10-Q 1 d724222d10q.htm 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 March 31, 2014

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

(Registrant’s 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. x Yes ¨ No

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted 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 and post such files). x Yes ¨ No

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definition of “large accelerated filer,” “accelerated filer,” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer |  | ¨ |  | Accelerated filer |  | ¨
Non-accelerated filer |  | ¨ |  | Smaller reporting company |  | x

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

APPLICABLE ONLY TO CORPORATE ISSUERS

State the number of shares outstanding of each of the issuer’s classes of common equity, as of the latest practicable date: 3,364,874 shares of Common Stock, par value $2.14 per share, were outstanding at May 12, 2014.

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Table of Contents

PART I – FINANCIAL INFORMATION |  |  | 1 |
Item 1. |  | Consolidated Financial Statements |  |  | 1 |
Item 2. |  | Management’s Discussion and Analysis of Financial Condition and Results of Operations |  |  | 29 |
Item 3. |  | Quantitative and Qualitative Disclosures About Market Risk |  |  | 45 |
Item 4. |  | Controls and Procedures |  |  | 45 |
PART II – OTHER INFORMATION |  |  | 45 |
Item 1. |  | Legal Proceedings |  |  | 45 |
Item 1A. |  | Risk Factors |  |  | 46 |
Item 2. |  | Unregistered Sales of Equity Securities and Use of Proceeds |  |  | 46 |
Item 3. |  | Defaults Upon Senior Securities |  |  | 46 |
Item 4. |  | Mine Safety Disclosures |  |  | 46 |
Item 5. |  | Other Information |  |  | 46 |
Item 6. |  | Exhibits |  |  | 47 |
SIGNATURES |  |  | 48 |

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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) (2014 unaudited)

|  | 3/31/2014 |  |  | 12/31/2013 |
Assets |  |  |  |  |  |  |  |
Cash and due from banks |  | $ | 17,853 |  |  | $ | 16,671 |
Federal funds sold |  |  | 62 |  |  |  | — |
Total cash and cash equivalents |  |  | 17,915 |  |  |  | 16,671 |
Securities held-to-maturity (fair value of $2,737 in 2014 and $3,740 in 2013) |  |  | 2,535 |  |  |  | 3,537 |
Securities available-for-sale, at fair value |  |  | 45,336 |  |  |  | 46,091 |
Restricted stock, at cost |  |  | 1,289 |  |  |  | 1,428 |
Loans, net of allowance for loan losses of $5,261 in 2014 and $5,186 in 2013 |  |  | 349,156 |  |  |  | 339,994 |
Loans held for sale |  |  | 1,831 |  |  |  | 1,921 |
Premises and equipment, net |  |  | 8,340 |  |  |  | 8,408 |
Software, net |  |  | 331 |  |  |  | 268 |
Interest receivable |  |  | 1,356 |  |  |  | 1,360 |
Cash value - bank owned life insurance |  |  | 9,301 |  |  |  | 9,230 |
Other real estate owned, net of valuation allowance |  |  | 1,714 |  |  |  | 1,451 |
Income taxes receivable |  |  | 145 |  |  |  | 448 |
Deferred tax asset |  |  | 2,193 |  |  |  | 2,628 |
Other assets |  |  | 1,142 |  |  |  | 1,076 |
Total assets |  | $ | 442,584 |  |  | $ | 434,511 |
Liabilities and Stockholders’ Equity |  |  |  |  |  |  |  |
Deposits |  |  |  |  |  |  |  |
Noninterest bearing demand |  | $ | 71,665 |  |  | $ | 63,256 |
NOW, money market and savings |  |  | 228,305 |  |  |  | 226,709 |
Time |  |  | 98,156 |  |  |  | 97,433 |
Total deposits |  |  | 398,126 |  |  |  | 387,398 |
Federal funds purchased |  |  | — |  |  |  | 4,108 |
FHLB borrowings |  |  | 2,000 |  |  |  | 2,000 |
Capital notes |  |  | 10,000 |  |  |  | 10,000 |
Interest payable |  |  | 67 |  |  |  | 65 |
Other liabilities |  |  | 1,068 |  |  |  | 1,168 |
Total liabilities |  | $ | 411,261 |  |  | $ | 404,739 |
Stockholders’ equity |  |  |  |  |  |  |  |
Common stock $2.14 par value; authorized 10,000,000 shares; issued and outstanding 3,364,874 as of March 31, 2014 and December 31, 2013 |  | $ | 7,201 |  |  | $ | 7,201 |
Preferred stock; authorized 1,000,000 shares; 0 issued and outstanding as of March 31, 2014 and December 31, 2013 |  |  | — |  |  |  | — |
Additional paid-in-capital |  |  | 22,868 |  |  |  | 22,868 |
Accumulated other comprehensive (loss) |  |  | (1,575 | ) |  |  | (2,421 | )
Retained earnings |  |  | 2,829 |  |  |  | 2,124 |
Total stockholders’ equity |  | $ | 31,323 |  |  | $ | 29,772 |
Total liabilities and stockholders’ equity |  | $ | 442,584 |  |  | $ | 434,511 |

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 March 31, |
|  | 2014 |  |  | 2013 |
Interest Income |  |  |  |  |  |  |  |
Loans |  | $ | 4,188 |  |  | $ | 4,163 |
Securities |  |  |  |  |  |  |  |
US Government and agency obligations |  |  | 180 |  |  |  | 190 |
Mortgage backed securities |  |  | 33 |  |  |  | 4 |
Municipals |  |  | 120 |  |  |  | 152 |
Dividends |  |  | 6 |  |  |  | 5 |
Other (Corporates) |  |  | 15 |  |  |  | 16 |
Federal Funds sold |  |  | 3 |  |  |  | 7 |
Total interest income |  |  | 4,545 |  |  |  | 4,537 |
Interest Expense |  |  |  |  |  |  |  |
Deposits |  |  |  |  |  |  |  |
NOW, money market savings |  |  | 118 |  |  |  | 124 |
Time Deposits |  |  | 301 |  |  |  | 323 |
Federal Funds purchased |  |  | 2 |  |  |  | — |
FHLB borrowings |  |  | 19 |  |  |  | 19 |
Reverse repurchase agreements |  |  | 1 |  |  |  | — |
Capital notes |  |  | 150 |  |  |  | 150 |
Total interest expense |  |  | 591 |  |  |  | 616 |
Net interest income |  |  | 3,954 |  |  |  | 3,921 |
Provision for loan losses |  |  | 55 |  |  |  | 235 |
Net interest income after provision for loan losses |  |  | 3,899 |  |  |  | 3,686 |
Other operating income |  |  |  |  |  |  |  |
Mortgage fee income |  |  | 289 |  |  |  | 319 |
Service charges, fees and commissions |  |  | 350 |  |  |  | 303 |
Increase in cash value of life insurance |  |  | 71 |  |  |  | 75 |
Other |  |  | 13 |  |  |  | 8 |
Gain (loss) on sale of available-for-sale securities, net |  |  | (6 | ) |  |  | 259 |
Total other operating income |  |  | 717 |  |  |  | 964 |
Other operating expenses |  |  |  |  |  |  |  |
Salaries and employee benefits |  |  | 1,885 |  |  |  | 1,776 |
Occupancy |  |  | 313 |  |  |  | 305 |
Equipment |  |  | 287 |  |  |  | 261 |
Supplies |  |  | 105 |  |  |  | 90 |
Professional, data processing, and other outside expense |  |  | 613 |  |  |  | 561 |
Marketing |  |  | 97 |  |  |  | 86 |
Credit expense |  |  | 37 |  |  |  | 55 |
Other real estate expenses |  |  | 57 |  |  |  | 79 |
FDIC insurance expense |  |  | 30 |  |  |  | 144 |
Other |  |  | 185 |  |  |  | 174 |
Total other operating expenses |  |  | 3,609 |  |  |  | 3,531 |
Income before income taxes |  |  | 1,007 |  |  |  | 1,119 |
Income tax expense |  |  | 302 |  |  |  | 331 |
Net Income |  | $ | 705 |  |  | $ | 788 |
Weighted average shares outstanding - basic |  |  | 3,364,874 |  |  |  | 3,352,725 |
Weighted average shares outstanding - diluted |  |  | 3,364,874 |  |  |  | 3,352,855 |
Income per common share - basic |  | $ | 0.21 |  |  | $ | 0.24 |
Income per common share - diluted |  | $ | 0.21 |  |  | $ | 0.24 |

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

Three months ended March 31, 2014 and 2013

(dollar amounts in thousands) (unaudited)

|  | For the Three Months Ended March 31, |
|  | 2014 |  |  | 2013 |
Net Income |  | $ | 705 |  |  | $ | 788 |
Other comprehensive income (loss): |  |  |  |  |  |  |  |
Unrealized gains (losses) on securities available-for-sale net of deferred taxes of $431 and $(132) |  |  | 842 |  |  |  | (258 | )
Reclassification adjustment for (gains) losses included in net income (1), net of taxes of $(2) and $88 (2) |  |  | 4 |  |  |  | (171 | )
Other comprehensive income (loss), net of tax |  |  | 846 |  |  |  | (429 | )
Comprehensive income |  | $ | 1,551 |  |  | $ | 359 |

(1) | Gains are included in net “gain on sale of available-for-sale securities” on the consolidated statements of income.

(2) | The tax effect on these reclassifications is reflected in “income tax expense” on the consolidated statements of income.

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

Three Months ended March 31, 2014 and 2013

(dollar amounts in thousands) (unaudited)

