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BOTJ > SEC Filings for BOTJ > Form 10-K on 19-Mar-2013All Recent SEC Filings

Show all filings for BANK OF THE JAMES FINANCIAL GROUP INC | Request a Trial to NEW EDGAR Online Pro



Annual Report

Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations

Management's Discussion and Analysis of Financial Condition and Results of Operations

The following discussion is intended to assist readers in understanding and evaluating our financial condition and results of operations. You should read this discussion in conjunction with our financial statements and accompanying notes included elsewhere in this report. Because Bank of the James Financial Group, Inc. ("Financial") has no material operations and conducts no business other than the ownership of its operating subsidiary, Bank of the James (and its divisions and subsidiary), the discussion primarily concerns the business of the Bank. However, for ease of reading and because our financial statements are presented on a consolidated basis, references to "we," "us," or "our" refer to Financial, Bank of the James, and their divisions and subsidiaries as appropriate. The comparison of operating results for Financial between the years ended December 31, 2012 and 2011 should be read in the context of both the size and the relatively short operating history of the Bank.

Cautionary Statement Regarding Forward-Looking Statements

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


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

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banking operations in July 1999. In 2001 we began offering mortgage services through the Bank's Mortgage Division. We began providing securities brokerage services to the public in April 2006 through Financial's BOTJ Investment Group, Inc. subsidiary. Following a restructuring, we now provide the securities brokerage services through Investment. Investment conducts its business primarily from one office located in the City of Lynchburg. We began offering insurance and annuity products in September 2008. Insurance currently operates out of the same location as Investment.

Although we intend to increase other sources of revenue, our operating results depend primarily upon the Bank's net interest income, which is determined by the difference between (i) interest and dividend income on earning assets, which consist primarily of loans, investment securities and other investments, and
(ii) interest expense on interest-bearing liabilities, which consist principally of deposits and other borrowings. The Bank's net income also is affected by its provision for loan losses, as well as the level of its noninterest income, including loan fees and service charges, and its noninterest expenses, including salaries and employee benefits, occupancy expense, data processing expenses, miscellaneous other expenses, franchise taxes, and income taxes.

As discussed in more detail below,

For the year ended December 31, 2012, Financial had net income of $2,132,000, an increase of $1,532,000 from net income of $600,000, from the year ended December 31, 2011;

For the year ended December 31, 2012, the income per basic and diluted share was $0.64, as compared income of $0.18 per basic and diluted share for the year ended December 31, 2011;

Net interest income increased to $15,737,000 for the current year from $15,327,000 for the year ended December 31, 2011;

Noninterest income (exclusive of gains and losses on sales of securities) increased to $2,944,000 for the year ended December 31, 2012 from $2,498,000 for the year ended December 31, 2011;

Total assets as of December 31, 2012 were $441,381,000 compared to $427,436,000 at the end of 2011, an increase of $13,945,000 or 3.26%;

Loans (excluding loans held for sale), net of unearned income and loan loss provision, increased to $319,922,000 as of December 31, 2012 from $318,754,000 as of the end of December 31, 2011, an increase of 0.37%; and

The net interest margin increased 14 basis points to 4.03% for 2012, compared to 3.89% for 2011.

The following table sets forth selected financial ratios:

                                                        For the Year Ended
                                                           December 31,
                                                   2012        2011        2010
         Return on average equity                   7.76 %      2.25 %      7.27 %
         Return on average assets                   0.50 %      0.14 %      0.44 %
         Dividend payout %                          0.00 %      0.00 %      0.00 %
         Average equity to total average assets     6.39 %      6.24 %      6.01 %

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Effect of Economic Trends

The year ended December 31, 2012 continued to reflect the turbulent economic conditions and continued weakness in the financial markets which have negatively impacted the liquidity and credit quality of financial institutions in the United States. Although the banking industry began to see some improvements regarding credit quality, concerns regarding credit losses from the weak economy continued to be a concern. Nationally, financial institutions have seen significant declines in the value of collateral for real estate loans and heightened credit losses. These declines have resulted in continued high levels of nonperforming assets, charge-offs and foreclosures.

