BANK OF THE JAMES FINANCIAL GROUP INC

10-Q 1 d828948d10q.htm 10-Q 10-Q

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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

Form 10-Q

Quarterly Report Pursuant to Section 13 or 15(d)

of the Securities Exchange Act of 1934

For the Quarterly Period Ended September 30, 2019

BANK OF THE JAMES FINANCIAL GROUP, INC.

(Exact Name of Registrant as Specified in Its Charter)

Virginia	001-35402	20-0500300
(State or other jurisdiction of incorporation or organization)	(Commission file number)	(I.R.S. Employer Identification No.)
828 Main Street, Lynchburg, VA		24504
(Address of principal executive offices)		(Zip Code)

(434) 846-2000

(Registrants telephone number, including area code)

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ☒ No ☐

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes ☒ No ☐

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

Large accelerated filer	☐	Accelerated filer	☐
Non-accelerated filer	☒	Smaller reporting company	☒
Emerging growth company	☐

Securities registered or to be registered pursuant to Section 12(b) of the Act

Title of each class	Trading Symbol(s)	Name of each exchange on which registered
Common Stock, 2.14 per share par value	BOTJ	The NASDAQ Stock Market LLC

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐

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

APPLICABLE ONLY TO CORPORATE ISSUERS

State the number of shares outstanding of each of the issuers classes of common equity, as of the latest practicable date: 4,372,436 shares of Common Stock, par value $2.14 per share, were outstanding at November 8, 2019.

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PART I FINANCIAL INFORMATION	1
Item 1. Consolidated Financial Statements	1
Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations	37
Item 3. Quantitative and Qualitative Disclosures About Market
Risk	56
Item 4. Controls and Procedures	56
PART II OTHER INFORMATION	57
Item 1. Legal Proceedings	57
Item 1A. Risk Factors	57
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds	57
Item 3. Defaults Upon Senior Securities	57
Item 4. Mine Safety Disclosures	57
Item 5. Other Information	58
Item 6. Exhibits	58
SIGNATURES	59

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PART I FINANCIAL INFORMATION

ITEM 1. Consolidated Financial Statements

Bank of the James Financial Group, Inc. and Subsidiaries

Consolidated Balance Sheets

(dollar amounts in thousands, except per share amounts) (2019 unaudited)

	September 30, — 2019	December 31, — 2018
Assets
Cash and due from banks	$ 27,315	$ 26,725
Federal funds sold	22,141	23,600
Total cash and cash equivalents	49,456	50,325
Securities held-to-maturity (fair value of $3,938 in 2019 and $3,515 in 2018)	3,690	3,700
Securities available-for-sale, at fair value	54,400	52,727
Restricted stock, at cost	1,506	1,462
Loans, net of allowance for loan losses of $4,773 in 2019 and $4,581 in 2018	551,005	530,016
Loans held for sale	5,630	1,670
Premises and equipment, net	16,578	13,426
Interest receivable	1,755	1,742
Cash value - bank owned life insurance	13,606	13,359
Other real estate owned	2,242	2,430
Income taxes receivable	83	1,102
Deferred tax asset, net	1,085	1,755
Other assets	7,078	1,183
Total assets	$ 708,114	$ 674,897
Liabilities and Stockholders Equity
Deposits
Noninterest bearing demand	$ 90,426	$ 91,356
NOW, money market and savings	350,885	331,298
Time	191,722	189,389
Total deposits	633,033	612,043
Capital notes	5,000	5,000
Interest payable	167	127
Other liabilities	8,875	2,584
Total liabilities	$ 647,075	$ 619,754
Commitments and Contingencies
Stockholders equity
Preferred stock; authorized 1,000,000 shares; none issued and outstanding	$	$
Common stock $2.14 par value; authorized 10,000,000 shares; issued and outstanding 4,378,436 as of
September 30, 2019 and December 31, 2018	9,370	9,370
Additional paid-in-capital	31,575	31,495
Retained earnings	19,817	16,521
Accumulated other comprehensive income (loss)	277	(2,243	)
Total stockholders equity	$ 61,039	$ 55,143
Total liabilities and stockholders equity	$ 708,114	$ 674,897

See accompanying notes to these consolidated financial statements

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Bank of the James Financial Group, Inc. and Subsidiaries

Consolidated Statements of Income

(dollar amounts in thousands, except per share amounts) (unaudited)

	For the Three Months Ended — September 30,		For the Nine Months Ended — September 30,
	2019	2018	2019	2018
Interest Income
Loans	$ 7,080	$ 6,460	$ 20,550	$ 18,329
Securities
US Government and agency obligations	176	187	545	571
Mortgage backed securities	54	62	171	196
Municipals - taxable	77	81	237	243
Municipals - tax exempt		2	2	5
Dividends	9	9	60	40
Other (Corporates)	23	23	70	70
Interest bearing deposits	88	60	253	151
Federal Funds sold	89	96	332	255
Total interest income	7,596	6,980	22,220	19,860
Interest Expense
Deposits
NOW, money market savings	414	261	1,082	684
Time Deposits	926	679	2,500	1,885
FHLB borrowings				17
Finance leases	41		41
Capital notes	50	50	150	150
Total interest expense	1,431	990	3,773	2,736
Net interest income	6,165	5,990	18,447	17,124
Provision for loan losses	108	190	434	527
Net interest income after	6,057	5,800	18,013	16,597
Noninterest income
Gain on sales of loans held for sale	1,337	767	3,103	2,260
Service charges, fees and commissions	448	446	1,348	1,375
Increase in cash value of life insurance	81	86	248	256
Other	4	20	49	55
Gain on sales and calls of securities, net	291		291
Total noninterest income	2,161	1,319	5,039	3,946
Noninterest expenses
Salaries and employee benefits	3,356	2,853	9,437	8,398
Occupancy	414	388	1,252	1,143
Equipment	527	414	1,521	1,191
Supplies	163	124	467	413
Professional, data processing, and other outside expense	887	761	2,561	2,413
Marketing	228	165	649	492
Credit expense	195	140	478	377
Other real estate expenses	200	110	340	236
FDIC insurance expense	87	99	275	299
Other	316	310	967	805
Total noninterest expenses	6,373	5,364	17,947	15,767
Income before income taxes	1,845	1,755	5,105	4,776
Income tax expense	371	351	1,020	949
Net Income	$ 1,474	$ 1,404	$ 4,085	$ 3,827
Weighted average shares outstanding - basic	4,378,436	4,378,436	4,378,436	4,378,436
Weighted average shares outstanding - diluted	4,385,331	4,378,436	4,383,128	4,378,466
Earnings per common share - basic	$ 0.34	$ 0.32	$ 0.93	$ 0.87
Earnings per common share - diluted	$ 0.34	$ 0.32	$ 0.93	$ 0.87

See accompanying notes to these consolidated financial statements

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Bank of the James Financial Group, Inc. and Subsidiaries

Consolidated Statements of Comprehensive Income

(dollar amounts in thousands) (unaudited)

	For the Three Months
	Ended September 30,			Ended September 30,
	2019	2018		2019		2018
Net Income	$ 1,474	$	1,404	$	4,085	$	3,827
Other comprehensive income (loss):
Unrealized gains (losses) on securities available-for-sale	990		(693	)	3,481		(2,009	)
Tax effect	(208	)	144		(731	)	421
Reclassification adjustment for gains included in net income (1)	(291	)			(291	)
Tax effect (2)	61				61
Other comprehensive income (loss), net of tax	552		(549	)	2,520		(1,588	)
Comprehensive income	$ 2,026	$	855	$	6,605	$	2,239

See accompanying notes to these consolidated financial statements

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Bank of the James Financial Group, Inc. and Subsidiaries

Consolidated Statements of Cash Flows

For the Nine Months Ended September 30, 2019 and 2018

(dollar amounts in thousands) (unaudited)

	For the Nine Months Ended September 30, — 2019		2018
Cash flows from operating activities
Net Income	$ 4,085		$ 3,827
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization	983		679
Stock based compensation expense	80
Net amortization and accretion of premiums and discounts on securities	298		312
(Gain) on sales of available-for-sale securities	(291	)
(Gain) on sales of loans held for sale	(3,103	)	(2,260	)
Proceeds from sales of loans held for sale	114,119		89,949
Origination of loans held for sale	(114,976	)	(87,592	)
Provision for loan losses	434		527
Loss on sale of other real estate owned	13		39
Impairment of other real estate owned	286		160
(Increase) in cash value of life insurance	(248	)	(256	)
(Increase) in interest receivable	(13	)	(163	)
Decrease (increase) in other assets	234		(79	)
Decrease in income taxes receivable	1,019		51
Increase in interest payable	40		20
(Decrease) increase in other liabilities	(1	)	671
Net cash provided by operating activities	$ 2,959		$ 5,885
Cash flows from investing activities
Proceeds from calls of securities held-to-maturity	$		$ 2,000
Purchases of securities available-for-sale	(6,369	)	(998	)
Proceeds from maturities, calls and paydowns of securities available-for-sale	1,462		1,666
Proceeds from sale of securities available-for-sale	6,427
(Purchase) redemption of Federal Home Loan Bank stock	(44	)	43
Proceeds from sale of other real estate owned	349		846
Origination of loans, net of principal collected	(21,883	)	(34,459	)
Purchases of premises and equipment	(3,890	)	(704	)
Net cash (used in) investing activities	$ (23,948	)	$ (31,606	)

See accompanying notes to these consolidated financial statements

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	2019
Cash flows from financing activities
Net increase in deposits	$ 20,990	$	39,954
Principal payments on finance lease obligations	(81	)
Dividends paid to common stockholders	(789	)	(787	)
Net cash provided by financing activities	$ 20,120	$	39,167
(Decrease) increase in cash and cash equivalents	(869	)	13,446
Cash and cash equivalents at beginning of period	$ 50,325	$	37,018
Cash and cash equivalents at end of period	$ 49,456	$	50,464
Non cash transactions
Transfer of loans to other real estate owned	$ 460	$	850
Fair value adjustment for securities available-for-sale	3,190		(2,009	)
Lease liabilities arising from right-of-use assets	6,373
Cash transactions
Cash paid for interest	$ 3,733	$	2,716
Cash paid for income taxes			975

See accompanying notes to these consolidated financial statements

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Bank of the James Financial Group, Inc. and Subsidiaries

Consolidated Statements of Changes in Stockholders Equity

For the Three and Nine Months Ended September 30, 2019 and 2018

(dollars in thousands, except per share amounts) (unaudited)


			Additional		Other
Shares		Common	Paid-in	Retained	Comprehensive
Outstanding		Stock	Capital	Earnings	(Loss)			Total
Balance at December 31, 2017	4,378,436	$ 9,370	$ 31,495	$ 12,269	$	(1,469	)	$ 51,665
Net Income				1,123				1,123
Dividends paid on common stock ($0.06 per share)				(263	)			(263	)
Other comprehensive loss						(850	)	(850	)
Balance at March 31, 2018	4,378,436	$ 9,370	$ 31,495	$ 13,129	$	(2,319	)	$ 51,675
Net Income				1,300				1,300
Dividends paid on common stock ($0.06 per share)				(262	)			(262	)
Other comprehensive loss						(189	)	(189	)
Balance at June 30, 2018	4,378,436	$ 9,370	$ 31,495	$ 14,167	$	(2,508	)	$ 52,524
Net Income				1,404				1,404
Dividends paid on common stock ($0.06 per share)				(262	)			(262	)
Other comprehensive loss						(549	)	(549	)
Balance at September 30, 2018	4,378,436	$ 9,370	$ 31,495	$ 15,309	$	(3,057	)	$ 53,117

See accompanying notes to these consolidated financial statements

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			Additional		Other
Shares		Common	Paid-in	Retained	Comprehensive
Outstanding		Stock	Capital	Earnings	Income (Loss)			Total
Balance at December 31, 2018	4,378,436	$ 9,370	$ 31,495	$ 16,521	$	(2,243	)	$ 55,143
Net Income				1,234				1,234
Dividends paid on common stock ($0.06 per share)				(263	)			(263	)
Stock-based compensation expense			27					27
Other comprehensive income						1,036		1,036
Balance at March 31, 2019	4,378,436	$ 9,370	$ 31,522	$ 17,492	$	(1,207	)	$ 57,177
Net Income				1,377				1,377
Dividends paid on common stock ($0.06 per share)				(263	)			(263	)
Stock-based compensation expense			26					26
Other comprehensive income						932		932
Balance at June 30, 2019	4,378,436	$ 9,370	$ 31,548	$ 18,606	$	(275	)	$ 59,249
Net Income				1,474				1,474
Dividends paid on common stock ($0.06 per share)				(263	)			(263	)
Stock-based compensation expense			27					27
Other comprehensive income						552		552
Balance at September 30, 2019	4,378,436	$ 9,370	$ 31,575	$ 19,817	$	277		$ 61,039

See accompanying notes to these consolidated financial statements

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Notes to Consolidated Financial Statements

Note 1 Basis of Presentation

The unaudited consolidated financial statements have been prepared by Bank of the James Financial Group, Inc. (Financial or the Company) pursuant to the rules and regulations of the Securities and Exchange Commission. In managements opinion the accompanying financial statements, which unless otherwise noted are unaudited, reflect all adjustments, consisting solely of normal recurring accruals, necessary for a fair presentation of the financial information as of September 30, 2019 and for the three and nine months ended September 30, 2019 and 2018 in conformity with accounting principles generally accepted in the United States of America. Additional information concerning the organization and business of Financial, accounting policies followed, and other related information is contained in Financials Annual Report on Form 10-K for the year ended December 31, 2018. These financial statements should be read in conjunction with the audited consolidated financial statements and footnotes for the year ended December 31, 2018 included in Financials Annual Report on Form 10-K. Results for the three and nine month periods ended September 30, 2019 are not necessarily indicative of the results that may be expected for the year ending December 31, 2019.