|  | Three Months Ended March 31, |
|  | 2014 |  |  | 2013 |
Cash flows from operating activities |  |  |  |  |  |  |  |
Net Income |  | $ | 705 |  |  | $ | 788 |
Adjustments to reconcile net income to net cash provided by operating activities: |  |  |  |  |  |  |  |
Depreciation |  |  | 193 |  |  |  | 179 |
Net amortization and accretion of premiums and discounts on securities |  |  | 84 |  |  |  | 96 |
(Gain) loss on sale of available for sale securities |  |  | 6 |  |  |  | (259 | )
Provision for loan losses |  |  | 55 |  |  |  | 235 |
(Gain) loss on sale of other real estate owned |  |  | (3 | ) |  |  | 21 |
Impairment of other real estate owned |  |  | 46 |  |  |  | 25 |
Decrease in loans held-for-sale |  |  | 90 |  |  |  | 100 |
(Increase) in cash value of life insurance |  |  | (71 | ) |  |  | (75 | )
Decrease in interest receivable |  |  | 4 |  |  |  | 182 |
(Increase) decrease in other assets |  |  | (64 | ) |  |  | 104 |
Decrease in income taxes receivable |  |  | 303 |  |  |  | 333 |
(Decrease) in interest payable |  |  | 2 |  |  |  | 3 |
(Decrease) increase in other liabilities |  |  | (100 | ) |  |  | 164 |
Net cash provided by operating activities |  | $ | 1,250 |  |  | $ | 1,896 |
Cash flows from investing activities |  |  |  |  |  |  |  |
Proceeds from maturities and calls of securities held to maturity |  | $ | 1,000 |  |  | $ | — |
Purchases of securities available for sale |  |  | — |  |  |  | (7,972 | )
Proceeds from maturities, calls and paydowns of securities available for sale |  |  | 60 |  |  |  | 2,041 |
Proceeds from sale of securities available for sale |  |  | 1,886 |  |  |  | 10,043 |
Redemption of Federal Home Loan Bank stock |  |  | 139 |  |  |  | 110 |
Proceeds from sale of other real estate owned |  |  | — |  |  |  | 159 |
Origination of loans, net of principal collected |  |  | (9,523 | ) |  |  | (6,234 | )
Purchases of premises and equipment |  |  | (188 | ) |  |  | (28 | )
Net cash (used in) provided by investing activities |  | $ | (6,626 | ) |  | $ | (1,881 | )
Cash flows from financing activities |  |  |  |  |  |  |  |
Net increase (decrease) in deposits |  | $ | 10,728 |  |  | $ | (13,821 | )
Net (decrease) in federal funds purchased |  |  | (4,108 | ) |  |  | — |
Net cash provided by (used in) financing activities |  | $ | 6,620 |  |  | $ | (13,821 | )
Increase (decrease) in cash and cash equivalents |  |  | 1,244 |  |  |  | (13,806 | )
Cash and cash equivalents at beginning of period |  | $ | 16,671 |  |  | $ | 40,998 |
Cash and cash equivalents at end of period |  | $ | 17,915 |  |  | $ | 27,192 |
Non cash transactions |  |  |  |  |  |  |  |
Transfer of loans to foreclosed assets |  | $ | 384 |  |  | $ | 411 |
Portion of foreclosed assets financed |  |  | 78 |  |  |  | — |
Fair value adjustment for securities |  |  | 1,279 |  |  |  | (649 | )
Cash transactions |  |  |  |  |  |  |  |
Cash paid for interest |  | $ | 589 |  |  | $ | 613 |
Cash paid for taxes |  |  | — |  |  |  | — |

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

(dollars in thousands) (unaudited)

|  | Total Shares Outstanding |  |  | Common Stock |  |  | Additional Paid-in Capital |  |  | Retained Earnings (Deficit) |  |  | Accumulated Other Comprehensive Income (Loss) |  |  | Total |
Balance at December 31, 2012 |  |  | 3,352,725 |  |  | $ | 7,175 |  |  | $ | 22,806 |  |  | $ | (936 | ) |  | $ | 568 |  |  | $ | 29,613 |
Net Income |  |  | — |  |  |  | — |  |  |  | — |  |  |  | 788 |  |  |  | — |  |  |  | 788 |
Other Comprehensive Loss |  |  | — |  |  |  | — |  |  |  | — |  |  |  | — |  |  |  | (429 | ) |  |  | (429 | )
Balance at March 31, 2013 |  |  | 3,352,725 |  |  | $ | 7,175 |  |  | $ | 22,806 |  |  | $ | (148 | ) |  | $ | 139 |  |  | $ | 29,972 |
Balance at December 31, 2013 |  |  | 3,364,874 |  |  | $ | 7,201 |  |  | $ | 22,868 |  |  | $ | 2,124 |  |  | $ | (2,421 | ) |  | $ | 29,772 |
Net Income |  |  | — |  |  |  | — |  |  |  | — |  |  |  | 705 |  |  |  | — |  |  |  | 705 |
Other Comprehensive Income |  |  | — |  |  |  | — |  |  |  | — |  |  |  | — |  |  |  | 846 |  |  |  | 846 |
Balance at March 31, 2014 |  |  | 3,364,874 |  |  | $ | 7,201 |  |  | $ | 22,868 |  |  | $ | 2,829 |  |  | $ | (1,575 | ) |  | $ | 31,323 |

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 management’s 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 and for the three months ended March 31, 2014 and 2013 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 Financial’s Annual Report on Form 10-K for the year ended December 31, 2013. These financial statements should be read in conjunction with the audited consolidated financial statements and footnotes for the year ended December 31, 2013 included in Financial’s Annual Report on Form 10-K. Results for the three month period ended March 31, 2014 are not necessarily indicative of the results that may be expected for the year ending December 31, 2014.

The Company’s 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.

Financial’s critical accounting policy relates to the evaluation of the allowance for loan losses which is based on management’s opinion of an amount that is adequate to absorb loss in the existing loan portfolio of Bank of the James (the “Bank”), Financial’s wholly-owned subsidiary. 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 (to the extent available due to limited history), 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 Bank’s allowance for loan losses could result in material changes in Financial’s financial condition and results of operations. The Bank’s policies with respect to the methodology for determining the allowance for loan losses involve a higher degree of complexity and require management to make subjective judgments that often require assumptions or estimates about uncertain matters. These critical policies and their assumptions are periodically reviewed with the Board of Directors.

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.

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Note 3 – Earnings Per Share

Currently, only the option shares granted to certain officers and other employees of Financial pursuant to the Amended and Restated Stock Option Plan of 1999 Financial (the “1999 Plan”) are considered in calculating dilutive earnings per share. The following is a summary of the earnings per share calculation for the three months ended March 31, 2014 and 2013.

|  | Three months ended |
|  | March 31, |
|  | 2014 |  |  | 2013 |
Net income |  | $ | 705,000 |  |  | $ | 788,000 |
Weight average number of shares |  |  | 3,364,874 |  |  |  | 3,352,725 |
Options affect of incremental shares |  |  | — |  |  |  | 130 |
Weighted average diluted shares |  |  | 3,364,874 |  |  |  | 3,352,855 |
Basic EPS (weighted avg shares) |  | $ | 0.21 |  |  | $ | 0.24 |
Diluted EPS (Including Option Shares) |  | $ | 0.21 |  |  | $ | 0.24 |

The following table sets forth the incremental shares associated with option shares that were not included in calculating the diluted earnings because their effect was anti-dilutive:

|  | Three months ended March 31, |
|  | 2014 |  |  | 2013 |
Incremental shares excluded from calculating diluted EPS because their effect was anti-dilutive |  |  | 111,371 |  |  |  | 169,600 |

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)

Stock option plan activity for the three months ended March 31, 2014 is summarized below:

|  | Shares |  |  | Weighted Average Exercise Price |  |  | Weighted Average Remaining Contractual Life (in years) |  |  | Average Intrinsic Value |
Options outstanding, January 1, 2014 |  |  | 111,371 |  |  | $ | 10.73 |  |  |  |  |  |  |  |  |
Granted |  |  | — |  |  |  | — |  |  |  |  |  |  |  |  |
Exercised |  |  | — |  |  |  | — |  |  |  |  |  |  |  |  |
Forfeited |  |  | — |  |  |  | — |  |  |  |  |  |  |  |  |
Options outstanding, March 31, 2014 |  |  | 111,371 |  |  |  | 10.73 |  |  |  | 1.3 |  |  | $ | — |
Options exercisable, March 31, 2014 |  |  | 111,371 |  |  | $ | 10.73 |  |  |  | 1.3 |  |  | $ | — |

Intrinsic value is calculated by subtracting the exercise price of option shares from the market price of underlying shares as of March 31, 2014 and multiplying that amount by the number of options outstanding. No intrinsic value exists where the exercise price is greater than the market price on a given date.

All compensation expense related to the foregoing stock option plan has been recognized. The Company’s ability to grant additional options shares under the 1999 Plan has expired.

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 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 Company’s 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 an orderly transaction (that is, not a forced 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.

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Note 5 – Fair Value Measurements (continued)

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.

Following is a description of the valuation methodologies used for instruments measured at fair value, as well as the general classification of such instruments pursuant to the valuation hierarchy:

Securities

Where quoted prices are available in an active market, 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 Company’s securities are considered to be Level 2 securities.

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Note 5 – Fair Value Measurements (continued)

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

|  |  |  |  | Carrying Value at March 31, 2014 |
Description |  | Balance as of March 31, 2014 |  |  | Quoted Prices in Active Markets for Identical Assets (Level 1) |  |  | Significant Other Observable Inputs (Level 2) |  |  | Significant Unobservable Inputs (Level 3) |
US Treasuries |  | $ | 3,699 |  |  | $ | — |  |  | $ | 3,699 |  |  | $ | — |
US agency obligations |  |  | 19,447 |  |  |  | — |  |  |  | 19,447 |  |  |  | — |
Mortgage-backed securities |  |  | 4,829 |  |  |  | — |  |  |  | 4,829 |  |  |  | — |
Municipals |  |  | 15,392 |  |  |  | — |  |  |  | 15,392 |  |  |  | — |
Other (corporates) |  |  | 1,969 |  |  |  | — |  |  |  | 1,969 |  |  |  | — |
Total available-for-sale securities |  | $ | 45,336 |  |  | $ | — |  |  | $ | 45,336 |  |  | $ | — |
|  |  |  |  | Carrying Value at December 31, 2013 |
Description |  | Balance as of December 31, 2013 |  |  | Quoted Prices in Active Markets for Identical Assets (Level 1) |  |  | Significant Other Observable Inputs (Level 2) |  |  | Significant Unobservable Inputs (Level 3) |
US Treasuries |  | $ | 3,611 |  |  | $ | — |  |  | $ | 3,611 |  |  | $ | — |
US agency obligations |  |  | 20,108 |  |  |  | — |  |  |  | 20,108 |  |  |  | — |
Mortgage-backed securities |  |  | 5,311 |  |  |  | — |  |  |  | 5,311 |  |  |  | — |
Municipals |  |  | 15,138 |  |  |  | — |  |  |  | 15,138 |  |  |  | — |
Other (corporates) |  |  | 1,923 |  |  |  | — |  |  |  | 1,923 |  |  |  | — |
Total available-for-sale securities |  | $ | 46,091 |  |  | $ | — |  |  | $ | 46,091 |  |  | $ | — |

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. 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, if the collateral is a house or building in the process of construction or if an appraisal of the real estate property is over one year old, then the fair 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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##### Table of Contents

Note 5 – Fair Value Measurements (continued)

Loans held for sale

Loans held for sale are carried at 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 March 31, 2014. Gains and losses on the sale of loans are recorded within mortgage fee income 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 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.

Any fair value adjustments are recorded in the period incurred and expensed against current earnings. The carrying values of all OREO properties are considered to be Level 3.

The following table summarizes the Company’s impaired loans, loans held for sale, and OREO measured at fair value on a nonrecurring basis during the period (in thousands).

|  |  |  |  | Carrying Value at March 31, 2014 |
Description |  | Balance as of March 31, 2014 |  |  | Quoted Prices in Active Markets for Identical Assets (Level 1) |  |  | Significant Other Observable Inputs (Level 2) |  |  | Significant Unobservable Inputs (Level 3) |
Impaired loans* |  | $ | 4,397 |  |  | $ | — |  |  | $ | — |  |  | $ | 4,397 |
Loans held for sale |  |  | 1,831 |  |  |  | — |  |  |  | 1,831 |  |  |  | — |
Other real estate owned |  |  | 1,714 |  |  |  | — |  |  |  | — |  |  |  | 1,714 |

* | Includes loans charged down during the quarter to the net realizable value of the collateral.

|  |  |  |  | Carrying Value at December 31, 2013 |
Description |  | Balance as of December 31, 2013 |  |  | Quoted Prices in Active Markets for Identical Assets (Level 1) |  |  | Significant Other Observable Inputs (Level 2) |  |  | Significant Unobservable Inputs (Level 3) |
Impaired loans* |  | $ | 4,307 |  |  | $ | — |  |  | $ | — |  |  | $ | 4,307 |
Loans held for sale |  |  | 1,921 |  |  |  | — |  |  |  | 1,921 |  |  |  | — |
Other real estate owned |  |  | 1,451 |  |  |  | — |  |  |  | — |  |  |  | 1,451 |

* | Includes loans charged down during the quarter to the net realizable value of the collateral.