Although management cannot be certain, it expects difficult economic conditions to persist in 2013. Financial institutions likely will continue to experience some credit losses and levels of nonperforming assets, charge-offs and foreclosures that are higher than historical averages. In light of these conditions, financial institutions also face heightened levels of scrutiny from federal and state regulators. Financial institutions experienced, and are expected to continue to experience, pressure on credit costs, loan yields, deposit and other borrowing costs, liquidity, and capital.

A variety and wide scope of economic factors affect Financial's success and earnings. Although interest rate trends are one of the most important of these factors, Financial believes that interest rates cannot be predicted with a reasonable level of confidence and therefore does not attempt to do so with complicated economic models. Management believes that the best defense against wide swings in interest rate levels is to minimize vulnerability at all potential interest rate levels. Rather than concentrate on any one interest rate scenario, Financial prepares for the opposite as well, in order to safeguard margins against the unexpected.

The downward trend in short term interest rates beginning in the last quarter of 2007 was due to the actions of the Federal Open Market Committee ("FOMC") resulting from a deteriorating economy. The federal funds target rate set by the Federal Reserve has remained at 0.00% to 0.25% since December 2008, following a decline from 4.25% in December 2007 through a series of rate reductions. As liquidity increased as a result of open market operations and other government actions, longer-term interest rates decreased and the yield curve remains positively sloped. Although it cannot be certain, as discussed below under "Results of Operations - Net Interest Income" management believes that short term interest rates will remain stable for the foreseeable future. An increase in long-term interest rates likely would have an adverse impact on the Mortgage Division, primarily due to reduced refinancing opportunities.

Stock Dividends

On May 19, 2010, Financial declared a 10% stock dividend, which was paid on July 23, 2010 to shareholders of record on June 21, 2010. Except as otherwise described in this report, all share amounts and dollar amounts per share in this report with regard to the common stock have been adjusted to reflect these and all prior stock dividends.

Critical Accounting Policies

Financial's 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. The Bank uses historical loss factors as one factor in determining the inherent loss that may be present in the loan portfolio. Actual losses could differ significantly from the historical factors that the Bank uses in estimating risk. In addition, GAAP itself may change from one previously acceptable method to another method. Although the economics of Financial's transactions would be the same, the timing of events that would impact the transactions could change.

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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").

Because Financial has a relatively short operating history, historical trends alone do not provide sufficient information to judge the adequacy of the allowance for loan losses. Therefore, management considers industry trends, peer comparisons, as well as individual classified impaired loans, in addition to historical experience to evaluate the allowance for loan losses. Our method for determining the allowance for loan losses is discussed more fully under "Asset Quality" below.


December 31, 2012 compared to year ended December 31, 2011

Net Income

The net income for Financial for the year ended December 31, 2012 was $2,132,000 or $0.64 per basic and diluted share compared with net income of $600,000 or $0.18 per basic and diluted share for the year ended December 31, 2011. Note 13 of the Audited Financial Statements provides additional information with respect to the calculation of Financial's earnings per share.

The increase of $1,532,000 in 2012 net income compared to 2011 was due in large part the following: i) a significant decrease in provisions for loan losses in 2012 as compared to 2011; ii) a slight increase in net interest income; and iii) a significant decrease in the loss on sale of other real estate owned. The increase was partially offset by a decrease in non-interest income and an increase in non-interest expense. As discussed in more detail below, we charged off $2,599,000 in nonperforming loans during the year ended December 31, 2012 as compared with $4,716,000 in 2011. The amount of the provision to the loan loss reserve was $2,289,000 in the year ended December 31, 2012 as compared to $4,807,000 in 2011.

These operating results represent a return on average shareholders' equity of 7.76% for the year ended December 31, 2012 compared to 2.25% for the year ended December 31, 2011. The return on average assets for the year ended December 31, 2012 was 0.50% compared to 0.14% in 2011.

Net Interest Income

The fundamental source of Financial's earnings, net interest income, is defined as the difference between income on earning assets and the cost of funds supporting those assets. The significant categories of earning assets are loans, federal funds sold, and investment securities, while deposits, fed funds purchased, and other borrowings represent interest-bearing liabilities. The level of net interest income is impacted primarily by variations in the volume and mix of these assets and liabilities, as well as changes in interest rates when compared to previous periods of operation.

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Interest income decreased to $18,753,000 for the year ended December 31, 2012 from $19,519,000 for the year ended December 31, 2011. This decrease was due to a decrease in the yields on average earning assets which primarily consist of loans and investment securities, as discussed below.

