional, data processing, and other outside expenses and the loss on the sale or writedown of OREO. The increase in these costs was largely offset by a decrease in personnel expenses. Our total personnel expense, net of fees collected from borrowers to cover direct salary costs incurred in originating certain loans (in accordance with current accounting rules), decreased to$5,668,000 for the year endedDecember 31, 2011 , from 33
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$6,686,000 for the twelve months endedDecember 31, 2010 . Compensation for some employees of the Mortgage Division and Investment is commission-based and therefore subject to fluctuation. Because of decreased volume of business at Mortgage, commission compensation and the corresponding employee benefits decreased significantly, in 2011. The Bank's occupancy expense also increased in large part due to an increase in rent at two of our locations. Our data processing expense also increased because of an increase in the number of customers and accounts. 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. Because of a slight increase in net interest income, Financial's efficiency ratio improved from 71.08% in 2010 to 70.74% in 2011. Management intends that additional interest earning assets will help further lower the efficiency ratio. Income Tax Expense For the year endedDecember 31, 2011 , Financial had a federal income tax benefit of$93,000 , as compared to a Federal income tax expense of$614,000 in 2010. Although we had net income, we realized a federal income tax benefit principally as a result of earnings on bank owned life insurance as well as the impact of tax credits. Note 11 of the Audited Financial Statements provides additional information with respect to our 2011 federal income tax expense and the deferred tax accounts.
Analysis of Financial Condition
As of
General
Our total assets were$427,436,000 atDecember 31, 2011 , an increase of$8,508,000 or 2.03% from$418,928,000 atDecember 31, 2010 , primarily due to an increase in cash and cash equivalents, securities available-for-sale (which was offset in part by a decrease in securities held-to-maturity), and the cash value of bank-owned life insurance. Deposits increased from$368,390,000 onDecember 31, 2010 to$374,234,000 onDecember 31, 2011 . Loans, net of unearned income and allowance, decreased slightly to$319,188,000 onDecember 31, 2011 from$320,715,000 onDecember 31, 2010 .
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 allowance, decreased slightly to$319,188,000 onDecember 31, 2011 from$320,715,000 onDecember 31, 2010 . Total loans decreased to$324,800,000 onDecember 31, 2011 from$326,182,000 onDecember 31, 2010 . The minimal decrease in both loans, net of unearned income and allowance and total loans was due in large part to a smaller number of qualified borrowers. Management expects that the number of qualified borrowers will remain limited until the economy further improves. 34
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As ofDecember 31, 2011 , the Bank had$10,375,000 , or 3.19% of its total loans, in non-accrual status compared with$8,366,000 , or 2.56% of its total loans, atDecember 31, 2010 . This increase is due primarily to continued difficulties in the commercial real estate market which has resulted in the inability of certain borrowers to make payments in accordance with the terms of the loan. 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, resolution across the portfolio is dependent on improvements in employment, housing, and overall economic conditions at the local, regional and national levels. See "Asset Quality" below.
The following table summarizes the composition of the Bank's loan portfolio for the periods indicated by dollar amount:
Loan Portfolio (dollars in thousands) December 31, 2011 2010 2009 2008 2007 Commercial $ 59,623 $ 62,786 $ 60,045 $ 51,675 $ 42,078 Commercial real estate 150,622 143,428 141,530 121,800 99,181 Consumer 72,488 68,289 67,744 58,300 47,473 Residential 42,067 51,679 53,421 45,974 37,436 Total loans 324,800 326,182 322,740 277,749 226,168 Less allowance for loan losses 5,612 5,467 4,288 2,859 2,146 Net loans $ 319,188 $ 320,715 $ 318,452 $ 274,890 $ 224,022 The following table sets forth the maturities of the loan portfolio atDecember 31, 2011 . Remaining Maturities of Selected Loans (dollars in thousands) At December 31, 2011 One to Greater Less than Five than Five One Year Years Years Total Commercial $ 12,080 $ 7,253 $ 40,290 $ 59,623 Commercial real estate 30,517 18,322 101,783 150,622 Consumer 14,686 8,818 48,984 72,488 Residential 8,523 5,117 28,427 42,067 Total $ 65,806 $ 39,510 $ 219,484 $ 324,800 For maturities over one year: Fixed Rates $ 116,573 45.01 % Variable Rates 142,421 54.99 % Total $ 258,994 35
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Deposits
We experienced an increase in deposits from$368,390,000 atDecember 31, 2010 to$374,234,000 atDecember 31, 2011 , for an increase of 1.59%. Noninterest-bearing deposits increased$11,297,000 or 25.52% from$44,272,000 atDecember 31, 2010 to$55,569,000 atDecember 31, 2011 . Interest-bearing deposits decreased$5,453,000 from$324,118,000 atDecember 31, 2010 to$318,665,000 atDecember 31, 2011 . This 1.68% decrease in interest bearing deposits was anticipated by management and largely resulted from the Bank's decision to lower its interest rates paid on deposit accounts to more closely track the local market. Additionally, the balance in non-FDIC insured sweep accounts (repurchase agreements) increased slightly from$7,330,000 onDecember 31, 2010 to$8,379,000 onDecember 31, 2011 .