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##### Table of Contents

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 March 31, 2014 (dollars in thousands)
|  | Fair Value |  |  | Valuation Technique(s) |  | Unobservable Input |  | Range (Weighted Average)
Assets |  |  |  |  |  |  |  |  |  |
Impaired loans |  | $ | 4,397 |  |  | Discounted appraised value |  | Selling cost |  | 5% - 10% (6%)
|  |  |  |  |  |  |  | Discount for lack of marketability and age of appraisal |  | 0% - 25% (15%)
OREO |  |  | 1,714 |  |  | Discounted appraised value |  | Selling cost |  | 5% - 10% (6%)
|  |  |  |  |  |  |  | Discount for lack of marketability and age of appraisal |  | 0% - 25% (15%)

Financial Instruments

Cash, cash equivalents and Federal Funds sold

The carrying amounts of cash and short-term instruments approximate fair values.

Loans

For variable-rate loans that reprice frequently and with no significant change in credit risk, fair values are based on carrying values. Fair values for certain fixed rate loans are based on quoted market prices of similar loans adjusted for differences in loan characteristics. Fair values for other loans such as commercial real estate and commercial and industrial loans are estimated using discounted cash flow analyses, using interest rates currently being offered for loans with similar terms to borrowers of similar credit quality. Fair values of impaired loans are estimated as described above. The carrying values of all loans are considered to be Level 3.

Bank Owned Life Insurance (BOLI)

The carrying amount approximates fair value. The carrying values of all BOLI is considered to be Level 2.

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##### Table of Contents

Note 5 – Fair Value Measurements (continued)

Deposits

Fair values disclosed for demand deposits (e.g., interest and noninterest checking, savings, and money market accounts) are, by definition, equal to the amount payable on demand at the reporting date (i.e., their carrying amounts). Fair values for fixed rate certificates of deposit are estimated using discounted cash flow analyses that applies interest rates currently being offered on certificates to a schedule of aggregated expected monthly maturities on time deposits. The carrying values of all deposits are considered to be Level 2.

FHLB borrowings

The fair value of FHLB borrowings is estimated using discounted cash flow analysis based on the rates currently offered for borrowings of similar remaining maturities and collateral requirements. The carrying values of all FHLB borrowings are considered to be Level 2.

Short-term borrowings

The carrying amounts of federal funds purchased, borrowings under repurchase agreements, and other short-term borrowings maturing within ninety days approximate fair value. The carrying values of all short term borrowings are considered to be Level 2.

Capital notes

Fair values of capital notes are based on market prices for debt securities having similar maturity and interest rate characteristics. The carrying values of all capital notes are considered to be Level 2.

Accrued interest

The carrying amounts of accrued interest approximate fair value. The carrying values of all accrued interest is considered to be Level 2.

Off-balance sheet credit-related instruments

Fair values for off-balance sheet, credit-related financial instruments are based on fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the counterparties’ credit standing. Fair value of off-balance sheet credit-related instruments were deemed to be immaterial at March 31, 2014 and December 31, 2013 and therefore are not included in the table below.

13

##### Table of Contents

Note 5 – Fair Value Measurements (continued)

The estimated fair values, and related carrying or notional amounts, of Financial’s financial instruments are as follows (in thousands):

|  |  | Fair Value Measurements at March 31, 2014 using |
|  | Carrying Amounts |  |  | Quoted Prices in Active Markets for Identical Assets (Level 1) |  |  | Significant Other Observable Inputs (Level 2) |  |  | Significant Unobservable Inputs (Level 3) |  |  | Balance |
Assets |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Cash and due from banks |  | $ | 17,853 |  |  | $ | 17,853 |  |  | $ | — |  |  | $ | — |  |  | $ | 17,853 |
Federal funds sold |  |  | 62 |  |  |  | 62 |  |  |  | — |  |  |  | — |  |  |  | 62 |
Securities |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Available-for-sale |  |  | 45,336 |  |  |  | — |  |  |  | 45,336 |  |  |  | — |  |  |  | 45,336 |
Held-to-maturity |  |  | 2,535 |  |  |  | — |  |  |  | 2,737 |  |  |  | — |  |  |  | 2,737 |
Loans, net |  |  | 349,156 |  |  |  | — |  |  |  | — |  |  |  | 353,625 |  |  |  | 353,625 |
Loans held for sale |  |  | 1,831 |  |  |  | — |  |  |  | 1,831 |  |  |  | — |  |  |  | 1,831 |
Interest receivable |  |  | 1,356 |  |  |  | — |  |  |  | 1,356 |  |  |  | — |  |  |  | 1,356 |
BOLI |  |  | 9,301 |  |  |  | — |  |  |  | 9,301 |  |  |  | — |  |  |  | 9,301 |
Liabilities |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Deposits |  | $ | 398,126 |  |  | $ | — |  |  | $ | 399,206 |  |  | $ | — |  |  | $ | 399,206 |
FHLB borrowings |  |  | 2,000 |  |  |  | — |  |  |  | 2,011 |  |  |  | — |  |  |  | 2,011 |
Capital notes |  |  | 10,000 |  |  |  | — |  |  |  | 10,057 |  |  |  | — |  |  |  | 10,057 |
Interest payable |  |  | 67 |  |  |  | — |  |  |  | 67 |  |  |  | — |  |  |  | 67 |

|  |  |  |  | Fair Value Measurements at December 31, 2013 using |
|  | Carrying Amounts |  |  | Quoted Prices in Active Markets for Identical Assets (Level 1) |  |  | Significant Other Observable Inputs (Level 2) |  |  | Significant Unobservable Inputs (Level 3) |  |  | Balance |
Assets |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Cash and due from banks |  | $ | 16,671 |  |  | $ | 16,671 |  |  | $ | — |  |  | $ | — |  |  | $ | 16,671 |
Securities |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Available-for-sale |  |  | 46,091 |  |  |  | — |  |  |  | 46,091 |  |  |  | — |  |  |  | 46,091 |
Held-to-maturity |  |  | 3,537 |  |  |  | — |  |  |  | 3,740 |  |  |  | — |  |  |  | 3,740 |
Loans, net |  |  | 339,994 |  |  |  | — |  |  |  | — |  |  |  | 346,658 |  |  |  | 346,658 |
Loans held for sale |  |  | 1,921 |  |  |  | — |  |  |  | 1,921 |  |  |  | — |  |  |  | 1,921 |
Interest receivable |  |  | 1,360 |  |  |  | — |  |  |  | 1,360 |  |  |  | — |  |  |  | 1,360 |
BOLI |  |  | 9,230 |  |  |  | — |  |  |  | 9,230 |  |  |  | — |  |  |  | 9,230 |
Liabilities |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Deposits |  | $ | 387,398 |  |  | $ | — |  |  | $ | 388,363 |  |  | $ | — |  |  | $ | 388,363 |
FHLB borrowings |  |  | 2,000 |  |  |  | — |  |  |  | 2,018 |  |  |  | — |  |  |  | 2,018 |
Federal funds purchased |  |  | 4,108 |  |  |  | 4,108 |  |  |  | — |  |  |  | — |  |  |  | 4,108 |
Capital notes |  |  | 10,000 |  |  |  | — |  |  |  | 10,091 |  |  |  | — |  |  |  | 10,091 |
Interest payable |  |  | 65 |  |  |  | — |  |  |  | 65 |  |  |  | — |  |  |  | 65 |

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##### Table of Contents

Note 5 – Fair Value Measurements (continued)

Fair value estimates are made at a specific point in time, based on relevant market information and information about the financial instrument. These estimates do not reflect any premium or discount that could result from offering for sale at one time Financial’s entire holdings of a particular financial instrument. Because no market exists for a significant portion of Financial’s financial instruments, fair value estimates are based on judgments regarding future expected loss experience, current economic conditions, risk characteristics of various financial instruments and other factors. These estimates are subjective in nature and involve uncertainties and matters of significant judgment, and therefore, cannot be determined with precision. Changes in assumptions could significantly affect the estimates.

Fair value estimates are based on existing on-balance-sheet and off-balance-sheet financial instruments without attempting to estimate the value of anticipated future business and the value of assets and liabilities that are not considered financial instruments. Significant assets that are not considered financial assets include deferred income taxes and bank premises and equipment; a significant liability that is not considered a financial liability is accrued post-retirement benefits. In addition, the tax ramifications related to the realization of the unrealized gains and losses can have a significant effect on fair value estimates and have not been considered in the estimates.

Financial assumes interest rate risk (the risk that general interest rate levels will change) as a result of its normal operations. As a result, the fair values of Financial’s financial instruments will change when interest rate levels change, and that change may be either favorable or unfavorable to Financial. Management attempts to match maturities of assets and liabilities to the extent believed necessary to minimize interest rate risk. However, borrowers with fixed rate obligations are less likely to prepay in a rising rate environment and more likely to prepay in a falling rate environment. Conversely, depositors who are receiving fixed rates are more likely to withdraw funds before maturity in a rising rate environment and less likely to do so in a falling rate environment.

Management monitors rates and maturities of assets and liabilities and attempts to minimize interest rate risk by adjusting terms of new loans and deposits and by investing in securities with terms that mitigate Financial’s overall interest rate risk.

Note 6 – Capital Notes

During the third quarter of 2012, Financial closed the private placement of unregistered debt securities (the “2012 Offering”) pursuant to which Financial issued $10,000,000 in principal 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 notes mature on April 1, 2017, but are 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 2012 to pay, on maturity, the principal due on notes issued in 2009.