Interest expense decreased, as discussed more fully below.

Net interest income for 2012 increased slightly $410,000 to $15,737,000 or 2.68% from net interest income of $15,327,000 in 2011. The growth in net interest income was due in large part to a decrease in our interest expense of $1,176,000 from $4,192,000 for the year ended December 31, 2011 to $3,016,000 for the year ended December 31, 2012. This decrease in interest expense was primarily due to reductions in the interest rate paid on time deposits and savings accounts, specifically savings accounts. The average interest rate paid on time deposits decreased by 36 basis points during 2012 as compared to 2011.

The net interest margin increased to 4.03% in 2012 from 3.89% in 2011. The average rate on earning assets decreased 15 basis points from 4.95% in 2011 to 4.80% in 2012 and the average rate on interest-bearing liabilities decreased from 1.20% in 2011 to 0.88% in 2012. Although management cannot predict with certainty future interest rate decisions by the FOMC, statements from the Federal Reserve Board indicate that interest rates will remain low at least as long as the unemployment rate remains above 6-1/2 percent, inflation (between one and two years ahead) is projected to be no more than half a percentage point above the Committee's 2 percent longer-run goal, and longer-term inflation expectations continue to be well anchored.

The following table shows the average balances of total interest earning assets and total interest bearing liabilities for the periods indicated, showing the average distribution of assets, liabilities, stockholders' equity and related revenue, expense and corresponding weighted average yields and rates. The average balances used in this table and other statistical data were calculated using average daily balances.

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Net Interest Margin Analysis

Average Balance Sheets

For the Year Ended December 31, 2012 and 2011

(dollars in thousands)

                                                       2012                                        2011
                                                                    Average                                     Average
                                       Average       Interest        Rates         Average       Interest        Rates
                                       Balance        Income/       Earned/        Balance        Income/       Earned/
                                        Sheet         Expense        Paid           Sheet         Expense        Paid

Loans, including fees (1) (2)         $ 322,989      $  16,956          5.25 %    $ 324,456      $  17,559          5.42 %
Loans AFS                                 1,109             42          3.79 %          409             13          3.18 %
Federal funds sold                        9,515             25          0.26 %        9,310             23          0.25 %
Securities (3)                           57,353          1,783          3.11 %       58,516          1,872          3.20 %
Federal agency equities                   1,773             60          3.38 %        1,976             52          2.63 %
CBB equity                                  116             -           0.00 %          116             -           0.00 %

Total earning assets                    392,855         18,866          4.80 %      394,374         19,519          4.95 %

Allowance for loan losses                (5,791 )                                    (5,169 )
Non-earning assets                       43,279                                      38,308

Total assets                          $ 430,343                                   $ 427,513


Demand interest bearing               $  81,448      $     235          0.29 %    $  63,666      $     346          0.54 %
Savings                                 150,850            473          0.31 %      175,866          1,329          0.76 %
Time deposits                            92,370          1,539          1.67 %       84,822          1,725          2.03 %

Total interest bearing deposits         324,668          2,247          0.69 %      324,354          3,400          1.05 %

Other borrowed funds
Fed funds purchased                          -              -           0.00 %           10             -           0.00 %
Repurchase agreements                     1,638             15          0.92 %        8,383             75          0.89 %
Other borrowings                          7,036            218          3.10 %       10,000            297          2.97 %
Capital notes                             8,950            537          6.00 %        7,000            420          6.00 %

Total interest-bearing liabilities      342,292          3,017          0.88 %      349,747          4,192          1.20 %

Noninterest bearing deposits             60,134                                      50,784
Other liabilities                           443                                         325

Total liabilities                       402,869                                     400,856

Stockholders' equity                     27,474                                      26,657

Total liabilities and Stockholders'
equity                                $ 430,343                                   $ 427,513

Net interest earnings                                $  15,849                                   $  15,327

Net interest margin                                                     4.03 %                                      3.89 %

Interest spread                                                         3.92 %                                      3.75 %

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(1) Net deferred loan fees and costs are included in interest income.

(2) Nonperforming loans are included in the average balances. However, interest income and yields calculated do not reflect any accrued interest associated with nonaccrual loans.

(3) The interest income and yields calculated on securities have been tax affected to reflect any tax exempt interest on municipal securities.