The following table sets forth the average deposit balance and the rates paid on deposits for the years indicated:
Average Deposits and Rates Paid (dollars in thousands) Year Ended December 31, 2011 2010 2009 Amount Rate Amount Rate Amount Rate Noninterest- bearing deposits $ 50,784 - $
45,293 -
Interest -bearing deposits Interest checking $ 23,766 0.44 % $ 21,324 0.75 % $ 17,877 0.72 % Money market 39,900 0.61 % 33,193 1.20 % 27,321 1.40 % Savings 175,866 0.76 % 179,998 1.52 % 152,606 2.84 % Time deposits Less than $100,000 51,926 2.00 % 51,930 2.61 % 64,424 3.37 % Greater than $100,000 32,896 2.08 % 32,389 2.67 % 32,504 3.54 % Total interest-bearing deposits $ 324,354 1.05 % $ 318,834 1.73 % $ 294,732 2.77 % Total deposits $ 375,138 $ 364,127 $ 335,051
The following table includes a summary of average deposits and average rates paid and maturities of CDs greater than
Maturities of CD's Greater than $ 100,000 (dollars in thousands) Less than Three to Six to Greater Three Six Twelve than One Months Months Months Year Total
At
Cash and Cash Equivalents
Cash and cash equivalents increased from$18,759,000 onDecember 31, 2010 to$23,340,000 onDecember 31, 2011 . This increase was due primarily to routine fluctuations in deposits, including fluctuations in transactional accounts and professional settlement accounts. Federal funds sold decreased from$7,094,000 onDecember 31, 2010 to$5,662,000 onDecember 31, 2011 . 36
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The investment securities portfolio of the Bank is used as a source of income and liquidity.
The following table summarizes the fair value of the Bank's securities portfolio for the periods indicated: Securities Portfolio (dollars in thousands) December 31, 2011 2010 2009 Held-to-maturity U.S. agency obligations $ 8,533 $ 14,601 $ 15,277 Available-for-sale U.S. agency obligations 25,485 14,341 38,442 Mortgage - backed securities 3,939 17,762 213 Municipals 18,914 5,465 3,622 Corporates - 1,018 2,962 Total available-for-sale $ 48,338 $ 38,586 $ 45,239 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. Management believes that this strategy will allow us to maximize interest margins while maintaining appropriate levels of liquidity.
