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BOTJ > SEC Filings for BOTJ > Form 10-Q on 9-Nov-2012All Recent SEC Filings




Quarterly Report

Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations


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.


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.

The allowance for loan losses is management's estimate of the losses that may be sustained in our loan portfolio. The allowance is based on two basic principles of accounting: (i) ASC 450 "Contingencies", which requires that losses be accrued when they are probable of occurring and are reasonably estimable and
(ii) ASC 310 "Impairment of a Loan", which requires that losses on impaired loans be accrued based on the differences between the value of collateral, present value of future cash flows or values that are observable in the secondary market and the loan balance. Guidelines for determining allowances for loan losses are also provided in the SEC Staff Accounting Bulletin No. 102 - "Selected Loan Loss Allowance Methodology and Documentation Issues" and the Federal Financial Institutions Examination Council's interagency guidance, "Interagency Policy Statement on the Allowance for Loan and Lease Losses" (the "FFIEC Policy Statement"). See "Management Discussion and Analysis Results of Operations - Allowance for Loan Losses and Loan Loss Reserve" below for further discussion of the allowance for loan losses.

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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 Bank's Mortgage division (which we refer to as "Mortgage"), investment services through the Bank's Investment division (which we refer to as "Investment"), and insurance activities through BOTJ Insurance, Inc., a subsidiary of the Bank, (which we refer to as "Insurance").

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 in the Central Virginia, Region 2000 area, which encompasses the seven jurisdictions of the Town of Altavista, Amherst County, Appomattox County, the City of Bedford, Bedford County, Campbell County, and the City of Lynchburg. 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 Bank's market area.

The Bank's 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

Our operating results depend primarily upon the Bank's net interest income, which is determined by the difference between (i) interest and dividend income on earning assets, which consist primarily of loans, investment securities and other investments, and (ii) interest expense on interest-bearing liabilities, which consist principally of deposits and other borrowings. The Bank's net income also is affected by its provision for loan losses, as well as the level of its non-interest income, including loan fees 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 the Region 2000 area, providing additional services to its customers, and controlling costs.

The Bank now services its banking customers through the following nine full service branch locations in the Region 2000 area.

The main office located at 828 Main Street in Lynchburg (opened October 2004) (the "Main Street Office"),

A branch located at 615 Church Street in Lynchburg (opened July 1999) (the "Church Street Branch"),

A branch located at 5204 Fort Avenue in Lynchburg (opened November 2000) (the "Fort Avenue Branch"),

A branch located on South Amherst Highway in Amherst County (opened June 2002) (the "Madison Heights Branch"),

A branch located at 17000 Forest Road in Forest (opened February 2005) (the "Forest Branch"),

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A branch located at 4935 Boonsboro Road, Suites C and D in Lynchburg (opened April 2006) (the "Boonsboro Branch"),

A branch located at 164 South Main Street, Amherst, Virginia (opened January 2007) (the "Amherst Branch"),

A branch located at 1405 Ole Dominion Boulevard in the City of Bedford, Virginia, located off of Independence Boulevard (opened October 2008) (the "Bedford Branch"), and

A branch located at 1110 Main Street, Altavista, Virginia (relocated from temporary branch in June 2009) (the "Altavista Branch").

The Bank also has opened a limited-service branch located in the Westminster-Canterbury facilities located at 501 VES Road, Lynchburg, Virginia 24503.

In addition, the Bank, through its Mortgage division, originates residential mortgage loans through two offices - one located at the Forest Branch and the other located at 1152 Hendricks Store Road, Moneta, Virginia.

The Investment division operates primarily out of its office located at the Church Street Branch.

The Bank continuously evaluates areas located within Region 2000 to identify additional viable branch locations. Based on this ongoing evaluation, the Bank may acquire one or more additional suitable sites.

Subject to regulatory approval, the Bank anticipates opening additional branches during the next two fiscal years. Although numerous factors could influence the Bank's expansion plans, the following discussion provides a general overview of the additional branch location that the Bank currently is considering.

