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MarketScreener Homepage  >  Equities  >  OTC Bulletin Board - Other OTC  >  Bay Banks of Virginia Inc    BAYK

BAY BANKS OF VIRGINIA INC (BAYK)
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BAY BANKS OF VIRGINIA : MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (form 10-Q)

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11/09/2018 | 08:48pm CET
The following discussion is intended to assist in understanding the results of
operations and the financial condition of Bay Banks of Virginia, Inc. (the
"Company"). This discussion should be read in conjunction with the consolidated
financial statements and the notes thereto included in Item 1 of this Form 10-Q
and in the Company's Annual Report on Form 10-K for the year ended December 31,
2017 (the "2017 Form 10-K").

STATEMENT REGARDING FORWARD-LOOKING STATEMENTS


This report contains statements concerning the Company's expectations, plans,
objectives, future financial performance, and other statements that are not
historical facts. These statements may constitute "forward-looking statements"
as defined by federal securities laws. These statements may address issues that
involve estimates and assumptions made by management, risks and uncertainties,
and actual results could differ materially from historical results or those
anticipated by such statements. These forward-looking statements include
statements about the Company's plans, obligations, expectations and intentions,
and other statements that are not historical facts. Words such as "anticipates,"
"believes," "intends," "should," "expects," "will," and variations of similar
expressions are intended to identify forward-looking statements. Factors that
could have a material adverse effect on the operations and future prospects of
the Company include, but are not limited to: changes in interest rates, general
economic conditions, the legislative/regulatory climate, monetary and fiscal
policies of the U.S. Government, including policies of the U.S.Treasury and the
Board of Governors of the Federal Reserve System; the quality or composition of
the loan or investment portfolios; demand for loan products; deposit flows;
competition; expansion activities; demand for financial services in the
Company's market area; accounting principles, policies, and guidelines; changes
in banking, tax, and other laws and regulations and interpretations or guidance
thereunder; and other factors detailed in the Company's publicly filed
documents, including the factors described in Item 1A., "Risk Factors," in the
2017 Form 10-K. These risks and uncertainties should be considered in evaluating
the forward-looking statements contained herein, and readers are cautioned not
to place undue reliance on such statements, which speak only as of the date they
are made.

EXECUTIVE SUMMARY

MERGER WITH VIRGINIA BANCORP


On April 1, 2017, the Company and Virginia BanCorp, Inc. ("Virginia BanCorp")
completed a merger pursuant to the Agreement and Plan of Merger, dated as of
November 2, 2016, by and between the Company and Virginia BanCorp (the
"Merger"). Pursuant to the Merger, the Company acquired approximately
$329.1 million in assets, including $266.1 million of loans, and assumed
approximately $294.5 million in liabilities as of April 1, 2017. Merger related
costs incurred by the Company were $363 thousand and $1.1 million for the first
nine months of 2018 and 2017, respectively.

The financial information for the periods ended September 30, 2017 and September 30, 2018 presented herein reflects the combined operations of the business combination since the effective time of the Merger, April 1, 2017.

All dollar amounts included in the tables of this discussion are in thousands, except per share data, unless otherwise stated.

GENERAL


The principal source of earnings for the Company is net interest income. Net
interest income is the amount by which interest income exceeds interest expense.
Net interest margin is net interest income expressed as a percentage of average
interest-earning assets. Changes in the volume and/or mix of interest-earning
assets and interest-bearing liabilities, the associated yields and rates, the
level of noninterest-bearing deposits, and the volume of nonperforming assets
have an effect on net interest income, net interest margin, and net income.

OVERVIEW OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

• Net income for the three months ended September 30, 2018 and 2017 was $1.0

million and $742 thousand, respectively, an increase of $284 thousand.

Diluted earnings per share was $0.08 for the three months ended September

        30, 2018 compared to $0.07 for the three months ended September 30, 2017.
        Net income for the nine months ended September 30, 2018 and 2017 was

$3.1 million and $1.1 million, respectively, an increase of $2.0 million.

Diluted earnings per share was $0.24 for the nine months ended September

30, 2018 compared to $0.14 for the nine months ended September 30, 2017.

• Income before income taxes was $1.2 million and $1.0 million for the three

months ended September 30, 2018 and 2017, respectively, which included $0

        and $141 thousand of merger related costs, respectively. Income before
        income taxes was $3.7 million and $1.5 million for the nine months ended

September 30, 2018 and 2017, respectively, which included $363 thousand

        and $1.1 million of merger related costs, respectively.


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• Return on average assets (annualized) increased to 0.41% and 0.42% for the

three and nine months ended September 30, 2018, respectively, from 0.32%

and 0.20% for the comparable 2017 periods.

• Return on average equity (annualized) increased to 3.55% and 3.61% for the

three and nine months ended September 30, 2018, respectively, from 3.10%

and 2.03% for the comparable 2017 periods.

• Total assets increased $56.9 million to $1.03 billion as of September 30,

2018 from $970.6 million as of December 31, 2017.

• Net loans increased by $88.3 million, or 11.6% (over 15% annualized),

during the first nine months of 2018. Excluding the pay down of

approximately $50.0 million in the first nine months of 2018 of purchased

portfolio loans, including those acquired in the Merger, net loan growth

on an annualized basis was approximately 24%.

• Total deposits increased by $47.3 million, or 6.2% (over 8% annualized),

        to $809.1 million as of September 30, 2018 from $761.8 million as of
        December 31, 2017.

• Asset quality improved during the first nine months of 2018 with the ratio

of nonperforming assets to total assets declining to 0.77% as of September

30, 2018 compared to 1.11% as of December 31, 2017, primarily attributable

        to reductions in nonaccrual loans and other real estate owned of $2.3
        million and $621 thousand, respectively.

