BANK OF THE JAMES FINANCIAL GROUP, INC. The following discussion is intended to assist readers in understanding and evaluating our financial condition and results of operations. You should read this discussion in conjunction with our financial statements and accompanying notes included elsewhere in this report.Bank of the James Financial Group, Inc. ("Financial") has no material operations and conducts no business other than the ownership of its operating subsidiaries,Bank of the James (and its divisions and subsidiary), andPettyjohn, Wood & White, Inc. BecausePettyjohn, Wood & White, Inc. was acquired onDecember 31, 2021 ,Pettyjohn, Wood & White, Inc. did not impact our operating results in 2021, the discussion primarily concerns the business of the Bank. However, for ease of reading and because our financial statements are presented on a consolidated basis, references to "we," "us," or "our" refer to Financial,Bank of the James , and their divisions and subsidiaries as appropriate. 30
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Cautionary Statement Regarding Forward-Looking Statements
This report contains statements that constitute "forward-looking statements"
within the meaning of Section 27A of the Securities Act of 1933, as amended, and
Section 21E of the Securities Exchange Act of 1934, as amended, and the Private
Securities Litigation Reform Act of 1995. Statements made in this document and
in any documents that are incorporated by reference which are not purely
historical are forward-looking statements, including any statements regarding
descriptions of management's plans, objectives, or goals for future operations,
products or services, and forecasts of its revenues, earnings, or other measures
of performance. Forward-looking statements are based on current management
expectations and, by their nature, are subject to risks and uncertainties. These
statements generally may be identified by the use of words such as "believe,"
"expect," "anticipate," "plan," "estimate," "should," "will," "intend," or
similar expressions. Shareholders should note that many factors, some of which
are discussed elsewhere in this document, could affect the future financial
results of Financial and could cause those results to differ materially from
those expressed in forward-looking statements contained in this document. These
factors, many of which are beyond Financial's control, include, but are not
necessarily limited to the following:
?the effects of a resurgence of COVID-19 or other pandemic on the business, customers, employees and third-party service providers of Financial or any of its acquisition targets;
?operating, legal and regulatory risks, including the effects of legislative or regulatory developments affecting the financial industry generally or Financial specifically;
?government legislation and policies (including the impact of the Dodd-Frank Wall Street Reform and the Consumer Protection Act and its related regulations);
?changes to statutes, regulations, or regulatory policies or practices, including changes to address the impact of COVID-19;
?economic, market, political and competitive forces affecting Financial's banking and other businesses;
?competition for our customers from other providers of financial services; government legislation and regulation relating to the banking industry (which changes from time to time and over which we have no control) including but not limited to the Dodd-Frank Wall Street Reform and Consumer Protection Act;
?changes in interest rates, monetary policy and general economic conditions, which may impact Financial's net interest income;
?changes in the value of real estate securing loans made by the Bank;
?adoption of new accounting standards or changes in existing standards;
?compliance or operational risks related to new products, services, ventures, or lines of business, if any, that Financial may pursue or implement;
?the risk that Financial's analysis of these risks and forces could be incorrect and/or that the strategies developed to address them could be unsuccessful;
?the stability of the overall banking industry in
?liquidity and perceived liquidity in the banking industry in
?economic and political tensions with
?other risks and uncertainties set forth in this Annual Report on Form 10-K and,
from time to time, in our other filings with the
Other risks, uncertainties and factors could cause our actual results to differ materially from those projected in any forward-looking statements we make.
These factors should be considered in evaluating the forward-looking statements, and you should not place undue reliance on such statements. Financial specifically disclaims any obligation to update factors or to publicly announce the results of revisions to any of the forward-looking statements or comments included herein to reflect future events or developments.
Overview
Financial is a bank holding company headquartered inLynchburg, Virginia . Our primary business is retail banking which we conduct through our wholly-owned subsidiary,Bank of the James (which we refer to as the "Bank"). We conduct four other business activities: mortgage banking through the Bank's Mortgage Division (which we refer to as "Mortgage"), investment services through the Bank's Investment division (which we refer to as "Investment Division"), insurance activities throughBOTJ Insurance, Inc. , a subsidiary of the Bank, (which we refer to as "Insurance"), and subsequent toDecember 31, 2021 , investment advisory services through the Company's wholly-owned subsidiary,Pettyjohn, Wood & White, Inc. (which we refer to as "PWW"). Although we intend to increase other sources of revenue, our operating results depend primarily upon the Bank's net interest income, which is determined by the difference between (i) interest and dividend income on earning assets, which consist primarily of 31
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loans, investment securities and other investments, and (ii) interest expense on interest-bearing liabilities, which consist principally of deposits and other borrowings. The Bank's net income also is affected by its provision for loan losses, as well as the level of its noninterest income, including deposit fees and service charges, gains on sales of mortgage loans, and its noninterest expenses, including salaries and employee benefits, occupancy expense, data processing expenses, miscellaneous other expenses, franchise taxes, and income taxes. We anticipate that going forward, PWW will enhance our operating results by providing additional noninterest income (generally investment advisory fees less operating expenses).
As discussed in more detail below,
?For the year ended
?For the year endedDecember 31, 2022 , earnings per basic and diluted common share were$1.91 , as compared to earnings of$1.60 per basic and diluted common share for the year endedDecember 31, 2021 ;
?Net interest income increased to
?Noninterest income (exclusive of net gains on sales and calls of securities) increased to$13,247,000 for the year endedDecember 31, 2022 from$11,209,000 for the year endedDecember 31, 2021 ;
?Total assets as of
?Net loans (excluding loans held for sale), net of unearned income and the
allowance for loan losses, increased to
?The net interest margin increased 9 basis points to 3.23% for 2022, compared to 3.14% for 2021.
The following table sets forth selected financial ratios:
For the Year Ended
December 31,
2022 2021
Return on average equity 15.59% 11.34%
Return on average assets 0.91% 0.82%
Dividend yield % 2.29% 1.75%Average equity to total average assets 5.86% 7.27%
Effect of Economic Trends
A variety and wide scope of economic factors affect Financial's success and earnings. Although interest rate trends are one of the most important of these factors, Financial believes that interest rates cannot be predicted with a reasonable level of confidence and therefore does not attempt to do so with complicated 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. BetweenJanuary 2018 andDecember 2018 , theFOMC raised rates by 25 basis points four times, at which point the target rate for federal funds ("fed funds") peaked at 2.25% to 2.50%. Beginning inJuly 2019 , theFOMC began to decrease rates. BetweenJuly 2019 andOctober 2019 , theFOMC decreased the target rate three times by 25 basis points. In itsDecember 11, 2019 statement, theFOMC stated it continues to seek to foster maximum employment and price stability. TheFOMC judged that the current stance of monetary policy was appropriate to support sustained expansion of economic activity, strong labor market conditions, and inflation near theFOMC's two percent objective. However, onMarch 3, 2020 , theFOMC lowered the target range of the fed funds rate by 50 basis points in response to concerns related to risks the coronavirus posed to economic activity. Further, in response to concerns that the coronavirus could push theU.S. economy towards a recession, onMarch 15, 2020 , theFOMC , at an emergency meeting lowered the target range of the fed funds rate by an additional 100 basis points. As ofMarch 20, 2020 , theFOMC had set a current target rate range of 0% to 0.25%. The target rate remained unchanged for the remainder of 2020 and 2021. However, as a result of COVID-19 stimulus and other factors, long term rates began to trend slightly upward in the first quarter of 2021. In response to higher inflation and supply chain issues exacerbated by the war inUkraine , onMarch 17, 2022 , theFOMC increased the target rate to a range of 0.25% to 0.50%. TheFOMC continued to increase the target rate, including raises of 50 basis 32
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points on
Prior toMarch 10, 2023 , theFOMC had r indicated that it is likely to increase the target rate one or more times in 2023 in a continued effort to bring the rate of inflation in line withFederal Reserve's target of 2.0%. In addition, many commentators had expressed a belief e that theJanuary 2023 inflation numbers will require multiple additional increases in the Fed funds target rate during 2023. Recent perceived instability in the banking industry caused in part by at least three regional bank failures has added uncertainty as to whether theFOMC will continue to raise the target rate. OnMarch 22, 2023 , theFOMC raised the target rate by 25 basis points, brining the target rate to 4.75% to 5.0%. TheFOMC indicated that it may increase the rate by an additional 25 basis points during 2023.