Timberlake Road Area, Campbell County (Lynchburg), Virginia. As previously disclosed, the Bank has purchased certain real property located at the intersection of Turnpike and Timberlake Roads, Campbell County, Virginia. The Bank does not anticipate opening a branch at this location prior to 2013. The Bank has determined that the existing structure is not suitable for use as a bank branch.

Rustburg, Virginia. In March, 2011 the Bank purchased certain real property near the intersection of Routes 501 and 24 in Rustburg, Virginia. The structure on the property is being demolished and removed. The Bank does not anticipate opening a branch at this location prior to the third quarter of 2013. The Bank has installed an ATM in a local municipal building in order to establish a presence in this market until the branch has been established.

The Bank estimates that the cost of improvements, furniture, fixtures, and equipment necessary to upfit the property will be between $900,000 and $1,500,000 per location.

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.

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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 Bank's exposure to credit loss in the event of nonperformance by the other party to the financial instrument for commitments to extend credit and standby letters of credit is represented by the contractual amount of those instruments. The Bank uses the same credit policies in making commitments and conditional obligations as it does for on-balance sheet instruments. A summary of the Bank's commitments is as follows:

                                                  September 30,
                                                 (in  thousands)
                 Commitments to extend credit   $          57,045
                 Letters of Credit                          1,694

                 Total                          $          58,739

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 Bank's credit evaluation of the customer.

Standby letters of credit are conditional commitments issued by the Bank to guarantee the performance of a customer to a third party. Those letters of credit are primarily issued to support public and private borrowing arrangements. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loans to customers. Collateral is required in instances that the Bank deems necessary.


The following discussion represents management's discussion and analysis of the financial condition of Financial as of September 30, 2012 and December 31, 2011 and the results of operations of Financial for the three month and nine month periods ended September 30, 2012 and 2011. 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.

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Financial Condition Summary

September 30, 2012 as Compared to December 31, 2011

Total assets were $426,077,000 on September 30, 2012 compared with $427,436,000 at December 31, 2011, a decrease of 0.32%. The decrease in total assets is due primarily to a decrease in Federal funds sold and a slight decrease in the Bank's securities portfolio, both of which funded a pay-down in Federal Home Loan Bank borrowings.

Total deposits increased from $374,234,000 as of December 31, 2011 to $384,349,000 on September 30, 2012, an increase of 2.70%. This increase occurred because of the Bank's increased efforts to obtain lower cost demand deposits and the Bank's increased presence in the market. In addition, the Dodd-Frank Act repealed the federal prohibition on the payment of interest on commercial demand deposits. As a result, the Bank discontinued offering sweep accounts (repurchase agreements) to its commercial customers and these accounts were reclassified as interest-bearing checking accounts.

Total loans increased to $324,405,000 on September 30, 2012 from $324,366,000 on December 31, 2011. Loans, net of unearned income and allowance, decreased slightly to $318,712,000 on September 30, 2012 from $318,754,000 on December 31, 2011, a decrease of 0.01%. The following summarizes the position of the Bank's loan portfolio as of the dates indicated by dollar amount and percentages (dollar amounts in thousands):

                                 September 30, 2012               December 31, 2011
                               Amount        Percentage        Amount        Percentage
    Commercial               $   56,191            17.33 %    $  59,623            18.39 %
    Commercial Real Estate      152,398            46.98 %      150,622            46.43 %
    Consumer                     71,063            21.91 %       72,488            22.34 %
    Residential                  44,753            13.78 %       41,633            12.84 %