• Capital levels and regulatory capital ratios for the Bank were above

regulatory minimums for well-capitalized banks, as of September 30, 2018,

with a total capital ratio and tier 1 leverage ratio of 11.72% and 9.45%,

        respectively.


RESULTS OF OPERATIONS

NET INTEREST INCOME AND NET INTEREST MARGIN


Loans acquired in the Merger were discounted to estimated fair value (for credit
losses and interest rates) as of the effective date of the Merger. A portion of
the acquisition accounting adjustments (discounts) to record the acquired loans
at estimated fair value is being recognized (accreted) into interest income over
the estimated remaining life of the loans for those loans that were deemed to
be, as of the Merger date, purchased performing and over the period of expected
cash flows from the loans that were deemed to be purchased credit-impaired
("PCI"). The amount of accretion income recognized within a period is based on
many factors, including among other factors, loan prepayments and curtailments;
therefore, amounts recognized are subject to volatility.

A time deposit (certificate of deposit) fair value adjustment was also recorded
as of the Merger date, which represents a premium over the value of the
contractual repayments of fixed-maturity deposits using prevailing market
interest rates for similar term deposits. The resulting fair value adjustment is
being amortized into interest expense on a level-yield basis over the weighted
average remaining life of the acquired time deposit portfolio.

                                       29

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The following table presents average interest-earning assets and
interest-bearing liabilities, tax-equivalent yields on such assets and rates
(costs) paid on such liabilities, net interest margin, and net interest spread,
as of and for the periods stated. Yields and costs are annualized.



                                                                              Average Balances, Income and Expense, Yields and Rates
                                                                                As of and for the Three Months Ended September 30,
                                                      2018                                         2017                                    2018 Compared to 2017
                                                                                                                                                Variance Attributable to (7)
                                                                                                                              Income/
                                     Average      Income/                         Average      Income/                        Expense
                                     Balance      Expense       Yield/ Cost       Balance      Expense       Yield/ Cost      Variance             Rate               Volume
INTEREST-EARNING ASSETS:
Taxable securities                  $  63,304$    498              3.12 %   $  58,838$    329              2.24 %   $        169     $         144         $      25
Tax-exempt securities (1)              19,149          151              3.12 %      19,285          176              3.64 %            (25 )             (24 )              (1 )
Total securities                       82,453          649              3.12 %      78,123          505              2.58 %            144               120                24
Gross loans (2) (3)                   821,778       10,126              4.89 %     737,742        8,874              4.81 %          1,252               241             1,011
Interest-bearing deposits and
federal funds sold                     21,769          110              2.00 %      48,764          159              1.30 %            (49 )              39               (88 )
Certificates of deposits                3,111           17              2.17 %       3,224           18              2.20 %             (1 )              (0 )              (1 )
Total interest-earning assets       $ 929,111$ 10,902              4.66 %   $ 867,853$  9,556              4.40 %   $      1,346     $         400         $     946
INTEREST-BEARING LIABILITIES:
Savings deposits                    $  62,258$     47              0.30 %   $  64,115$     32              0.20 %   $         15     $          16         $      (1 )
Demand deposits                        78,556           38              0.19 %      93,809           40              0.17 %             (2 )               5                (7 )
Time deposits (4)                     365,444        1,462              1.59 %     330,496          999              1.21 %            463               357               106
Money market deposits                 171,529          480              1.11 %     134,148          221              0.66 %            259               197                62
Total deposits                        677,787        2,027              1.19 %     622,568        1,292              0.83 %            735               575               160
Securities sold under repurchase
agreements                              5,724            3              0.21 %      13,939            5              0.13 %             (2 )               1                (3 )
Subordinated notes and ESOP debt        7,932          128              6.40 %       6,871          118              6.86 %             10                (8 )              18
FHLB advances                          70,543          441              2.48 %      72,500          279              1.54 %            162               170                (8 )
Total interest-bearing
liabilities                         $ 761,986$  2,599              1.35 %   $ 715,878$  1,694              0.95 %   $        905     $         737         $     168
Net interest income and net
interest margin (5)                               $  8,303              3.57 %                 $  7,862              3.62 %   $        441$        (338 )$     778
Noninterest-bearing deposits        $ 108,594$  96,644
Total cost of funds (8)                                                 1.19 %                                       0.83 %
Net interest spread (6)                                                 3.31 %                                       3.45 %





(1) Income and yield on tax-exempt securities assumes a federal income tax rate

of 21% and 34% for the 2018 and 2017 periods, respectively.

(2) Includes loan fees and nonaccrual loans.

(3) Includes accretion of fair value adjustments (discounts) on loans of

$357 thousand and $409 thousand for the three months ended September 30, 2018

and 2017, respectively.

(4) Includes amortization of fair value adjustments on time deposits of

$40 thousand and $103 thousand for the three months ended September 30, 2018

and 2017, respectively.

(5) Net interest margin is net interest income divided by average

interest-earning assets.

(6) Net interest spread is the yield on average interest-earning assets less the

cost of average interest-bearing liabilities.

(7) Change in income/expense due to both volume and rates has been allocated in

proportion to the absolute dollar amounts of the change in each.

(8) Cost of funds is total interest expense divided by total interest-bearing

liabilities and noninterest-bearing deposits.