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. Actual losses could differ significantly from the historical factors that the Bank uses in estimating risk. In addition, GAAP itself may change from one previously acceptable method to another method. Although the economics of Financial's transactions would be the same, the timing of events that would impact the transactions could change. The allowance for loan losses is management's estimate of the probable losses inherent in our loan portfolio. Management considers impaired loans, historical loss experience, and various qualitative factors (both internal and external) in the Company's determination of the allowances. The Bank uses historical loss factors as one factor in determining the inherent loss that may be present in the loan portfolio. Historical and industry trends, as well as peer comparisons are also considered in the Company's ongoing evaluation of the allowance for loan losses. The allowance is based on two basic principles of accounting: (i) ASC 450, Contingencies, which requires that losses be accrued when they are probable of occurring and are reasonably estimable and (ii) ASC 310, Receivables, which requires that losses on impaired loans be accrued based on the differences between the value of collateral, present value of future cash flows or values that are observable in the secondary market and the loan balance. Guidelines for determining allowances for loan losses are also provided in 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 - Asset Quality" below and Note 2 of the Notes to Consolidated Financial Statements for further discussion of the allowance for loan losses.Goodwill arises from business combinations and is generally determined as the excess of fair value of the consideration transferred, plus the fair value of any noncontrolling interests in the acquired entity, over the fair value of the nets assets acquired and liabilities assumed as of the acquisition date.Goodwill and intangible assets acquired in a business combination and determined to have an indefinite useful life are not amortized, but tested for impairment at least annually or more frequently in events and circumstances exists that indicate that a goodwill impairment test should be performed. The Company has selectedSeptember 1 of each year as the date to perform the annual impairment test. Impairment testing requires a qualitative assessment or that the fair value of each of the Company's reporting units be compared to the carrying amount of their net assets, including goodwill. If the fair value of a reporting unit is less than its carrying value, an expense may be required to write down the related goodwill to record an impairment loss. Determining fair value is subjective, requiring the use of estimates, assumptions and management judgment. Intangible assets with finite useful lives are amortized over their estimated useful lives to their estimated residual values, if any.Goodwill is the only intangible asset with an indefinite life on our consolidated balance sheet.
RESULTS OF OPERATIONS
Year Ended
Net Income
The net income for Financial for the year endedDecember 31, 2022 was$8,959,000 or$1.91 per basic and diluted share compared with net income of$7,589,000 or$1.60 per basic and diluted share for the year endedDecember 31, 2021 . All earnings per share figures have been adjusted to reflect the 10% stock dividend paid in 2021. Note 13 of the consolidated financial statements provides additional information with respect to the calculation of Financial's earnings per share. The increase of$1,370,000 in 2022 net income compared to 2021 was due in large part to an increase in net interest income of$2,624,000 or 9.69%, an increase in wealth management fees to$3,932,000 in 2022 from$0 in 2021, and an increase in service charges, fees, and commissions to$3,591,000 in 2022 from$2,496,000 in 2021. These changes were partially offset by a decrease in 33
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gains of loans held for sale to
These operating results represent a return on average stockholders' equity of 15.59% for the year endedDecember 31, 2022 compared to 11.34% for the year endedDecember 31, 2021 . Our return on average stockholder's equity increased because of an increase in net income and a decrease in the market value of the available-for-sale securities portfolio, which in turn decreased our equity. The return on average assets for the year endedDecember 31, 2022 was 0.91% compared to 0.82% in 2021 primarily due to the increase in net income and a decrease in total assets. Net Interest Income The fundamental source of Financial's earnings, net interest income, is defined as the difference between income on earning assets and the cost of funds supporting those assets. The significant categories of earning assets are loans, federal funds sold, interest-bearing balances at other banks, and investment securities, while deposits, federal 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 increased to$31,853,000 for the year endedDecember 31, 2022 from$29,181,000 for the year endedDecember 31, 2021 . This increase was due primarily to an increase in loan volume as well as an increase in the yields on average earning assets which primarily consist of loans and investment securities, as discussed below. Net interest income for 2022 increased$2,624,000 , or 9.69%, to$29,703,000 from$27,079,000 in 2021. The rates charged on loans and received on investments grew faster than rates paid on deposits, which was the primary driver in the increase of our net interest income. Our interest expense increased slightly from$2,102,000 in 2021 from$2,150,000 in 2022. The average balance of interest bearing liabilities increased 9.44% from$682,089,000 for the year endedDecember 31, 2021 to$746,479,000 for the year endedDecember 31, 2022 . The average interest rate paid on interest bearing liabilities decreased by 2 basis points to 0.29% in 2022 from 0.31% in 2021. The net interest margin increased to 3.23% in 2022 from 3.14% in 2021. The average rate on earning assets increased 8 basis points from 3.38% in 2021 to 3.46% in 2022 and the average rate on interest-bearing deposits decreased from 0.25% in 2021 to 0.18% in 2022. The decrease was primarily caused by a decrease in average time deposits, which pay a higher rate than demand interest bearing and savings deposits, from$144,206,000 for the year endedDecember 31, 2021 to$134,821,000 for the year endedDecember 31, 2022 . One of the results of the spread of COVID-19 was a sustained low interest rate environment, which negatively impacted our net interest margin in 2021. Because of Financial's asset interest rate sensitivity, we anticipate that a gradual increase in interest rates generally would have a positive impact on our results of operations. The following table shows the average balances of total interest earning assets and total interest bearing liabilities for the periods indicated, showing the average distribution of assets, liabilities, stockholders' equity and related revenue, expense and corresponding weighted average yields and rates. The average balances used in this table and other statistical data were calculated using average daily balances. 34
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Table of Contents Net Interest Margin Analysis Average Balance Sheets For the Years EndedDecember 31, 2022 and 2021 (dollars in thousands) 2022 2021 Average Average Average Interest Rates Average Interest Rates Balance Income/ Earned/ Balance Income/ Earned Sheet Expense Paid Sheet Expense /Paid ASSETS Loans, including fees (1)(2)$ 604,990 $ 25,992 4.30%$ 601,272 $ 26,336 4.38% Loans held for sale 3,913 183 4.68% 5,815 193 3.32% Federal funds sold 68,580 721 1.05% 106,310 107 0.10% Interest-bearing bank balances 18,005 282 1.57% 18,820 33 0.18% Securities (3) 223,137 4,628 2.07% 128,886 2,459 1.91% Federal agency equities 1,251 66 5.28% 1,281 67 5.23% CBB equity 116 - 0.00% 116 - 0.00% Total earning assets 919,992 31,872 3.46% 862,500 29,195 3.38% Allowance for loan losses (6,715) (7,223) Non-earning assets 67,230 65,197 Total assets$ 980,507 $ 920,474 LIABILITIES AND STOCKHOLDERS' EQUITY Deposits Demand interest bearing 454,974 480 0.11% 412,301 446 0.11% Savings 132,318 75 0.06% 111,571 118 0.11% Time deposits 134,821 732 0.54% 144,206 1,105 0.77% Total interest bearing deposits 722,113 1,287 0.18% 668,078 1,669 0.25% Other borrowed funds Other borrowings 10,738 440 4.10% 30 - 0.00% Financing leases 3,593 96 2.67% 3,951 106 2.68% Capital Notes 10,035 327 3.26% 10,030 327 3.26% Total interest-bearing liabilities 746,479 2,150 0.29% 682,089 2,102 0.31% Noninterest bearing deposits 166,179 165,138 Other liabilities 10,371 6,310 Total liabilities 923,029 853,537 Stockholders' equity 57,478 66,937 Total liabilities and Stockholders' equity$ 980,507 $ 920,474 Net interest earnings$ 29,722 $ 27,093 Net interest margin 3.23% 3.14% Interest spread 3.17% 3.07% 35
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(1)Net deferred loan fees and costs are included in interest income.