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##### Table of Contents

Note 7 – Investments

The following tables summarize the Bank’s holdings for both securities held-to-maturity and securities available-for-sale as of March 31, 2014 and December 31, 2013 (amounts in thousands):

|  | March 31, 2014 |
|  |  |  |  | Gross Unrealized |  |  |  |
|  | Amortized Costs |  |  | Gains |  |  | (Losses) |  |  | Fair Value |
Held-to-Maturity |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
US agency obligations |  | $ | 2,535 |  |  | $ | 202 |  |  | $ | — |  |  | $ | 2,737 |
Available-for-Sale |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
US Treasuries |  | $ | 3,909 |  |  | $ | — |  |  | $ | (210 | ) |  | $ | 3,699 |
US agency obligations |  |  | 21,093 |  |  |  | 7 |  |  |  | (1,653 | ) |  |  | 19,447 |
Mortgage-backed securities |  |  | 4,928 |  |  |  | 44 |  |  |  | (143 | ) |  |  | 4,829 |
Municipals |  |  | 15,782 |  |  |  | 81 |  |  |  | (471 | ) |  |  | 15,392 |
Other (corporates) |  |  | 2,011 |  |  |  | — |  |  |  | (42 | ) |  |  | 1,969 |
|  | $ | 47,723 |  |  | $ | 132 |  |  | $ | (2,519 | ) |  | $ | 45,336 |
|  | December 31, 2013 |
|  |  |  |  | Gross Unrealized |  |  |  |
|  | Amortized Costs |  |  | Gains |  |  | (Losses) |  |  | Fair Value |
Held-to-Maturity |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
US agency obligations |  | $ | 3,537 |  |  | $ | 203 |  |  | $ | — |  |  | $ | 3,740 |
Available-for-Sale |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
US Treasuries |  | $ | 3,907 |  |  | $ | — |  |  | $ | (296 | ) |  | $ | 3,611 |
US agency obligations |  |  | 22,544 |  |  |  | — |  |  |  | (2,436 | ) |  |  | 20,108 |
Mortgage-backed securities |  |  | 5,450 |  |  |  | 11 |  |  |  | (150 | ) |  |  | 5,311 |
Municipals |  |  | 15,845 |  |  |  | 35 |  |  |  | (742 | ) |  |  | 15,138 |
Other (corporates) |  |  | 2,011 |  |  |  | — |  |  |  | (88 | ) |  |  | 1,923 |
|  | $ | 49,757 |  |  | $ | 46 |  |  | $ | (3,712 | ) |  | $ | 46,091 |

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##### Table of Contents

Note 7 – Investments (continued)

The following tables show the gross unrealized losses and fair value of the Bank’s 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 March 31, 2014 and December 31, 2013 (amounts in thousands):

|  | Less than 12 months |  |  | More than 12 months |  |  | Total |
|  | Fair |  |  | Unrealized |  |  | Fair |  |  | Unrealized |  |  | Fair |  |  | Unrealized |
March 31, 2014 |  | Value |  |  | Losses |  |  | Value |  |  | Losses |  |  | Value |  |  | Losses |
Description of securities |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
US Treasuries |  | $ | 3,699 |  |  | $ | 210 |  |  | $ | — |  |  | $ | — |  |  | $ | 3,699 |  |  | $ | 210 |
U.S. agency obligations |  |  | 10,141 |  |  |  | 752 |  |  |  | 7,081 |  |  |  | 901 |  |  |  | 17,222 |  |  |  | 1,653 |
Mortgage-backed securities |  |  | 1,903 |  |  |  | 143 |  |  |  | — |  |  |  | — |  |  |  | 1,903 |  |  |  | 143 |
Municipals |  |  | 5,059 |  |  |  | 211 |  |  |  | 6,170 |  |  |  | 260 |  |  |  | 11,229 |  |  |  | 471 |
Other (corporates) |  |  | 491 |  |  |  | 2 |  |  |  | 1,478 |  |  |  | 40 |  |  |  | 1,969 |  |  |  | 42 |
Total |  | $ | 21,293 |  |  | $ | 1,318 |  |  | $ | 14,729 |  |  | $ | 1,201 |  |  | $ | 36,022 |  |  | $ | 2,519 |
|  | Less than 12 months |  |  | More than 12 months |  |  | Total |
|  | Fair |  |  | Unrealized |  |  | Fair |  |  | Unrealized |  |  | Fair |  |  | Unrealized |
December 31, 2013 |  | Value |  |  | Losses |  |  | Value |  |  | Losses |  |  | Value |  |  | Losses |
Description of securities |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
US Treasuries |  | $ | 3,611 |  |  | $ | 296 |  |  | $ | — |  |  | $ | — |  |  | $ | 3,611 |  |  | $ | 296 |
U.S. agency obligations |  |  | 14,087 |  |  |  | 1,473 |  |  |  | 5,021 |  |  |  | 963 |  |  |  | 19,108 |  |  |  | 2,436 |
Mortgage-backed securities |  |  | 4,830 |  |  |  | 150 |  |  |  | — |  |  |  | — |  |  |  | 4,830 |  |  |  | 150 |
Municipals |  |  | 11,163 |  |  |  | 574 |  |  |  | 1,479 |  |  |  | 168 |  |  |  | 12,642 |  |  |  | 742 |
Other (corporates) |  |  | 1,923 |  |  |  | 88 |  |  |  | — |  |  |  |  |  |  |  | 1,923 |  |  |  | 88 |
Total |  | $ | 35,614 |  |  | $ | 2,581 |  |  | $ | 6,500 |  |  | $ | 1,131 |  |  | $ | 42,114 |  |  | $ | 3,712 |

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 security’s entire amortized cost basis (even if Financial does not intend to sell the security).

At March 31, 2014, the Company did not consider the unrealized losses as other-than-temporary losses due to the nature of the securities involved. As of March 31, 2014, the Bank owned 41 securities that were being evaluated for other than temporary impairment. Eleven of these securities were S&P rated AAA, 29 were S&P rated AA, and one was S&P rated A. As of March 31, 2014, 15 of these securities were direct obligations of the U.S. government or government sponsored entities, 23 were municipal issues, and three were investments in domestic corporate issued securities.

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##### Table of Contents

Note 7 – Investments (continued)

Based on the analysis performed by management as mandated by the Bank’s investment policy, management believes the default risk to be minimal. Because the Bank expects to recover the entire amortized cost basis, no declines currently are deemed to be other-than-temporary.

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 Company’s reportable segments are service based. The mortgage business is a fee-based business while the Bank’s 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.

Information about reportable business segments and reconciliation of such information to the consolidated financial statements for the three months ended March 31, 2014 and 2013 was as follows (dollars in thousands):

Business Segments

|  | Community Banking |  |  | Mortgage |  |  | Total |
Three months ended March 31, 2014 |  |  |  |  |  |  |  |  |  |  |  |
Net interest income |  | $ | 3,954 |  |  | $ | — |  |  | $ | 3,954 |
Provision for loan losses |  |  | 55 |  |  |  | — |  |  |  | 55 |
Net interest income after provision for loan losses |  |  | 3,899 |  |  |  | — |  |  |  | 3,899 |
Noninterest income |  |  | 428 |  |  |  | 289 |  |  |  | 717 |
Noninterest expenses |  |  | 3,350 |  |  |  | 259 |  |  |  | 3,609 |
Income before income taxes |  |  | 977 |  |  |  | 30 |  |  |  | 1,007 |
Income tax expense |  |  | 292 |  |  |  | 10 |  |  |  | 302 |
Net income |  | $ | 685 |  |  | $ | 20 |  |  | $ | 705 |
Total assets |  | $ | 440,610 |  |  | $ | 1,974 |  |  | $ | 442,584 |
Three months ended March 31, 2013 |  |  |  |  |  |  |  |  |  |  |  |
Net interest income |  | $ | 3,921 |  |  | $ | — |  |  | $ | 3,921 |
Provision for loan losses |  |  | 235 |  |  |  | — |  |  |  | 235 |
Net interest income after provision for loan losses |  |  | 3,686 |  |  |  | — |  |  |  | 3,686 |
Noninterest income |  |  | 645 |  |  |  | 319 |  |  |  | 964 |
Noninterest expenses |  |  | 3,278 |  |  |  | 253 |  |  |  | 3,531 |
Income before income taxes |  |  | 1,053 |  |  |  | 66 |  |  |  | 1,119 |
Income tax expense |  |  | 309 |  |  |  | 22 |  |  |  | 331 |
Net income |  | $ | 744 |  |  | $ | 44 |  |  | $ | 788 |
Total assets |  | $ | 427,233 |  |  | $ | 853 |  |  | $ | 428,086 |

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##### Table of Contents

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: |  |  |  | Loan Classes: |  |
|  | 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: |
|  | March 31, |  |  | December 31, |
|  | 2014 |  |  | 2013 |
Commercial |  | $ | 58,951 |  |  | $ | 55,803 |
Commercial real estate |  |  | 178,352 |  |  |  | 172,117 |
Consumer |  |  | 71,651 |  |  |  | 71,165 |
Residential |  |  | 45,463 |  |  |  | 46,095 |
Total loans |  |  | 354,417 |  |  |  | 345,180 |
Less allowance for loan losses |  |  | 5,261 |  |  |  | 5,186 |
Net loans |  | $ | 349,156 |  |  | $ | 339,994 |

The Bank’s 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 borrower’s 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 Bank’s 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 borrower’s operations and the borrower’s ability to generate positive cash flow on a sustained basis. The borrower’s recent payment history may currently or in the future be characterized by late payments. The Bank’s 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 management’s close attention. If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the asset or in the bank’s 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 Bank’s 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 borrower’s performance and financial condition provides evidence that it is probable that the Bank will be unable to collect all amounts due.

• |  | “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)

Financing Receivables on Non-Accrual Status

(dollars in thousands)

|  | As of |
|  | March 31, 2014 |  |  | December 31, 2013 |
Commercial |  | $ | 1,941 |  |  | $ | 1,585 |
Commercial Real Estate: |  |  |  |  |  |  |  |
Commercial Mortgages-Owner Occupied |  |  | 323 |  |  |  | 537 |
Commercial Mortgages-Non-Owner Occupied |  |  | 83 |  |  |  | 353 |
Commercial Construction |  |  | 460 |  |  |  | 375 |
Consumer |  |  |  |  |  |  |  |
Consumer Unsecured |  |  | — |  |  |  | — |
Consumer Secured |  |  | 123 |  |  |  | 33 |
Residential: |  |  |  |  |  |  |  |
Residential Mortgages |  |  | 377 |  |  |  | 183 |
Residential Consumer Construction |  |  | — |  |  |  | — |
Totals |  | $ | 3,307 |  |  | $ | 3,066 |

We also classify other real estate owned (OREO) as a nonperforming asset. OREO represents real property owned by the Bank either through purchase at foreclosure or received from the borrower through a deed in lieu of foreclosure. OREO increased to $1,714,000 on March 31, 2014 from $1,451,000 on December 31, 2013. The following table represents the changes in OREO balance during the three months ended March 31, 2014.