Interest income for the three months ended September 30, 2018, on a
taxable-equivalent basis, was $10.9 million, an increase of $1.3 million from
the third quarter of 2017, primarily driven by higher average interest-earning
assets of $929.1 million in the 2018 period compared to $867.9 million in the
2017 period, an increase of $61.3 million. This increase in average
interest-earning assets was primarily attributable to organic loan growth in the
2018 period and higher yields on loans and securities due to the increasing
interest rate environment, partially offset by lower accretion of loan discounts
in the 2018 period of $357 thousand compared to $409 thousand in the 2017
period.

Interest expense for the three months ended September 30, 2018 was $2.6 million,
an increase of $905 thousand from the third quarter of 2017, primarily driven by
higher average interest-bearing liabilities of $762.0 million in the 2018 period
compared to

                                       30
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$715.9 million in the 2017 period, an increase of $46.1 million. This increase
in average interest-bearing liabilities was primarily attributable to organic
retail deposit growth, particularly time and money market deposits. Contributing
to the increase in interest expense in the third quarter of 2018 compared to the
third quarter of 2017 were higher costs of deposits (1.19% and 0.83% for the
third quarters of 2018 and 2017, respectively) due to heightened competition for
deposits in the Company's markets and promotional deposit products as the
Company expands in the Hampton Roads market. In addition, higher rates were paid
on Federal Home Loan Bank of Atlanta ("FHLB") advances (2.48% and 1.53% for the
third quarters of 2018 and 2017, respectively) due to the increasing interest
rate environment.

Due to the changes in interest income and interest expense discussed above, net
interest income for the three months ended September 30, 2018, on a
taxable-equivalent basis, was $8.3 million, an increase of $441 thousand from
the third quarter of 2017.



Net interest margin was 3.57% and 3.62% for the three months ended September 30,
2018 and 2017, respectively. This decrease is primarily attributable to the
increase in funding costs, as noted above, and lower accretion of fair value
adjustments (discounts) on acquired loans ($357 thousand and $409 thousand for
2018 and 2017, respectively) and the amortization of fair value adjustments
(premium) on time deposits ($40 thousand and $103 thousand for 2018 and 2017,
respectively). Excluding the acquisition accounting adjustments on loans and
time deposits, net interest margin was 3.40% in the 2018 period compared to
3.39% in the 2017 period.



The following table presents average interest-earning assets and
interest-bearing liabilities, tax-equivalent yields on such assets and rates
(costs) paid on such liabilities, and net interest margin, as of and for the
periods stated. Yields and costs are annualized.



                                                                               Average Balances, Income and Expense, Yields and Rates
                                                                                 As of and for the Nine Months Ended September 30,
                                                      2018                                         2017                                     2018 Compared to 2017
                                                                                                                                                 Variance Attributable to (7)
                                                                                                                              Income/
                                     Average      Income/                         Average      Income/                        Expense
                                     Balance      Expense       Yield/ Cost       Balance      Expense       Yield/ Cost      Variance             Rate               Volume
INTEREST-EARNING ASSETS:
Taxable securities                  $  62,490$  1,392              2.98 %   $  40,765$    946              3.10 %   $        446     $         (58 )     $         504
Tax-exempt securities (1)              19,195          451              3.14 %      19,233          521              3.61 %            (70 )             (69 )                (1 )
Total securities                       81,685        1,843              3.02 %      59,998        1,467              3.26 %            376              (127 )               503
Gross loans (2) (3)                   799,080       29,853              4.99 %     601,278       21,588              4.79 %          8,265             1,163               7,102
Interest-bearing deposits and
federal funds sold                     32,217          413              1.71 %      27,566          253              1.23 %            160               117                  43
Certificates of deposits                3,186           54              2.27 %       3,564           55              2.05 %             (1 )               5                  (6 )
Total interest-earning assets       $ 916,168$ 32,163              4.69 %   $ 692,406$ 23,363              4.50 %   $      8,800$       1,285$       7,139
INTEREST-BEARING LIABILITIES:
Savings deposits                    $  63,078$    139              0.29 %   $  58,563$     91              0.21 %   $         48     $          41       $           7
Demand deposits                        81,236          121              0.20 %      76,558          103              0.18 %             18                12                   6
Time deposits (4)                     367,524        4,030              1.47 %     247,839        2,248              1.21 %          1,782               696               1,086
Money market deposits                 158,077        1,137              0.96 %     116,419          557              0.64 %            580               381                 199
Total deposits                        669,915        5,427              1.08 %     499,379        2,999              0.80 %          2,428             1,130               1,298
Federal funds purchased                     -            -              0.00 %       1,999           10              0.69 %            (10 )               -                 (10 )
Securities sold under repurchase
agreements                              6,575           10              0.20 %       9,827           12              0.16 %             (2 )               2                  (4 )
Subordinated notes and ESOP debt        7,969          384              6.44 %       6,867          354              6.87 %             30               (27 )                57
FHLB advances                          68,059        1,140              2.24 %      64,659          681              1.41 %            459               423                  36
Total interest-bearing
liabilities                         $ 752,518$  6,961              1.24 %   $ 582,731$  4,056              0.93 %   $      2,905$       1,528$       1,377
Net interest income and net
interest margin (5)                               $ 25,202              3.67 %                 $ 19,307              3.72 %   $      5,895$        (243 )$       5,762
Noninterest-bearing deposits        $ 105,166$  87,776
Total cost of funds (8)                                                 1.08 %                                       0.81 %
Net interest spread (6)                                                 3.46 %                                       3.57 %



(1) Income and yield on tax-exempt securities assumes a federal income tax rate

of 21% and 34% for the 2018 and 2017 periods, respectively.

(2) Includes loan fees and nonaccrual loans.

(3) Includes accretion of fair value adjustments (discounts) on loans of

$1.4 million and $860 thousand for the nine months ended September 30, 2018

    and 2017, respectively.