(2)Nonperforming loans are included in the average balances. However, interest income and yields calculated do not reflect any accrued interest associated with non-accrual loans.
(3)The interest income and yields calculated on securities have been tax affected to reflect any tax-exempt interest on municipal securities using the Company's applicable federal tax rate of 21% for each year.
Interest income and expenses are affected by fluctuations in interest rates, by
changes in the volume of earning assets and interest-bearing liabilities, and by
the interaction of rate and volume factors. The following table shows the direct
causes of the year-to-year changes in components of net interest income on a
taxable equivalent basis.
Volume and Rate
(dollars in thousands)
Years Ending December 31,
2022 2021
Change in Change in
Volume Rate Income/ Volume Rate Income/
Effect Effect Expense Effect Effect Expense
Loans $ 69 $ (423) $ (354) $ (376) $ (1,116) $ (1,492)
Federal funds sold (24) 638 614 10 (5) 5
Interest-bearing deposits (1) 250 249 2 (58) (56)
Securities 1,946 223 2,169 1,192 (132) 1,060
Restricted stock (2) 1 (1) (7) (4) (11)
Total earning assets 1,988 689 2,677 821 (1,315) (494)
Liabilities:
Demand interest bearing 34 - 34 261 (467) (206)
Savings 30 (73) (43) 62 (96) (34)
Time deposits (67) (306) (373) (577) (1,666) (2,243)
Capital notes - - - 78 (24) 54
Financing leases (10) - (10) (9) - (9)
Repurchase agreements and
other borrowings - - - - - -
Total interest-bearing
liabilities $ (13) $ (379) $ (392) $ (185) $ (2,253) $ (2,438)
Change in net interest
income $ 2,001 $ 1,068 $ 3,069 $ 1,006 $ 938 $ 1,944 Noninterest Income of Financial
Noninterest income has been and will continue to be an important factor for increasing our profitability. Our management continues to review and consider areas where noninterest income can be increased. Noninterest income (excluding securities gains and losses) consists of income from mortgage originations and sales, service fees, income from life insurance, income from credit and debit card transactions, fees generated by the investment services of Investment, and sinceJanuary 1, 2022 , income from PWW. Service fees consist primarily of monthly service and minimum account balance fees and charges on transactional deposit accounts, treasury management fees, overdraft charges, and ATM service fees. The Bank, through the Mortgage Division originates both conforming and non-conforming consumer residential mortgages and reverse mortgage loans primarily in the Region 2000 area as well as inCharlottesville ,Harrisonburg ,Roanoke ,Lexington , andBlacksburg . 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. In addition, overall home inventory for sale decreased in our market areas. Beginning in 2013 we began operating the Mortgage Division with hybrid correspondent relationships that allow the Bank to close loans in its name before an investor purchases the loan. By using the Bank's funds to close the loan (as compared to a broker relationship in which loans are funded by the purchaser of the mortgage), the Bank is able to obtain better pricing due to the slight increase in risk. The Mortgage Division originated 798 mortgage loans, totaling approximately$213,406,000 during the year endedDecember 31, 2022 as compared with 1,335 mortgage loans, totaling$331,235,000 in 2021. The decrease in originations was due in large part to a rapid increase in mortgage rates during 2022, particularly the second half of the year. Loans for new home purchases comprised 75% of the total volume in 2022 as compared to 54% in 2021. The Mortgage Division's revenue is derived from gains on sales of loans held-for-sale to the secondary market. For the year endedDecember 31, 2022 , the Mortgage Division accounted for 36
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11.65% of Financial's total revenue as compared with 20.46% of Financial's total revenue for the year endedDecember 31, 2021 . Mortgage contributed$790,000 and$2,360,000 to Financial's pre-tax net income in 2022 and 2021, respectively. Because of the uncertainty surrounding current and near-term economic conditions, management cannot predict future mortgage rates. Management also anticipates that in the near to medium term if rates continue to stay above 5% to 6% and prices remain relatively steady or increase, refinancing opportunities will be scarce and the majority of the loan mix will continue to lean towards new home purchases and away from refinancing. Recently, the Mortgage Division has established a presence in theWytheville market area. Management expects that the Mortgage Division's reputation in its markets and our recently-added offices and producers present an opportunity for us to continue to grow the Mortgage Division's market share and, in the longer term, revenue. Service charges and fees and commissions increased to$3,591,000 for the year endedDecember 31, 2022 from$2,496,000 for the year endedDecember 31, 2021 primarily due to increases related to commissions on the sales of securities, debit card fees, and treasury management fees. Investment provides brokerage services through an agreement with a third-party broker-dealer. Pursuant to this arrangement, the third party broker-dealer operates a service center adjacent to one of the branches of the Bank. The center is staffed by dual employees of the Bank and the broker-dealer. Investment receives commissions on transactions generated and in some cases ongoing management fees such as mutual fund 12b-1 fees. Investment's financial impact on our consolidated revenue has been minimal. Although management cannot predict the financial impact of Investment with certainty, management anticipates it will continue to be a relatively small component of revenue in 2023. In the third quarter of 2008, we began providing insurance and annuity products to Bank customers and others, through the Bank's Insurance subsidiary. 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 2023. We conduct our investment advisory business through PWW, which Financial acquired onDecember 31, 2021 . PWW is aLynchburg, Virginia -based investment advisory firm that had approximately$650 million in assets under management and advisement at the time of the acquisition. PWW operates as a subsidiary of Financial. PWW generates revenue primarily through investment advisory fees. The investment advisory fees will vary based on the value of assets under management. Assets under management may fluctuate due to both client action and fluctuations in the equity and debt markets. Despite the potential for fluctuation, we anticipate that PWW will continue to contribute meaningfully to the Company's consolidated net income. For the year endedDecember 31, 2022 , its first year of operations as a subsidiary of Financial, PWW had fee income of$3,932,000 . For the year endedDecember 31, 2022 , PWW accounted for 8.72% of Financial's total revenue. In 202,1 PWW did not contribute any revenue to Financial. Noninterest income, exclusive of gains and losses on the sale and call of securities, increased to$13,247,000 in 2022 from$11,209,000 in 2021. Inclusive of gains and losses on the sale and call of securities, noninterest income increased to$13,244,000 in 2022 from$11,209,000 in 2021. The following table summarizes our noninterest income for the periods indicated. Noninterest Income (dollars in thousands)December 31, 2022 2021
Gains on sale of loans held for sale
3,591 2,496
Wealth management fees 3,932 -
Life insurance income 452 430
Other 16 18
Loss on sales and calls of securities, net (3) -
Total noninterest income $ 13,244 $ 11,209
The increase in noninterest income for 2022 as compared to 2021 was due to an
increase in service charges, fees and commissions and wealth management fees and
was offset by a decrease in gain on sales of loans held for sale. The increase
in noninterest income was driven primarily by wealth management fees following
the acquisition of PWW and an increase in overdraft fees, debit card income,
which resulted from an increased volume of debit card transactions. The decrease
in the gain on sales of loans held for sale was caused by an increase in
mortgage loan rates.