Securities held-to-maturity decreased from$14,297,000 as ofDecember 31, 2010 to$8,133,000 as ofDecember 31, 2011 . This decrease resulted in large part by certain issuers exercising their contractual right to redeem (call) certain of the securities. 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. 37
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The portfolio of securities available-for-sale increased to$48,338,000 as ofDecember 31, 2011 from$38,586,000 as ofDecember 31, 2010 . During 2011, the Bank purchased available-for-sale securities in order to maintain the ability to fund loans if demand and quality of credits increased. The following table shows the maturities of held-to-maturity and available-for-sale securities at amortized cost and market value atDecember 31, 2011 andDecember 31, 2010 and approximate weighted average yields of such securities. Yields on state and political subdivision securities are not shown on a tax equivalent 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) At December 31, 2011 Greater Less than Ten than One to Five to Years and One Five Ten Other Year Years Years Securities Total Held-to-maturity U.S. agency Amortized cost $ - $ - $ 2,072 $ 6,061 $ 8,133 Market value $ - $ - $ 2,362 $ 6,171 $ 8,533 Weighted average yield 4.00 % 3.63 % Available-for-sale securities U.S. agency Amortized cost $ - $ - $ 6,146 $ 19,270 $ 25,416 Market value $ - $ - $ 6,157 $ 19,328 $ 25,485 Weighted average yield 2.63 % 2.85 %Mortgage Backed Securities Amortized cost $ - $ - $ - $ 3,938 $ 3,938 Market value $ - $ - $ - $ 3,939 $ 3,939 Weighted average yield 2.18 % Municipals Amortized cost $ - $ - $ 1,138 $ 17,924 $ 19,062 Market value $ - $ - $ 1,204 $ 17,710 $ 18,914 Weighted average yield 4.39 % 3.52 % Total portfolio Amortized cost $ - $ - $ 9,356 $ 47,193 $ 56,549 Market value $ - $ - $ 9,723 $ 47,148 $ 56,871 Weighted average yield 3.15 % 3.15 % 38
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Securities Portfolio
Maturity Distribution / Yield Analysis
(dollars in thousands) At December 31, 2010 Greater Less than Ten than One to Five to Years and One Five Ten Other Year Years Years Securities Total
Held-to-maturity U.S. agency Amortized cost $ - $ - $ 2,083 $ 12,214 $ 14,297 Market value $ - $ - $ 2,191 $ 12,410 $ 14,601 Weighted average yield 4.00 % 3.41 % Available-for-sale securities U.S. agency Amortized cost $ - $ 1,993 $ 3,000 $ 9,765 $ 14,758 Market value $ - $ 1,929 $ 2,910 $ 9,502 $ 14,341 Weighted average yield 1.58 % 2.20 % 3.61 %Mortgage Backed Securities Amortized cost $ - $ - $ 1,010 $ 17,047 $ 18,057 Market value $ - $ - $ 1,011 $ 16,751 $ 17,762 Weighted average yield 2.76 % 3.17 % Municipals Amortized cost $ - $ - $ 919 $ 4,868 $ 5,787 Market value $ - $ - $ 921 $ 4,545 $ 5,466 Weighted average yield 4.81 % 5.45 % Corporate Amortized cost $ - $ - $ - $ 1,033 $ 1,033 Market value $ - $ - $ - $ 1,017 $ 1,017 Weighted average yield 7.38 % Total portfolio Amortized cost $ - $ 1,993 $ 7,012 $ 44,927 $ 53,932 Market value $ - $ 1,929 $ 7,033 $ 44,225 $ 53,187 Weighted average yield 1.58 % 3.16 % 3.68 % 39
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Cash surrender value of bank owned life insurance
OnJuly 1, 2009 , the Company funded bank owned life insurance (BOLI) for a chosen group of its officers, where the Company is the owner and sole beneficiary of the policies. As ofDecember 31, 2011 , the BOLI had a cash surrender value of$8,609,000 , an increase of$3,249,000 from the cash surrender value of$5,360,000 as ofDecember 31, 2010 . Of the increased amount,$3,000,000 resulted from the purchase of additional policies insuring an additional group of employees and$249,000 is attributed to an increase in the cash surrender value relating to the aggregate earnings on all of the BOLI policies. 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 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. 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 theFederal Reserve Board and is tied to the regulatory capital requirements. Although Financial's liquidity is limited, 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 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 ofAtlanta ("FHLBA") and correspondents, and brokered certificate of deposit arrangements. Management believes that the Bank has the ability to meet its liquidity needs. AtDecember 31, 2011 , liquid assets, which include cash, interest-bearing and noninterest-bearing deposits with banks, federal funds sold, and securities available-for-sale totaled$71,678,000 onDecember 31, 2011 as compared to$57,345,000 atDecember 31, 2010 . Investment securities traditionally provide a secondary source of liquidity since they can be converted into cash in a timely manner. However, approximately$19,300,000 of these securities are pledged against outstanding debt or lines of credit. Therefore, the related debt would need to be repaid prior to the securities being sold in order for these securities to be converted to cash. 40