Certain immaterial reclassifications have been made to prior period balances to conform to the current period presentation. Reclassifications had no effect on prior year net income or stockholders equity.

The Companys primary market area consists of the area commonly referred to as Region 2000 which encompasses the seven jurisdictions of the Town of Altavista, Amherst County, Appomattox County, the Town of Bedford, Bedford County, Campbell County, and the City of Lynchburg. Recently, the Company has expanded into Charlottesville, Roanoke, Blacksburg, Harrisonburg, and Lexington.

Financials critical accounting policies include the evaluation of the allowance for loan losses which is based on managements estimate of an amount that is adequate to absorb probable losses inherent in the loan portfolio of Bank of the James (the Bank), Financials wholly-owned subsidiary. The allowance for loan losses is established through a provision for loan losses based on available information including the composition of the loan portfolio, historical loan losses, specific impaired loans, availability and quality of collateral, age of the various portfolios, changes in local economic conditions, and loan performance and quality of the portfolio. Different assumptions used in evaluating the adequacy of the Banks allowance for loan losses could result in material changes in Financials financial condition and results of operations. The Banks policy with respect to the methodology for determining the allowance for loan losses involves a higher degree of complexity and requires management to make subjective judgments that often require assumptions or estimates about uncertain matters. This critical policy and its assumptions are periodically reviewed with the Board of Directors.

Financial also considers valuation of other real estate owned (OREO) a critical accounting policy. OREO consists of properties acquired through foreclosure or deed in lieu of foreclosure. These properties are carried at fair value less estimated costs to sell at the date of foreclosure. Losses from the acquisition of property in full or partial satisfaction of loans are charged against the allowance for loan losses. Subsequent write-downs, if any, are charged against expense. Gains and losses on the sales of foreclosed properties are included in determining net income in the year of the sale. Operating costs after acquisition are expensed.

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Note 2 Use of Estimates

The consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States of America which require management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates.

Note 3 Earnings Per Common Share (EPS)

The following is a summary of the earnings per share calculation for the three and nine months ended September 30, 2019 and 2018.

	Three Months Ended — September 30,		Nine Months Ended — September 30,
	2019	2018	2019	2018
Net income	$ 1,474,000	$ 1,404,000	$ 4,085,000	$ 3,827,000
Weighted average number of shares	4,378,436	4,378,436	4,378,436	4,378,436
Restricted stock units/stock options affect of incremental shares	6,895		4,692	30
Weighted average diluted shares	4,385,331	4,378,436	4,383,128	4,378,466
Basic EPS (weighted avg shares)	$ 0.34	$ 0.32	$ 0.93	$ 0.87
Diluted EPS (Including incremental shares)	$ 0.34	$ 0.32	$ 0.93	$ 0.87

No restricted stock units or stock options were excluded in calculating diluted earnings per share for any of the periods presented.

Note 4 Stock Based Compensation

Accounting standards require companies to recognize the cost of employee services received in exchange for awards of equity instruments, such as stock options and restricted stock, based on the fair value of those awards at the date of grant.

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Note 4 Stock Based Compensation (continued)

At December 31, 2018, there were no stock-based compensation awards outstanding that were issued under the Companys 1999 Stock Option Plan. The final stock-based compensation issued under this plan consisting solely of employee stock options which expired during the second quarter of 2018.

At the annual meeting of shareholders held on May 15, 2018, the shareholders approved the Bank of the James Financial Group, Inc. 2018 Equity Incentive Plan (the 2018 Incentive Plan). The 2018 Incentive Plan permits the issuance of up to 250,000 shares of common stock for awards to key employees of the Company and its subsidiaries in the form of stock options, restricted stock, restricted stock units, stock awards and performance units.

On January 2, 2019, the Company granted its first block of equity compensation under the 2018 Incentive Plan consisting of 24,500 restricted stock units. The recipients of restricted stock units do not receive shares of the Companys stock immediately, but instead receive shares upon satisfying the requisite service period specified by the terms and conditions of the grant. Additionally, the recipients of restricted stock units do not enjoy the rights of holder of the Companys common stock until the units have vested and as such, they do not have voting rights or rights to nonforfeitable dividends. The related compensation expense is based on the grant date fair value of the Companys stock of $13.00 per share. Shares vest over 3 years in thirds with the first one-third vesting one year from the grant date. The total expense recognized for the three and nine months ended September 30, 2019, in connection with the restricted stock unit awards was approximately $27,000 and $80,000, respectively. There were no forfeitures during the three and nine month periods ending September 30, 2019.

At September 30, 2019, the unrecognized stock-based compensation expense related to unvested restricted stock awards amounted to approximately $239,000. The unrecognized expense will be recognized ratably over the remaining vesting period of 2.25 years. The Company accounts for forfeitures as they occur.

Note 5 Fair Value Measurements

Determination of Fair Value

The Company uses fair value measurements to record fair value adjustments to certain assets and liabilities and to determine fair value disclosures. In accordance with the Fair Value Measurements and Disclosures topic of FASB ASC, the fair value of a financial instrument is the price that would be received to sell an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market and in an orderly transaction between market participants at the measurement date. Fair value is best determined based upon quoted market prices. However, in many instances, there are no quoted market prices for the Companys various financial instruments. In cases where quoted market prices are not available, fair values are based on estimates using present value or other valuation techniques. Those techniques are significantly affected by the assumptions used, including the discount rate and estimates of future cash flows. Accordingly, the fair value estimates may not be realized in an immediate settlement of the instrument.

The fair value guidance provides a consistent definition of fair value, which focuses on exit price in the principal or most advantageous market and in an orderly transaction (that is, not a forced

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Note 5 Fair Value Measurements (continued)

liquidation or distressed sale) between market participants at the measurement date under current market conditions. If there has been a significant decrease in the volume and level of activity for the asset or liability, a change in valuation technique or the use of multiple valuation techniques may be appropriate. In such instances, determining the price at which willing market participants would transact at the measurement date under current market conditions depends on the facts and circumstances and requires the use of significant judgment. The fair value is a reasonable point within the range that is most representative of fair value under current market conditions.

Fair Value Hierarchy

In accordance with this guidance, the Company groups its financial assets and financial liabilities generally measured at fair value in three levels, based on the markets in which the assets and liabilities are traded and the reliability of the assumptions used to determine fair value.

Level 1 inputs to the valuation methodology are quoted prices (unadjusted) for identical assets or liabilities in active markets.

Level 2 inputs to the valuation methodology include quoted prices for similar assets and liabilities in active markets, and inputs that are observable for the asset or liability, either directly or indirectly, for substantially the full term of the financial instrument.

Level 3 inputs to the valuation methodology are unobservable and significant to the fair value measurement.

Fair Value on a Recurring Basis

Securities Available-for-Sale

Fair values of securities available-for sale are based on quoted prices available in an active market. If quoted prices are available, these securities are classified within Level 1 of the valuation hierarchy. Level 1 securities would include highly liquid government bonds, mortgage products and exchange traded equities. If quoted market prices are not available, then fair values are estimated by using pricing models, quoted prices of securities with similar characteristics, or discounted cash flow.

Level 2 securities would include U.S. agency securities, mortgage-backed agency securities, obligations of states and political subdivisions and certain corporate, asset backed and other securities. In certain cases where there is limited activity or less transparency around inputs to the valuation, securities are classified within Level 3 of the valuation hierarchy. Currently, all of the Companys securities are considered to be Level 2 securities.

The following table summarizes the Companys financial assets that were measured at fair value on a recurring basis during the period.

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Note 5 Fair Value Measurements (continued)

Description	Balance as of September 30, 2019	Carrying Value at September 30, 2019 (in thousands) — Quoted Prices in Active Markets for Identical Assets (Level 1)	Significant Other Observable Inputs (Level 2)	Significant Unobservable Inputs (Level 3)
US Treasuries	$ 1,980	$	$ 1,980	$
US agency obligations	26,235		26,235
Mortgage-backed securities	10,808		10,808
Municipals	11,304		11,304
Corporates	4,073		4,073
Total available-for-sale securities	$ 54,400	$	$ 54,400	$
		Carrying Value at December 31, 2018 (in thousands)
Description	Balance as of December 31, 2018	Quoted Prices in Active Markets for Identical Assets (Level 1)	Significant Other Observable Inputs (Level 2)	Significant Unobservable Inputs (Level 3)
US Treasuries	$ 1,845	$	$ 1,845	$
US agency obligations	23,267		23,267
Mortgage-backed securities	11,876		11,876
Municipals	12,009		12,009
Corporates	3,730		3,730
Total available-for-sale securities	$ 52,727	$	$ 52,727	$

Fair Value on a Non-recurring Basis

Impaired loans

Loans are designated as impaired when, in the judgment of management based on current information and events, it is probable that all amounts due according to the contractual terms of the loan agreement will not be collected when due. The measurement of loss associated with impaired loans can be based on either the observable market price of the loan or the fair value of the collateral. Fair value is measured based on the value of the collateral securing the loans. Collateral may be in the form of real estate or business assets including equipment, inventory, and accounts receivable. The vast majority of the collateral is real estate. The value of real estate collateral is determined utilizing an income or market valuation approach based on an appraisal conducted by an independent, licensed appraiser outside of the Bank using observable market data (Level 2). However, in situations where the collateral is a house or building in the process of construction, the appraisal is more than 12 months old, management has determined the fair value of the collateral is further impaired below the appraised value, or the appraisal is not based solely on market comparables adjusted for observable inputs, the value is considered Level 3. The value of business equipment is based upon an outside appraisal if deemed significant, or the net book value on the applicable business financial statements if not considered significant using observable market data. Likewise, values for inventory and accounts receivables collateral are based on financial statement balances or aging reports (Level 3). Any fair value adjustments are recorded in the period incurred as provision for loan losses on the Consolidated Statements of Income.

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Note 5 Fair Value Measurements (continued)

Loans held for sale

Loans held for sale are carried at cost which approximates estimated fair value. These loans currently consist of one-to-four family residential loans originated for sale in the secondary market. Fair value is based on the price secondary markets are currently offering for similar loans using observable market data which is not materially different than cost due to the short duration between origination and sale (Level 2). As such, the Company records fair value adjustments on a nonrecurring basis. No nonrecurring fair value adjustments were recorded on loans held for sale during the period ended September 30, 2019. Gains and losses on the sale of loans are recorded within gains on sales of loans held for sale, net on the Consolidated Statements of Income.

Other real estate owned

Certain assets such as other real estate owned (OREO) are measured at fair value less cost to sell. We believe that the fair value component in its valuation follows the provisions of ASC 820.

Real estate acquired through foreclosure is transferred to OREO. The measurement of loss associated with OREO is based on the fair value of the collateral compared to the unpaid loan balance and anticipated costs to sell the property. The value of OREO property is determined utilizing an income or market valuation approach based on an appraisal conducted by an independent, licensed appraiser outside of the Bank using observable market data (Level 2).

Any fair value adjustments are recorded in the period incurred and expensed against current earnings. However, in situations where the collateral is a house or building in the process of construction, the appraisal is more than 12 months old, management has determined the fair value of the collateral is further impaired below the appraised value, or the appraisal is not based solely on market comparables adjusted for observable inputs, the value is considered Level 3.

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Note 5 Fair Value Measurements (continued)

The following table summarizes the Companys impaired loans and OREO measured at fair value on a nonrecurring basis during the period (in thousands):

Description	Balance as of September 30, 2019	Carrying Value at September 30, 2019 — Quoted Prices in Active Markets for Identical Assets (Level 1)	Significant Other Observable Inputs (Level 2)	Significant Unobservable Inputs (Level 3)
Impaired loans*	$ 1,010	$	$	$ 1,010
Other real estate owned	2,242			2,242

Includes loans charged down to the net realizable value of the collateral.

Description	Balance as of December 31, 2018	Carrying Value at December 31, 2018 — Quoted Prices in Active Markets for Identical Assets (Level 1)	Significant Other Observable Inputs (Level 2)	Significant Unobservable Inputs (Level 3)
Impaired loans*	$ 1,587	$	$	$ 1,587
Other real estate owned	2,430			2,430

Includes loans charged down to the net realizable value of the collateral.