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Noninterest Expense of Financial
Noninterest expenses increased from$29,337,000 for the year endedDecember 31, 2021 to$32,737,000 for the year endedDecember 31, 2022 . The following table summarizes our noninterest expense for the periods indicated. Noninterest Expense (dollars in thousands) December 31, 2022 2021 Salaries and employee benefits$ 17,682 $ 16,377 Occupancy 1,814 1,673 Equipment 2,553 2,526 Supplies 521 471
Professional and other outside expenses 2,589 2,286 Data processing
2,467 1,808
Marketing 920 934
Credit expense 923 1,103
Other real estate expenses, net 214 102
FDIC insurance expense 500 548
Amortization of intangibles 560 -
Other 1,994 1,509
Total noninterest expense $ 32,737 $ 29,337
The increase in noninterest expense was due in large part to an increase in
compensation and benefits, primarily related to the addition of PWW, and
professional, data processing and other outside expenses, professional, data
processing, and other outside expense increased primarily due to increased
charges by our core service provider relating to the additional volume of
transactions in 2022. Our compensation and benefits expense has a variable
component related to mortgage origination, which offset some of the increase
noted above due to lower mortgage volume in 2022. In addition, noninterest
expense increased in part due to an increase in other expenses, primarily
related to an isolated check forgery that resulted in a charge of $362,000 . We
have filed a proof of loss with our insurance carrier and are waiting for a
coverage determination.
The efficiency ratio, that is the cost of producing each dollar of revenue, is
determined by dividing noninterest expense by the sum of net interest income
plus noninterest income. Financial's efficiency ratio decreased from 76.62% in
2021 to 76.23% in 2022. Our efficiency ratio decreased because the increase in
interest income and wealth management fees were greater than the increase in
noninterest expense. This is a non-GAAP financial measure that the Company
believes provides investors with important information regarding operational
efficiency. No non-recurring adjustments were made to the calculation of the
efficiency ratio.
Income Tax Expense
For the year ended December 31, 2021 , Financial had federal income tax expense
of $1,862,000 , as compared to a federal income tax expense of $2,151,000 in
2022, which equates to effective tax rates of 19.70% and 19.36%, respectively.
Our effective tax rate was lower than the statutory corporate tax rate in 2021
and 2022 because of federal income tax benefits resulting from the tax treatment
of earnings on bank owned life insurance, and certain tax-free municipal
securities. Note 12 of the consolidated financial statements provides additional
information with respect to our 2021 and 2022 federal income tax expense and
deferred tax accounts.
ANALYSIS OF FINANCIAL CONDITION
As of
General
Our total assets were$928,571,000 atDecember 31, 2022 , a decrease of$59,063,000 or 5.98% from$987,634,000 atDecember 31, 2021 , primarily due to a decrease in federal funds sold which was partially offset by increases in securities available-for-sale, loans, net of allowance for loan losses, and other assets. As explained in more detail below, deposits decreased from$887,056,000 onDecember 31, 2021 to$848,138,000 onDecember 31, 2022 . Loans, net of unearned income and the allowance, increased to$605,366,000 onDecember 31, 2022 from$576,469,000 onDecember 31, 2021 .
Loans
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Our loan portfolio is the largest and most profitable component of our earning assets. The Bank has comprehensive policies and procedures which cover both commercial and consumer loan origination and management of credit risk. Loans are underwritten in a manner that focuses on the borrower's ability to repay. Management's goal is not to avoid risk, but to manage it and to include credit risk as part of the pricing decision for each product. The Bank's loan portfolio consists of commercial short-term lines of credit, term loans, mortgage financing and construction loans that are used by the borrower to build or develop real estate properties, and consumer loans. The consumer portfolio includes residential real estate mortgages, home equity lines and installment loans. Loans, net of unearned income and the allowance, increased to$605,366,000 onDecember 31, 2022 from$576,469,000 onDecember 31, 2021 . Total loans, including loans held for sale increased to$614,048,000 onDecember 31, 2022 from$585,012,000 onDecember 31, 2021 . The increase in total loans was in large part due to demand for commercial and residential mortgage loans. Competition for qualified borrowers remains strong. As ofDecember 31, 2022 , the Bank had$633,000 , or 0.10% of its total loans, in non-accrual status compared with$954,000 , or 0.16% of its total loans, atDecember 31, 2021 . Management is continuing its efforts to reduce non-performing assets through enhanced collection efforts and the liquidation of underlying collateral when applicable. The Bank attempts to work with borrowers on a case-by-case basis to attempt to protect the Bank's interests. However, despite our commitment, a reduction of non-accrual loans can be dependent on a number of factors, including an increase in unemployment, adverse housing market conditions, and overall economic conditions at the local, regional and national levels. See "Asset Quality" below. The following table summarizes net charge-offs, average loan balance and the percentage of net (charge-offs) recoveries to average loan balance for each of the Company's loan segments at the end of the period: Loan Portfolio (dollars in thousands) December 31, Ratio of (Recovery Annualized of) Net Provision Net (Charge-offs) for Loan (Charge-offs) Recoveries to 2022 Losses Recoveries Average Loans Average Loans Commercial$ (473) $ 104$ 101,734 0.10% Commercial real estate (810) 75 350,424 0.02% Consumer 51 (7) 94,702 -0.01% Residential 332 72 58,130 0.12% Total loans$ (900) $ 244$ 604,990 0.04% 2021 Commercial$ (589) $ 59$ 126,162 0.05% Commercial real estate 15 72 326,591 0.02% Consumer 1 (9) 91,489 -0.01% Residential 73 137 57,030 0.24% Total loans$ (500) $ 259$ 601,272 0.04% ? 39
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The following table sets forth the maturities of the loan portfolio atDecember 31, 2022 : Remaining Maturities of Selected Loans (dollars in thousands) At December 31, 2022 After One but After Five but After Less than Within Within Fifteen Fifteen ?One Year ?Five Years Years Years Total Commercial$ 16,639 $ 41,466 $ 16,736 $ 21,044 $ 95,885 Commercial real estate 15,635 16,051 134,577 187,762 354,025 Consumer 4,476 23,945 55,074 14,464 97,959 Residential 20,759 399 3,436 39,162 63,756 Total$ 57,509 $ 81,861 $ 209,823 $ 262,432 $ 611,625 Loans with fixed interest rates: Commercial$ 2,937 $ 22,967 $ 3,423$ 1,786 $ 31,113 Commercial real estate 9,239 11,044 35,006 566 55,855 Consumer 536 13,000 17,562 9,212 40,310 Residential 15,645 399 2,706 767 19,517 Total$ 28,357 $ 47,410 $ 58,697 $ 12,331 $ 146,795 Loans with variable interest rates: Commercial$ 13,702 $ 18,499 $ 13,313 $ 19,258 $ 64,772 Commercial real estate 6,396 5,007 99,571 187,196 298,170 Consumer 3,940 10,945 37,512 5,252 57,649 Residential 5,114 - 730 38,395 44,239 Total$ 29,152 $ 34,451 $ 151,126 $ 250,101 $ 464,830 Deposits We experienced a decrease in deposits from$887,056,000 atDecember 31, 2021 to$848,138,000 atDecember 31, 2022 , for a decrease of 4.39%. Noninterest-bearing deposits decreased$7,402,000 or 4.56% from$162,286,000 atDecember 31, 2021 to$154,884,000 atDecember 31, 2022 . The decrease in noninterest-bearing deposits was due to customers moving funds to higher rate accounts both within and outside the Bank. The decrease was offset by our growth in theCharlottesville ,Harrisonburg ,Roanoke ,Appomattox , andRustburg markets, as well as increased and continued efforts to procure the primary checking accounts of our commercial loan customers through offering treasury services. Interest-bearing deposits including certificates of deposit decreased$31,516,000 , or 4.35%, from$724,770,000 atDecember 31, 2021 to$693,254,000 atDecember 31, 2022 . ? 40
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The following table sets forth the average deposit balances and the rates paid on deposits for the years indicated:
Average Deposits and Rates Paid
(dollars in thousands)
Year Ended December 31,
2022 2021
Amount Rate Amount Rate
Noninterest-bearing deposits $ 166,179 - $ 165,138 -
Interest-bearing deposits
Interest checking $ 356,160 0.09% $ 333,974 0.10%
Money market 98,814 0.15% 78,327 0.15%
Savings 132,318 0.06% 111,571 0.11%
Time deposits
Less than or equal to
16,768 0.63% 18,964 0.81%
Total interest-bearing deposits
$ 888,292 $ 833,216 The following table includes a summary of maturities of CDs greater than$250 ,000: Maturities of CD's Greater than$ 250,000 (dollars in thousands) Less than Three to Six to Greater than ?Three Months ?Six Months ?Twelve Months
?One Year Total
At
The total amount of all deposit categories in excess of the
Cash and Cash Equivalents Cash and cash equivalents decreased from$183,153,000 onDecember 31, 2021 to$61,762,000 onDecember 31, 2022 . Federal funds sold amounted to$31,737,000 onDecember 31, 2022 compared to$153,816,000 onDecember 31, 2021 . The decrease in the balance of federal funds sold is due in part to the decrease in deposits, the use of cash and cash equivalents to fund loans, and the purchase of available-for-sale securities to take advantage of increased available yields. In addition, fluctuations in federal funds sold generally are related to fluctuations in transactional accounts and professional settlement accounts. The large decrease in cash and cash equivalents in 2022 can be directly attributed to the decrease in federal funds sold.