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The following table sets forth non-deposit sources of funding:
Funding Sources (dollars in thousands) December 31, 2011 Source Capacity Outstanding Available
Fed funds purchased lines (unsecured)
Reverse repurchase agreements 3,000 -
3,000
Borrowings from FHLB Atlanta 85,850 10,000 75,850 Total $ 106,850 $ 10,000 $ 96,850 At the end of 2011, approximately 64.11%, or$208,227 of the loan portfolio would mature or could reprice within a one-year period. AtDecember 31, 2011 non-deposit sources of available funds totaled$96,850 , which included$75,400 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). The Bank's regulatory capital levels exceed those established for well-capitalized institutions. The following table (along with Note 16 of the Audited Financial Statements) shows the minimum capital requirements and the Bank's capital position as ofDecember 31, 2011 and 2010. Analysis of Capital for Bank of the James (Bank only) (dollars in thousands) December 31, 2011 2010 Tier 1 Capital: Common stock $ 3,742 $ 3,742
Additional paid in capital 19,325
19,325 Retained earnings 10,394 9,049 Total Tier 1 Capital $ 33,461 $ 32,116 Tier 2 Capital: Allowable portion of allowance for loan losses 3,991 3,989 Total Tier 2 Capital $ 3,991 $ 3,989
Total risk-based capital $ 37,452 $
36,105 Risk weighted assets $ 317,684 $ 317,606 Average total assets $ 427,680 $ 423,349 41
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Table of Contents Regulatory Minimums December 31, Capital Well 2011 2010 Adequacy Capitalized Capital Ratios Tier 1 capital to average total assets 7.82 % 7.59 % 4.00 % 5.00 % Tier 1 risk-based capital ratio 10.53 % 10.11 % 4.00 % 6.00 % Total risk-based capital ratio 11.79 % 11.37 % 8.00 % 10.00 % The Bank, as predecessor to Financial, was initially capitalized through a public offering of its common stock,$4.00 (split adjusted to$2.14 ) par value per share ("Common Stock"), at$10.00 per share, which concluded in February, 1999 and resulted in a capitalization of the Bank of$9,356,300 . OnDecember 22, 2006 , Financial completed a follow-on offering pursuant to which it raised$5,147,000 (net of costs and expenses of$106,000 ). In 2009, Financial completed a private placement of unregistered debt securities pursuant to which it issued notes to accredited investors in an amount of$7,000,000 (the "2009 Notes"). The debt issued pursuant to this offering bears interest at the rate of 6% per year with interest payable quarterly in arrears. The first interest payment was due and paid onJuly 1, 2009 . No principal payments are due until the debt matures onApril 1, 2012 (the "Maturity Date"). Financial used$6,000,000 of the proceeds to provide additional capital to the Bank. Financial retained$1,000,000 which it has used to service interest payments on the debt. On the Maturity Date the principal and all accrued but unpaid interest on the debt will be due and payable. Financial currently is conducting a private placement of unregistered debt securities (the "2012 Offering"). Financial will sell a maximum of$12,000,000 in principal of notes in the 2012 Offering (the "2012 Notes"). The 2012 Notes will not be and have not been registered under the Securities Act of 1933 and may not be offered or sold inthe United States absent registration or an applicable exemption from registration requirements. The 2012 Notes will bear interest at the rate of 6% per year with interest payable quarterly in arrears. The first interest payment will be due onJuly 1, 2012 . The notes mature onApril 1, 2017 , but are subject to prepayment in whole or in part on or afterApril 1, 2013 at Financial's sole discretion on 30 days written notice to the holders. Unless prepaid, no principal payments are due until the debt matures onApril 1, 2017 (the "Maturity Date"). Financial intends to use up to the first$7,000,000 in proceeds from the 2012 Offering to pay the 2009 Notes on maturity. As ofMarch 20, 2012 , Financial has accepted subscription agreements for the purchase of$7,820,000 . Financial anticipates that it will close on these purchases on or beforeMarch 30, 2012 . Financial anticipates that it will continue to sell the 2012 Notes until it has sold$12,000,000 in principal of 2012 Notes, Financial terminates the offering, orApril 30, 2012 , whichever occurs first.