OREO Changes

(dollars in thousands)

|  | Three Months ended |
|  | March 31, 2014 |
Balance at the beginning of the year (net) |  | $ | 1,451 |
Transfers from loans |  |  | 384 |
Capitalized costs |  |  | — |
Writedowns |  |  | (46 | )
Sales proceeds |  |  | (78 | )
Gain on disposition |  |  | 3 |
Balance at the end of the period (net) |  | $ | 1,714 |

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

|  | Impaired Loans |
|  | (dollars in thousands) |
|  | For the Three Months Ended March 31, 2014 |
|  |  |  |  | Unpaid |  |  |  |  |  | Average |  |  | Interest |
|  | Recorded |  |  | Principal |  |  | Related |  |  | Recorded |  |  | Income |
2014 |  | Investment |  |  | Balance |  |  | Allowance |  |  | Investment |  |  | Recognized |
With No Related Allowance Recorded: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Commercial |  | $ | 3,987 |  |  | $ | 4,456 |  |  | $ | — |  |  | $ | 3,626 |  |  | $ | 35 |
Commercial Real Estate |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Commercial Mortgages-Owner Occupied |  |  | 749 |  |  |  | 807 |  |  |  | — |  |  |  | 644 |  |  |  | 11 |
Commercial Mortgage Non-Owner Occupied |  |  | 598 |  |  |  | 598 |  |  |  | — |  |  |  | 801 |  |  |  | 8 |
Commercial Construction |  |  | 460 |  |  |  | 1,135 |  |  |  | — |  |  |  | 606 |  |  |  | — |
Consumer |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Consumer Unsecured |  |  | — |  |  |  | — |  |  |  | — |  |  |  | — |  |  |  | — |
Consumer Secured |  |  | 21 |  |  |  | 21 |  |  |  | — |  |  |  | 21 |  |  |  | — |
Residential |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Residential Mortgages |  |  | 330 |  |  |  | 330 |  |  |  | — |  |  |  | 400 |  |  |  | 3 |
Residential Consumer Construction |  |  | — |  |  |  | — |  |  |  | — |  |  |  | — |  |  |  | — |
With An Allowance Recorded: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Commercial |  | $ | 921 |  |  | $ | 929 |  |  | $ | 482 |  |  | $ | 747 |  |  | $ | 11 |
Commercial Real Estate |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Commercial Mortgages-Owner Occupied |  |  | 1,826 |  |  |  | 2,027 |  |  |  | 308 |  |  |  | 2,123 |  |  |  | 25 |
Commercial Mortgage Non-Owner Occupied |  |  | 218 |  |  |  | 218 |  |  |  | 12 |  |  |  | 219 |  |  |  | 3 |
Commercial Construction |  |  | — |  |  |  | — |  |  |  | — |  |  |  | — |  |  |  | — |
Consumer |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Consumer Unsecured |  |  | — |  |  |  | — |  |  |  | — |  |  |  | — |  |  |  | — |
Consumer Secured |  |  | 40 |  |  |  | 40 |  |  |  | 40 |  |  |  | 40 |  |  |  | 1 |
Residential |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Residential Mortgages |  |  | 2,129 |  |  |  | 2,277 |  |  |  | 252 |  |  |  | 1,907 |  |  |  | 26 |
Residential Consumer Construction |  |  | — |  |  |  | — |  |  |  | — |  |  |  | — |  |  |  | — |
Totals: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Commercial |  | $ | 4,908 |  |  | $ | 5,385 |  |  | $ | 482 |  |  | $ | 4,373 |  |  | $ | 46 |
Commercial Real Estate |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Commercial Mortgages-Owner Occupied |  |  | 2,575 |  |  |  | 2,834 |  |  |  | 308 |  |  |  | 2,767 |  |  |  | 36 |
Commercial Mortgage Non-Owner Occupied |  |  | 816 |  |  |  | 816 |  |  |  | 12 |  |  |  | 1,020 |  |  |  | 11 |
Commercial Construction |  |  | 460 |  |  |  | 1,135 |  |  |  | — |  |  |  | 606 |  |  |  | — |
Consumer |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Consumer Unsecured |  |  | — |  |  |  | — |  |  |  | — |  |  |  | — |  |  |  | — |
Consumer Secured |  |  | 61 |  |  |  | 61 |  |  |  | 40 |  |  |  | 61 |  |  |  | 1 |
Residential |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Residential Mortgages |  |  | 2,459 |  |  |  | 2,607 |  |  |  | 252 |  |  |  | 2,307 |  |  |  | 29 |
Residential Consumer Construction |  |  | — |  |  |  | — |  |  |  | — |  |  |  | — |  |  |  | — |
|  | $ | 11,279 |  |  | $ | 12,838 |  |  | $ | 1,094 |  |  | $ | 11,134 |  |  | $ | 123 |

22

##### Table of Contents

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

|  | Impaired Loans |
|  | (dollars in thousands) |
|  | For the Year Ended December 31, 2013 |
|  |  |  |  | Unpaid |  |  |  |  |  | Average |  |  | Interest |
|  | Recorded |  |  | Principal |  |  | Related |  |  | Recorded |  |  | Income |
2013 |  | Investment |  |  | Balance |  |  | Allowance |  |  | Investment |  |  | Recognized |
With No Related Allowance Recorded: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Commercial |  | $ | 3,265 |  |  | $ | 3,699 |  |  | $ | — |  |  | $ | 2,898 |  |  | $ | 101 |
Commercial Real Estate |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Commercial Mortgages-Owner Occupied |  |  | 539 |  |  |  | 593 |  |  |  | — |  |  |  | 1,566 |  |  |  | 38 |
Commercial Mortgage Non-Owner Occupied |  |  | 1,003 |  |  |  | 1,003 |  |  |  | — |  |  |  | 3,686 |  |  |  | 47 |
Commercial Construction |  |  | 751 |  |  |  | 1,274 |  |  |  | — |  |  |  | 746 |  |  |  | 8 |
Consumer |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Consumer Unsecured |  |  | — |  |  |  | — |  |  |  | — |  |  |  | — |  |  |  | — |
Consumer Secured |  |  | 21 |  |  |  | 21 |  |  |  | — |  |  |  | 245 |  |  |  | 1 |
Residential |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Residential Mortgages |  |  | 470 |  |  |  | 517 |  |  |  | — |  |  |  | 1,304 |  |  |  | 24 |
Residential Consumer Construction |  |  | — |  |  |  | — |  |  |  | — |  |  |  | — |  |  |  | — |
With An Allowance Recorded: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Commercial |  | $ | 573 |  |  | $ | 573 |  |  | $ | 406 |  |  | $ | 597 |  |  | $ | 38 |
Commercial Real Estate |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Commercial Mortgages-Owner Occupied |  |  | 2,420 |  |  |  | 2,617 |  |  |  | 280 |  |  |  | 3,046 |  |  |  | 108 |
Commercial Mortgage Non-Owner Occupied |  |  | 220 |  |  |  | 221 |  |  |  | 14 |  |  |  | 530 |  |  |  | 15 |
Commercial Construction |  |  | — |  |  |  | — |  |  |  | — |  |  |  | 412 |  |  |  | — |
Consumer |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Consumer Unsecured |  |  | — |  |  |  | — |  |  |  | — |  |  |  | 1 |  |  |  | — |
Consumer Secured |  |  | 40 |  |  |  | 40 |  |  |  | 40 |  |  |  | 285 |  |  |  | 3 |
Residential |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Residential Mortgages |  |  | 1,684 |  |  |  | 1,820 |  |  |  | 224 |  |  |  | 1,350 |  |  |  | 118 |
Residential Consumer Construction |  |  | — |  |  |  | — |  |  |  | — |  |  |  | — |  |  |  | — |
Totals: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Commercial |  | $ | 3,838 |  |  | $ | 4,272 |  |  | $ | 406 |  |  | $ | 3,495 |  |  | $ | 139 |
Commercial Real Estate |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Commercial Mortgages-Owner Occupied |  |  | 2,959 |  |  |  | 3,210 |  |  |  | 280 |  |  |  | 4,612 |  |  |  | 146 |
Commercial Mortgage Non-Owner Occupied |  |  | 1,223 |  |  |  | 1,224 |  |  |  | 14 |  |  |  | 4,216 |  |  |  | 62 |
Commercial Construction |  |  | 751 |  |  |  | 1,274 |  |  |  | — |  |  |  | 1,158 |  |  |  | 8 |
Consumer |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Consumer Unsecured |  |  | — |  |  |  | — |  |  |  | — |  |  |  | 1 |  |  |  | — |
Consumer Secured |  |  | 61 |  |  |  | 61 |  |  |  | 40 |  |  |  | 530 |  |  |  | 4 |
Residential |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Residential Mortgages |  |  | 2,154 |  |  |  | 2,337 |  |  |  | 224 |  |  |  | 2,654 |  |  |  | 142 |
Residential Consumer Construction |  |  | — |  |  |  | — |  |  |  | — |  |  |  | — |  |  |  | — |
|  | $ | 10,986 |  |  | $ | 12,378 |  |  | $ | 964 |  |  | $ | 16,666 |  |  | $ | 501 |

23

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

|  | Allowance for Credit Losses and Recorded Investment in Financing Receivables (dollars in thousands) For the Three Months Ended March 31, 2014 |
|  |  |  |  | Commercial |  |  |  |  |  |  |  |  |  |
2014 |  | Commercial |  |  | Real Estate |  |  | Consumer |  |  | Residential |  |  | Total |
Allowance for Credit Losses: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Beginning Balance |  | $ | 1,015 |  |  | $ | 2,631 |  |  | $ | 935 |  |  | $ | 605 |  |  | $ | 5,186 |
Charge-offs |  |  | — |  |  |  | — |  |  |  | (4 | ) |  |  | — |  |  |  | (4 | )
Recoveries |  |  | 10 |  |  |  | 7 |  |  |  | — |  |  |  | 7 |  |  |  | 24 |
Provision |  |  | 87 |  |  |  | 93 |  |  |  | (117 | )(1) |  |  | (8 | ) |  |  | 55 |
Ending Balance |  |  | 1,112 |  |  |  | 2,731 |  |  |  | 814 |  |  |  | 604 |  |  |  | 5,261 |
Ending Balance: Individually evaluated for impairment |  | $ | 482 |  |  | $ | 320 |  |  | $ | 40 |  |  | $ | 252 |  |  | $ | 1,094 |
Ending Balance: Collectively evaluated for impairment |  |  | 630 |  |  |  | 2,411 |  |  |  | 774 |  |  |  | 352 |  |  |  | 4,167 |
Totals: |  | $ | 1,112 |  |  | $ | 2,731 |  |  | $ | 814 |  |  | $ | 604 |  |  | $ | 5,261 |
Financing Receivables: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Ending Balance: Individually evaluated for impairment |  | $ | 4,908 |  |  | $ | 3,851 |  |  | $ | 61 |  |  | $ | 2,459 |  |  | $ | 11,279 |
Ending Balance: Collectively evaluated for impairment |  |  | 54,043 |  |  |  | 174,501 |  |  |  | 71,590 |  |  |  | 43,004 |  |  |  | 343,138 |
Totals: |  | $ | 58,951 |  |  | $ | 178,352 |  |  | $ | 71,651 |  |  | $ | 45,463 |  |  | $ | 354,417 |

(1) | The experience within the historical charge-off period used to calculate the allowance has improved which reduced the need for a provision relating to this segment.