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Note 5 Fair Value Measurements (continued)

The following table sets forth information regarding the quantitative inputs used to value assets classified as Level 3:

	Quantitative information about Level 3 Fair Value Measurements for September 30, 2019 (dollars in thousands) — Fair Value	Valuation Technique(s)	Unobservable Input	Range (Weighted Average)
Assets
Impaired loans	$ 1,010	Discounted appraised value	Selling cost	0% - 10% (8%)
			Discount for lack of marketability and age of appraisal	0% - 20% (6%)
OREO	2,242	Discounted appraised value	Selling cost	0% - 10% (6%)
			Discount for lack of marketability and age of appraisal	0% - 25% (15%)
	Quantitative information about Level 3 Fair Value Measurements for December 31,
2018 (dollars in thousands)
	Fair Value	Valuation Technique(s)	Unobservable Input	Range (Weighted Average)
Assets
Impaired loans	$ 1,587	Discounted appraised value	Selling cost	0% - 10% (8%)
			Discount for lack of marketability and age of appraisal	0% - 20% (6%)
OREO	2,430	Discounted appraised value	Selling cost	0% - 10% (6%)
			Discount for lack of marketability and age of appraisal	0% - 25% (15%)

Financial Instruments

FASB ASC 825, Financial Instruments, requires disclosure about fair value of financial instruments, including those financial assets and financial liabilities that are not required to be measured and reported at fair value on a recurring or nonrecurring basis. ASC 825 excludes certain financial instruments and all nonfinancial instruments from its disclosure requirements. Accordingly, the aggregate fair value amounts presented may not necessarily represent the underlying fair value of the Company. The carrying amounts and estimated fair values of the Companys financial instruments are presented in the following tables whether or not recognized on the Consolidated Balance Sheets at fair value.

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Note 5 Fair Value Measurements (continued)

The estimated fair values, and related carrying or notional amounts, of Financials financial instruments and their placement in the fair value hierarchy at September 30, 2019 and December 31, 2018 was as follows (in thousands):

		Fair Value Measurements at September 30, 2019 using
		Quoted Prices	Significant
		in Active	Other	Significant
		Markets for	Observable	Unobservable
	Carrying	Identical Assets	Inputs	Inputs
	Amounts	(Level 1)	(Level 2)	(Level 3)	Balance
Assets
Cash and due from banks	$ 27,315	$ 27,315	$	$	$ 27,315
Fed funds sold	22,141	22,141			22,141
Securities
Available-for-sale	54,400		54,400		54,400
Held-to-maturity	3,690		3,938		3,938
Restricted stock	1,506		1,506		1,506
Loans, net (1)	551,005			551,540	551,540
Loans held for sale	5,630		5,630		5,630
Interest receivable	1,755		1,755		1,755
BOLI	13,606		13,606		13,606
Liabilities
Deposits	$ 633,033	$	$ 634,750	$	$ 634,750
Capital notes	5,000		4,773		4,773
Interest payable	167		167		167
		Fair Value Measurements at December 31, 2018 using
		Quoted Prices	Significant
		in Active	Other	Significant
		Markets for	Observable	Unobservable
	Carrying	Identical Assets	Inputs	Inputs
	Amounts	(Level 1)	(Level 2)	(Level 3)	Balance
Assets
Cash and due from banks	$ 26,725	$ 26,725	$	$	$ 26,725
Fed funds sold	23,600	23,600			23,600
Securities
Available-for-sale	52,727		52,727		52,727
Held-to-maturity	3,700		3,515		3,515
Restricted stock	1,462		1,462		1,462
Loans, net (1)	530,016			522,782	522,782
Loans held for sale	1,670		1,670		1,670
Interest receivable	1,742		1,742		1,742
BOLI	13,359		13,359		13,359
Liabilities
Deposits	$ 612,043	$	$ 612,532	$	$ 612,532
Capital notes	5,000		4,710		4,710
Interest payable	127		127		127

(1) Carrying amount is net of unearned income and the Allowance.

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Note 6 Leases

On January 1, 2019, the Company adopted ASU No. 2016-02 Leases (Topic 842) and all subsequent ASUs that modified Topic 842. The Company elected the prospective application approach provided by ASU 2018-11 and did not adjust prior periods for ASC 842. The Company also elected certain practical expedients within the standard and consistent with such elections did not reassess whether any expired or existing contracts are or contain leases, did not reassess the lease classification for any expired or existing leases, and did not reassess any initial direct costs for existing leases. As stated in the Companys 2018 Form 10-K, the implementation of the new standard resulted in recognition of right-of-use assets and lease liabilities of $3.0 million at the date of adoption, which is related to the Companys lease of premises used in operations. The right-of-use assets and lease liabilities are included in other assets and other liabilities, respectively, in the Consolidated Balance Sheets.

Lease liabilities represent the Companys obligation to make lease payments and are presented at each reporting date as the net present value of the remaining contractual cash flows. Cash flows are discounted at the Companys incremental borrowing rate in effect at the commencement date of the lease. Right-of-use assets represent the Companys right to use the underlying asset for the lease term and are calculated as the sum of the lease liability and if applicable, prepaid rent, initial direct costs and any incentives received from the lessor.

The Company leases six of its operating locations under long-term leases (greater than 12 months). Leases for four of these locations are classified as operating leases. One new lease which commenced near the end of the current period was classified as a finance lease upon managements assessment of the lease. Also near the end of the current period, another lease which was classified as operating upon adoption of ASU 2016-02 was modified, and upon reassessment of the modified lease, was transitioned to the finance lease classification. Certain of these leases offer the option to extend the lease term and the Company has included such extensions in its calculation of the lease liabilities to the extent the options are reasonably certain of being exercised. The lease agreements do not provide for residual value guarantees and have no restrictions or covenants that would impact dividends or require incurring additional financial obligations.

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Note 6 Leases (continued)

The following tables present information about the Companys operating leases:

(Dollars in thousands)	September 30, 2019
Lease liabilities	$ 1,557
Right-of-use assets	$ 1,544
Weighted average remaining lease term	14.8 years
Weighted average discount rate	3.39 %

The following tables present information about the Companys finance leases:

(Dollars in thousands)	September 30, 2019
Lease liabilities	$ 4,492
Right-of-use assets	$ 4,420
Weighted average remaining lease term	11.3 years
Weighted average discount rate	2.70 %
Lease cost (in thousands)	For the Three Months Ended September 30, 2019
Operating lease cost	$ 147
Finance lease cost:
Amortization of right-of-use assets	138
Interest on lease liabilities	41
Total lease cost	$ 326
Cash paid for amounts included in the measurement of operating lease liabilities	$ 240
Cash paid for amounts included in the measurement of finance lease liabilities	$ 106
Lease cost (in thousands)	For the Nine Months Ended September 30, 2019
Operating lease cost	$ 433
Finance lease cost:
Amortization of right-of-use assets	138
Interest on lease liabilities	41
Total lease cost	$ 612
Cash paid for amounts included in the measurement of operating lease liabilities	$ 518
Cash paid for amounts included in the measurement of finance lease liabilities	$ 106

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Note 6 Leases (continued)

A maturity analysis of operating and finance lease liabilities and reconciliation of the undiscounted cash flows to the total of lease liabilities is as follows:

	Operating Lease — Liabilities	Liabilities
	As of	As of
Lease payments due (in thousands)	September 30, 2019	September 30, 2019
Three months ending December 31, 2019	$ 45	$	101
Twelve months ending December 31, 2020	184		445
Twelve months ending December 31, 2021	111		454
Twelve months ending December 31, 2022	110		454
Twelve months ending December 31, 2023	110		454
Twelve months ending December 31, 2024	110		479
Thereafter	1,352		2,881
Total undiscounted cash flows	$ 2,022	$	5,268
Discount	(465	)	(776	)
Lease liabilities	$ 1,557	$	4,492

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Note 7 Securities

The following tables summarize the Banks holdings for both securities held-to-maturity and securities available-for-sale as of September 30, 2019 and December 31, 2018 (amounts in thousands):

	September 30, 2019
	Amortized	Gross Unrealized
	Costs	Gains	(Losses)		Fair Value
Held-to-Maturity
US agency obligations	$ 3,690	$ 248	$		$ 3, 938
Available-for-Sale
US Treasuries	1,964	16			1,980
US agency obligations	25,963	374	(102	)	26,235
Mortgage-backed securities	10,887	40	(119	)	10,808
Municipals	11,145	167	(8	)	11,304
Corporates	4,090	28	(45	)	4,073
	$ 54,049	$ 625	$ (274	)	$ 54,400
	December 31, 2018
	Amortized	Gross Unrealized
	Costs	Gains	(Losses)		Fair Value
Held-to-Maturity
US agency obligations	$ 3,700	$ 3	$ (185	)	$ 3,515
Available-for-Sale
US Treasuries	1,961		(116	)	1,845
US agency obligations	24,701		(1,434	)	23,267
Mortgage-backed securities	12,390		(514	)	11,876
Municipals	12,412	3	(406	)	12,009
Corporates	4,102		(372	)	3,730
	$ 55,566	$ 3	$ (2,842	)	$ 52,727

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Note 7 Securities (continued)

The following tables show the gross unrealized losses and fair value of the Banks investments with unrealized losses that are not deemed to be other-than-temporarily impaired, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position, at September 30, 2019 and December 31, 2018 (amounts in thousands):

	Less than 12 months — Fair	Unrealized	More than 12 months — Fair	Unrealized	Total — Fair	Unrealized
September 30, 2019	Value	Losses	Value	Losses	Value	Losses
Description of securities
Held-to-maturity
US agency obligations	$	$	$	$	$	$
Available-for-sale
US Treasuries
US agency obligations	5,252	54	10,990	48	16,242	102
Mortgage-backed securities			9,078	119	9,078	119
Municipals			1,332	8	1,332	8
Corporates			2,024	45	2,024	45
Total	$ 5,252	$ 54	$ 23,424	$ 220	$ 28,676	$ 274
	Less than 12 months		More than 12 months		Total
	Fair	Unrealized	Fair	Unrealized	Fair	Unrealized
December 31, 2018	Value	Losses	Value	Losses	Value	Losses
Description of securities
Held-to-maturity
US agency obligations	$	$	$ 3,515	$ 185	$ 3,515	$ 185
Available-for-sale
US Treasuries			1,845	116	1,845	116
US agency obligations			23,267	1,434	23,267	1,434
Mortgage-backed securities	966	20	10,910	494	11,876	514
Municipals			10,994	406	10,994	406
Corporates			3,730	372	3,730	372
Total	$ 966	$ 20	$ 50,746	$ 2,822	$ 51,712	$ 2,842

Management evaluates securities for other-than-temporary impairment at least on a quarterly basis, and may do so more frequently when economic or market concerns warrant such evaluation. Consideration is given to (1) the length of time and the extent to which the fair value has been less than cost, (2) the financial condition and near-term prospects of the issuer, (3) the intent of Financial, if any, to sell the security; (4) whether Financial more likely than not will be required to sell the security before recovering its cost; and (5) whether Financial does not expect to recover the securitys entire amortized cost basis (even if Financial does not intend to sell the security).

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Note 7 Securities (continued)

At September 30, 2019, the Company did not consider the unrealized losses as other-than-temporary losses due to the nature of the securities involved. As of September 30, 2019, the Bank owned 25 securities in an unrealized loss position that were being evaluated for other than temporary impairment. Two of these securities were S&P rated AAA, 22 were rated AA, and one was rated BBB+. As of September 30, 2019, 21 of these securities were direct obligations of the U.S. government or government sponsored entities, two were municipal issues, and two were investments in domestic corporate issued securities.

Based on the analysis performed by management as mandated by the Banks investment policy, management believes the default risk to be minimal. Because management does not intend to sell and it is likely that management will not be required to sell the securities prior to their anticipated recovery, and the decline in fair value is largely due to change in interest rates and other market conditions, no declines currently are deemed to be other-than-temporary.

Gross gains on sales of available-for-sale securities were $291 during the three and nine months ended September 30, 2019 as compared to $0 during the same periods in 2018. There were no gross losses on sales of available-for-sale securities during the three and nine month periods ended September 30, 2019 and 2018. There were no sales of held-to-maturity securities during the three and nine month periods ended September 30, 2019 and 2018.

Note 8 Business Segments

The Company has two reportable business segments: (i) a traditional full-service community banking segment and, (ii) a mortgage loan origination business. The community banking business segment includes Bank of the James which provides loans, deposits, investments and insurance to retail and commercial customers throughout Region 2000 and other areas within Central Virginia. The mortgage segment provides a variety of mortgage loan products principally within Region 2000. Mortgage loans are originated and sold in the secondary market through purchase commitments from investors with servicing released. Because of the pre-arranged purchase commitments, there is minimal risk to the Company.

Both of the Companys reportable segments are service based. The mortgage business is a gain on sale business while the Banks primary source of revenue is net interest income. The Bank also provides a referral network for the mortgage origination business. The mortgage business may also be in a position to refer its customers to the Bank for banking services when appropriate.