Based on these accepted subscription agreements, and funds generated from operations, Financial will have sufficient liquidity and capital with which to operate.
The capital ratios set forth in above tables state the capital position and analysis for the Bank only. Because total assets on a consolidated basis are less than$500,000,000 , 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 no longer be comparable to the capital ratios of the Bank because the proceeds from these private placements do not qualify as equity capital on a consolidated basis. InDecember 2010 , theBasel Committee on Banking Supervision (the Basel Committee) released its final framework for strengthening international capital and liquidity regulation, now officially identified by the Basel Committee as "Basel III." Basel III, when implemented by the U.S. banking agencies and fully phased-in, will require bank holding companies and their bank subsidiaries to maintain substantially more capital, with a greater emphasis on common equity. Implementation is presently scheduled to be phased in between 2014 and 2019, although it is possible that implementation may be delayed as a result of multiple factors including the current condition of the banking industry within the U.S. and abroad. 42
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In addition to Basel III, Dodd-Frank requires or permits the U.S. banking agencies to adopt regulations affecting banking institutions' capital requirements in a number of respects, including potentially more stringent capital requirements for systemically important financial institutions. Accordingly, the regulations ultimately applicable to the Company may be substantially different from the Basel III final framework as published inDecember 2010 . Requirements to maintain higher levels of capital or to maintain higher levels of liquid assets could adversely impact the Company's net income and return on equity. Stockholder's Equity Stockholders' equity increased by$1,310,000 from$25,495,000 onDecember 31, 2010 to$26,805,000 onDecember 31, 2011 because of the net income of$600,000 , plus the adjustment for other comprehensive income, in the year endedDecember 31, 2011 .
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 nonaccrual when interest it 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. During 2011, the quality of certain classes of our assets declined. Specifically, as a result of the economic downturn, commercial development loans and residential speculative housing construction loans were impacted by a decline in the value of the collateral supporting those loans. Although asset quality declined in 2011, management believes that it has been proactive in quantifying and mitigating the risk. Non-accrual loans increased to$10,375,000 onDecember 31, 2011 from$8,366,000 onDecember 31, 2010 . Management has provided for the anticipated losses on these loans in the loan loss reserve. We also classify other real estate owned (OREO) as a nonperforming asset. OREO is the value of real property acquired by the Bank either at a foreclosure sale of collateral on which the Bank has a lien or by deed in lieu of foreclosure. OREO decreased slightly to$3,253,000 onDecember 31, 2011 from$3,440,000 onDecember 31, 2010 . The following table represents the changes in OREO balance in 2011 and 2010. OREO Changes (Dollars in Thousands) Year EndedDecember 31, 2011 2010
Balance at the beginning of the year (gross) $ 3,440 $
666
Transfers from Loans 4,619
2,509
Transfer from premises and equipment -
1,031 Capitalized Costs 20 31 Charge-Offs (220 ) (132 ) Sales Proceeds (3,944 ) (612 )
Gain (loss) on disposition (487 )
(53 )
Balance at the end of the year (gross) $ 3,428
Less valuation allowance (175 )
-
Balance at the end of the year (net) $ 3,253 $
3,440 43
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We also classify troubled debt restructurings (TDRs) as both performing and nonperforming assets. As discussed above, we measure impaired loans based on the present value of expected future cash flows discounted at the effective interest rate of the loan or, as a practical expedient, at the loan's observable market price or the fair value of the collateral if the loan is collateral dependent. We maintain a valuation allowance to the extent that the measure of the impaired loan is less than the recorded investment. TDRs occur when we agree to significantly modify the original terms of a loan by granting a concession due to the deterioration in the financial condition of the borrower. TDRs are considered impaired loans. These concessions typically are made for loss mitigation purposes and could include reductions in the interest rate, payment extensions, forgiveness of principal, forbearance or other actions. Performing TDRs decreased to$783,000 onDecember 31, 2011 from$4,987,000 onDecember 31, 2010 .