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(4) Includes amortization of fair value adjustments on time deposits of

$150 thousand and $220 thousand for the nine months ended September 30, 2018

and 2017, respectively.

(5) Net interest margin is net interest income divided by average

interest-earning assets.

(6) Net interest spread is the yield on average interest-earning assets less the

cost of average interest-bearing liabilities.

(7) Change in income/expense due to both volume and rates has been allocated in

proportion to the absolute dollar amounts of the change in each.

(8) Cost of funds is total interest expense divided by total interest-bearing

    liabilities and noninterest-bearing deposits.




Interest income for the nine months ended September 30, 2018, on a
taxable-equivalent basis, was $32.2 million, an increase of $8.8 million from
the first nine months of 2017, primarily driven by higher average
interest-earning assets of $916.2 million in the 2018 period compared to
$692.4 million in the 2017 period, an increase of $223.8 million. This increase
in average interest-earning assets was primarily attributable to organic loan
growth and interest-earning assets acquired in the Merger included from the
effective date of the Merger. Also contributing to the increase in interest
income in the first nine months of 2018 compared to the first nine months of
2017 were higher yields on loans due to the increasing interest rate environment
and higher accretion of discounts on acquired loans of $1.4 million in the 2018
period compared to $860 thousand in the 2017 period.

Interest expense for the nine months ended September 30, 2018 was $7.0 million,
an increase of $2.9 million from the first nine months of 2017, primarily driven
by higher average interest-bearing liabilities of $752.5 million in the 2018
period compared to $582.7 million in the 2017 period, an increase of
$169.8 million. This increase in average interest-bearing liabilities was
primarily attributable to organic deposit growth and liabilities assumed in the
Merger included from the effective date of the Merger. Contributing to the
increase in interest expense in the first nine months of 2018 compared to the
first nine months of 2017 was higher rates paid on deposits (1.08% and 0.80% for
the first nine months of 2018 and 2017, respectively) due to heightened
competition for deposits, as mentioned above. In addition, higher rates were
paid on FHLB advances (2.24% and 1.41% for the first nine months of 2018 and
2017, respectively) due to the increasing interest rate environment.

Due to the changes in interest income and interest expense discussed above, net
interest income for the nine months ended September 30, 2018, on a
taxable-equivalent basis, was $25.2 million, an increase of $5.9 million from
the first nine months of 2017.

Net interest margin was 3.67% and 3.72% for the nine months ended September 30,
2018 and 2017, respectively. This decrease is primarily attributable to higher
funding costs, partially offset by the effects of accretion of discounts on
acquired loans and higher yields on loans. Excluding the acquisition accounting
adjustments on loans and time deposits, net interest margin was 3.44% in the
2018 period compared to 3.51% in the 2017 period.

The following table presents the effect of acquisition accounting adjustments
(accretion of loan discounts and amortization of time deposits) on net interest
margin for the periods stated:

                                                          Three Months Ended                                  Nine Months Ended
                                             September 30, 2018        September 30, 2017       September 30, 2018         September 30, 2017
Net interest margin                                         3.57 %                    3.62 %                   3.67 %                     3.72 %
Acquisition accounting adjustments effect
(1)                                                         0.17 %                    0.23 %                   0.23 %                     0.21 %
Net interest margin excluding the effect
of acquisition accounting adjustments                       3.40 %                    3.39 %                   3.44 %                     3.51 %



(1) Acquisition accounting adjustments for the three and nine months ended

September 30, 2018 include accretion of discounts on acquired loans of

$357 thousand and $1.4 million, respectively, and amortization of premium on

acquired time deposits of $40 thousand and $150 thousand, respectively.

Acquisition accounting adjustments for the three and nine months ended

      September 30, 2017 include accretion of discounts on acquired loans and
      amortization of premium on acquired time deposits of $860 thousand and
      $220 thousand, respectively.

PROVISION FOR LOAN LOSSES


Provision for loan losses was $509 thousand for the three months ended September
30, 2018, while the provision for loan losses was $1.1 million in the same
period of 2017. Provision for loan losses was $481 thousand for the nine months
ended September 30, 2018, while provision for loan losses for the first nine
months of 2017 was $1.8 million. Provision for loan losses in the third quarter
of 2018 was primarily attributable to an increase of approximately $52.7 million
of gross loans in the quarter, while the provision in the third quarter of 2017
includes reserves for a select portfolio of consumer loans. The provision for
loan losses for the first nine months of 2018 included a benefit of $580
thousand to correct for an overstatement recorded in the Company's year-end 2017
allowance for loan losses for acquired loans, as reported in the Company's Form
10-Q for the second quarter of 2018.

                                       32

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NONINTEREST INCOME


The following tables present a summary of noninterest income and the dollar and
percentage change for the periods presented. Noninterest income for the nine
months ended September 30, 2017 included the operations of Virginia BanCorp
since the effective date of the Merger.