The investment securities portfolio of the Bank is used as a source of income and liquidity.
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The following table summarizes the fair value of the Bank's securities portfolio
for the periods indicated:
Securities Portfolio
(dollars in thousands)
December 31,
2022 2021
Held-to-maturity
U.S. agency obligations $ 3,135 $ 4,006
Available-for-sale
U.S. treasuries $ 4,741 $ 2,002
U.S. agency obligations 59,273 58,470
Mortgage - backed securities 67,842 37,438
Municipals 37,855 50,204
Corporates 16,076 13,153
Total available-for-sale $ 185,787 $ 161,267
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 theU.S. Treasury yield curve. Management is cognizant of its credit standards policy and does not feel pressure to maintain loan growth at the same levels as deposit growth and thus sacrifice credit quality in order to avoid security purchases. Management has made the decision to maintain a significant portion of its available funds in liquid assets so that funds are available to fund future growth of the loan portfolio and in anticipation of rising rates. Management believes that this strategy will allow us to maximize interest margins while maintaining appropriate levels of liquidity. Securities held-to-maturity at amortized cost decreased slightly from$3,655,000 as ofDecember 31, 2021 to$3,639,000 as ofDecember 31, 2022 . This decrease resulted from the amortization of premiums within the held-to-maturity portfolio. The decision to invest in securities held-to-maturity is based on the same factors as the decision to invest in securities available-for-sale except that management invests surplus funds in securities held-to-maturity only after concluding that such funds will not be necessary for liquidity purposes during the term of such security. However, the held-to-maturity securities may be pledged for such purposes as short term borrowings and as collateral for public deposits. The portfolio of securities available-for-sale increased to$185,787,000 as ofDecember 31, 2022 from$161,267,000 as ofDecember 31, 2021 . The increase was due to the deployment of federal funds sold into fixed income securities in an attempt secure higher yields on our investments. The increase was offset in part by a decrease in the fair value of available-for-sale securities of$25,395,000 (net of tax) caused by rising interest rates. The Bank realized$11,718,000 from pay-downs related to the normal amortization of principal related to the Bank's mortgage backed securities, calls, and maturities. During 2022, the Bank sold$7,681,000 in available-for-sale securities. During 2022, the Bank purchased$76,562,000 of available-for-sale securities. 42
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The following table shows the maturities of held-to-maturity and available-for-sale securities at fair value atDecember 31, 2022 and 2021 and approximate weighted average yields of such securities. Weighted average yields on all securities including state and political subdivision securities are shown on a pre-tax basis. Financial attempts to maintain diversity in its portfolio and maintain credit quality and repricing terms that are consistent with its asset/liability management and investment practices and policies. For further information on Financial's securities, see Note 4 to the consolidated financial statements included in Item 8 of this Form 10-K. Securities Portfolio Maturity
Distribution / Yield Analysis
(dollars in thousands)
At December 31, 2022
Less than One to Five to Greater than
?One Year ?Five Years ?Ten Years ?Ten Years Total
Held-to-maturity
U.S. Agency
Fair value $ - $ - $ 2,131 $ 1,004 $ 3,135
Weighted average yield 2.88% 3.25%
Available-for-sale securities
U.S Treasury
Fair value $ - $ 4,741 $ - $ - $ 4,741
Weighted average yield 1.73%
U.S. Agency
Fair value $ - $ 30,842 $ 26,728 $ 1,703 $ 59,273
Weighted average yield 1.44% 1.61% 2.07%
Mortgage Backed Securities
Fair value $ 40 $ 657 $ 12,179 $ 54,966 $ 67,842
Weighted average yield 1.00% 2.00% 1.68% 2.23%
Municipals
Fair value $ 790 $ 682 $ 10,413 $ 25,970 $ 37,855
Weighted average yield 2.02% 1.84% 2.00% 2.44%
Corporates
Fair value $ 1,482 $ 4,138 $ 10,456 $ - $ 16,076
Weighted average yield 2 2.61% 3.85%
Total portfolio
Fair value $ 2,312 $ 41,060 $ 61,907 $ 83,643 $ 188,922
Weighted average yield 2.08% 1.61% 2.07% 2.31%
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Securities Portfolio Maturity Distribution / Yield Analysis
(dollars in thousands)
At December 31, 2021
Less than One to Five to Greater than
?One Year ?Five Years ?Ten Years ?Ten Years Total
Held-to-maturity
U.S. Agency
Fair value $ - $ - $ 2,634 $ 1,372 $ 4,006
Weighted average yield 2.88% 3.23%
Available-for-sale securities
U.S Treasury
Fair value $ 2,002 $ - $ - $ - $ 2,002
Weighted average yield 1.37%
U.S. Agency
Fair value $ - $ 6,131 $ 47,884 $ 4,455 $ 58,470
Weighted average yield 1.21% 1.42% 1.62%
Mortgage Backed Securities
Fair value $ - $ 1,178 $ 6,843 $ 29,417 $ 37,438
Weighted average yield 2.32% 1.58% 1.82%
Municipals
Fair value$ 734 $ 1,563 $ 7,480 $ 40,427 $ 50,204 Weighted average yield 2.41% 1.94% 1.90% 2.27%
Corporates
Fair value $ -$ 4,162 $ 8,503 $ 488$ 13,153 Weighted average yield 2.29% 3.75% 2.00% Total portfolio Fair value$ 2,736 $ 13,033 $ 73,345 $ 76,159 $ 165,273 Weighted average yield 1.64% 1.74% 2.06% 1.93%
Cash surrender value of bank-owned life insurance
The Company has funded bank-owned life insurance (BOLI) for a small group of its officers. The Company is the owner and sole beneficiary of the BOLI policies. As ofDecember 31, 2022 , the BOLI had a cash surrender value of$19,237,000 , an increase of$452,000 from the cash surrender value of$18,785,000 as ofDecember 31, 2021 . The Company did not purchase any additional BOLI during 2022. With the exception of purchases, the value of BOLI increases from the cash surrender values of the pool of insurance. The increase in cash surrender value is recorded as a component of noninterest income; however, the Company does not pay tax on the increase in cash value. This profitability is used to offset a portion of current and future employee benefit costs. BOLI can be liquidated if necessary with associated tax costs. However, the Company intends to hold this pool of insurance, because it provides income that enhances the Company's capital position. Therefore, the Company has not provided for deferred income taxes on the earnings from the increase in cash surrender value.