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Note 8 Business Segments (continued)

Information about reportable business segments and reconciliation of such information to the consolidated financial statements for the three and nine months ended September 30, 2019 and 2018 was as follows (dollars in thousands):

Business Segments

	Community — Banking	Mortgage	Total
Nine months ended September 30, 2019
Net interest income	$ 18,447	$	$ 18,447
Provision for loan losses	434		434
Net interest income after provision for loan losses	18,013		18,013
Noninterest income	1,936	3,103	5,039
Noninterest expenses	15,700	2,247	17,947
Income before income taxes	4,249	856	5,105
Income tax expense	840	180	1,020
Net income	$ 3,409	$ 676	$ 4,085
Total assets	$ 702,215	$ 5,899	$ 708,114
Nine months ended September 30, 2018
Net interest income	$ 17,124	$	$ 17,124
Provision for loan losses	527		527
Net interest income after provision for loan losses	16,597		16,597
Noninterest income	1,684	2,262	3,946
Noninterest expenses	13,922	1,845	15,767
Income before income taxes	4,359	417	4,776
Income tax expense	891	58	949
Net income	$ 3,468	$ 359	$ 3,827
Total assets	$ 665,698	$ 2,740	$ 668,438
	Community
	Banking	Mortgage	Total
Three months ended September 30, 2019
Net interest income	$ 6,165	$	$ 6,165
Provision for loan losses	108		108
Net interest income after provision for loan losses	6,057		6,057
Noninterest income	824	1,337	2,161
Noninterest expenses	5,453	920	6,373
Income before income taxes	1,428	417	1,845
Income tax expense	283	88	371
Net income	$ 1,145	$ 329	$ 1,474
Total assets	$ 702,215	$ 5,899	$ 708,114
Three months ended September 30, 2018
Net interest income	$ 5,990	$	$ 5,990
Provision for loan losses	190		190
Net interest income after provision for loan losses	5,800		5,800
Noninterest income	552	767	1,319
Noninterest expenses	4,715	649	5,364
Income before income taxes	1,637	118	1,755
Income tax expense	345	6	351
Net income	$ 1,292	$ 112	$ 1,404
Total assets	$ 665,698	$ 2,740	$ 668,438

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Note 9 Loans, allowance for loan losses and OREO

Management has an established methodology used to determine the adequacy of the allowance for loan losses that assesses the risks and losses inherent in the loan portfolio. For purposes of determining the allowance for loan losses, the Bank has segmented certain loans in the portfolio by product type. Within these segments, the Bank has sub-segmented its portfolio into classes, based on the associated risks. The classifications set forth below do not correspond directly to the classifications set forth in the call report (Form FFIEC 041). Management has determined that the classifications set forth below are more appropriate for use in identifying and managing risk in the loan portfolio.

Loan Segments:
Commercial	Commercial and industrial loans
Commercial real estate	Commercial mortgages owner occupied
	Commercial mortgages non-owner occupied
	Commercial construction
Consumer	Consumer unsecured
	Consumer secured
Residential	Residential mortgages
	Residential consumer construction

A summary of loans, net is as follows (dollars in thousands):

	As of: — September 30,	December 31,
	2019	2018
Commercial	$ 102,191	$ 92,877
Commercial real estate	301,016	289,171
Consumer	83,271	86,191
Residential	69,300	66,358
Total loans (1)	555,778	534,597
Less allowance for loan losses	4,773	4,581
Net loans	$ 551,005	$ 530,016

(1) Includes net deferred costs and premiums of $299 and $457 as of September 30, 2019 and December 31, 2018, respectively.

The Banks internal risk rating system is in place to grade commercial and commercial real estate loans. Category ratings are reviewed periodically by lenders and the credit review area of the Bank based on the borrowers individual situation. Additionally, internal and external monitoring and review of credits are conducted on an annual basis.

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Note 9 Loans, allowance for loan losses and OREO (continued)

Below is a summary and definition of the Banks risk rating categories:

RATING 1	Excellent
RATING 2	Above Average
RATING 3	Satisfactory
RATING 4	Acceptable / Low Satisfactory
RATING 5	Monitor
RATING 6	Special Mention
RATING 7	Substandard
RATING 8	Doubtful
RATING 9	Loss

We segregate loans into the above categories based on the following criteria and we review the characteristics of each rating at least annually, generally during the first quarter. The characteristics of these ratings are as follows:

Pass. These are loans having risk ratings of 1 through 4. Pass loans are to persons or business entities with an acceptable financial condition, appropriate collateral margins, appropriate cash flow to service the existing loan, and an appropriate leverage ratio. The borrower has paid all obligations as agreed and it is expected that this type of payment history will continue. When necessary, acceptable personal guarantors support the loan.

Monitor. These are loans having a risk rating of 5. Monitor loans have currently acceptable risk but may have the potential for a specific defined weakness in the borrowers operations and the borrowers ability to generate positive cash flow on a sustained basis. The borrowers recent payment history may currently or in the future be characterized by late payments. The Banks risk exposure is mitigated by collateral supporting the loan. The collateral is considered to be well-margined, well maintained, accessible and readily marketable.

Special Mention. These are loans having a risk rating of 6. Special Mention loans have weaknesses that deserve managements close attention. If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the asset or in the banks credit position at some future date. Special Mention loans are not adversely classified and do not expose an institution to sufficient risk to warrant adverse classification. These loans do warrant more than routine monitoring due to a weakness caused by adverse events.

Substandard. These are loans having a risk rating of 7. Substandard loans are considered to have specific and well-defined weaknesses that jeopardize the viability of the Banks credit extension. The payment history for the loan has been inconsistent and the expected or projected primary repayment source may be inadequate to service the loan. The estimated net liquidation value of the collateral pledged and/or ability of the personal guarantor(s) to pay the loan may not adequately protect the Bank. There is a distinct possibility that the Bank will sustain some loss if the deficiencies associated with the loan are not corrected in the near term. A substandard loan would not automatically meet our definition of impaired unless the loan is significantly past due and the borrowers performance and financial condition provides evidence that it is probable that the Bank will be unable to collect all amounts due.

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Note 9 Loans, allowance for loan losses and OREO (continued)

Doubtful. These are loans having a risk rating of 8. Doubtful rated loans have all the weaknesses inherent in a loan that is classified substandard but with the added characteristic that the weaknesses make collection or liquidation in full, on the basis of currently existing facts, conditions, and values, highly questionable and improbable. The possibility of loss is extremely high.

Loss. These are loans having a risk rating of 9. Loss rated loans are not considered collectible under normal circumstances and there is no realistic expectation for any future payment on the loan. Loss rated loans are fully charged off.

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Note 9 Loans, allowance for loan losses and OREO (continued)

Loans on Non-Accrual Status
( dollars in thousands )
	As of
	September 30, 2019	December 31, 2018
Commercial	$ 285	$ 973
Commercial Real Estate:
Commercial Mortgages-Owner Occupied	405	317
Commercial Mortgages-Non-Owner Occupied	503	173
Commercial Construction
Consumer
Consumer Unsecured
Consumer Secured	28	84
Residential:
Residential Mortgages	550	1,391
Residential Consumer Construction
Totals	$ 1,771	$ 2,939

We also classify other real estate owned (OREO) as a nonperforming asset. OREO represents real property owned by the Bank which was acquired through purchase at foreclosure or from the borrower through a deed in lieu of foreclosure. OREO decreased to $2,242 on September 30, 2019 from $2,430 on December 31, 2018. The following table represents the changes in OREO balance during the nine months ended September 30, 2019 and year ended December 31, 2018.

OREO Changes
( dollars in thousands )
	Nine Months Ended September 30, 2019	Year Ended December 31, 2018
Balance at the beginning of the year (net)	$ 2,430	$	2,650
Transfers from loans	460		850
Capitalized costs
Valuation adjustments	(286	)	(185	)
Sales proceeds	(349	)	(846	)
Loss on disposition	(13	)	(39	)
Balance at the end of the period (net)	$ 2,242	$	2,430

At September 30, 2019 and December 31, 2018, the Company had no consumer mortgage loans secured by residential real estate for which foreclosure was in process. The Company held two residential real estate properties carried on the books in other real estate owned at a value of $228 as of September 30, 2019 and four residential real estate properties carried on the books at a value of $156 in other real estate owned as of December 31, 2018.

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Note 9 Loans, allowance for loan losses and OREO (continued)

	Impaired Loans
	( dollars in thousands )
	As of and For the the Nine Months Ended September 30, 2019
		Unpaid		Average	Interest
	Recorded	Principal	Related	Recorded	Income
2019	Investment	Balance	Allowance	Investment	Recognized
With No Related Allowance Recorded:
Commercial	$ 488	$ 1,041	$	$ 959	$ 29
Commercial Real Estate
Commercial Mortgages-Owner Occupied	2,258	2,448		2,336	132
Commercial Mortgage Non-Owner Occupied	671	696		401	23
Commercial Construction
Consumer
Consumer Unsecured
Consumer Secured	109	109		99	5
Residential
Residential Mortgages	1,499	1,513		1,688	51
Residential Consumer Construction
With an Allowance Recorded:
Commercial	$ 8	$ 8	$ 8	$ 20	$ 1
Commercial Real Estate
Commercial Mortgages-Owner Occupied	15	15	15	27	1
Commercial Mortgage Non-Owner Occupied	15	15	6	53	1
Commercial Construction
Consumer
Consumer Unsecured				1
Consumer Secured				53
Residential
Residential Mortgages	140	156	34	258	3
Residential Consumer Construction
Totals:
Commercial	$ 496	$ 1,049	$ 8	$ 979	$ 30
Commercial Real Estate
Commercial Mortgages-Owner Occupied	2,273	2,463	15	2,363	133
Commercial Mortgage Non-Owner Occupied	686	711	6	454	24
Commercial Construction
Consumer
Consumer Unsecured				1
Consumer Secured	109	109		152	5
Residential
Residential Mortgages	1,639	1,669	34	1,946	54
Residential Consumer Construction
	$ 5,203	$ 6,001	$ 63	$ 5,895	$ 246

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Note 9 Loans, allowance for loan losses and OREO (continued)

	Impaired Loans
	( dollars in thousands )
	As of and For the the Year Ended December 31, 2018
		Unpaid		Average	Interest
	Recorded	Principal	Related	Recorded	Income
2018	Investment	Balance	Allowance	Investment	Recognized
With No Related Allowance Recorded:
Commercial	$ 1,430	$ 1,922	$	$ 1,178	$ 24
Commercial Real Estate
Commercial Mortgages-Owner Occupied	2,414	2,511		2,421	167
Commercial Mortgage Non-Owner Occupied	131	132		403	8
Commercial Construction
Consumer
Consumer Unsecured
Consumer Secured	88	88		184	6
Residential
Residential Mortgages	1,876	1,953		1,728	89
Residential Consumer Construction
With an Allowance Recorded:
Commercial	$ 31	$ 31	$ 15	$ 174	$ 3
Commercial Real Estate
Commercial Mortgages-Owner Occupied	39	132	36	352	3
Commercial Mortgage Non-Owner Occupied	90	90	20	82	6
Commercial Construction				85
Consumer
Consumer Unsecured	1	1	1	2
Consumer Secured	105	105	105	266	7
Residential
Residential Mortgages	375	390	61	263	11
Residential Consumer Construction
Totals:
Commercial	$ 1,461	$ 1,953	$ 15	$ 1,352	$ 27
Commercial Real Estate
Commercial Mortgages-Owner Occupied	2,453	2,643	36	2,773	170
Commercial Mortgage Non-Owner Occupied	221	222	20	485	14
Commercial Construction				85
Consumer
Consumer Unsecured	1	1	1	2
Consumer Secured	193	193	105	450	13
Residential
Residential Mortgages	2,251	2,343	61	1,991	100
Residential Consumer Construction
	$ 6,580	$ 7,355	$ 238	$ 7,138	$ 324

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Note 9 Loans, allowance for loan losses and OREO (continued)

	Allowance for Loan Losses and Recorded Investment in Loans
	( dollars in thousands )
	As of and For the Nine Months Ended September 30, 2019
		Commercial
2019	Commercial	Real Estate		Consumer		Residential		Total
Allowance for Credit Losses:
Beginning Balance	$ 1,136	$	1,831	$	956	$	658	$	4,581
Charge-Offs	(104	)	(6	)	(188	)	(21	)	(319	)
Recoveries	34		5		34		4		77
Provision	222		89		56		67		434
Ending Balance	1,288		1,919		858		708		4,773
Ending Balance: Individually evaluated for impairment	8		21				34		63
Ending Balance: Collectively evaluated for impairment	1,280		1,898		858		674		4,710
Totals:	$ 1,288	$	1,919	$	858	$	708	$	4,773
Financing Receivables:
Ending Balance: Individually evaluated for impairment	496		2,959		109		1,639		5,203
Ending Balance: Collectively evaluated for impairment	101,695		298,057		83,162		67,661		550,575
Totals:	$ 102,191	$	301,016	$	83,271	$	69,300	$	555,778

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Note 9 Loans, allowance for loan losses and OREO (continued)

	Allowance for Loan Losses and Recorded Investment in Loans
	( dollars in thousands )
	As of and For the Year Ended December 31, 2018
		Commercial
2018	Commercial	Real Estate		Consumer		Residential		Total
Allowance for Credit Losses:
Beginning Balance	$ 1,264	$	1,738	$	1,172	$	578	$	4,752
Charge-Offs	(395	)	(230	)	(405	)	(34	)	(1,064	)
Recoveries	113		4		60				177
Provision	154		319		129		114		716
Ending Balance	1,136		1,831		956		658		4,581
Ending Balance: Individually evaluated for impairment	15		56		106		61		238
Ending Balance: Collectively evaluated for impairment	1,121		1,775		850		597		4,343
Totals:	$ 1,136	$	1,831	$	956	$	658	$	4,581
Financing Receivables:
Ending Balance: Individually evaluated for impairment	1,461		2,674		194		2,251		6,580
Ending Balance: Collectively evaluated for impairment	91,416		286,497		85,997		64,107		528,017
Totals:	$ 92,877	$	289,171	$	86,191	$	66,358	$	534,597

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Note 9 Loans, allowance for loan losses and OREO (continued)