                                                         Three Months Ended
                                            September 30, 2018         September 30, 2017      $ Change      % Change
Income from fiduciary activities           $                151       $                217     $     (66 )       -30.4 %
Service charges and fees on deposit                         251                        238            13           5.5 %
accounts
Non-deposit product income                                  144                        105            39          37.1 %
Interchange fees, net                                       105                        101             4           4.0 %
Other service charges and fees                               30                         40           (10 )       -25.0 %
Secondary market lending income                             152                        157            (5 )        -3.2 %
Increase in cash surrender value of bank                    123                        133           (10 )        -7.5 %
owned life insurance
Net gains on disposition of other assets                     51                          -            51         100.0 %
Other                                                       (11 )                       17           (28 )      -164.7 %
Total noninterest income                   $                996       $              1,008     $     (12 )        -1.2 %




                                                        Nine Months Ended
                                           September 30, 2018      September 30, 2017      $ Change       % Change
Income from fiduciary activities           $               596     $               691     $      (95 )       -13.7 %
Service charges and fees on deposit                        538                     696           (158 )       -22.7 %
accounts
Non-deposit product income                                 558                     300            258          86.0 %
Interchange fees, net                                      221                     314            (93 )       -29.6 %
Other service charges and fees                              91                      75             16          21.3 %
Secondary market lending income                            528                     358            170          47.5 %
Increase in cash surrender value of bank                   374                     341             33           9.7 %
owned life insurance
Net gains on sale of available-for-sale                      -                       2             (2 )      -100.0 %

securities

Net losses on disposition of other                         (18 )                     -            (18 )      -100.0 %

assets

Gain on curtailment of post-retirement                     352                       -            352         100.0 %
benefit plan
Other                                                       90                     169            (79 )       -46.7 %
Total noninterest income                   $             3,330     $             2,946     $      384          13.0 %


Non-deposit product income increased $39 thousand in the third quarter of 2018
compared to the third quarter of 2017 due to higher commissions from the wealth
management business of the Company's wholly-owned subsidiary, VCB Financial
Group, Inc. ("VCBFG"). This increase was offset by lower income from fiduciary
activities from the trust and estate administration business of VCBFG of $66
thousand. Net gains on disposition of other assets was primarily attributable to
the sale of a former branch building and land in the third quarter of 2018.

Noninterest income in the nine months ended September 30, 2018 included a gain
of $352 thousand on the curtailment of the Company's post-retirement benefit
plan effective March 1, 2018. Non-deposit product income increased by $258
thousand in the 2018 period compared to the 2017 period due to higher wealth
management commissions earned by VCBFG. Additionally, secondary market lending
income increased $170 thousand in the 2018 period compared to the 2018 period
due to higher sales volume of originated residential mortgages sold to
governmental agencies and other third-party buyers.

                                       33

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NONINTEREST EXPENSE


The following tables present a summary of noninterest expense and the dollar and
percentage change for the periods presented. Noninterest expenses for the nine
months ended September 30, 2017 included the operations of Virginia BanCorp from
the effective date of the Merger.



                                                  Three Months Ended
                                     September 30, 2018       September 30, 2017      $ Change       % Change
Salaries and employee benefits       $             4,022      $             3,687     $      335           9.1 %
Occupancy                                            962                      811            151          18.6 %
Data processing                                      556                      299            257          86.0 %
Bank franchise tax                                   178                      141             37          26.2 %
Telecommunications                                   132                      111             21          18.9 %
FDIC assessments                                     151                      119             32          26.9 %
Foreclosed property                                   45                       45              -           0.0 %
Consulting                                           228                       58            170         293.1 %
Advertising and marketing                            126                      100             26          26.0 %
Directors' fees                                      146                      135             11           8.1 %
Audit and accounting                                 236                      121            115          95.0 %
Legal                                                123                        9            114        1266.7 %
Merger related                                         -                      141           (141 )      -100.0 %
Core deposit intangible
amortization                                         196                      227            (31 )       100.0 %
Net other real estate owned
(gains) losses                                      (112 )                      9           (121 )     -1344.4 %
Other                                                543                      707           (164 )       -23.2 %
Total noninterest expense            $             7,532      $             6,720     $      812          12.1 %




                                                   Nine Months Ended
                                      September 30, 2018       September 30, 2017      $ Change       % Change
Salaries and employee benefits       $             12,407     $              9,832     $    2,575          26.2 %
Occupancy                                           2,639                    1,943            696          35.8 %
Data processing                                     1,941                      897          1,044         116.4 %
Bank franchise tax                                    531                      359            172          47.9 %
Telecommunications                                    369                      215            154          71.6 %
FDIC assessments                                      521                      315            206          65.4 %
Foreclosed property                                   110                      114             (4 )        -3.5 %
Consulting                                            957                      209            748         357.9 %
Advertising and marketing                             347                      227            120          52.9 %
Directors' fees                                       382                      466            (84 )       -18.0 %
Audit and accounting                                  839                      366            473         129.2 %
Legal                                                 380                       95            285         300.0 %
Merger related                                        363                    1,126           (763 )       -67.8 %
Core deposit intangible
amortization                                          610                      461            149         100.0 %
Net other real estate owned
(gains) losses                                       (169 )                    102           (271 )      -265.7 %
Other                                               1,988                    1,988              -           0.0 %
Total noninterest expense            $             24,215     $             18,715     $    5,500          29.4 %


Noninterest expenses increased $812 thousand in the third quarter of 2018
compared to the third quarter of 2017, primarily due to higher salaries and
benefits (greater number of full-time equivalents) and higher data processing
expenses. There were no merger related expenses reported in the three months
ended September 30, 2018. In the third quarter of 2018, the Company announced
initiatives and other anticipated reductions to decrease noninterest expenses.
The benefits of these items are reflected in data processing, consulting, and
salaries and employee benefits expenses in the third quarter of 2018. The
decrease in other expense is primarily due to a $172 thousand benefit recorded
in the third quarter of 2018 to correct for an overstatement of other expense in
2017 related to contributions to employee stock ownership plans (ESOP).