Goodwill arises from business combinations and is generally determined as the excess of fair value of the consideration transferred, plus the fair value of any noncontrolling interests in the acquired entity, over the fair value of the nets assets acquired and liabilities assumed as of the acquisition date.Goodwill and intangible assets acquired in a purchase business combination and determined to have an indefinite useful life are not amortized, but tested for impairment at least annually or more frequently in events and circumstances exists that indicate that a goodwill impairment test should be performed. The Company has selectedSeptember 1 of each year as the date to perform the annual impairment test. Intangible assets with definite useful lives are amortized over their estimated useful lives to their estimated residual values.Goodwill is the only intangible asset with an indefinite life on our balance sheet. OnDecember 31, 2021 , Financial completed its acquisition ofPettyjohn, Wood & White, Inc. ("PWW"), aLynchburg, Virginia -based investment advisory firm with approximately$650 million in assets under management and advisement at the time of the acquisition. PWW operates as a subsidiary of Financial. The acquisition date fair value of consideration transferred totaled$10.5 million , which was paid in cash. 44
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In connection with the transaction, the Company recorded intangibles relating to customer relationships and the resultant goodwill, representing the excess of the fair value of the consideration transferred over the fair value of the assets acquired and liabilities assumed in accordance with the acquisition method of accounting. Other assets acquired and liabilities assumed in the combination were not significant. Refer to Note 26. Acquisitions, included in Item 8 of this Annual Report on Form 10-K for additional information.
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 and PWW. Payment of cash dividends by the Bank is limited by regulations of theFederal Reserve Board and is tied to the regulatory capital requirements. Management believes that Financial has sufficient liquidity to meet its current obligations. See "Capital Resources," below. The objective of liquidity management for the Bank is to ensure the continuous availability of funds to meet the demands of depositors, borrowers, creditors, and others. Liquidity management involves monitoring the Bank's sources and uses of funds in order to meet the day-to-day cash flow requirements while maximizing profits. Stable core deposits and a strong capital position are the components of a solid foundation for the Bank's liquidity position. Liquidity management is made more complicated because different balance sheet components are subject to varying degrees of management control. For example, the timing of maturities of securities held-to-maturity is fairly predictable and subject to a high degree of control at the time investment decisions are made. However, net non-maturity deposit inflows and outflows are far less predictable and are not subject to the same degree of control. Funding sources for the Bank primarily include paid-in capital and customer-based deposits but also include borrowed funds and cash flow from operations. The Bank has in place several agreements that will provide alternative sources of funding, including, but not limited to, lines of credit, sale of investment securities, purchase of federal funds, advances through theFederal Home Loan Bank of Atlanta ("FHLBA") and correspondents, and brokered certificate of deposit arrangements. Specifically, ?Additional borrowings may be obtained through the FHLBA. The Bank's remaining available credit through the FHLBA was$229,637,000 as ofDecember 31, 2022 , the most recent calculation. Currently the Bank has in place pledged collateral in the amount of approximately$21,907,000 against which$0 was drawn and outstanding onDecember 31, 2022 . Additional collateral would be required to be pledged in order for the full amount to be available. ?Unsecured federal funds lines and their respective limits are maintained with the following institutions:Community Bankers' Bank ,$13,000,000 , PNC Bank$6,000,000 ,First National Bankers' Bank ,$10,000,000 , andZions Bank ,$4,000,000 . ?The Bank maintains a$5,000,000 reverse repurchase agreement withTruist Bank 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 withCommunity Bankers' Bank whereby it may pledge securities as collateral with no specified minimum or maximum amount or term. In response to the failures ofSilicon Valley Bank and Signature Bank, theFederal Reserve authorized all 12 regional reserve banks to make additional funding available to eligible depository institutions, including the Bank, through the Bank Term Funding Program (the "Program") in order to help assure the depository institutions that they have an additional source of liquidity to meet the needs of their depositors. Under the Program, eligible depository institutions may pledge eligible collateral (which includes direct obligations of theU.S. Department of Treasury and most federal agencies and mortgage-backed securities issued and/or fully guaranteed byGinnie Mae , Freddie Mac, and Fannie Mae) in exchange for advances equal to 100% of the par value of the collateral pledged. The advances have a term of one year and bear interest at a fixed rate equal to the one-year overnight swap index rate plus 10 basis points. As of March, the Bank has approximately$100,000,000 of collateral available to pledge under the Program. AtDecember 31, 2022 , liquid assets, which include cash, interest-bearing and noninterest-bearing deposits with banks, federal funds sold, and securities available-for-sale totaled$247,549,000 as compared to$344,420,000 atDecember 31, 2021 . Management deems liquidity to be sufficient. Investment securities traditionally provide a secondary source of liquidity because they can be converted into cash in a timely manner. However, approximately$30,166,000 (current market value) of these securities are pledged to secure public deposits and$5,210,000 (current market value) are pledged to secure unfunded lines of credit. In the event any secured line of credit is drawn upon, the related debt would need to be repaid before the securities could be sold and converted to cash. 45
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While we have not experienced any unusual pressure on our deposit balances or our liquidity position as a result of increased interest rates or recent turmoil in the banking system, management continues to monitor our sources and uses of funds in order to meet our cash needs and cash flow requirements while maximizing profits.
Management believes that the Bank has the ability to meet its liquidity needs.
The following table sets forth non-deposit sources of funding:
Funding Sources
(dollars in thousands)
December 31, 2022
Source Capacity Outstanding Available
Federal funds purchased lines (unsecured) $ 33,000 $ - $ 33,000
Federal funds purchased lines (secured) 4,689 -
4,689
Reverse repurchase agreements 5,000 -
5,000
Borrowings from FHLB Atlanta (1) 229,637 - 229,637 Total$ 272,326 $ -$ 272,326 December 31, 2021 Source Capacity Outstanding Available Federal funds purchased lines (unsecured)$ 33,000 $ - $
33,000
Federal funds purchased lines (secured) 7,294 -
7,294
Reverse repurchase agreements 5,000 -
5,000
Borrowings from FHLB Atlanta 235,788 - 235,788 Total$ 281,082 $ -$ 281,082 (1)Currently the Bank has in place pledged collateral in the form of 1-4 family residential mortgages in the amount of approximately$21,907,000 against which$0 was drawn and outstanding onDecember 31, 2022 . Additional collateral would be required to be pledged in order for the full$229,637,000 to be available. At the end of 2022, approximately 29.56%, or$180,811,000 of the loan portfolio could mature or could reprice within a one-year period. AtDecember 31, 2022 , non-deposit sources of available funds totaled$272,326,000 , which included$229,637,000 available from the FHLBA.
Capital Resources
Capital adequacy is an important measure of financial stability and performance. Management's objectives are to maintain a level of capitalization that is sufficient to sustain asset growth and promote depositor and investor confidence.
Regulatory agencies measure capital adequacy utilizing a formula that takes into account the individual risk profiles of financial institutions. The guidelines define capital as Tier 1 (primarily common stockholders' equity, defined to include certain debt obligations) and Tier 2 (remaining capital generally consisting of a limited amount of subordinated debt, certain hybrid capital instruments and other debt securities, preferred stock and a limited amount of the general valuation allowance for loan losses). OnJune 7, 2012 , theFederal Reserve issued a series of proposed rules that would revise and strengthen its risk-based and leverage capital requirements and its method for calculating risk-weighted assets. The rules were proposed to implement the Basel III regulatory capital reforms from theBasel Committee on Banking Supervision and certain provisions of the Dodd-Frank Act. OnJuly 2, 2013 , theFederal Reserve approved certain revisions to the proposals and finalized new capital requirements for banking organizations. EffectiveJanuary 1, 2015 , the final rules require the Bank to comply with the following minimum capital ratios: (i) a common equity Tier 1 capital ratio of 4.5% of risk-weighted assets; (ii) a Tier 1 capital ratio of 6.0% of risk-weighted assets; (iii) a total capital ratio of 8.0% of risk-weighted assets (unchanged from the previous requirement); and (iv) a leverage ratio of 4.0% of total assets. A capital conservation buffer requirement was phased in beginningJanuary 1, 2016 , at 0.625% of risk-weighted assets, increasing each year until fully implemented at 2.5% onJanuary 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 46
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minimum but below the conservation buffer will face constraints on dividends, equity repurchases, and compensation based on the amount of the shortfall.