    Total loans              $  324,405           100.00 %    $ 324,366           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 $8,020,000 on September 30, 2012 from $13,628,000 on December 31, 2011. This decrease was primarily due to a decrease in non-accrual (or nonperforming) loans. Non-accrual loans decreased 44.55% to $5,753,000 on September 30, 2012 from $10,375,000 on December 31, 2011. The decrease primarily resulted from the liquidation of real estate collateral associated with several relationships, including one large commercial relationship, and the payment in full of certain non-accrual loans. The proceeds from the liquidations were used to curtail principal on a non-accrual loan. As discussed in more detail below under "Results of Operations - Allowance for Loan Losses", management has provided for the anticipated losses on these loans in the loan loss reserve. If interest on non-accrual loans had been accrued, such interest on a cumulative basis would have approximated $485,000 and $1,233,000, as of September 30, 2012 and December 31, 2011, respectively. 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 credit losses charged against earnings. These loans were included in the non-performing loan totals listed above.

OREO represents real property acquired by the Bank for debts previously contracted, including through foreclosure, deeds in lieu of foreclosure or repossession. On December 31, 2011, the Bank was carrying 18 OREO properties on its books at a value of $3,253,000. During the Nine Months ended September 30, 2012, the Bank acquired 22 additional OREO properties and disposed of 22 OREO

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properties, and as of September 30, 2012 the Bank is carrying 18 OREO properties at a value of $2,267,000. The OREO properties are available for sale and are being actively marketed on the Bank's website and through other means.

The Bank had loans in the amount of $187,000 at September 30, 2012 classified as performing Troubled Debt Restructurings ("TDRs") as compared to $783,000 at December 31, 2011. This decrease was due entirely to the liquidation of collateral associated with one commercial relationship with the proceeds from the liquidation being used to pay off the TDR loans. 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 to $21,018,000 on September 30, 2012 from $23,340,000 on December 31, 2011. Cash and cash equivalents consist of cash due from correspondents, cash in vault, and overnight investments (including federal funds sold). This decrease is in large part due to the Bank's use of cash to repay Federal Home Loan Bank advances. The decrease was offset in part by an increase in deposits. Cash and cash equivalents can vary due to routine fluctuations in deposits, including fluctuations in transactional accounts and professional settlement accounts, both of which are subject to fluctuations.

Securities held-to-maturity decreased to $3,081,000 on September 30, 2012 from $8,133,000 on December 31, 2011. During the nine months ended September 30, 2012, the Bank received $5,000,000 in proceeds from maturities and calls of securities-held-to-maturity. Securities available-for-sale increased to $52,260,000 on September 30, 2012, from $48,338,000 December 31, 2011. During the nine months ended September 30, 2012 the Bank received $16,696,000 in proceeds from maturities and/or calls of securities available-for-sale and $15,585,000 in proceeds from the sale of securities available-for-sale. The Bank purchased $34,930,000 in securities available-for sale during the same period. The increase from December 31, 2011 in securities available-for-sale was primarily due to the investment of funds received from an increase in deposit accounts and the reinvestment of the proceeds from the call of held-to-maturity securities in securities available-for-sale.

Financial's investment in Federal Home Loan Bank of Atlanta (FHLBA) stock totaled $1,092,000 at September 30, 2012 and $1,170,000 at December 31, 2011, a decrease of $78,000. 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, 2012, Financial, on a consolidated basis, had liquid assets of $73,278,000 in the form of cash, interest-bearing and noninterest-bearing deposits with banks, federal funds sold and available-for-sale investments. Management believes that liquid assets were adequate at September 30, 2012. Management anticipates that additional liquidity will be provided by the growth in deposit accounts and loan repayments at the Bank. In addition, the Bank has the ability to purchase federal funds on the open market and borrow from the Federal Reserve Bank's discount window, if necessary.