24

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

|  | Allowance for Credit Losses and Recorded Investment in Financing Receivables (dollars in thousands) For the Year Ended December 31, 2013 |
|  |  |  |  | Commercial |  |  |  |  |  |  |  |  |  |
2013 |  | Commercial |  |  | Real Estate |  |  | Consumer |  |  | Residential |  |  | Total |
Allowance for Credit Losses: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Beginning Balance |  | $ | 987 |  |  | $ | 2,849 |  |  | $ | 1,057 |  |  | $ | 642 |  |  | $ | 5,535 |
Charge-offs |  |  | (19 | ) |  |  | (932 | ) |  |  | (126 | ) |  |  | (28 | ) |  |  | (1,105 | )
Recoveries |  |  | 37 |  |  |  | 42 |  |  |  | 137 |  |  |  | — |  |  |  | 216 |
Provision |  |  | 10 |  |  |  | 672 |  |  |  | (133 | ) |  |  | (9 | ) |  |  | 540 |
Ending Balance |  | $ | 1,015 |  |  | $ | 2,631 |  |  | $ | 935 |  |  | $ | 605 |  |  | $ | 5,186 |
Ending Balance: Individually evaluated for impairment |  | $ | 406 |  |  | $ | 294 |  |  | $ | 40 |  |  | $ | 224 |  |  | $ | 964 |
Ending Balance: Collectively evaluated for impairment |  |  | 609 |  |  |  | 2,337 |  |  |  | 895 |  |  |  | 381 |  |  |  | 4,222 |
Totals: |  | $ | 1,015 |  |  | $ | 2,631 |  |  | $ | 935 |  |  | $ | 605 |  |  | $ | 5,186 |
Financing Receivables: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Ending Balance: Individually evaluated for impairment |  | $ | 3,838 |  |  | $ | 4,933 |  |  | $ | 61 |  |  | $ | 2,154 |  |  | $ | 10,986 |
Ending Balance: Collectively evaluated for impairment |  |  | 51,965 |  |  |  | 167,184 |  |  |  | 71,104 |  |  |  | 43,941 |  |  |  | 334,194 |
Totals: |  | $ | 55,803 |  |  | $ | 172,117 |  |  | $ | 71,165 |  |  | $ | 46,095 |  |  | $ | 345,180 |

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

|  | Age Analysis of Past Due Financing Receivables as of |
|  | March 31, 2014 |
|  | (dollars in thousands) |
2014 |  | 30-59 Days Past Due |  |  | 60-89 Days Past Due |  |  | Greater than 90 Days |  |  | Total Past Due |  |  | Current |  |  | Total Financing Receivables |  |  | Recorded Investment > 90 Days & Accruing |
Commercial |  | $ | 623 |  |  | $ | 22 |  |  | $ | 1,941 |  |  | $ | 2,586 |  |  | $ | 56,365 |  |  | $ | 58,951 |  |  | $ | — |
Commercial Real Estate: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Commercial Mortgages-Owner Occupied |  |  | 1,081 |  |  |  | — |  |  |  | 323 |  |  |  | 1,404 |  |  |  | 66,970 |  |  |  | 68,374 |  |  |  | — |
Commercial Mortgages-Non-Owner Occupied |  |  | 404 |  |  |  | — |  |  |  | 83 |  |  |  | 487 |  |  |  | 99,575 |  |  |  | 100,062 |  |  |  | — |
Commercial Construction |  |  | — |  |  |  | — |  |  |  | 460 |  |  |  | 460 |  |  |  | 9,456 |  |  |  | 9,916 |  |  |  | — |
Consumer: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Consumer Unsecured |  |  | 5 |  |  |  | — |  |  |  | — |  |  |  | 5 |  |  |  | 3,572 |  |  |  | 3,577 |  |  |  | — |
Consumer Secured |  |  | 17 |  |  |  | 17 |  |  |  | 100 |  |  |  | 134 |  |  |  | 67,940 |  |  |  | 68,074 |  |  |  | — |
Residential: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Residential Mortgages |  |  | 154 |  |  |  | 366 |  |  |  | 410 |  |  |  | 930 |  |  |  | 39,554 |  |  |  | 40,484 |  |  |  | — |
Residential Consumer Construction |  |  | — |  |  |  | 95 |  |  |  | — |  |  |  | 95 |  |  |  | 4,884 |  |  |  | 4,979 |  |  |  | — |
Total |  | $ | 2,284 |  |  | $ | 500 |  |  | $ | 3,317 |  |  | $ | 6,101 |  |  | $ | 348,316 |  |  | $ | 354,417 |  |  | $ | — |
|  | Age Analysis of Past Due Financing Receivables as of |
|  | December 31, 2013 |
|  | (dollars in thousands) |
2013 |  | 30-59 Days Past Due |  |  | 60-89 Days Past Due |  |  | Greater than 90 Days |  |  | Total Past Due |  |  | Current |  |  | Total Financing Receivables |  |  | Recorded Investment > 90 Days & Accruing |
Commercial |  | $ | 389 |  |  | $ | — |  |  | $ | 1,586 |  |  | $ | 1,975 |  |  | $ | 53,828 |  |  | $ | 55,803 |  |  | $ | — |
Commercial Real Estate: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Commercial Mortgages-Owner Occupied |  |  | 1,099 |  |  |  | — |  |  |  | 409 |  |  |  | 1,508 |  |  |  | 63,813 |  |  |  | 65,321 |  |  |  | — |
Commercial Mortgages-Non-Owner Occupied |  |  | 96 |  |  |  | — |  |  |  | 85 |  |  |  | 181 |  |  |  | 94,542 |  |  |  | 94,723 |  |  |  | — |
Commercial Construction |  |  | — |  |  |  | — |  |  |  | 375 |  |  |  | 375 |  |  |  | 11,698 |  |  |  | 12,073 |  |  |  | — |
Consumer: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Consumer Unsecured |  |  | 5 |  |  |  | — |  |  |  | — |  |  |  | 5 |  |  |  | 4,717 |  |  |  | 4,722 |  |  |  | — |
Consumer Secured |  |  | 71 |  |  |  | — |  |  |  | 33 |  |  |  | 104 |  |  |  | 66,339 |  |  |  | 66,443 |  |  |  | — |
Residential: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Residential Mortgages |  |  | 704 |  |  |  | — |  |  |  | 183 |  |  |  | 887 |  |  |  | 39,909 |  |  |  | 40,796 |  |  |  | — |
Residential Consumer Construction |  |  | — |  |  |  | 95 |  |  |  | — |  |  |  | 95 |  |  |  | 5,204 |  |  |  | 5,299 |  |  |  | — |
Total |  | $ | 2,364 |  |  | $ | 95 |  |  | $ | 2,671 |  |  | $ | 5,130 |  |  | $ | 340,050 |  |  | $ | 345,180 |  |  | $ | — |

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

|  | Credit Loss Disclosures |
|  | Credit Quality Information - by Class |
|  | March 31, 2014 |
|  | (dollars in thousands) |
2014 |  | Pass |  |  | Monitor |  |  | Special Mention |  |  | Substandard |  |  | Doubtful |  |  | Totals |
Commercial |  | $ | 51,567 |  |  | $ | 1,549 |  |  | $ | 878 |  |  | $ | 4,957 |  |  | $ | — |  |  | $ | 58,951 |
Commercial Real Estate: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Commercial Mortgages-Owner Occupied |  |  | 62,857 |  |  |  | 1,674 |  |  |  | 1,343 |  |  |  | 2,500 |  |  |  | — |  |  |  | 68,374 |
Commercial Mortgages-Non Owner Occupied |  |  | 92,143 |  |  |  | 1,988 |  |  |  | 5,294 |  |  |  | 637 |  |  |  | — |  |  |  | 100,062 |
Commercial Construction |  |  | 9,032 |  |  |  | 424 |  |  |  | — |  |  |  | 460 |  |  |  | — |  |  |  | 9,916 |
Consumer |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Consumer Unsecured |  |  | 3,576 |  |  |  | — |  |  |  | — |  |  |  | 1 |  |  |  | — |  |  |  | 3,577 |
Consumer Secured |  |  | 66,653 |  |  |  | 703 |  |  |  | 340 |  |  |  | 378 |  |  |  | — |  |  |  | 68,074 |
Residential: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Residential Mortgages |  |  | 36,402 |  |  |  | 783 |  |  |  | 587 |  |  |  | 2,712 |  |  |  | — |  |  |  | 40,484 |
Residential Consumer Construction |  |  | 4,979 |  |  |  | — |  |  |  | — |  |  |  | — |  |  |  | — |  |  |  | 4,979 |
Totals |  | $ | 327,209 |  |  | $ | 7,121 |  |  | $ | 8,442 |  |  | $ | 11,645 |  |  | $ | — |  |  | $ | 354,417 |
|  | Credit Loss Disclosures |
|  | Credit Quality Information - by Class |
|  | December 31, 2013 |
|  | (dollars in thousands) |
2013 |  | Pass |  |  | Monitor |  |  | Special Mention |  |  | Substandard |  |  | Doubtful |  |  | Totals |
Commercial |  | $ | 48,827 |  |  | $ | 2,109 |  |  | $ | 979 |  |  | $ | 3,888 |  |  | $ | — |  |  | $ | 55,803 |
Commercial Real Estate: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Commercial Mortgages-Owner Occupied |  |  | 58,740 |  |  |  | 2,355 |  |  |  | 1,356 |  |  |  | 2,870 |  |  |  | — |  |  |  | 65,321 |
Commercial Mortgages-Non Owner Occupied |  |  | 85,474 |  |  |  | 2,737 |  |  |  | 5,468 |  |  |  | 1,044 |  |  |  | — |  |  |  | 94,723 |
Commercial Construction |  |  | 11,455 |  |  |  | — |  |  |  | — |  |  |  | 618 |  |  |  | — |  |  |  | 12,073 |
Consumer |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Consumer Unsecured |  |  | 4,721 |  |  |  | — |  |  |  | — |  |  |  | 1 |  |  |  | — |  |  |  | 4,722 |
Consumer Secured |  |  | 65,056 |  |  |  | 814 |  |  |  | 283 |  |  |  | 290 |  |  |  | — |  |  |  | 66,443 |
Residential: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Residential Mortgages |  |  | 36,962 |  |  |  | 786 |  |  |  | 589 |  |  |  | 2,459 |  |  |  | — |  |  |  | 40,796 |
Residential Consumer Construction |  |  | 5,299 |  |  |  | — |  |  |  | — |  |  |  | — |  |  |  | — |  |  |  | 5,299 |
Totals |  | $ | 316,534 |  |  | $ | 8,801 |  |  | $ | 8,675 |  |  | $ | 11,170 |  |  | $ | — |  |  | $ | 345,180 |

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

There were no loan modifications that would have been classified as Troubled Debt Restructurings (TDR) during the three months ended March 31, 2014 and 2013.

There were no loan modifications classified as TDRs within the last twelve months that defaulted during the three months ended March 31, 2014 and 2013.

Note 10 – Subsequent Events

In preparing these financial statements, Financial has evaluated events and transactions for potential recognition or disclosure through the date the financial statements were issued.

Note 11 – Recent accounting pronouncements

In January 2014, the FASB issued ASU 2014-01, “Investments—Equity Method and Joint Ventures (Topic 323): Accounting for Investments in Qualified Affordable Housing Projects (a consensus of the FASB Emerging Issues Task Force).” The amendments in this ASU permit reporting entities to make an accounting policy election to account for their investments in qualified affordable housing projects using the proportional amortization method if certain conditions are met. Under the proportional amortization method, an entity amortizes the initial cost of the investment in proportion to the tax credits and other tax benefits received and recognizes the net investment performance in the income statement as a component of income tax expense (benefit). The amendments in this ASU should be applied retrospectively to all periods presented. A reporting entity that uses the effective yield method to account for its investments in qualified affordable housing projects before the date of adoption may continue to apply the effective yield method for those preexisting investments. The amendments in this ASU are effective for public business entities for annual periods and interim reporting periods within those annual periods, beginning after December 15, 2014. Early adoption is permitted. The Company is currently assessing the impact that ASU 2014-01 will have on its consolidated financial statements.