Higher noninterest expenses in the first nine months of 2018 were primarily due
to higher personnel costs (greater number of full-time equivalents) and higher
consulting, audit and accounting, and legal fees, due to various regulatory and
corporate activities in the 2018

                                       34

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period. Expenses associated with the succession of the Company's Chief Financial
Officer and fees incurred in the first nine months of 2018 in the completion of
the Company's 2017 year-end reporting were approximately $1.2 million. Expenses
associated with these items are primarily recorded in consulting, audit and
accounting, and legal.

The table below presents the income tax expense and effective tax rate for the
periods presented.



                                   Three Months Ended                                   Nine Months Ended
                      September 30, 2018         September 30, 2017      
September 30, 2018         September 30, 2017
Income tax expense   $                198       $                273     $                645       $                406
Effective tax rate                   16.2 %                     26.9 %                   17.2 %                     26.6 %

Lower effective tax rates in the 2018 periods reflected the Tax Cuts and Jobs Act of 2017 enacted in December 2017, which reduced the federal corporate marginal income tax rate from 34% to 21%, effective January 1, 2018.

ASSET QUALITY


Loans charged-off during the third quarter of 2018, net of recoveries, totaled
$335 thousand compared to $396 thousand for the third quarter of 2017. This
resulted in a slight decrease in the annualized net charge-off ratio to 0.17%
for the third quarter of 2018 compared to 0.22% for the third quarter of 2017.
For the nine months ended September 30, 2018, the annualized net charge off
ratio was 0.12% compared to 0.18% for the nine months ended September 30, 2017.

The ratio of allowance for loan losses ("ALL") to gross loans was 0.85% as of
September 30, 2018 compared to 1.01% as of December 31, 2017. The decline in the
ratio of ALL to gross loans is primarily due to the overstatement in the ALL at
year-end 2017, as previously discussed, and the reduction in historical loss
factors as older periods are released from the calculation. Gross loans is
inclusive of loans acquired in the Merger, which were recorded at fair value as
of the date of the Merger.

The following table presents certain asset quality measures as of the dates stated.


                                                        September 30, 2018       December 31, 2017
Loans 90 days or more past due and still accruing (1)   $                 -     $                48
Nonaccrual loans (1)                                                  4,204                   6,496
Total nonperforming loans                                             4,204                   6,544
Other real estate owned, net                                          3,663                   4,284
Total nonperforming assets                              $             7,867     $            10,828
Allowance for loan losses                               $             7,287     $             7,770
ALL to gross loans                                                     0.85 %                  1.01 %
Nonperforming assets to total assets                                   0.77 %                  1.12 %
Nonperforming loans to gross loans                                     0.49 %                  0.85 %





(1) Excludes PCI loans.


FINANCIAL CONDITION

Total assets increased by $56.9 million to $1.03 billion as of September 30,
2018 from $970.6 million as of December 31, 2017, primarily due to organic loan
growth in the first nine months of 2018. Cash, including federal funds sold and
interest-bearing deposits, was $22.7 million and $58.3 million as of September
30, 2018 and December 31, 2017, respectively.

The following tables present information about the Company's securities
portfolio on a taxable-equivalent basis as of the dates stated. The increase in
fair value of $4.1 million since year-end 2017 in the available-for-sale
securities portfolio was primarily attributable to approximately $9.7 million of
purchases of available-for-sale securities, partially offset by principal
amortization and an increase in unrealized losses of $1.9 million, primarily due
to an increase in interest rates. As of September 30, 2018 and December 31,
2017, available-for-sale securities represented 7.9% of total assets.





                                       35
--------------------------------------------------------------------------------
                                                                     September 30, 2018
                                                                                    Weighted
                                                                                  Average Life        Weighted
                                            Amortized Cost       Fair Value         in Years        Average Yield
U.S. Government agencies and mortgage
backed securities                           $        52,073$     50,136               6.02              2.21 %
State and municipal obligations                      20,525           19,938               5.53              3.17 %
Corporate bonds                                      11,177           11,141               2.40              5.59 %
Total available-for-sale securities                  83,775           81,215               4.65              2.81 %
Restricted securities                                 6,750            6,750          n/a                    5.75 %
Total securities                            $        90,525$     87,965                                 3.02 %




                                                                      December 31, 2017
                                                                                    Weighted
                                                                                  Average Life        Weighted
                                            Amortized Cost       Fair Value         in Years        Average Yield
U.S. Government agencies and mortgage
backed securities                           $        49,964$     49,283               5.76              1.76 %
State and municipal obligations                      21,113           21,153               5.45              3.47 %
Corporate bonds                                       6,696            6,717               5.16              6.41 %
Total available-for-sale securities                  77,773           77,153               5.46              2.79 %
Restricted securities                                 5,787            5,787          n/a                    6.54 %
Total securities                            $        83,560$     82,940                                 3.02 %


During the nine months ended September 30, 2018, gross loans increased by
$87.8 million, or 11.5% (over 15% annualized), since December 31, 2017.
Excluding the pay down of approximately $50 million in the first nine months of
2018 of purchased portfolio loans, including those acquired in the Merger, gross
loan growth on an annualized basis was approximately 24%. The largest components
of this increase were a $30.0 million increase in commercial and industrial
loans, a $28.7 million increase in construction, land, and land development
loans, a $27.6 million increase in commercial mortgages, and a $23.9 million
increase in residential first mortgages, partially offset by a $14.6 million
decline in consumer loans, primarily the decline in balances of certain
portfolios of consumer loans acquired in the Merger and in the second and third
quarters of 2017.

The following table presents the Company's composition of loans in dollar amounts and as a percentage of total loans as of the dates stated.