	Age Analysis of Past Due Loans as of
	September 30, 2019
	( dollars in thousands )
			Greater				Recorded Investment
	30-59 Days	60-89 Days	than	Total Past		Total	> 90 Days &
2019	Past Due	Past Due	90 Days	Due	Current	Loans	Accruing
Commercial	$ 2	$	$ 134	$ 136	$ 102,055	$ 102,191	$
Commercial Real Estate:
Commercial Mortgages- Owner Occupied	674	19	405	1,098	105,162	106,260
Commercial Mortgages-Non-Owner Occupied	126	706	503	1,335	176,611	177,946
Commercial Construction					16,810	16,810
Consumer:
Consumer Unsecured	7			7	8,218	8,225
Consumer Secured	498	153		651	74,395	75,046
Residential:
Residential Mortgages	994	94	478	1,556	54,215	55,781
Residential Consumer Construction					13,519	13,519
Total	$ 2,301	$ 972	$ 1,520	$ 4,793	$ 550,985	$ 555,778	$
	Age Analysis of Past Due Loans as of
	December 31, 2018
	( dollars in thousands )
			Greater				Recorded Investment
	30-59 Days	60-89 Days	than	Total Past		Total	> 90 Days &
2018	Past Due	Past Due	90 Days	Due	Current	Loans	Accruing
Commercial	$ 54	$ 56	$ 220	$ 330	$ 92,547	$ 92,877	$
Commercial Real Estate:
Commercial Mortgages-Owner Occupied	209		307	516	97,910	98,426
Commercial Mortgages-Non-Owner Occupied	149	468		617	174,657	175,274
Commercial Construction					15,471	15,471
Consumer:
Consumer Unsecured	8	1		9	8,745	8,754
Consumer Secured	369	44		413	77,024	77,437
Residential:
Residential Mortgages	882	164	567	1,613	56,559	58,172
Residential Consumer Construction					8,186	8,186
Total	$ 1,671	$ 733	$ 1,094	$ 3,498	$ 531,099	$ 534,597	$

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Note 9 Loans, allowance for loan losses and OREO (continued)

	Credit Quality Information - by Class
	September 30, 2019
	( dollars in thousands )
2019	Pass	Monitor	Special Mention	Substandard	Doubtful	Totals
Commercial	$ 96,753	$ 352	$ 4,546	$ 540	$	$ 102,191
Commercial Real Estate:
Commercial Mortgages-Owner Occupied	95,133	452	8,402	2,273		106,260
Commercial Mortgages-Non-Owner Occupied	170,699	6,156	348	743		177,946
Commercial Construction	16,520	290				16,810
Consumer
Consumer Unsecured	8,225					8,225
Consumer Secured	74,825			221		75,046
Residential:
Residential Mortgages	53,611	329		1,841		55,781
Residential Consumer Construction	13,278	241				13,519
Totals	$ 529,044	$ 7,820	$ 13,296	$ 5,618	$	$ 555,778
	Credit Quality Information - by Class
	December 31, 2018
	( dollars in thousands )
2018	Pass	Monitor	Special Mention	Substandard	Doubtful	Totals
Commercial	$ 90,142	$ 818	$ 374	$ 1,543	$	$ 92,877
Commercial Real Estate:
Commercial Mortgages-Owner Occupied	90,995	1,461	3,517	2,453		98,426
Commercial Mortgages-Non -Owner Occupied	172,342	2,285	332	315		175,274
Commercial Construction	14,892	579				15,471
Consumer
Consumer Unsecured	8,747		6	1		8,754
Consumer Secured	77,092		88	257		77,437
Residential:
Residential Mortgages	55,336	334		2,502		58,172
Residential Consumer Construction	8,186					8,186
Totals	$ 517,732	$ 5,477	$ 4,317	$ 7,071	$	$ 534,597

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Note 9 Loans, allowance for loan losses and OREO (continued)

Troubled Debt Restructurings (TDR)

There were no loan modifications that would have been classified as TDRs during the three and nine months ended September 30, 2019 and 2018.

There were no loan modifications classified as TDRs within the last twelve months that defaulted during the three and nine months ended September 30, 2019 and 2018.

At September 30, 2019 and December 31, 2018, the Bank had no outstanding commitments to disburse additional funds on loans classified as TDRs.

Note 10 Revenue Recognition

On January 1, 2018, the Company adopted ASU No. 2014-09 Revenue from Contracts with Customers (Topic 606) and all subsequent ASUs that modified Topic 606. The implementation of the new standard did not have a material impact on the measurement or recognition of revenue; as such, a cumulative effect adjustment to opening retained earnings was not deemed necessary. Results for reporting periods beginning after January 1, 2018 are presented under Topic 606, while prior period amounts were not adjusted and continue to be reported in accordance with our historic accounting under Topic 605.

Topic 606 does not apply to revenue associated with financial instruments, including revenue from loans and securities. Topic 606 is applicable to noninterest revenue streams such as deposit related fees, interchange fees, merchant income, and annuity and insurance commissions. However, the recognition of these revenue streams did not change significantly upon adoption of Topic 606. Substantially all of the Companys revenue is generated from contracts with customers. Noninterest revenue streams in-scope of Topic 606 are discussed below.

Service Charges on Deposit Accounts

Service charges on deposit accounts consist of account analysis fees (i.e., net fees earned on analyzed business checking accounts), monthly service fees, check orders, and other deposit account related fees. The Companys performance obligation for account analysis fees and monthly service fees is generally satisfied, and the related revenue recognized, over the period in which the service is provided. Check orders and other deposit account related fees are largely transactional based, and therefore, the Companys performance obligation is satisfied, and related revenue recognized, at a point in time. Payment for service charges on deposit accounts is primarily received immediately or at the end of the month through a direct charge to customers accounts.

Fees, Exchange, and Other Service Charges

Fees, exchange, and other service charges are primarily comprised of debit and credit card income, ATM fees, merchant services income, treasury services income and other service charges. Debit and credit card income is primarily comprised of interchange fees earned whenever the Companys debit and credit cards are processed through card payment networks such as Visa. ATM fees are primarily generated when a Company cardholder uses a non-Company ATM or a non-Company cardholder uses a Company ATM. Merchant services income

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Note 10 Revenue Recognition (continued)

mainly represents fees charged to merchants to process their debit and credit card transactions, in addition to account management fees. Treasury services income primarily represents fees charged to customers for sweep, positive pay and lockbox services. Other service charges include revenue from processing wire transfers, bill pay service, cashiers checks, and other services. The Companys performance obligation for fees, exchange, and other service charges are largely satisfied, and related revenue recognized, when the services are rendered or upon completion. Payment is typically received immediately or at the end of the month.

Other

Other noninterest income consists of other recurring revenue streams such as commissions from sales of mutual funds and other investments, safety deposit box rental fees, and other miscellaneous revenue streams. Commissions from the sale of mutual funds and other investments are recognized on trade date, which is when the Company has satisfied its performance obligation. The Company also receives periodic service fees (i.e., trailers) from mutual fund companies typically based on a percentage of net asset value. Trailer revenue is recorded over time, usually monthly or quarterly, as net asset value is determined. Safe deposit box rental fees are charged to the customer on an annual basis and recognized upon receipt of payment. The Company determined that since rentals and renewals occur fairly consistently over time, revenue is recognized on a basis consistent with the duration of the performance obligation.

Note 11 Recent accounting pronouncements

In June 2016, the FASB issued ASU No. 2016-13, Financial Instruments Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments. The amendments in this ASU, among other things, require the measurement of all expected credit losses for financial assets held at the reporting date based on historical experience, current conditions, and reasonable and supportable forecasts. Financial institutions and other organizations will now use forward-looking information to better inform their credit loss estimates. Many of the loss estimation techniques applied today will still be permitted, although the inputs to those techniques will change to reflect the full amount of expected credit losses. In addition, the ASU amends the accounting for credit losses on available-for-sale debt securities and purchased financial assets with credit deterioration. At the FASBs October 16, 2019 meeting, the Board affirmed its decision to amend the effective date of this ASU for many companies. Public business entities that are SEC filers, excluding those meeting the smaller reporting company definition, will retain the initial required implementation date of fiscal years, and interim periods within those fiscal years, beginning after December 15, 2019. All other entities will be required to apply the guidance for fiscal years, and interim periods within those years, beginning after December 15, 2022. The Company is currently assessing the impact that ASU 2016-13 will have on its consolidated financial statements The Company has been in discussions with its core processor to coordinate its plans for implementation and has contracted with an additional vendor to begin implementation.

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Note 11 Recent accounting pronouncements (continued)

In August 2018, the FASB issued ASU 2018-13, Fair Value Measurement (Topic 820): Disclosure FrameworkChanges to the Disclosure Requirements for Fair Value Measurement. The amendments modify the disclosure requirements in Topic 820 to add disclosures regarding changes in unrealized gains and losses, the range and weighted average of significant unobservable inputs used to develop Level 3 fair value measurements and the narrative description of measurement uncertainty. Certain disclosure requirements in Topic 820 are also removed or modified. The amendments are effective for fiscal years beginning after December 15, 2019, and interim periods within those fiscal years. Certain of the amendments are to be applied prospectively while others are to be applied retrospectively. Early adoption is permitted. The Company does not expect the adoption of ASU 2018-13 to have a material impact on its consolidated financial statements.

In April 2019, the FASB issued ASU 2019-04, Codification Improvements to Topic 326, Financial InstrumentsCredit Losses, Topic 815, Derivatives and Hedging, and Topic 825, Financial Instruments. This ASU clarifies and improves areas of guidance related to the recently issued standards on credit losses, hedging, and recognition and measurement including improvements resulting from various TRG Meetings. The amendments are effective for fiscal years beginning after December 15, 2019, and interim periods within those fiscal years. Early adoption is permitted. The Company is currently assessing the impact that ASU 2019-04 will have on its consolidated financial statements.

In May 2019, the FASB issued ASU 2019-05, Financial InstrumentsCredit Losses (Topic 326): Targeted Transition Relief. The amendments in this ASU provide entities that have certain instruments within the scope of Subtopic 326-20 with an option to irrevocably elect the fair value option in Subtopic 825-10, applied on an instrument-by-instrument basis for eligible instruments, upon the adoption of Topic 326. The fair value option election does not apply to held-to-maturity debt securities. An entity that elects the fair value option should subsequently measure those instruments at fair value with changes in fair value flowing through earnings. The amendments are effective for fiscal years beginning after December 15, 2019, and interim periods within those fiscal years. The amendments should be applied on a modified-retrospective basis by means of a cumulative-effect adjustment to the opening balance of retained earnings balance in the balance sheet. Early adoption is permitted. The Company is currently assessing the impact that ASU 2019-05 will have on its consolidated financial statements.

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ITEM 2. Managements Discussion and Analysis of Financial Condition and Results of Operations

CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS

This report contains statements that constitute forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended, and the Private Securities Litigation Reform Act of 1995. The words believe, estimate, expect, intend, anticipate, plan and similar expressions and variations thereof identify certain of such forward-looking statements which speak only as of the dates on which they were made. We undertake no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events, or otherwise. Readers are cautioned that any such forward-looking statements are not guarantees of future performance and involve risks and uncertainties, and that actual results may differ materially from those indicated in the forward-looking statements as a result of various factors. Factors that could cause actual results to differ from the results discussed in the forward-looking statements include, but are not limited to: economic conditions (both generally and more specifically in the markets in which we operate); competition for our customers from other providers of financial services; government legislation and regulation relating to the banking industry (which changes from time to time and over which we have no control) including but not limited to the Dodd-Frank Wall Street Reform and Consumer Protection Act; changes in the value of real estate securing loans made by the Bank; changes in interest rates; and material unforeseen changes in the liquidity, results of operations, or financial condition of our customers. Other risks, uncertainties and factors could cause our actual results to differ materially from those projected in any forward-looking statements we make.

GENERAL

Critical Accounting Policies

Bank of the James Financial Group, Inc.s (Financial) financial statements are prepared in accordance with accounting principles generally accepted in the United States (GAAP). The financial information contained within our statements is, to a significant extent, based on measures of the financial effects of transactions and events that have already occurred. A variety of factors could affect the ultimate value that is obtained either when earning income, recognizing an expense, recovering an asset or relieving a liability. We use historical loss ratios as one factor in determining the inherent loss that may be present in our loan portfolio. Actual losses could differ significantly from the historical factors that we use in estimating risk. In addition, GAAP itself may change from one previously acceptable method to another method. Although the economics of our transactions would be the same, the timing of events that would impact our transactions could change.

Financials critical accounting policies include the evaluation of the allowance for loan losses which is based on managements estimate of an amount that is adequate to absorb probable losses inherent in the loan portfolio of the Bank. The allowance for loan losses is established through a provision for loan loss based on available information including the composition of the loan portfolio, historical loan losses, specific impaired loans, availability and quality of collateral, age of the various portfolios, changes in local economic conditions, and loan performance and quality of the portfolio. Different assumptions used in evaluating the adequacy of the Banks allowance for loan losses could result in material changes in Financials financial condition and results of operations.

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The allowance is based on two basic principles of accounting: (i) ASC 450 Contingencies, which requires that losses be accrued when they are probable of occurring and are reasonably estimable and (ii) ASC 310 Impairment of a Loan, which requires that losses on impaired loans be accrued based on the differences between the value of collateral, present value of future cash flows or values that are observable in the secondary market and the loan balance. Guidelines for determining allowances for loan losses are also provided in the SEC Staff Accounting Bulletin No. 102 Selected Loan Loss Allowance Methodology and Documentation Issues and the Federal Financial Institutions Examination Councils interagency guidance, Interagency Policy Statement on the Allowance for Loan and Lease Losses (the FFIEC Policy Statement).