The following table sets forth the number of outstanding TDR contracts and the total amount of the Bank's TDRs as of
Troubled Debt Restructurings (Dollars in Thousands) December 31, 2011 2010 Number of performing TDR contracts 3 6 Number of nonperforming TDR contracts 2 - Total number of TDR contracts 5 6 Amount of performing TDR contracts $ 783 $ 4,987 Amount of nonperforming TDR contracts 1,935 - Total amount of TDRs contracts $ 2,718 $ 4,987 The amount allocated during the year to the provision for loan losses represents management's analysis of the existing loan portfolio and credit risks. Management's policy is to maintain the allowance for loan losses at a level sufficient to absorb the estimated losses inherent in the loan portfolio. Both the amount of the provision and the level of the allowance for loan losses are impacted by many factors, including general economic conditions, actual and expected credit losses, loan performance measures, historical trends and specific conditions of the individual borrower.
In performing its loan loss analysis, the Bank assigns a risk rating to each commercial loan in the Bank's portfolio.
The Bank's allowance for loan losses increased 2.65% from$5,467,000 onDecember 31, 2010 to$5,612,000 onDecember 31, 2011 . This increase resulted primarily from the current economic conditions and recent historic charge-off trends and reflects a slight decrease in the balances in the Bank's loan portfolio. While impairment resulting from the individual impairment analysis (ASC 310) decreased, the overall reserve increased because of the application of the Bank's loan rating system and the increase in reserve related to the unallocated portion of the reserve (ASC 450). As ofDecember 31, 2011 the allowance for loan losses was equal to 1.73% of the total loan portfolio as compared with 1.68% atDecember 31, 2010 . No nonaccrual loans were excluded from impaired loan disclosure under current accounting rules atDecember 31, 2011 and 2010. If interest on these loans had been accrued, such income would have approximated$1,259,000 and$1,059,000 for 2011 and 2010, respectively. Loan payments received on nonaccrual loans are applied to principal. When a loan is placed on non-accrual status there are several negative implications. First, all interest accrued but unpaid at the time of the classification is deducted from the interest income totals for the Bank. Second, accruals of interest are discontinued until it becomes certain that both principal and interest can be repaid. Third, there may be actual losses that necessitate additional provisions for credit losses charged against earnings. These loans were included in the nonperforming loan totals listed below. 44
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The following table sets forth the detail of loans charged-off, recovered, and the changes in the allowance for loan losses as of the dates indicated:
Allowance for Loan Losses (dollars in thousands) At December 31, 2011 2010 2009 2008 2007 Balance, beginning of period $ 5,467 $ 4,288 $ 2,859 $ 2,146 $ 2,091 Loans charged-off:
Commercial, financial and agricultural 723 845 733
379 165 Real estate-construction 454 300 917 31 25 Real estate-mortgage 2,912 369 918 82 125 Installment and other 627 385 229 197 127 Total loans charged off $ 4,716 $ 1,899 $ 2,797 $ 689 $ 442 Recoveries:
Commercial, financial and agricultural
$ 17 $ 22 Real estate-construction 1 - - - - Real estate-mortgage 3 119 - - - Installment and other 35 44 40 30 24 Total recoveries $ 54 $ 295 $ 75 $ 47 $ 46 Net charge-offs $ 4,662 $ 1,604 $ 2,722 $ 642 $ 396 Provision for loan losses 4,807 2,783 4,151 1,355 451 Balance, end of period $ 5,612 $ 5,467 $ 4,288 $ 2,859 $ 2,146
The following table shows the balance and percentage of the Bank's allowance for loan losses allocated to each major category of loans:
Percent of Loans to Total Loans
Allocation of Allowance for Loan Losses (dollars in thousands) At December 31, 2011 2010 2009 2008 2007 Percent Percent Percent Percent Percent of Loans of Loans of Loans of Loans of Loans to Total to Total to Total to Total to Total Amount Loans Amount Loans Amount Loans Amount Loans Amount Loans Commercial $ 892 18.36 % $ 473 19.25 % $ 777 18.60 % $ 536 19.03 % $ 523 19.40 % Commercial - real estate 2,677 46.37 % 2,897 43.97 % 697 52.44 % 1,864 49.27 % 1,226 50.53 % Consumer 1,486 22.3 % 1,207 20.94 % 619 19.00 % 305 16.04 % 292 14.02 % Residential 557 12.96 % 890 15.84 % 2,195 9.96 % 154 15.66 % 105 16.05 % $ 5,612 100.00 % $ 5,467 100.00 % $ 4,288 100.00 % $ 2,859 100.00 % $ 2,146 100.00 % 45