                                              September 30, 2018

December 31, 2017

                                        Amount         Percent of Total         Amount        Percent of Total
Mortgage loans on real estate:
Construction, land and land
development                           $    94,750                   11.1 %    $   66,042                    8.6 %
Farmland                                      748                    0.1 %           923                    0.1 %
Commercial mortgages (non-owner
occupied)                                 171,996                   20.1 %       146,757                   19.2 %
Commercial mortgages (owner
occupied)                                  82,391                    9.6 %        80,052                   10.4 %
Residential first mortgages               293,266                   34.2 %       269,365                   35.2 %
Residential revolving and junior
mortgages                                  39,170                    4.6 %        46,498                    6.1 %
Commercial and industrial                 144,118                   16.9 %       114,093                   14.9 %
Consumer                                   27,920                    3.3 %        42,566                    5.5 %
Total loans                               854,359                  100.0 %       766,296                  100.0 %
Net unamortized deferred loan
(fees) costs                                  (79 )                                  200
Allowance for loan losses                  (7,287 )                               (7,770 )
Loans receivable, net                 $   846,993$  758,726


Allowance for loan losses decreased by $483 thousand since December 31, 2017 to
$7.3 million as of September 30, 2018, primarily due to charge-offs (net of
recoveries) and the correction in the second quarter of 2018 of an amount
recorded in the Company's year-end 2017 allowance for loan losses, as previously
noted.

The following table presents the Company's allowance for loan losses by loan
type and the percent of loans in each category to total loans as of the dates
stated.



                                       36
--------------------------------------------------------------------------------
                                           September 30, 2018                December 31, 2017
                                                       Percent of                       Percent of
                                                        loans in                         loans in
                                                          each                             each
                                                      category to                      category to
                                        Amount        total loans         Amount       total loans
Mortgage loans on real estate         $    4,407              79.8 %    $    3,864             79.6 %
Commercial and industrial                  1,130              16.9 %           878             14.9 %
Consumer                                   1,750               3.3 %         3,028              5.5 %
Total allowance for loan losses       $    7,287             100.0 %    $    7,770            100.0 %


Other real estate owned, net as of September 30, 2018 was $3.7 million,
consisting of 25 individual properties (18 of which were land lots), compared to
$4.3 million in OREO (29 properties) as of December 31, 2017, or a $621 thousand
decline. This decline was primarily attributable to the sale of two properties
($2.3 million carrying amount) in the first quarter of 2018 resulting in a net
gain of approximately $257 thousand.

As of September 30, 2018, total deposits were $809.1 million compared to
$761.8 million at year-end 2017, a $47.3 million (or 8.3% annualized) increase.
The increase was primarily due to an increase of $30.9 million in savings and
interest-bearing demand deposits and a $10.8 million increase in time deposits.

Maturities of large denomination time deposits (equal to or greater than $100 thousand) as of September 30, 2018 are presented in the following table.

                                                                                                                           Percent of
                   Within 3                                                         Over 12                                   Total
                    Months            3-6 Months            6-12 Months             Months               Total              Deposits
Time deposits         32,275                13,335                 45,121             110,690             201,421                  26.0 %


As of September 30, 2018, the Company had two fixed rate FHLB advances totaling
$70.0 million and one variable rate FHLB advance of $10.0 million outstanding.
As of December 31, 2017, the Company had one fixed rate FHLB advance of $60.0
million and one variable rate FHLB advance of $10.0 million outstanding. The
following table summarizes the period-end balance, highest month balance,
average balance, and weighted average rate paid as of and for the periods
presented.



                                     Nine Months Ended September 30, 2018                                                Twelve Months Ended December 31, 2017
                                              Highest                                                                             Highest
                                             Month-End          Average           Weighted                                       Month-End            Average           Weighted
                 Period-End Balance           Balance           Balance         Average Rate        Period-End Balance            Balance             Balance         Average Rate
FHLB advances    $            80,000       $      80,000$   68,059                2.46 %     $            70,000       $         75,000       $   52,500                1.87 %


LIQUIDITY

Liquidity represents an institution's ability to meet present and future
financial obligations (such as commitments to fund loans or meet depositors'
requirements) through either the sale or maturity of existing assets or the
acquisition of additional funds through liability management. Liquid assets
include cash, interest-bearing deposits with other banks, federal funds sold,
and investments and loans maturing within one year. The Company's ability to
obtain deposits and purchase funds at favorable rates are major factors for
liquidity. Management believes that the Company maintains overall liquidity that
is sufficient to satisfy its depositors' requirements and its customers' credit
needs.

At September 30, 2018, cash and cash equivalents totaled $22.5 million,
investment securities maturing in one year or less totaled $2.4 million and
loans maturing in one year or less totaled $176.9 million. This resulted in a
liquidity ratio as of September 30, 2018 of 19.6% compared to 14.7% as of
December 31, 2017. The Company determines this ratio by dividing the sum of cash
and cash equivalents, and investment securities and loans maturing in one year
or less by total assets. The Bank has formal liquidity management plans, which
includes periodic evaluation of cash flow projections.

The Company has a line of credit with the FHLB of $245.1 million, with
$150.1 million available as of September 30, 2018 and federal funds lines of
credit with correspondent banks totaling $24.5 million. Federal funds lines of
credit can be cancelled at any time by the correspondent bank.

As of September 30, 2018, the Company was not aware of any other known trends,
events, or uncertainties that have or are reasonably likely to have a material
effect on liquidity.