SinceJanuary 1, 2019 the rules have required the Bank to maintain (i) a minimum ratio of common equity Tier 1 to risk-weighted assets of at least 4.5%, plus the 2.5% "capital conservation buffer" (which is added to the 4.5% common equity Tier 1 ratio, effectively resulting in a minimum ratio of common equity Tier 1 to risk-weighted assets of at least 7.0%), (ii) a minimum ratio of Tier 1 capital to risk-weighted assets of at least 6.0%, plus the capital conservation buffer (which is added to the 6.0% Tier 1 capital ratio, effectively resulting in a minimum Tier 1 capital ratio of 8.5%), (iii) a minimum ratio of total capital to risk-weighted assets of at least 8.0%, plus the capital conservation buffer (which is added to the 8.0% total capital ratio, effectively resulting in a minimum total capital ratio of 10.5%), and (iv) a minimum leverage ratio of 4.0%, calculated as the ratio of Tier 1 capital to average assets. With respect to the Bank, the rules also revised the "prompt corrective action" regulations pursuant to Section 38 of the FDIA by (i) introducing a common equity Tier 1 capital ratio requirement at each level (other than critically undercapitalized), with the required ratio being 6.5% for well-capitalized status; (ii) increasing the minimum Tier 1 capital ratio requirement for each category, with the minimum ratio for well-capitalized status being 8.0% (as compared to the previous 6.0%); and (iii) eliminating the current provision that provides that a bank with a composite supervisory rating of 1 may have a 3.0% Tier 1 leverage ratio and still be well-capitalized. The capital requirements also include changes in the risk weights of assets to better reflect credit risk and other risk exposures. These include a 150% risk weight (up from 100%) for certain high volatility commercial real estate acquisition, development and construction loans and nonresidential mortgage loans that are 90 days past due or otherwise on non-accrual status, a 20% (up from 0%) credit conversion factor for the unused portion of a commitment with an original maturity of one year or less that is not unconditionally cancellable, a 250% risk weight (up from 100%) for mortgage servicing rights and deferred tax assets that are not deducted from capital, and increased risk-weights (from 0% to up to 600%) for equity exposures. Pursuant to the Regulatory Relief Act, onSeptember 17, 2019 , the federal banking agencies adopted a final rule regarding a community bank leverage ratio. Under the final rule, which was effective onJanuary 1, 2020 , depository institutions and depository institution holding companies that have less than$10 billion in total consolidated assets and meet other qualifying criteria, including a leverage ratio (equal to tier 1 capital divided by average total consolidated assets) of greater than 9 percent, will be eligible to opt into the community bank leverage ratio framework (qualifying community banking organizations). Qualifying community banking organizations that elect to use the community bank leverage ratio framework and that maintain a leverage ratio of greater than 9 percent will be considered to have satisfied the generally applicable risk-based and leverage capital requirements in the agencies' capital rules (generally applicable rule) and, if applicable, will be considered to have met the well-capitalized ratio requirements for purposes of section 38 of the Federal Deposit Insurance Act.
The Bank's regulatory capital levels exceed those established for well-capitalized institutions.
The following table (along with Note 18 of the consolidated financial
statements) shows the minimum capital requirements and the Bank's capital
position as of
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Analysis of Capital for Bank of the James (Bank only)
(dollars in thousands)
December 31, December 31,
Analysis of Capital (in 000> 2022 2021
Tier 1 capital
Common Stock $ 3,742 $ 3,742
Surplus 22,325 22,325
Retained earnings 57,840 52,821
Total Tier 1 capital $ 83,907 $ 78,888
Common Equity Tier 1 Capital
(CET1) $ 83,907 $ 78,888
Tier 2 capital
Allowance for loan losses $ 6,259 $ 6,915
Total Tier 2 capital: $ 6,259 $ 6,915
Total risk-based capital $ 90,166 $ 85,803
Risk weighted assets $ 752,515 $ 693,400
Average total assets $ 934,277 $ 959,794
Actual Regulatory Benchmarks
For Capital For Well
December 31, December 31, Adequacy Capitalized
2022 2021 Purposes (1) Purposes
Capital Ratios:
Tier 1 capital to average total
assets 8.98% 8.22% 4.000% 5.000%
Common Equity Tier 1 capital 11.15% 11.38% 7.000% 6.500%
Tier 1 risk-based capital ratio 11.15% 11.38% 8.500% 8.000%
Total risk-based capital ratio 11.98% 12.37% 10.500% 10.000%
(1)Includes capital conservation buffer of 2.5%, where applicable.
OnApril 13, 2020 , the Company commenced a private placement of unregistered debt securities (the "2020 Offering"). In the 2020 Offering, the Company sold and closed$10,050,000 in principal of notes (the "2020 Notes") during the second and third quarters of 2020. The 2020 Offering officially ended onJuly 8, 2020 . The 2020 Notes bear interest at the rate of 3.25% per year with interest payable quarterly in arrears. The 2020 Notes will mature onJune 30, 2025 and are subject to full or partial repayment on or afterJune 30, 2021 . The balance of the 2020 Notes as presented on theDecember 31, 2022 consolidated balance sheet is net of unamortized issuance costs. OnSeptember 24, 2020 the Bank used$5,000,000 of the proceeds for the payment of principal of unregistered debts securities issued by Financial in 2017. The Company has used the balance of the proceeds from the 2020 Offering for general corporate purposes. Such uses have included payment of interest on the 2020 Notes and the contribution of additional capital to the Bank. The capital ratios set forth in the above tables state the capital position and analysis for the Bank only. Because total assets on a consolidated basis are less than$3 billion , Financial is not subject to the consolidated capital requirements imposed by the Bank Holding Company Act. Consequently, Financial does not calculate its financial ratios on a consolidated basis. If calculated, the capital ratios for the Company on a consolidated basis would be slightly lower than the capital ratios of the Bank because of the Company's decision to contribute a portion of the debt offerings to the Bank. 48
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Stockholders' Equity
Stockholders' equity decreased by$19,203,000 from$69,429,000 onDecember 31, 2021 to$50,226,000 onDecember 31, 2022 . The decrease was due to a decrease in the market value (mark to market) of available-for-sale securities of$32,146,000 . This decrease is attributable to changes in market rates of interest rather than the credit worthiness of the issuers. Financial does not expect to realize the losses as it has the intent and ability to hold the securities until their recovery, which may be at maturity. The decrease was partially offset by net income of$8,959,000 , less cash dividends paid.
ASSET QUALITY
We perform monthly reviews of all delinquent loans and loan officers are charged with working with customers to resolve potential payment issues. We generally classify a loan as non-accrual when interest is deemed uncollectible or when the borrower is 90 days or more past due. We generally restore a loan if i) a borrower is no longer 90 days past due on the loan and the borrower has demonstrated the capacity to repay the loan for six consecutive months or ii) the loan committee of the Board of Directors determines that a borrower has the capacity to repay the loan.
Non-accrual loans decreased to
We also classify other real estate owned (OREO) as a nonperforming asset. OREO is the value of real property acquired by the Bank following default by the borrower. During the twelve months endedDecember 31, 2022 the Bank neither acquired nor disposed of any OREO properties and as ofDecember 31, 2022 was carrying two (2) OREO properties at a value of$566,000 , as compared to two (2) properties with a value of$761,000 as ofDecember 31, 2021 . The OREO properties are available for sale and are being actively marketed on the Bank's website and through other means. The following table represents the changes in OREO balance in 2022 and 2021. OREO Changes (dollars in thousands) Year Ended December 31, 2022 2021 Balance at the beginning of the year (net) $ 761$ 1,105 Transfers from Loans - 111 Capitalized costs - - Valuation Adjustment (195) - Sales proceeds - (368) Gain (loss) on disposition - (87) Balance at the end of the year (net) $ 566 $
761
Non-accrual loans plus OREO decreased to
We also classify troubled debt restructurings (TDRs) as both performing and nonperforming assets. 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 increased to$431,000 onDecember 31, 2022 from$372,000 onDecember 31, 2021 .