The Banks policy with respect to the methodology for determining the allowance for loan losses involves a higher degree of complexity and requires management to make subjective judgments that often require assumptions or estimates about uncertain matters. This critical policy and its assumptions are periodically reviewed with the Board of Directors.

See Management Discussion and Analysis Results of Operations Allowance for Loan Losses and Loan Loss Reserve below for further discussion of the allowance for loan losses.

Overview

Financial is a bank holding company headquartered in Lynchburg, Virginia. Our primary business is retail banking which we conduct through our wholly-owned subsidiary, Bank of the James (which we refer to as the Bank). We conduct three other business activities: mortgage banking through the Banks Mortgage division (which we refer to as Mortgage division), investment services through the Banks Investment division (which we refer to as Investment division), and insurance activities through BOTJ Insurance, Inc., a subsidiary of the Bank, (which we refer to as Insurance business). Of these three other business activities, only the Mortgage division is material to the Banks results and operations.

The Bank is a Virginia banking corporation headquartered in Lynchburg, Virginia. The Bank was incorporated under the laws of the Commonwealth of Virginia as a state-chartered bank in 1998 and began banking operations in July 1999. The Bank was organized to engage in general retail and commercial banking business. The Bank is a community-oriented financial institution that provides varied banking services to individuals, small and medium-sized businesses, and professional concerns. Historically, our primary market area has been the Central Virginia, Region 2000 area, which encompasses the seven jurisdictions of the Town of Altavista, Amherst County, Appomattox County, the Town of Bedford, Bedford County, Campbell County, and the City of Lynchburg. Recently the Bank has begun to expand to other

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areas in Virginia, specifically Roanoke, Charlottesville, Harrisonburg, Blacksburg, and Lexington. The Bank strives to provide its customers with products comparable to statewide regional banks located in its market area, while maintaining the prompt response time and level of service of a community bank. Management believes this operating strategy has particular appeal in the Banks market areas.

The Banks principal office is located at 828 Main Street, Lynchburg, Virginia 24504 and its telephone number is (434) 846-2000. The Bank also maintains a website at www.bankofthejames.bank.

Our operating results depend primarily upon the Banks net interest income, which is determined by the difference between (i) interest and dividend income on earning assets, which consist primarily of loans, investment securities and other investments, and (ii) interest expense on interest-bearing liabilities, which consist principally of deposits and other borrowings. The Banks net income also is affected by its provision for loan losses, as well as the level of its non-interest income, including gains on sales of loans held for sale and service charges, and its non-interest expenses, including salaries and employee benefits, occupancy expense, data processing expenses, Federal Deposit Insurance Corporation premiums, expense in complying with the Sarbanes-Oxley Act of 2002, miscellaneous other expenses, franchise taxes, and income taxes.

The Bank intends to enhance its profitability by increasing its market share in our service areas, providing additional services to its customers, and controlling costs.

The Bank services its banking customers through the following locations in Virginia:

Full-Service Branches

The main office located at 828 Main Street in Lynchburg (the Main Street Office),

A branch located at 5204 Fort Avenue in Lynchburg (the Fort Avenue Branch),

A branch located at 4698 South Amherst Highway in Amherst County (the Madison Heights Branch),

A branch located at 17000 Forest Road in Forest (the Forest Branch),

A branch located at 4935 Boonsboro Road, Suites C and D in Lynchburg (the Boonsboro Branch),

A branch located at 164 South Main Street, Amherst, Virginia (the Amherst Branch),

A branch located at 1405 Ole Dominion Boulevard in the Town of Bedford, Virginia, located off of Independence Boulevard (the Bedford Branch),

A branch located at 1110 Main Street, Altavista, Virginia (the Altavista Branch),

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A branch located at 1391 South High Street, Harrisonburg, VA (the Harrisonburg Branch),

A branch located at 1745 Confederate Blvd, Appomattox, VA (the Appomattox Branch),

A branch located at 225 Merchant Walk Avenue, Charlottesville, VA (the 5 th Street Station Branch),

A branch located at 3562 Electric Road, Roanoke, VA (the Roanoke Branch),

A branch located at 45 South Main St., Lexington, VA (the Lexington Branch),

A branch located at 550 Water St., Charlottesville, VA (the Water Street Branch), and

A branch located at 2101 Electric Rd, Roanoke, VA (the Oak Grove Branch).

Limited Service Branches

Westminster-Canterbury facilities located at 501 VES Road, Lynchburg, Virginia, and

Westminster-Canterbury facilities located at 250 Pantops Mountain Road, Charlottesville, Virginia.

Loan Production Offices

Residential mortgage loan production office located at the Forest Branch,

Residential mortgage loan production office located at 2001 South Main Street, Blacksburg, Virginia, and

Commercial, consumer and residential mortgage loan production office located at the Water Street Branch.

The Investment division and the Insurance business operate primarily out of offices located at the Main Street Office.

The Bank recently closed its location formerly located at 615 Church Street, Lynchburg, Virginia and is consolidating its operations into an expanded Main Street Office.

The Bank has applied and received approval to open a branch location at 5 Village Highway (near the intersection of Routes 501 and 24) in Rustburg, Virginia (the Rustburg Branch). This location will open in the fourth quarter of 2019.

The Bank continuously evaluates areas located within our service areas to identify additional viable branch locations. Based on this ongoing evaluation, the Bank may acquire one or more additional suitable sites.

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Subject to regulatory approval, the Bank anticipates may open additional branches during the next two fiscal years. Although numerous factors could influence the Banks expansion plans, the following discussion provides a general overview of the additional branch locations that the Bank currently is considering, including the following properties that we own and are holding for expansion:

Real property located in the Timberlake Road area of Campbell County (Lynchburg), Virginia . The Timberlake property is not suitable for its intended use as a branch bank. Management anticipates that it will be necessary to raze the current structures and replace it with appropriate new construction.

The Bank estimates that the cost of improvements, furniture, fixtures, and equipment necessary to upfit and construct a branch at this location could be between $900,000 and $1,500,000.

Although the Bank cannot predict with certainty the financial impact of each new branch, management generally anticipates that each new branch will become profitable within 12 to 18 months of operation.

Except as set forth herein, the Bank does not expect to purchase any significant property or equipment in the upcoming 12 months. Future branch openings are subject to regulatory approval.

OFF-BALANCE SHEET ARRANGEMENTS

The Bank is a party to various financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of our 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 and could impact the overall liquidity and capital resources to the extent customers accept and/or use these commitments.

The Banks 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 Banks commitments is as follows:

	September 30, 2019 ( in thousands )
Commitments to extend credit	$ 131,589
Letters of Credit	3,469
Total	$ 135,058

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 the Banks credit evaluation of the customer.

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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. The amount of collateral obtained, if deemed necessary by the Bank upon extension of credit, is based on the Banks credit evaluation of the customer.

The Bank has rate lock commitments to originate mortgage loans through its Mortgage Division. The Bank has entered into corresponding commitments with third party investors to sell each of these loans that close. No other obligation exists. As a result of these contractual relationships with these investors, the Bank is not exposed to losses nor will it realize gains related to its rate lock commitments due to changes in interest rates.

SUMMARY OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following discussion represents managements discussion and analysis of the financial condition of Financial as of September 30, 2019 and December 31, 2018 and the results of operations of Financial for the three and nine-month periods ended September 30, 2019 and 2018. This discussion should be read in conjunction with the financial statements included elsewhere herein.

All financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America.

Financial Condition Summary

September 30, 2019 as Compared to December 31, 2018

Total assets were $708,114,000 on September 30, 2019 compared with $674,897,000 at December 31, 2018, an increase of 4.92%. The increase in total assets was funded from the growth in deposits. In addition, total assets increased because of an increase in right of use assets pursuant to ASC 842, which is discussed in the Note 6 to the Financial Statements filed herewith.

Total deposits increased from $612,043,000 as of December 31, 2018 to $633,033,000 on September 30, 2019, an increase of 3.43%. The increase resulted in large part from increases in NOW, money market, savings accounts, and time deposits and was partially offset by a decrease in non-interest-bearing demand deposits. Noninterest bearing demand deposits decreased slightly from $91,356,000 on December 31, 2018 to $90,426,000 on September 30, 2019.

Total loans, excluding loans held for sale, increased to $555,778,000 on September 30, 2019 from $534,597,000 on December 31, 2018. Loans, excluding loans held for sale and net of deferred fees and costs and the allowance for loan losses, increased to $551,005,000 on September 30, 2019 from $530,016,000 on December 31, 2018, an increase of 3.96%. The

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following summarizes the position of the Banks loan portfolio as of the dates indicated by dollar amount and percentages (dollar amounts in thousands):

	September 30, 2019 — Amount	Percentage	December 31, 2018 — Amount	Percentage
Commercial	$ 102,191	18,39 %	$ 92,877	17.37 %
Commercial Real Estate	301,016	54.16 %	289,171	54.10 %
Consumer	83,271	14.98 %	86,191	16.12 %
Residential	69,300	12.47 %	66,358	12.41 %
Total loans	$ 555,778	100.00 %	$ 534,597	100.00 %

Total nonperforming assets, which consist of non-accrual loans, loans past due 90 days or more and still accruing, and other real estate owned (OREO) decreased to $4,013,000 on September 30, 2019 from $5,369,000 on December 31, 2018. OREO decreased to $2,242,000 on September 30, 2019 from $2,430,000 on December 31, 2018. This slight decrease was due in large part to a downward adjustment of the carrying value of certain OREO resulting from a change in appraised value and the Banks ability to sell OREO properties during the nine months ended September 30, 2019 and was offset in part by new foreclosures during the period. Non-performing loans decreased from $2,939,000 at December 31, 2018 to $1,771,000 at September 30, 2019. As discussed in more detail below under Results of OperationsAllowance for Loan Losses, management has provided for the anticipated losses on these loans in the allowance for loan losses. Loan payments received on non-accrual loans are first 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 reversed and 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 loan losses charged against earnings.

OREO represents real property acquired by the Bank for debts previously contracted, including through foreclosure or deeds in lieu of foreclosure. On December 31, 2018, the Bank was carrying ten OREO properties on its books at a value of $2,430,000. During the nine months ended September 30, 2019, the Bank acquired four additional OREO properties and disposed of six OREO properties, and as of September 30, 2019 the Bank is carrying eight OREO properties at a value of $2,242,000. The OREO properties are available for sale and are being actively marketed.

The Bank had loans in the amount of $413,000 at September 30, 2019 classified as performing Troubled Debt Restructurings (TDRs) as compared to $424,000 at December 31, 2018. None of these TDRs were included in non-accrual loans. These loans have had their original terms modified to facilitate payment by the borrower. The loans have been classified as TDRs primarily due to a change to interest only payments and the maturity of these modified loans is primarily less than one year.

Cash and cash equivalents decreased slightly to $49,456,000 on September 30, 2019 from $50,325,000 on December 31, 2018. Cash and cash equivalents consist of cash due from correspondents, cash in vault, and overnight investments (including federal funds sold). Cash and cash equivalents are subject to routine fluctuations in deposits, including fluctuations in transactional accounts and professional settlement accounts.

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Securities held-to-maturity were flat, decreasing to $3,690,000 on September 30, 2019 from $3,700,000 on December 31, 2018. This slight decrease is a result of normal amortization of premiums within the held-to-maturity portfolio.

Securities available-for-sale which are carried on the balance sheet at fair market value, increased to $54,400,000 on September 30, 2019, from $52,727,000 on December 31, 2018. The increase resulted from an increase in fair value related to a decrease in market interest rates. During the nine months ended September 30, 2019 the Bank received $1,462,000 in proceeds from calls, maturities, and paydowns of securities available-for-sale. During the nine months ended September 30, 2019 the Bank received $6,427,000 from the sale of securities available-for-sale. During the same period, the Bank purchased $6,369,000 in available-for-sale securities.

Financials investment in Federal Home Loan Bank of Atlanta (FHLBA) stock totaled $608,000 at September 30, 2019 as compared to $564,000 at December 31, 2018. FHLBA stock is generally viewed as a long-term investment and because there is no market for the stock other than other Federal Home Loan Banks or member institutions, FHLBA stock is viewed as a restricted security. Therefore, when evaluating FHLBA stock for impairment, its value is based on the ultimate recoverability of the par value rather than by recognizing temporary declines in value.

Liquidity and Capital

At September 30, 2019, Financial, on a consolidated basis, had liquid assets of $103,856,000 in the form of cash, interest-bearing and noninterest-bearing deposits with banks, and available-for-sale investments. Of this amount, approximately $20,193,000 (representing current book value) of the available-for-sale securities are pledged as collateral with $11,802,000 pledged as security for public deposits, and $8,391,000 pledged as security on a line of credit the Bank may draw on from time to time to meet liquidity needs. This line of credit currently has a zero balance. Management believes that liquid assets were adequate at September 30, 2019. Management anticipates that additional liquidity will be provided by the growth in deposit accounts and loan repayments at the Bank. In addition, if additional liquidity is needed, the Bank has the ability to purchase federal funds on the open market, borrow from the FHLBA using loans or investments within the Banks portfolio as collateral, and to borrow from the Federal Reserve Banks discount window.