In January 2014, the FASB issued ASU 2014-04, “Receivables—Troubled Debt Restructurings by Creditors (Subtopic 310-40): Reclassification of Residential Real Estate Collateralized Consumer Mortgage Loans upon Foreclosure (a consensus of the FASB Emerging Issues Task Force).” The amendments in this ASU clarify that an in substance repossession or foreclosure occurs, and a creditor is considered to have received physical possession of residential real estate property collateralizing a consumer mortgage loan, upon either (1) the creditor obtaining legal title to the residential real estate property upon completion of a foreclosure or (2) the borrower conveying all interest in the residential real estate property to the creditor to satisfy that loan through completion of a deed in lieu of foreclosure or through a similar legal agreement. Additionally, the amendments require interim and annual disclosure of both (1) the amount of foreclosed residential real estate property held by the creditor and (2) the recorded investment in consumer mortgage loans collateralized by residential real estate property that are in the process of foreclosure according to local requirements of the applicable jurisdiction. The amendments in this ASU are effective for public business entities for annual periods, and interim periods within those annual periods, beginning after December 15, 2014. The Company is currently assessing the impact that ASU 2014-04 will have on its consolidated financial statements.

In April 2014, the FASB issued ASU 2014-08, “Presentation of Financial Statements (Topic 205) and Property, Plant, and Equipment (Topic 360): Reporting Discontinued Operations and Disclosures of Disposals of Components of an Entity.” The amendments in this ASU change the criteria for reporting discontinued operations while enhancing disclosures in this area. Under the new guidance, only disposals representing a strategic shift in operations should be presented as discontinued operations. Those strategic shifts should have a major effect on the organization’s operations and financial results and include

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Note 11 – Recent accounting pronouncements (continued)

disposals of a major geographic area, a major line of business, or a major equity method investment. The new guidance requires expanded disclosures about discontinued operations that will provide financial statement users with more information about the assets, liabilities, income, and expenses of discontinued operations. Additionally, the new guidance requires disclosure of the pre-tax income attributable to a disposal of a significant part of an organization that does not qualify for discontinued operations reporting. The amendments in the ASU are effective for public business entities for annual periods, and interim periods within those annual periods, beginning after December 15, 2014. Early adoption is permitted. The Company does not expect the adoption of ASU 2014-08 to have a material impact on its consolidated financial statements.

Item 2. Management’s 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.

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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”). 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 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 Town 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 www.bankofthejames.com.

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”),

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| • |  | 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”),

| • |  | 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 Town of Bedford, Virginia, located off of Independence Boulevard (opened October 2008) (the “Bedford Branch”),

| • |  | A branch located at 1110 Main Street, Altavista, Virginia (relocated from temporary branch in June 2009) (the “Altavista Branch”), and

The Bank also has opened a limited-service branch located in the Westminster-Canterbury facilities located at 501 VES Road, Lynchburg, Virginia 24503 and a commercial loan production office located at Luxor Office Park LLC, 1430 Rolkin Court Suite 203, Charlottesville, Virginia

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 133 Salem Avenue, NW, in Roanoke, 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 locations 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 has not determined when it will open a branch at this location. The Bank has determined that the existing structure is not suitable for use as a bank branch.

Rustburg, Virginia. As previously disclosed, 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 has not determined when it will open a branch at this location.

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Appomattox, Virginia. As previously disclosed, in July, 2013 the Bank purchased certain real property located near the intersection of Confederate Boulevard and Moses Avenue for future branch expansion. The Bank has not determined when it will open a branch at this location.

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.

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 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:

|  | March 31, 2014 (in thousands) |
Commitments to extend credit |  | $ | 72,123 |
Letters of Credit |  |  | 762 |
Total |  | $ | 72,885 |

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.

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SUMMARY OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following discussion represents management’s discussion and analysis of the financial condition of Financial as of March 31, 2014 and December 31, 2013 and the results of operations of Financial for the three month periods ended March 31, 2014 and 2013. 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

March 31, 2014 as Compared to December 31, 2013

Total assets were $442,584,000 on March 31, 2014 compared with $434,511,000 at December 31, 2013, an increase of 1.86%. The increase as of March 31, 2014 reflects the increased demand deposit accounts generated from new commercial relationships.

Total deposits increased from $387,398,000 as of December 31, 2013 to $398,126,000 on March 31, 2014, an increase of 2.77%. Total deposits increased for the reasons set forth in the prior paragraph.

Total loans, excluding loans held for sale, increased to $354,417,000 on March 31, 2014 from $345,180,000 on December 31, 2013. Loans, net of unearned income and allowance, increased to $349,156,000 on March 31, 2014 from $339,994,000 on December 31, 2013, an increase of 2.69%. 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):

|  | March 31, 2014 |  |  | December 31, 2013 |
|  | Amount |  |  | Percentage |  |  | Amount |  |  | Percentage |
Commercial |  | $ | 58,951 |  |  |  | 16.64 | % |  | $ | 55,803 |  |  |  | 16.17 | %
Commercial Real Estate |  |  | 178,352 |  |  |  | 50.32 | % |  |  | 172,117 |  |  |  | 49.86 | %
Consumer |  |  | 71,651 |  |  |  | 20.21 | % |  |  | 71,165 |  |  |  | 20.61 | %
Residential |  |  | 45,463 |  |  |  | 12.83 | % |  |  | 46,095 |  |  |  | 13.36 | %
Total loans |  | $ | 354,417 |  |  |  | 100.00 | % |  | $ | 345,180 |  |  |  | 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”) increased to $5,021,000 on March 31, 2014 from $4,517,000 on December 31, 2013. This increase was due to an increase in both non-accrual (or nonperforming) loans and OREO. Non-accrual loans increased 7.08% to $3,307,000 on March 31, 2014 from $3,066,000 on December 31, 2013. 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 $1,214,000 and $1,173,000 as of March 31, 2014 and December 31, 2013, 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.

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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, 2013, the Bank was carrying 17 OREO properties on its books at a value of $1,451,000. During the three months ended March 31, 2014, the Bank acquired 2 additional OREO properties and disposed of 3 OREO properties, and as of March 31, 2014 the Bank is carrying 16 OREO properties at a value of $1,714,000. 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 $561,000 at March 31, 2014 classified as performing Troubled Debt Restructurings (“TDRs”) as compared to $564,000 at December 31, 2013. 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 increased to $17,915,000 on March 31, 2014 from $16,671,000 on December 31, 2013. Cash and cash equivalents consist of cash due from correspondents, cash in vault, and overnight investments (including federal funds sold). This increase is in large part due to the increase in Federal funds sold and due from bank balances resulting from the increase in deposits as explained above. 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 $2,535,000 on March 31, 2014 from $3,537,000 on December 31, 2013. Securities available-for-sale decreased to $45,336,000 on March 31, 2014, from $46,091,000 December 31, 2013. During the three months ended March 31, 2014 the Bank received $60,000 in proceeds from maturities, paydowns, and/or calls of securities available-for-sale and $1,886,000 in proceeds from the sale of securities available-for-sale. The Bank purchased no securities held-to-maturity or available-for sale during the same period. The decrease from December 31, 2013 in securities available-for-sale was primarily due to the liquidation of securities in anticipation of funding loan growth.

Financial’s investment in Federal Home Loan Bank of Atlanta (FHLBA) stock totaled $481,000 at March 31, 2014 and $620,000 at December 31, 2013, a decrease of $139,000. 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 March 31, 2014, Financial, on a consolidated basis, had liquid assets of $63,251,000 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 March 31, 2014. 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.

Financial has $12,000,000 categorized as “Other borrowings” which consists of the following: i) $2,000,000, on which the Bank pays a fixed rate of 3.785%, from a Federal Home Loan Bank Advance that matures in April 2015; and ii) $10,000,000 from the private placement of unregistered debt securities as previously disclosed (the “2012 Notes”). The 2012 Notes bear interest at the rate of 6% per year with interest payable quarterly in arrears. The notes mature on April 1, 2017, but are 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.

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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 March 31, 2014, the Bank had a leverage ratio of 9.29%, a Tier 1 risk-based capital ratio of 11.96% and a total risk-based capital ratio of 13.21%. As of March 31, 2014 and December 31, 2013 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 March 31, 2014 and December 31, 2013:

Bank Level Only Capital Ratios

Analysis of Capital (in 000’s) |  | March 31, 2014 |  |  | December 31, 2013 |
Tier 1 capital |  |  |  |  |  |  |  |
Common Stock |  | $ | 3,742 |  |  | $ | 3,742 |
Surplus |  |  | 19,325 |  |  |  | 19,325 |
Retained earnings |  |  | 17,389 |  |  |  | 16,563 |
Total Tier 1 capital |  | $ | 40,456 |  |  | $ | 39,630 |
Tier 2 capital |  |  |  |  |  |  |  |
Allowance for loan losses |  | $ | 4,241 |  |  | $ | 4,166 |
Total Tier 2 capital: |  | $ | 4,241 |  |  | $ | 4,166 |
Total risk-based capital |  | $ | 44,697 |  |  | $ | 43,796 |
Risk weighted assets |  | $ | 338,271 |  |  | $ | 332,280 |
Average total assets |  | $ | 435,532 |  |  | $ | 435,236 |

|  | Actual |  |  | Regulatory Benchmarks |
| March 31, 2014 |  |  | December 31, 2013 |  |  | For Capital Adequacy Purposes |  |  | For Well Capitalized Purposes |
Capital Ratios: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Tier 1 capital to average total assets |  |  | 9.29 | % |  |  | 9.11 | % |  |  | 4.00 | % |  |  | 5.00 | %
Tier 1 risk-based capital ratio |  |  | 11.96 | % |  |  | 11.93 | % |  |  | 4.00 | % |  |  | 6.00 | %
Total risk-based capital ratio |  |  | 13.21 | % |  |  | 13.18 | % |  |  | 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. The capital ratios for the Company on a consolidated basis, while remaining “well capitalized,” would be lower than the comparable 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.

In July 2013, the Federal Reserve Board approved a final rule establishing a regulatory capital framework for smaller, less complex financial institutions. The rule implements in the United States the Basel III regulatory capital reforms from the Basel Committee on Banking Supervision and certain changes required by the Dodd-Frank Wall Street Reform and Consumer Protection Act. Under the final

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rule, minimum requirements will increase for both the quantity and quality of capital held by banking organizations. The rule includes a new minimum ratio of common equity Tier 1 capital to risk-weighted assets of 4.5% and a common equity Tier 1 capital conservation buffer of 2.5% of risk-weighted assets that will apply to all supervised financial institutions. The rule also raises 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. The phase-in period for this rule is not scheduled to begin until January 2015. We are currently evaluating the impact of the implementation of the new capital standards.

Results of Operations

Comparison of the Three months Ended March 31, 2014 and 2013

Earnings Summary

Financial had net income including all operating segments of $705,000 for the three months ended March 31, 2014 compared to $788,000 for the comparable period in 2013. The basic and diluted earnings per common share for the three months ended March 31, 2014 was $0.21, compared to basic and diluted earnings per share of $0.24 for the three months ended March 31, 2013.