                                       37

--------------------------------------------------------------------------------

CAPITAL RESOURCES


Capital resources represent funds, earned or obtained, over which a financial
institution can exercise greater long-term control in comparison with deposits
and borrowed funds. The adequacy of the Company's capital is reviewed by
management on an ongoing basis with reference to size, composition, and quality
of the Company's resources, and consistency with regulatory requirements and
industry standards. Management seeks to maintain a capital structure that will
assure an adequate level of capital to support anticipated asset growth and to
absorb potential losses, yet allows management to effectively leverage its
capital to maximize return to shareholders. The Company's capital, also known as
shareholders' equity, is comprised primarily of outstanding common stock and
retained earnings.

Capital resources are primarily affected by net income and net unrealized gains
or losses on available-for-sale securities (net of tax). The available-for-sale
securities portfolio is reported at fair value with unrealized gains or losses,
net of taxes, recognized as accumulated other comprehensive income (loss) on the
Company's consolidated balance sheets. Another factor affecting accumulated
other comprehensive income (loss) is changes in the fair value of the Company's
pension and post-retirement benefit plans and changes in said plan obligations.
Shareholders' equity before accumulated other comprehensive loss was
$119.2 million as of September 30, 2018 compared to $115.7 million as of
December 31, 2017. The increase of $3.5 million was primarily attributable to
net income of $3.1 million for the nine months ended September 30, 2018.
Accumulated other comprehensive loss increased by $1.5 million from December 31,
2017 to September 30, 2018, primarily due to an increase in unrealized net
losses (net of tax) in the available-for-sale securities portfolio, primarily
due to an increasing interest rate environment.

Book value per share of the Company's common stock, including accumulated other
comprehensive loss, increased to $8.80 as of September 30, 2018 from $8.68 as of
December 31, 2017.

The Bank is subject to minimum regulatory capital ratios as defined by the Board of Governors of the Federal Reserve System (the "Federal Reserve"). As of September 30, 2018, the Bank's capital ratios continue to be in excess of regulatory minimums and the Bank was well-capitalized by these guidelines.


In July 2013, the Federal Reserve issued final rules that made changes to its
capital rules to align them with the Basel III regulatory capital framework and
meet certain requirements of the Dodd-Frank Wall Street Reform and Consumer
Protection Act. Effective January 1, 2015, the final rules require the Bank to
comply with the following minimum capital ratios: (i) a new 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 (increased from the prior requirement of 4.0%);
(iii) a total capital ratio of 8.0% of risk-weighted assets (unchanged from the
prior requirement); and (iv) a leverage ratio of 4.0% of total assets (unchanged
from the prior requirement). The following additional capital requirements
related to the capital conservation buffer are being phased in over a four-year
period, which began on January 1, 2016. When fully phased in on January 1, 2019,
the rules will 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 as
that buffer is phased in, 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 2.5% capital conservation buffer (which is added to
the 6.0% Tier 1 capital ratio as that buffer is phased in, 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 2.5% capital conservation buffer (which is added to the 8.0% total capital
ratio as that buffer is phased in, 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 is being phased in as of January 1,
2016, at 0.625% of risk-weighted assets, increasing by the same amount 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.

The following table presents capital ratios for the Bank, minimum capital ratios
required, and ratios defined as "well-capitalized" by the Bank's regulators as
of the dates stated.



                               Actual        Minimum Capital              Well-
    As of September 30, 2018    Ratio       Requirement Ratio       Capitalized Ratio
    Total risk-based capital     11.72 %                  8.00 %                 10.00 %
    Tier 1 capital               10.86 %                  6.00 %                  8.00 %
    Common equity tier 1         10.86 %                  4.50 %                  6.50 %
    Tier 1 leverage ratio         9.45 %                  4.00 %                  5.00 %




                               Actual        Minimum Capital              Well-
    As of December 31, 2017     Ratio       Requirement Ratio       Capitalized Ratio
    Total risk-based capital     12.70 %                  8.00 %                 10.00 %
    Tier 1 capital               11.65 %                  6.00 %                  8.00 %
    Common equity tier 1         11.65 %                  4.50 %                  6.50 %
    Tier 1 leverage ratio         8.97 %                  4.00 %                  5.00 %


                                       38

--------------------------------------------------------------------------------

OFF BALANCE SHEET COMMITMENTS


In the normal course of business, the Company offers various financial products
to its customers to meet their credit and liquidity needs. These instruments may
involve elements of liquidity, credit and interest rate risk in excess of the
amount recognized in the Company's consolidated balance sheets. The Company's
exposure to credit loss in the event of nonperformance by the other party to the
financial instruments for commitments to extend credit and standby-letters of
credit is represented by the contractual amount of these instruments. Subject to
its normal credit standards and risk monitoring procedures, the Company makes
contractual commitments to extend credit. Commitments generally have fixed
expiration dates or other termination clauses and may require payment of a fee.
Since many of the commitments may expire without being completely drawn upon,
the total commitment amounts do not necessarily represent future cash
requirements. Conditional commitments are issued by the Company in the form of
performance stand-by letters of credit, which guarantee the performance of a
customer to a third party. The credit risk of issuing letters of credit is
essentially the same as that involved in extending loan facilities to customers.

The following table presents the Company's off balance sheet commitments as of
the dates stated.



                                        September 30, 2018       December 31, 2017
  Total loan commitments outstanding   $            154,014     $           144,249
  Stand-by letters of credit                          1,637                     447


CONTRACTUAL OBLIGATIONS

There have been no material changes outside the ordinary course of business to the contractual obligations disclosed in the Company's 2017 Form 10-K.

RECENT ACCOUNTING PRONOUNCEMENTS

Refer to Note 2, Amendments to the Accounting Standards Codification, in the Notes to the Consolidated Financial Statements contained in Item 1 of this report, for information related to the adoption of new amendments to the Accounting Standards Codification.

© Edgar Online, source Glimpses

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