Management is not aware of any trends, events or uncertainties that are reasonably likely to have a material negative impact on Financials short-term or long-term liquidity. Based in part on recent loan growth, the Bank is monitoring liquidity to ensure it is able to fund future loans.

At September 30, 2019, the Bank had a leverage ratio of approximately 9.30%, a Tier 1 risk-based capital ratio and a CET1 ratio of approximately 11.03% and a total risk-based capital ratio of approximately 11.84%. As of September 30, 2019 and December 31, 2018 the Banks regulatory capital levels exceeded those established for well-capitalized institutions. The

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following table sets forth the minimum capital requirements and the Banks capital position as of September 30, 2019 and December 31, 2018:

Bank Level Only Capital Ratios

	September 30,	December 31,
Analysis of Capital (in 000s)	2019	2018
Tier 1 capital
Common Stock	$ 3,742	$ 3,742
Surplus	22,325	22,325
Retained earnings	39,161	35,985
Total Tier 1 capital	$ 65,228	$ 62,052
Tier 2 capital
Allowance for loan losses	$ 4,773	$ 4,581
Total Tier 2 capital:	$ 4,773	$ 4,581
Total risk-based capital	$ 70,001	$ 66,633
Risk weighted assets	$ 591,365	$ 564,184
Average total assets	$ 701,389	$ 670,879

		For Capital	For Well
September 30,	December 31,	Adequacy	Capitalized
2019	2018	Purposes (1)	Purposes
Capital Ratios:
Tier 1 capital to average total assets	9.30 %	9.25 %	4.000 %	5.000 %
Common Equity Tier 1 capital	11.03 %	11.00 %	7.000 %	6.500 %
Tier 1 risk-based capital ratio	11.03 %	11.00 %	8.500 %	8.000 %
Total risk-based capital ratio	11.84 %	11.81 %	10.500 %	10.000 %

(1) Includes the capital conservation buffer of 2.50% for all ratios, excluding the Tier 1 capital to average total assets ratio.

The above tables set forth the capital position and analysis for the Bank only. Because total assets on a consolidated basis are less than $3,000,000,000, Financial is not subject to the consolidated capital requirements imposed by the Bank Holding Company Act. Consequently, Financial does not calculate its financial ratios on a consolidated basis. If calculated, the capital ratios for the Company on a consolidated basis at September 30, 2019 would be slightly lower than those of the Bank because proceeds from the sale of the capital notes were contributed to the Bank and counted as equity at the Bank level.

In July 2013, the Federal Reserve Board approved a final rule establishing a regulatory capital framework for smaller, less complex financial institutions. The rule was fully implemented on January 1, 2019 and implemented a capital conservation buffer of 2.5%. As result, the Bank is requited to have a minimum ratio of common equity Tier 1 capital to risk-weighted assets of 7.0% (inclusive of the capital conservation buffer) and a Tier 1 capital ratio of 8.5% (inclusive of the capital conservation buffer). The capital conservation buffer will limit capital distributions, stock redemptions, and certain discretionary bonuses. Failure to maintain the capital conservation buffer will limit the ability of the Bank and Financial to pay dividends, repurchase shares or pay discretionary bonuses. The rule also raised the minimum ratio of Tier 1 capital to risk-weighted assets from 4% to 6% and includes a minimum leverage ratio of 4% for all banking organizations.

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On September 17, 2019 the Federal Deposit Insurance Corporation finalized a rule that introduces an optional simplified measure of capital adequacy for qualifying community banking organizations (i.e., the community bank leverage ratio (CBLR) framework), as required by the Economic Growth, Regulatory Relief and Consumer Protection Act. The CBLR framework is designed to reduce burden by removing the requirements for calculating and reporting risk-based capital ratios for qualifying community banking organizations that opt into the framework.

In order to qualify for the CBLR framework, a community banking organization must have a tier 1 leverage ratio of greater than 9 percent, less than $10 billion in total consolidated assets, and limited amounts of off-balance-sheet exposures and trading assets and liabilities. A qualifying community banking organization that opts into the CBLR framework and meets all requirements under the framework will be considered to have met the well-capitalized ratio requirements under the Prompt Corrective Action regulations and will not be required to report or calculate risk-based capital.

The CBLR framework will be available for banks to use in their March 31, 2020, Call Report. The Company is currently evaluating whether to opt into the CBLR framework.

Results of Operations

Comparison of the Three and Nine Months Ended September 30, 2019 and 2018

Earnings Summary

Financial had net income including all operating segments of $1,474,000 and $4,085,000 for the three and nine months ended September 30, 2019, compared to $1,404,000 and $3,827,000 for the comparable periods in 2018. Basic and diluted earnings per common share for the three and nine months ended September 30, 2019 was $0.34 and $0.93, compared to basic and diluted earnings per share of $0.32 and $0.87 for the three and nine months ended September 30, 2018.

The increase in net income for the three and nine months ended September 30, 2019, as compared to the prior year was due primarily to an increase in interest income and non-interest income and was partially offset by an increase in interest expense and non-interest expense. Non-interest expense increased in large part because of the Banks continued emphasis on growth in Charlottesville, Harrisonburg, Roanoke, and, most recently, Lexington. These efforts resulted primarily in increases in personnel, occupancy, equipment, marketing, and other outside expenses. In addition, variable expenses, such as credit expenses and some personnel expenses, increased due to an increase in the volume of residential mortgage originations (which is discussed in more detail below).

These operating results represent an annualized return on average stockholders equity of 9.84% and 9.36% for the three and nine months ended September 30, 2019, compared with 10.13% and 9.49% for the three and nine months ended September 30, 2018. This decrease for the three and nine months ended September 30, 2019 was due to an increase in total average equity resulting from an increase in the market value of the securities available-for-sale portfolio. The increase in the market value of the securities-available-for sale portfolio resulted from a decrease in market interest rates. The Company had an annualized return on average assets of 0.83% and 0.79% for the three and nine months ended September 30, 2019 compared with 0.84% and 0.79% for the same periods in 2018. The decrease for the three months ended September 30, 2019 largely resulted from an increase in the Banks assets.

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See Non-Interest Income below for mortgage business segment discussion.

Interest Income, Interest Expense, and Net Interest Income

Interest income increased to $7,596,000 and $22,220,000 for the three and nine months ended September 30, 2019 from $6,980,000 and $19,860,000 for the same periods in 2018, increases of 8.83% and 11.88%, respectively. Interest income increased because of increased balances in the loan portfolio and an increase in loan yields. The average rate received on loans increased from 4.83% and 4.72% to 5.00% and 4.99% for the three and nine months ended September 30, 2019 from the comparable period in 2018. The rate on total average earning assets increased for the three and nine months ended September 30, 2019 as compared to the three and nine months ended September 30, 2018 primarily because an increase in the rates paid by borrowers on loans.

Interest expense increased to $1,431,000 and $3,773,000 for the three and nine months ended September 30, 2019 from $990,000 and $2,736,000 for the same periods in 2018, increases of 44.55% and 37.90%, respectively. The increase in interest expense resulted primarily from increases in both the rates paid on and balances of deposits. The Banks average rate paid on interest bearing deposits was 0.99% and 0.90% during the three and nine months ended September 30, 2019 as compared to 0.73% and 0.71% for the same periods in 2018.

The fundamental source of the Banks net revenue is net interest income, which is determined by the difference between (i) interest and dividend income on interest earning assets, which consist primarily of loans, investment securities and other investments, and (ii) interest expense on interest-bearing liabilities, which consist principally of deposits and other borrowings. Net interest income for the three and nine months ended September 30, 2019 was $6,165,000 and $18,447,000 as compared to $5,990,000 and $17,124,000 for the same periods in 2018, increases of 2.92% and 7.73%. The increases in net interest income for the three and nine months ended September 30, 2019 as compared with the comparable period in 2018 primarily is attributable to the increase in interest income resulting from increased loan balances. The net interest margin was 3.75% and 3.83% for the three and nine months ended September 30, 2019 as compared with 3.80% and 3.73% for the same periods in 2018.

Financials net interest margin analysis and average balance sheets are shown in Schedule I below.

Non-Interest Income

Non-interest income is comprised primarily of fees and charges on transactional deposit accounts, gains on sales of mortgage loans held for sale, commissions on sales of investments, fees generated from treasury management services, and the Banks ownership interest in a title insurance agency. Non-interest income increased to $2,161,000 and $5,039,000 for the three and nine months ended September 30, 2019 from $1,319,000 and $3,946,000 for the three and nine months ended September 30, 2018.

These increases for the three and nine months ended September 30, 2019 as compared to the same period last year were due primarily due to an increase in gains on sales of loans held for sale from $767,000 and $2,260,000 for the three and nine months ended September 30, 2018 to $1,337,000 and $3,103,000 for the same periods ended September 30, 2019. In addition, gains on sales of available-for-sale securities increased from $0 for both the three and nine-month periods ended September 30, 2018 to $291,000 for the same periods in 2019.

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The Bank, through its Mortgage division, originates both conforming and non-conforming consumer residential mortgage loans in the markets we serve. As part of the Banks overall risk management strategy, all of the loans originated and closed by the Mortgage division are presold to major national mortgage banking or financial institutions. The Mortgage division assumes, except in limited circumstances such as first payment default, no credit or interest rate risk on these mortgages.

Purchase mortgage originations totaled $34,750,000 and $83,524,000, or 69.63% and 72.64%, respectively, of the total mortgage loans originated in the three and nine months ended September 30, 2019 as compared to $23,785,000 and $65,271,000, or 83.02% and 74.52%, respectively of the total mortgage loans originated in the same periods in 2018. Management anticipates that in the short term purchase mortgage originations will continue to represent a majority of mortgage originations as they have in the recent past. However, management also believes that further decreases in long term market interest rates could trigger increased refinancing activity.

Despite slight decreases in the first nine months of 2019, management anticipates that residential mortgage rates will remain flat or trend slightly downward during the remainder of 2019. Management expects that the Mortgage divisions reputation in Region 2000, steady residential real estate inventory and the recent hiring of additional mortgage loan originators in Roanoke, Harrisonburg and Charlottesville, and Blacksburg, will result in strong mortgage originations through the remainder of 2019. Management also believes that in the event that interest rates rise, revenue from the mortgage segment could be under pressure.

Our Investment division provides brokerage services through an agreement with a third-party broker-dealer. Pursuant to this arrangement, the third-party broker-dealer operates a service center adjacent to one of the branches of the Bank. The center is staffed by two dual employees of the Bank and the broker-dealer. Investment receives commissions on transactions generated and in some cases ongoing management fees such as mutual fund 12b-1 fees. The Investment divisions financial impact on our consolidated revenue has been immaterial. Although management cannot predict the financial impact of Investment with certainty, management anticipates the Investment divisions impact on noninterest income will remain immaterial in 2019.

The Bank provides insurance and annuity products to Bank customers and others, through the Banks Insurance subsidiary. The Bank has three employees that are licensed to sell insurance products through Insurance. Insurance generates minimal revenue and its financial impact on our consolidated revenue has been immaterial. Management anticipates that Insurances impact on noninterest income will remain immaterial in 2019.

Non-Interest Expense

Non-interest expense for the three and nine months ended September 30, 2019 increased to $6,373,000 and $17,947,000 from $5,364,000 and $15,767,000, increases of 18.81% and 13.83% from the comparable periods in 2018. These increases resulted from increases for personnel expense primarily related to the expansion into Lexington and Roanoke, as well as increases in occupancy, equipment, marketing and credit expense. Total personnel expense was $3,356,000 and $9,437,000 for the three and nine-month periods ended September 30, 2019 as compared to $2,853,000 and $8,398,000 for the same periods in 2018.

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Allowance and Provision for Loan Losses

The allowance for loan losses represents an amount that, in our judgment, will be adequate to absorb probable losses inherent in the loan portfolio. The provision for loan losses increases the allowance, and loans charged off, net of recoveries, reduce the allowance. The provision for the allowance for loan losses is charged to earnings to bring the total allowance to a level deemed appropriate by management and is based upon two components specific impairment and general reserves. As discussed below, loans having a risk rating of 7 or below that are significantly past due, and the borrowers performance and financial condition provide evidence that it is probable that the Bank will be unable to collect all amounts when due as well as all TDRs, are evaluated for specific impairment. The general reserve component is based on an evaluation of general economic conditions, actual and expected credit losses, and loan performance measures. Based on the application of the loan loss calculation, the Bank provided $108,000 and $434,000 to the allowance for loan losses for the three and nine-month periods ended September 30, 2019. This compares to a provision of $190,000 and $527,000 for the comparable periods in 2018, representing decreases of 43.16% and 17.65%, respectively.

Charged-off loans, which are loans that management deems uncollectible, are charged against the allowance for loan losses and constitute a realized loss. Charged-off loans were $100,000 and $319,000 for the three and nine months ended September 30, 2019 as compared to $324,000 and $879,000 for the comparable periods in 2018. While a charged-off loan may subsequently be collected, such recoveries generally are realized over an extended period of time. In the three and nine months ended September 30, 2019, the Bank had recoveries of charged-off loans of $41,000 and $77,000 as compared with $7,000 and $161,000 for the comparable periods in 2018.

In light of the current economic environment, management continues its ongoing assessment of specific impairment in the Banks loan portfolio. As set forth in the tables below, the Banks allowance arising from the specific impairment evaluation as of September 30, 2019 decreased as compared to December 31, 2018.