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The following table provides information on the Bank's nonperforming assets as of the dates indicated: Nonperforming Assets (dollars in thousands) At December 31, 2011 2010 2009 2008 2007 Nonaccrual loans $ 10,376 $ 8,366 $ 5,687 $ 3,859 $ 1,246 Foreclosed property (OREO) 3,253 3,440 666 81 - Loans past due 90 days accruing interest - - - - - Total nonperforming assets $ 13,629 $ 11,806
Restructured loans - performing portion (TDR)
Allowance for loan losses to period end loans 1.73 % 1.68 %
1.33 % 1.03 % 0.95 % Nonperforming assets to period end loans 4.20 % 3.62 % 2.25 % 1.39 % 0.55 % Net charge-offs (recoveries) to average loans 1.44 % 0.49 %
0.90 % 0.26 % 0.19 %
Interest Rate Sensitivity
The most important element of asset/liability management is the monitoring of Financial's sensitivity to interest rate movements. The income stream of Financial is subject to risk resulting from interest rate fluctuations to the extent there is a difference between the amount of Financial's interest earning assets and the amount of interest bearing liabilities that prepay, mature or reprice in specified periods. Management's goal is to maximize net interest income with acceptable levels of risk to changes in interest rates. Management seeks to meet this goal by influencing the maturity and re-pricing characteristics of the various lending and deposit taking lines of business and by managing discretionary balance sheet asset and liability portfolios. Management also is attempting to mitigate interest rate risk by limiting the dollar amount of loans carried on its balance sheet that have fixed rates in excess of five years. To reduce our exposure to interest rate risks inherent with longer term fixed rate loans, we generally do not hold such mortgages on our books. The Bank established the Mortgage Division to serve potential customers that desired fixed rate loans in excess of five years. Management monitors interest rate levels on a daily basis and meets in the form of the Asset/Liability Committee ("ALCO") at least monthly or when a special situation arises (e.g., FOMC unscheduled rate change). The following reports and/or tools are used to assess the current interest rate environment and its impact on Financial's earnings and liquidity: monthly and year-to-date net interest margin and spread calculations, monthly and year-to-date balance sheet and income statements versus budget (including quarterly interest rate shock analysis), quarterly net portfolio value analysis, a weekly survey of rates offered by other local competitive institutions, and gap analysis which matches maturities or repricing dates of interest sensitive assets to those of interest sensitive liabilities.
Financial currently subscribes to computer simulated modeling tools made available through its consultant,
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Other Borrowings
Financial uses borrowing in conjunction with deposits to fund lending and investing activities. Borrowings include funding of a short-term nature.
Short-term borrowings consist of securities sold under agreements to repurchase, which are secured transactions with customers and generally mature the day following the date sold. The short-term borrowings totaled$8,379,000 and$7,330,000 as ofDecember 31, 2011 and 2010, respectively. The highest average daily balance for any month for repurchase agreements was approximately$9,573,000 and$9,980,000 in the years endedDecember 31, 2011 andDecember 31, 2010 , respectively. Short-term borrowings may also include federal funds purchased, which are unsecured overnight borrowings from other financial institutions. Unsecured federal funds lines and their respective limits are maintained with the following institutions: Community Bankers'Bank ,$11,000,000 ,Suntrust Bank ,$3,000,000 , andZions Bank ,$4,000,000 . In addition, the Bank maintains a$3,000,000 reverse repurchase agreement with Suntrust whereby securities may be pledged as collateral in exchange for funds for a minimum of 30 days with a maximum of 90 days. The Bank also maintains a secured federal funds line with Community Bankers'Bank whereby it may pledge securities as collateral with no specified minimum or maximum amount or term. No amounts were outstanding on the facilities at eitherDecember 31, 2011 orDecember 31, 2010 . The highest average daily balance for any month for federal funds lines was approximately$0 and$2,053,000 in the years endedDecember 31, 2011 andDecember 31, 2010 , respectively. Long-term borrowing are obtained through the Federal Home Loan Bank ofAtlanta ("FHLBA"). The Bank's available credit through the FHLBA is$85,400,000 as ofSeptember 30, 2011 , the most recent calculation. The following information is provided for borrowings balances, rates and maturities: (dollars in thousands) As ofDecember 31, 2011 2010 Short Term:
Securities sold under agreements to repurchase
Maximum month-end outstanding balance $ 9,204 $
9,590
Average outstanding balance during the year 8,383 8,756
Average interest rate during the year 0.89 %
1.32 %
Average interest rate at end of year 0.91 %
1.03 %
Long Term:
Maximum month-end outstanding balance $ 10,000 $
10,000
Average outstanding balance during the year 10,000 10,959
Average interest rate during the year 2.97 %
2.96 %
Average interest rate at end of year 2.97 %
2.96 % 47
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Table of Contents Maturities of FHLBA advances: Amount (dollars in Ultimate Maturity thousands) Type Rate Date $ 3,000 Fixed rate credit 3.410 % 4/15/2013 5,000 Fixed rate credit 2.360 % 4/15/2013 2,000 Fixed rate credit 3.785 % 4/15/2015 Total $ 10,000 Weighted average rate 2.960 %
The maximum balance on the FHLBA credit was approximately
Off-Balance Sheet Arrangements
The Bank is a party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments to extend credit and standby letters of credit. Such commitments involve, to varying degrees, elements of credit risk and interest rate risk in excess of the amount recognized in the balance sheets. The Bank's exposure to credit loss in the event of nonperformance by the other party to the financial instrument for commitments to extend credit and standby letters of credit is represented by the contractual amount of those instruments. The Bank uses the same credit policies in making commitments and conditional obligations as it does for on-balance sheet instruments. A summary of the Bank's commitments is as follows: Contract Amounts (dollars in thousands) at December 31, 2011 2010 Commitments to extend credit $ 51,153 $ 52,963 Standby letters of credit 2,574 3,111 Total $ 53,727 $ 56,074 Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Because many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The amount of collateral obtained, if deemed necessary by the Bank upon extension of credit, is based on its credit evaluation of the customer.
Standby letters of credit are conditional commitments issued by the Bank to guarantee the performance of a customer to a third party. Those letters of credit are primarily issued to support public and private borrowing arrangements. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loans to customers. Collateral is required in instances which the Bank deems necessary.
Management does not anticipate any material losses as a result of these transactions.
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The Bank rents, under non-cancelable leases, three of its banking facilities and one mortgage production office. The Bank has liability in the form of minimum annual rental commitments under these leases as follows: Amount Year Ending (in thousands) 2012 $ 537 2013 546 2014 417 2015 240 2016 196 Thereafter 534 $ 2,470 Expansion Plans Subject to regulatory approval, the Bank anticipates opening additional branches during the next two fiscal years. Although numerous factors could influence the Bank's expansion plans, the following discussion provides a general overview of the additional branch location that the Bank currently is considering. Timberlake Road Area,Campbell County (Lynchburg ),Virginia . As previously disclosed, the Bank has purchased certain real property located at the intersection of Turnpike andTimberlake Roads ,Campbell County, Virginia . The Bank does not anticipate opening a branch at this location prior to 2013 or beyond. The Bank has determined that the existing structure is not suitable for use as a bank branch.Rustburg, Virginia . In March, 2011 the Bank purchased certain real property near the intersection ofRoutes 501 and 24 inRustburg, Virginia . The structure on the property is being demolished and removed. The Bank does not anticipate opening a branch at this location prior to the first quarter of 2014 or beyond.
The Bank estimates that the cost of improvements, furniture, fixtures, and equipment necessary to upfit the property will be between
Although the Bank cannot predict with certainty the financial impact of each new branch, management generally anticipates that each new branch will become profitable within 12 to 18 months of operation.
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Recent Accounting Pronouncements
For information regarding recent accounting pronouncements and their effect on us, see "Recent Accounting Pronouncements" in Note 21 to the consolidated financial statements included in Item 8 of this Form 10-K.
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Petaluma man arrested after leaving scene of hit-and-run crash [The Press Democrat, Santa Rosa, Calif.]
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