Interest income and expenses are affected by fluctuations in interest rates, by changes in the volume of earning assets and interest bearing liabilities, and by the interaction of rate and volume factors. The following table shows the direct causes of the year-to-year changes in components of net interest income on a taxable equivalent basis.

                                                                       Volume and Rate
                                                                   (dollars in thousands)
                                                                  Years Ending December 31,
                                                       2012                                      2011
                                                                    Change                                    Change
                                                                      in                                        in
                                        Volume         Rate        Income/        Volume         Rate        Income/
                                        Effect        Effect       Expense        Effect        Effect       Expense
Loans                                   $   (20 )    $   (554 )    $   (574 )    $ (1,180 )    $   (958 )    $ (2,138 )
Federal funds sold                            1             1             2            -             (1 )          (1 )
Securities                                  (37 )         (52 )         (89 )          91           (27 )          64
Restricted stock                             (4 )          12             8           (13 )          18             5

Total earning assets                        (60 )        (593 )        (653 )      (1,101 )        (969 )      (2,070 )

Demand interest bearing                     169          (280 )        (111 )        (566 )         358          (208 )
Savings                                    (166 )        (690 )        (856 )         (67 )      (1,355 )      (1,422 )
Time deposits                               187          (373 )        (186 )          13          (509 )        (496 )
Fed funds purchased                          -             -             -              1            (3 )          (2 )
Capital notes                               117            -            117            -             -             -
FHLB borrowings                             (93 )          14           (79 )         (48 )          21           (27 )
Repurchase agreements                       (63 )           3           (60 )          (9 )         (32 )         (41 )

Total interest-bearing liabilities      $   151      $ (1,326 )    $ (1,175 )    $   (678 )    $ (1,518 )    $ (2,196 )

Change in net interest income           $  (211 )    $    733      $    522      $   (424 )    $    550      $    126

Noninterest Income of Financial

Noninterest income has been and will continue to be an important factor for increasing our profitability. We recognize this and our management continues to review and consider areas where noninterest income can be increased. Noninterest income (excluding securities gains and losses) consists of mortgage loan origination fees, service fees, distributions from a title insurance agency in which we have an

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ownership interest, and fees generated by the investment services of Investment. Service fees consist primarily of monthly service and minimum account balance fees and charges on transactional deposit accounts, overdraft charges, and ATM service fees.

The Bank, through the Mortgage division originates both conforming and non-conforming consumer residential mortgage loans primarily in the Region 2000 area. As part of the Bank's overall risk management strategy, all of the loans originated and closed by the Mortgage division are presold to mortgage banking or other financial institutions. The Mortgage division assumes no credit or interest rate risk on these mortgages.

The Mortgage Division originated 335 mortgage loans, totaling $59,286,000 in 2012 as compared with 290 mortgage loans, totaling $49,481,000 during the year ended December 31, 2011. In 2012, the Mortgage Division faced an improving real estate market and loans for new home purchase comprised 37% of the total volume. Refinancing increased significantly in response to continued historical low interest rates. For the year ended December 31, 2012, the Mortgage Division accounted for 5.62% of Financial's total revenue as compared with 4.49% of Financial's total revenue for the year ended December 31, 2011. Mortgage contributed $270,000 and $159,000 to Financial's pre-tax net income in 2012 and 2011, respectively. Although management anticipates that residential mortgage rates will remain low by historical standards throughout 2013, management also anticipates that if rates trend higher, the loan mix will shift towards new home purchases and away from refinancing. The Mortgage Division continues to improve its market share in Region 2000. Management expects that low rates coupled with the Mortgage Division's reputation in Region 2000 will allow us to continue to grow revenue at the Mortgage Division.

Service charges and fees and commissions increased to $1,230,000 for the year ended December 31, 2012 from $1,149,000 for the year ended December 31, 2011. This increase was due in large part to an increase in debit card fees, which increased $86,000 from $505,000 for the year ended December 31, 2011 to $591,000 for the year ended December 31, 2012. The increase was offset in part by a decrease in commissions earned on the sale of securities to $51,000 for the year ended December 31, 2012 from $69,000 for the year ended December 31, 2011.

Our Investment division provides brokerage services through an agreement with a third-party broker-dealer. Pursuant to this arrangement, the third party . . .

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