The following table sets forth the number of outstanding TDR contracts and the
total amount of the Bank's TDRs as of
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Troubled Debt Restructurings
(dollars in thousands)
December 31,
2022 2021
Number of performing TDR contracts 1 3
Number of nonperforming TDR contracts - - Total number of TDR contracts
1 3
Amount of performing TDR contracts
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 probable 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 loan in the Bank's portfolio.
The Bank's allowance for loan losses decreased 9.49% from$6,915,000 onDecember 31, 2021 to$6,259,000 onDecember 31, 2022 , primarily due to a decrease in the general reserves, which led to a$900,000 recovery of loan loss provision. AtDecember 31, 2022 , the allowance for loan losses was 1.02% of total loans outstanding, versus 1.19% of total loans outstanding atDecember 31, 2021 . A decline in historical loss experience, improved delinquency and other asset quality trends, and other net improvements in qualitative factors, including those relating to the Company's consideration of the COVID-19 pandemic, all contributed to the reduction in the Company's allowance for loan losses sinceDecember 31, 2021 . There were no specific reserves recorded at either period end. Management intends to continue to be proactive in quantifying and mitigating the ongoing risk associated with all asset classes. If interest rates continue to rise and/or theU.S. economy experiences a recession, certain borrowers may experience difficulty and the level of nonperforming loans, charge-offs and delinquencies could rise and require increases in the allowance for loan losses. The process of identifying potential credit losses is a subjective process. Therefore, the Company maintains a general reserve to cover credit losses within the portfolio. No non-accrual loans were excluded from impaired loans atDecember 31, 2022 and 2021. If interest on these loans had been accrued, such income cumulatively would have approximated$79,000 and$177,000 atDecember 31, 2022 and 2021, respectively. Loan payments received on non-accrual 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. 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:
The following table shows the balance and percentage of the Bank's allowance for loan losses allocated to each major category of loans:
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Allocation of Allowance for Loan Losses
(dollars in thousands)
At December 31,
2022 2021
Percent of Percent of
Loans to Total Loans to Total
Amount Loans Amount Loans
Commercial $ 1,102 15.68% $ 1,471 18.01%
Commercial real estate 2,902 57.88% 3,637 57.97%
Consumer 904 16.02% 860 15.27%
Residential 1,351 10.42% 947 8.75%
Total $ 6,259 100.00% $ 6,915 100.00%
The following table provides information on the Bank's nonperforming assets as
of the dates indicated:
Nonperforming Assets
(dollars in thousands)
At December 31,
2022 2021
Nonaccrual loans
Commercial $ - $ 25
Commercial Real Estate 518 640
Consumer 20 127
Residential 95 163
Total nonaccrual loans $ 633 $ 955
Foreclosed Properties
Commercial - 695
Commercial Real Estate 500 -
Consumer - 66
Residential 66 -
Total foreclosed properties $ 566 $ 761
Repossessed Assets - -
Total Nonperforming assets $ 1,199 $ 1,716
Total nonperforming loans as a percentage of total loans
0.10% 0.16%
Total nonperforming loans as a percentage of total assets
0.07% 0.10%
Allowance for loan losses on loans as a percentage of nonperforming loans
989.42% 724.08%
Allowance for loan losses on loans as a percentage of period end loans
1.02% 1.19%
Total nonaccrual loans as a percentage of total loans 0.10%
0.16%
Allowance for loan losses on loans as a percentage of nonaccrual loans
989.42% 724.08%
The allowance for loan losses as a percentage of nonaccrual loans increased from 2021 to 2022 due to the sharp decrease in nonaccrual loans for the same periods.
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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 anEnterprise Risk Management andAsset/Liability Committee ("ALCO") meeting at least quarterly, 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 economic value of equity 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,
Other Borrowings OnApril 13, 2020 , the Company commenced a private placement of unregistered debt securities (the "2020 Offering"). In the 2020 Offering, the Company sold and closed$10,050,000 in principal of notes (the "2020 Notes") during the 2nd and 3rd quarters of 2020. The 2020 Offering officially ended onJuly 8, 2020 . The 2020 Notes bear interest at the rate of 3.25% per year with interest payable quarterly in arrears. The 2020 Notes will mature onJune 30, 2025 and are subject to full or partial repayment on or afterJune 30, 2021 . The balance of the 2020 Notes as presented on theDecember 31, 2022 consolidated balance sheet is net of unamortized issuance costs. OnDecember 29, 2021 Financial borrowed$11,000,000 fromNational Bank of Blacksburg pursuant to a secured promissory note (the "NBB Note"). The NBB Note bears interest at the rate of 4.00%, and is being amortized over a fifteen year period with a balloon payment of approximately$9,375,000 due onDecember 31, 2024 . The note is secured by a first priority lien on approximately 4.95% of the Bank's common stock. The balance of the NBB Note is presented on theDecember 31, 2022 consolidated balance sheet under "other borrowings" and is net of unamortized issuance costs. A portion of the proceeds were used to purchase 100% of the capital stock of PWW. OnJune 30, 2022 , NBB agreed to modify the terms of the NBB Note effectiveJuly 1, 2022 . Pursuant to the modification, the balloon payment date was extended toDecember 31, 2026 fromDecember 31, 2024 and the interest rate was lowered to 3.90% from 4.00%. The approximate amount of the balloon payment onDecember 31, 2026 will be$8,104,000 .
Financial uses borrowing in conjunction with deposits to fund lending and investing activities. Borrowings include funding of a short and long-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. Short-term borrowings may also include federal funds purchased, which are unsecured overnight borrowings from other financial institutions, which totaled$0 as ofDecember 31, 2022 andDecember 31, 2021 . As set forth under "Analysis of Financial Condition - Liquidity," above, the Bank has the ability to borrow funds from a number of sources. The Bank had no amounts outstanding on these facilities as ofDecember 31, 2022 and 2021.
Off-Balance Sheet Arrangements
AtDecember 31, 2022 , the Bank had rate lock commitments to originate mortgage loans through its Mortgage Division amounting to approximately$11,200,000 and loans held for sale of$2,423,000 . The Bank recorded$117,000 in other assets in relation to its interest rate lock commitments atDecember 31, 2022 . The Bank has entered into corresponding commitments with third party investors to sell each of these loans that close. No other obligation exists. 52
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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,
2022 2021
Commitments to extend credit $ 196,218 $ 179,953
Standby letters of credit 3,606 4,335
Total $ 199,824 $ 184,288
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.
The Bank rents, under non-cancelable leases eight of its banking facilities and one mortgage production office. "Note 23 - Leases" in the Notes to Consolidated Financial Statements provides information on the Company's liability under the Company's leases of significance.
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 real property the Bank is holding for potential branch expansion. Timberlake Road Area,Campbell County (Lynchburg ),Virginia . As previously disclosed, the Bank has purchased certain undeveloped real property located at the intersection of Turnpike andTimberlake Roads ,Campbell County, Virginia . The Bank has not determined when it will open a branch at this location. The Bank has determined that the existing structure is not suitable for use as a bank branch. The Bank estimates that the cost of improvements, furniture, fixtures, and equipment necessary to upfit the property at the undeveloped Timberlake location will be between$900,000 and$1,500,000 .Atherholt Road ,Lynchburg, Virginia . OnDecember 31, 2021 , the Bank purchased real property located at1925 Atherholt Road ,Lynchburg, Virginia . The building currently serves as the offices for Financial's wholly-owned subsidiary, PWW. PWW is currently leasing the space from the Bank on a month-to-month basis. While the Bank currently does not have a timeline for a branch at this location, the space is attractive for a branch due to its close proximity to Centra'sLynchburg General Hospital . Management expects that the investment needed to upfit the property will be minimal.
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 opening.
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Recent Accounting Pronouncements
For information regarding recent accounting pronouncements and their effect on us, see "Impact of Recent Accounting Pronouncements" in Note 24 to the consolidated financial statements included in Item 8 of this Form 10-K.
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