As shown in the table below, the total balance in the allowance increased, from $4,581,000 as of December 31, 2018 to $4,773,000 on September 30, 2019. The allowance for loan losses as a percent of loans remained flat at 0.86% as of September 30, 2019 and 0.86% as of December 31, 2018. Increased loan balances during the three months led to an increase in the balance of the general reserve as of September 30, 2019 as compared to December 31, 2018, but this increase was offset primarily by a decrease in specific reserves and the allocation of updated historical loss rates when comparing the same periods. The allowance for loan losses as a percent of unimpaired loans was 0.87% as of both September 30, 2019 and December 31, 2018. The general reserve as a percentage of unimpaired loan balances increased slightly to 0.86% as of September 30, 2019 as compared to 0.82% as of December 31, 2018. This increase was primarily due to a slight increase in the rate of qualitative factors assessed in the general reserve based on managements evaluation of those factors at September 30, 2019. Management believes that the current allowance for loan losses is adequate.

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The following tables summarize the allowance activity for the periods indicated:

	Allowance for Loan Losses and Recorded Investment in Loans
	(dollars in thousands)
	As of and For the Nine Months Ended September 30, 2019
		Commercial
2019	Commercial	Real Estate		Consumer		Residential		Total
Allowance for Credit Losses:
Beginning Balance	$ 1,136	$	1,831	$	956	$	658	$	4,581
Charge-Offs	(104	)	(6	)	(188	)	(21	)	(319	)
Recoveries	34		5		34		4		77
Provision	222		89		56		67		434
Ending Balance	1,288		1,919		858		708		4,773
Ending Balance: Individually evaluated for impairment	8		21				34		63
Ending Balance: Collectively evaluated for impairment	1,280		1,898		858		674		4,710
Totals:	$ 1,288	$	1,919	$	858	$	708	$	4,773
Financing Receivables:
Ending Balance: Individually evaluated for impairment	496		2,959		109		1,639		5,203
Ending Balance: Collectively evaluated for impairment	101,695		298,057		83,162		67,661		550,575
Totals:	$ 102,191	$	301,016	$	83,271	$	69,300	$	555,778

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	Allowance for Loan Losses and Recorded Investment in Loans
	(dollars in thousands)
	As of and For the Year Ended December 31, 2018
		Commercial
2018	Commercial	Real Estate		Consumer		Residential		Total
Allowance for Credit Losses:
Beginning Balance	$ 1,264	$	1,738	$	1,172	$	578	$	4,752
Charge-Offs	(395	)	(230	)	(405	)	(34	)	(1,064	)
Recoveries	113		4		60				177
Provision	154		319		129		114		716
Ending Balance	1,136		1,831		956		658		4,581
Ending Balance: Individually evaluated for impairment	15		56		106		61		238
Ending Balance: Collectively evaluated for impairment	1,121		1,775		850		597		4,343
Totals:	$ 1,136	$	1,831	$	956	$	658	$	4,581
Financing Receivables:
Ending Balance: Individually evaluated for impairment	1,461		2,674		194		2,251		6,580
Ending Balance: Collectively evaluated for impairment	91,416		286,497		85,997		64,107		528,017
Totals:	$ 92,877	$	289,171	$	86,191	$	66,358	$	534,597

The following sets forth the reconciliation of the allowance for loan loss:

	Three Months Ended
	September 30,			September 30,
	(in thousands)			(in thousands)
	2019	2018		2019		2018
Balance, beginning of period	$ 4,724	$	4,688	$	4,581	$	4,752
Provision for loan losses	108		190		434		527
Loans charged off	(100	)	(324	)	(319	)	(879	)
Recoveries of loans charged off	41		7		77		161
Net (charge offs)	(59	)	(317	)	(242	)	(718	)
Balance, end of period	$ 4,773	$	4,561	$	4,773	$	4,561

No nonaccrual loans were excluded from the impaired loan disclosures at September 30, 2019 and December 31, 2018. If interest on these loans had been accrued, such income

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cumulatively would have approximated $216,000 and $198,000 on September 30, 2019 and December 31, 2018, respectively. Loan payments received on nonaccrual loans are applied to principal. When a loan is placed on nonaccrual 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.

Below is a summary and definition of the Banks risk rating categories:

RATING 1	Excellent
RATING 2	Above Average
RATING 3	Satisfactory
RATING 4	Acceptable / Low Satisfactory
RATING 5	Monitor
RATING 6	Special Mention
RATING 7	Substandard
RATING 8	Doubtful
RATING 9	Loss

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Income Taxes

For the three and nine months ended September 30, 2019, Financial had an income tax expense of $371,000 and $1,020,000 as compared to $351,000 and $949,000 for the three and nine months ended September 30, 2018. This represents an effective tax rate of 20.11% and 19.98% for the three and nine months ended September 30, 2019 as compared with 20.00% and 19.87% for the three and nine months ended September 30, 2018. Our effective rate was lower than the statutory corporate tax rate in all periods because of federal income tax benefits resulting from the tax treatment of earnings on bank owned life insurance and certain tax free municipal securities.

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Schedule I

Net Interest Margin Analysis

Average Balance Sheets

For the Quarter Ended September 30, 2019 and 2018

(dollars in thousands)

	2019 — Average Balance Sheet	Interest Income/ Expense	Average Rates Earned/ Paid	2018 — Average Balance Sheet	Interest Income/ Expense	Average Rates Earned/ Paid
ASSETS
Loans, including fees (1) (2)	$ 558,483	$ 7,037	5.00 %	$ 527,566	$ 6,424	4.83 %
Loans held for sale	4,435	43	3.85 %	3,134	36	4.56 %
Fed funds sold	17,056	89	2.07 %	20,148	96	1.89 %
Interest bearing bank balances	14,636	88	2.39 %	13,102	60	1.82 %
Securities (3)	55,528	330	2.36 %	60,281	355	2.36 %
Federal agency equities	1,390	9	2.57 %	1,346	9	2.65 %
CBB equity	116			116
Total earning assets	651,644	7,596	4.68 %	625,693	6,980	4.43 %
Allowance for loan losses	(4,768	)		(4,622	)
Non-earning assets	54,131			42,614
Total assets	$ 701,007			$ 663,685
LIABILITIES AND STOCKHOLDERS EQUITY
Deposits
Demand interest bearing	$ 257,407	$ 357	0.55 %	$ 226,880	$ 211	0.37 %
Savings	90,483	57	0.25 %	102,557	50	0.19 %
Time deposits	189,225	926	1.94 %	184,798	679	1.46 %
Total interest bearing deposits	537,115	1,340	0.99 %	514,235	940	0.73 %
Other borrowed funds
Financing leases	4,542	41	3.58 %
Capital Notes	5,000	50	4.00 %	5,000	50	4.00 %
Total interest-bearing liabilities	546,657	1,431	1.04 %	519,235	990	0.73 %
Non-interest bearing deposits	90,995			88,314
Other liabilities	3,940			1,169
Total liabilities	641,592			608,718
Stockholders equity	59,415			54,967
Total liabilities and Stockholders equity	$ 701,007			$ 663,685
Net interest income		$ 6,165			$ 5,990
Net interest margin			3.75 %			3.80 %
Interest spread			3.64 %			3.67 %

(1) Net accretion or amortization of 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. Assumed income tax rates of 21% were used for the periods presented.

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Net Interest Margin Analysis

Average Balance Sheets

For the Nine Months Ended September 30, 2019 and 2018

(dollars in thousands)

	2019 — Average Balance Sheet	Interest Income/ Expense	Average Rates Earned/ Paid	2018 — Average Balance Sheet	Interest Income/ Expense	Average Rates Earned/ Paid
ASSETS
Loans, including fees (1) (2)	$ 547,833	$ 20,439	4.99 %	$ 516,237	$ 18,231	4.72 %
Loans held for sale	3,471	111	4.28 %	3,096	98	4.23 %
Federal funds sold	19,303	332	2.30 %	19,701	255	1.73 %
Interest bearing bank balances	14,487	253	2.33 %	12,418	151	1.63 %
Securities (3)	57,779	1,026	2.37 %	61,302	1,086	2.37 %
Federal agency equities	1,374	60	5.84 %	1,420	40	3.77 %
CBB equity	116			116
Total earning assets	644,363	22,221	4.61 %	614,290	19,861	4.32 %
Allowance for loan losses	(4,694	)		(4,664	)
Non-earning assets	50,346			41,863
Total assets	$ 690,015			$ 651,489
LIABILITIES AND STOCKHOLDERS EQUITY
Deposits
Demand interest bearing	$ 245,590	$ 917	0.50 %	$ 198,319	$ 537	0.36 %
Savings	93,992	165	0.23 %	103,032	147	0.19 %
Time deposits	190,132	2,500	1.76 %	183,460	1,885	1.37 %
Total interest bearing deposits	529,714	3,582	0.90 %	484,811	2,569	0.71 %
Other borrowed funds
FHLB borrowings				1,136	17	2.00 %
Financing leases	1,547	41	3.54 %
Capital Notes	5,000	150	4.00 %	5,000	150	4.00 %
Total interest-bearing liabilities	536,261	3,773	0.94 %	490,947	2,736	0.75 %
Non-interest bearing deposits	91,858			105,508
Other liabilities	3,546			1,117
Total liabilities	631,655			597,572
Stockholders equity	58,350			53,917
Total liabilities and Stockholders equity	$ 690,015			$ 651,489
Net interest income		$ 18,448			$ 17,125
Net interest margin			3.83 %			3.73 %
Interest spread			3.67 %			3.57 %

(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. Assumed income tax rate of 21% was used for the periods presented.

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ITEM 3. Quantitative and Qualitative Disclosures About Market Risk

Not applicable

ITEM 4. Controls and Procedures

EVALUATION OF DISCLOSURE CONTROLS AND PROCEDURES

Financials management, including Financials principal executive officer and principal financial officer, have evaluated the effectiveness of the Companys disclosure controls and procedures, as such term is defined in Rule 13a-15(e) promulgated under the Securities Exchange Act of 1934, as amended, (the Exchange Act). Based upon their evaluation, the principal executive officer and principal financial officer concluded that, as of the end of the period covered by this report, Financials disclosure controls and procedures were effective for the purpose of ensuring that the information required to be disclosed in the reports that Financial files or submits under the Exchange Act with the Securities and Exchange Commission (the SEC) (1) is recorded, processed, summarized and reported within the time periods specified in the SECs rules and forms, and (2) is accumulated and communicated to the Companys management, including its principal executive and principal financial officers, as appropriate to allow timely decisions regarding required disclosure.

There have been no significant changes during the quarter ended September 30, 2019, in the Companys internal controls over financial reporting (as defined in Rules 13a-15(e) and 15d-15(e) of the Securities Exchange Act of 1934) or in other factors that could have significantly affected those controls subsequent to the date of our most recent evaluation of internal controls over financial reporting.

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PART II OTHER INFORMATION

ITEM 1. Legal Proceedings

The Company is not involved in any pending legal proceedings at this time, other than routine litigation incidental to its business.

Item 1A. Risk Factors

For information regarding the Companys risk factors, see Part I, Item 1A Risk Factors in the Companys Annual Report on Form 10-K for the year ended December 31, 2018, filed with the Securities and Exchange Commission on March 22, 2019. There have been no material changes from risk factors as previously disclosed in Part 1 Item 1A of the Companys Form 10-K for the year ended December 31, 2018.

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

(a) Not applicable.

(b) To date, the Company has made no purchases under the stock repurchase plan adopted on December 19, 2018. Consequently, up to 75,000 shares of common stock may yet be repurchased under this plan.

ITEM 3. Defaults Upon Senior Securities

Not applicable

ITEM 4. Mine Safety Disclosures

Not applicable

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ITEM 5. Other Information

Not applicable

ITEM 6. Exhibits

Exhibit No.	Description of Exhibit
31.1	Certification of Robert R. Chapman III Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002, dated November 8, 2019
31.2	Certification of J. Todd Scruggs Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002, dated November 8, 2019
32.1	Certification Pursuant To 18 U.S.C. Section 1350, As Adopted Pursuant To Section 906 Of The Sarbanes-Oxley Act Of 2002, dated November 8, 2019
101	The following materials from Bank of the James Financial Group, Inc.s Quarterly Report on Form 10-Q for the quarter ended September 30, 2019, formatted in eXtensible Business
Reporting Language (XBRL): (i) Consolidated Balance Sheets (unaudited) as of September 30, 2019 and December 31, 2018; (ii) Consolidated Statements of Income (unaudited) for the three and nine months ended September 30, 2019 and 2018;
(iii) Consolidated Statements of Comprehensive Income (unaudited) for the three and nine months ended September 30, 2019 and 2018 (iv) Consolidated Statements of Cash Flows (unaudited) for the nine months ended September 30, 2019 and 2018
(v) Consolidated Statements of Changes in Stockholders Equity (unaudited) for the three and nine months ended September 30, 2019 and 2018; (vi) Notes to Unaudited Consolidated Financial Statements.

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SIGNATURES

In accordance with the requirements of the Exchange Act, the registrant caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

Date: November 8, 2019	BANK OF THE JAMES FINANCIAL GROUP, INC. — By	/S/ Robert R. Chapman III
		Robert R. Chapman III, President
		(Principal Executive Officer)
Date: November 8, 2019	By	/S/ J. Todd Scruggs
		J. Todd Scruggs, Secretary and Treasurer
		(Principal Financial Officer and Principal Accounting Officer)

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