During the third quarter, Financial closed the private placement of unregistered debt securities (the "2012 Offering") pursuant to which Financial issued $10,000,000 in principal ($373,000 of which was received in the third quarter) of notes (the "2012 Notes"). The 2012 Notes have not been and will not be registered under the Securities Act of 1933 and may not be offered or sold in the United States absent registration or an applicable exemption from registration requirements. The 2012 Notes bear interest at the rate of 6% per year with interest payable quarterly in arrears. The first interest payment of $133,000 was due on July 1, 2012 and paid on or about June 29, 2012. The notes mature on April 1, 2017, but are

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subject to prepayment in whole or in part on or after April 1, 2013 at Financial's sole discretion on 30 days written notice to the holders. Financial used $7,000,000 of the proceeds from the 2012 Offering in April to pay on maturity the principal due on notes issued in 2009.

Management is not aware of any trends, events or uncertainties that are reasonably likely to have a material negative impact on Financial's short-term or long-term liquidity.

At September 30, 2012, the Bank had a leverage ratio of 8.17%, a Tier 1 risk-based capital ratio of 10.97% and a total risk-based capital ratio of 12.23%. As of September 30, 2012 and December 31, 2011 the Bank's regulatory capital levels exceeded those established for well-capitalized institutions. The following table sets forth the minimum capital requirements and the Bank's capital position as of September 30, 2012 and December 31, 2011:

Bank Level Only Capital Ratios

                                           September 30,       December 31,
         Analysis of Capital (in 000's)        2012                2011

         Tier 1 capital
         Common Stock                     $         3,742     $        3,742
         Surplus                                   19,325             19,325
         Retained earnings                         12,097             10,394

         Total Tier 1 capital             $        35,164     $       33,461

         Tier 2 capital
         Allowance for loan losses        $         4,031     $        3,991

         Total Tier 2 capital:            $         4,031     $        3,991

         Total risk-based capital         $        39,195     $       37,452

         Risk weighted assets             $       320,595     $      317,684
         Average total assets             $       430,582     $      427,680

                                                        Actual                             Regulatory Benchmarks
                                                                                     For Capital            For Well
                                           September 30,        December 31,          Adequacy            Capitalized
                                               2012                 2011              Purposes              Purposes
Capital Ratios:
Tier 1 capital to average total assets               8.17 %              7.82 %              4.00 %                5.00 %
Tier 1 risk-based capital ratio                     10.97 %             10.53 %              4.00 %                6.00 %
Total risk-based capital ratio                      12.23 %             11.79 %              8.00 %               10.00 %

The above tables set forth the capital position and analysis for the Bank only. Because total assets on a consolidated basis are less than $500,000,000, Financial is not subject to the consolidated capital requirements imposed by the Bank Holding Company Act. Consequently, Financial does not calculate its financial ratios on a consolidated basis. If calculated, the capital ratios for the Company on a consolidated basis would no longer be comparable to the capital ratios of the Bank because the proceeds from the private placement of the 6% capital notes due on April 1, 2017 do not qualify as equity capital on a consolidated basis.

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Results of Operations

Comparison of the Three and Nine Months Ended September 30, 2012 and 2011

Earnings Summary

Financial had net income including all operating segments of $539,000 and $1,385,000 for the three and nine months ended September 30, 2012 compared to $64,000 and $818,000 for the for the comparable periods in 2011. The basic and diluted earnings per common share for the three and nine months ended September 30, 2012 were $0.16 and $0.41, compared to basic and diluted earnings per share of $0.02 and $0.25 for the three and nine months ended September 30, 2011.

The increase in net income was due in large part to a decreased provision to the allowance for loan loss reserve as discussed in more detail below (See "Allowance for Loan Losses") and a decrease in interest expense. The increase was partially offset by an increase in non-interest expense and a slight decrease in non-interest income.

These operating results represent an annualized return on stockholders' equity of 7.73% and 6.78% for the three and nine months ended September 30, 2012, compared with 0.94% and 4.12% for the same periods in 2011. The Company had an annualized return on average assets for the three and nine months ended September 30, 2012 of 0.49% and 0.43%, compared with 0.06% and 0.26% for three and nine months ended September 30, 2011.

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

Interest Income, Interest Expense, and Net Interest Income

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