The decrease in net income was due in large part to a decrease in non-interest income, which primarly was due to decrease in loan originations and the Mortgage Division, and a decrease in gains on sales of securities-available-for-sale. The decrease income was partially offset by a decrease in the expense associated with the loan loss provision.

These operating results represent an annualized return on stockholders’ equity of 8.90% for the three months ended March 31, 2014, compared with 11.02% for the same period in 2013 The Company had an annualized return on average assets for the three months ended March 31, 2014 of 0.65% compared with 0.74% for the same period in 2013.

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

Interest Income, Interest Expense, and Net Interest Income

Interest income increased to $4,545,000 for the three months ended March 31, 2014 from $4,537,000 for the same period in 2013, an increase of 0.18%. Interest income increased primarily because increased balances in the loan portfolio. The average rate received on earning assets decreased to 4.60% for the three months ended March 31, 2014 as compared with 4.74% for the comparable period in 2013. The rate on total average earning assets decreased largely because of a decrease in market rates of interest resulting from a competitive banking environment. Management expects that competition will continue to pressure the rates we receive on loans and therefore may negatively impact our interest income.

Interest expense decreased to $591,000 for the three months ended March 31, 2014 from $616,000 for the same period in 2013, a decrease of 4.06%. This decrease in interest expense resulted in large part from a decrease in rates paid on time deposits and demand interest bearing accounts. The Bank’s average rate paid on interest earning deposits was 0.52% during the three month period ended March 31, 2014 as compared to 0.56% for the same period in 2013. This resulted from management’s efforts to minimize the Bank’s interest expense and maximize its net interest margin.

The fundamental source of the Bank’s 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 months

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ended March 31, 2014 was $3,954,000 compared with $3,921,000 for the same period in 2013. The change in net interest income for the three months ended March 31, 2014 as compared with the comparable period in 2013 was immaterial because the increase in interest earning assets offset the decrease in rates received. The net interest margin was 4.01% for the three months ended March 31, 2014, as compared to 4.10% for the same period a year ago.

Financial’s 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, mortgage loan origination fees, commissions on sales of investments and the Bank’s ownership interest in a title insurance agency. Non-interest income exclusive of gains on sales of securities increased to $723,000 for the three months ended March 31, 2014 from $705,000 for the three months ended March 31, 2013. This increase for the three months ended March 31, 2014 as compared to the same period last year was due primarily to an increase in service charges, fees and commissions which were partially offset by a decrease in mortgage fee income. Purchase mortgage originations comprised 75% of the mortgage loans originated in the quarter ended March 31, 2014. The percentage and amount of home purchase mortgages increased as a result of an increase in interest rates and the resulting decrease in refinancing activity. Management expects that although purchase money loans will offset a portion of the decline in refinance activity, revenue from the mortgage segment will be under pressure during the rising interest rate environment. In addition, Management believes that regulatory pressure may result in a decreased number of competitors to the Mortgage division and this could result in an increase in market share. Net gain (loss) on sales of securities decreased to ($6,000) for the three months ended March 31, 2014 from $259,000 for the same period in 2013.

The Bank, through the Mortgage division, originates both conforming and non-conforming consumer residential mortgage loans 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 major national mortgage banking or financial institutions. The Mortgage division assumes no credit or interest rate risk on these mortgages.

Despite the recent increase in rates, management anticipates that residential mortgage rates will remain near the current historic lows for the remainder of 2014. Management expects that low rates and government-assisted programs such as Home Affordable Refinance Program (HARP) coupled with the Mortgage division’s reputation in Region 2000 will allow us to maintain revenue at the Mortgage division. Because many people able to refinance mortgages have already done so, management expects refinancing activity to decrease. As a result of the rising interest rates, management expects that loans for home purchases (as opposed to refinances) will constitute the majority of mortgage originations.

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 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 division’s financial impact on our consolidated revenue has been immaterial. Although management cannot predict the financial impact of Investment with certainty, management anticipates the Investment division’s impact on noninterest income will remain immaterial in 2014.

In the third quarter of 2008, we began providing insurance and annuity products to Bank customers and others, through the Bank’s Insurance subsidiary. The Bank has one full-time and one part-time

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employee that are dedicated to selling insurance products through Insurance. Insurance generates minimal revenue and its financial impact on our consolidated revenue has been immaterial. Management anticipates that Insurance’s impact on noninterest income will remain immaterial in 2014.

Non-Interest Expense

Non-interest expense for the three months ended March 31, 2014 increased to $3,609,000 from $3,531,000, or a increase of 2.21%, for the comparable period in 2013. This increase resulted from an increase in expenses related to increased data processing charges related to a larger customer based and the startup costs related to the introduction of new products. Total personnel expense was $1,885,000 for the three month period ended March 31, 2014 as compared to $1,776,000 for the same period in 2013. The increase in personnel expense can primarily be attributed to an increase in pay for some staff and the cost of additional staff in the new Charlottesville loan production office.

Allowance for Loan Losses

The allowance for loan losses represents an amount that, in our judgment, will be adequate to absorb any losses on existing loans that may become uncollectible. The provision for loan losses increases the allowance, and loans charged off, net of recoveries, reduce the allowance. The provision to 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 many factors, including calculations of specific impairment of certain loans, general economic conditions, actual and expected credit losses, loan performance measures, historical trends and specific conditions of the individual borrower. Based on the application of the loan loss calculation, the bank provided $55,000 to the allowance for loan loss for the three month period ended March 31, 2014. This compares to provisions of $235,000 for the comparable period in 2013, representing a decrease of 76.60%.

The decrease in the loan loss provision for the three months ended March 31, 2014 as compared to the same period in 2013 was due to the following factors:

| • |  | The Bank’s asset quality has improved as problem assets, including certain commercial loans and residential speculative housing construction loans have decreased as the collateral for those loans has been liquidated or the loans have been paid off. Management’s evaluation of these asset classes resulted in the decreased provision in the quarter ended March 31, 2014.

| • |  | In light of the current economic environment, management continues its ongoing assessment of specific impairment in the Bank’s loan portfolio. The analysis resulted in a decrease in the provision for the quarter ended March 31, 2014 as compared to the same quarter in 2013.

| • |  | General reserves related to consumer loans collectively evaluated for impairment have also increased, but this increase has been offset by a significant decline in charge-offs from $186,000 for the three month period ended March 31, 2013 to $4,000 for the comparable period in 2014.

The decrease in the percentage of the allowance for loan loss reserve to total loans as of March 31, 2014 to 1.48% as compared to 1.50% as of December 31, 2013 is a direct result of the increase in the average balances in the loan portfolio. The overall balance in the allowance for loan loss increased from $5,186,000 as of December 31, 2013 to $5,261,000 as of March 31, 2014. This increase is a result of the slight increase in non-performing loans and OREO previously discussed in “Financial Condition Summary.”

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Management believes that the current allowance for loan loss of $5,261,000 (or 1.48% of total loans) at March 31, 2014, as compared to $5,186,000 (or 1.50% of total loans) as of December 31, 2013, is adequate.

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

2014 |  | Allowance for Credit Losses and Recorded Investment in Financing Receivables (dollars in thousands) For the Three months Ended March 31, 2014 |
| Commercial |  |  | Commercial Real Estate |  |  | Consumer |  |  | Residential |  |  | Total |
Allowance for Credit Losses: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Beginning Balance |  | $ | 1,015 |  |  | $ | 2,631 |  |  | $ | 935 |  |  | $ | 605 |  |  | $ | 5,186 |
Charge-offs |  |  | — |  |  |  | — |  |  |  | (4 | ) |  |  | — |  |  |  | (4 | )
Recoveries |  |  | 10 |  |  |  | 7 |  |  |  | — |  |  |  | 7 |  |  |  | 24 |
Provision |  |  | 87 |  |  |  | 93 |  |  |  | (117 | ) |  |  | (8 | ) |  |  | 55 |
Ending Balance |  |  | 1,112 |  |  |  | 2,731 |  |  |  | 814 |  |  |  | 604 |  |  |  | 5,261 |
Ending Balance: Individually evaluated for impairment |  | $ | 482 |  |  | $ | 320 |  |  | $ | 40 |  |  | $ | 252 |  |  | $ | 1,094 |
Ending Balance: Collectively evaluated for impairment |  |  | 630 |  |  |  | 2,411 |  |  |  | 774 |  |  |  | 352 |  |  |  | 4,167 |
Totals: |  | $ | 1,112 |  |  | $ | 2,731 |  |  | $ | 814 |  |  | $ | 604 |  |  | $ | 5,261 |
Financing Receivables: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Ending Balance: Individually evaluated for impairment |  | $ | 4,908 |  |  | $ | 3,851 |  |  | $ | 61 |  |  | $ | 2,459 |  |  | $ | 11,279 |
Ending Balance: Collectively evaluated for impairment |  |  | 54,043 |  |  |  | 174,501 |  |  |  | 71,590 |  |  |  | 43,004 |  |  |  | 343,138 |
Totals: |  | $ | 58,951 |  |  | $ | 178,352 |  |  | $ | 71,651 |  |  | $ | 45,463 |  |  | $ | 354,417 |

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2013 |  | Allowance for Credit Losses and Recorded Investment in Financing Receivables (dollars in thousands) For the Year Ended December 31, 2013 |
| Commercial |  |  | Commercial Real Estate |  |  | Consumer |  |  | Residential |  |  | Total |
Allowance for Credit Losses: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Beginning Balance |  | $ | 987 |  |  | $ | 2,849 |  |  | $ | 1,057 |  |  | $ | 642 |  |  | $ | 5,535 |
Charge-offs |  |  | (19 | ) |  |  | (932 | ) |  |  | (126 | ) |  |  | (28 | ) |  |  | (1,105 | )
Recoveries |  |  | 37 |  |  |  | 42 |  |  |  | 137 |  |  |  | — |  |  |  | 216 |
Provision |  |  | 10 |  |  |  | 672 |  |  |  | (133 | ) |  |  | (9 | ) |  |  | 540 |
Ending Balance |  |  | 1,015 |  |  |  | 2,631 |  |  |  | 935 |  |  |  | 605 |  |  |  | 5,186 |
Ending Balance: Individually evaluated for impairment |  | $ | 406 |  |  | $ | 294 |  |  | $ | 40 |  |  | $ | 224 |  |  | $ | 964 |
Ending Balance: Collectively evaluated for impairment |  |  | 609 |  |  |  | 2,337 |  |  |  | 895 |  |  |  | 381 |  |  |  | 4,222 |
Totals: |  | $ | 1,015 |  |  | $ | 2,631 |  |  | $ | 935 |  |  | $ | 605 |  |  | $ | 5,186 |
Financing Receivables: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Ending Balance: Individually evaluated for impairment |  | $ | 3,838 |  |  | $ | 4,933 |  |  | $ | 61 |  |  | $ | 2,154 |  |  | $ | 10,986 |
Ending Balance: Collectively evaluated for impairment |  |  | 51,965 |  |  |  | 167,184 |  |  |  | 71,104 |  |  |  | 43,941 |  |  |  | 334,194 |
Totals: |  | $ | 55,803 |  |  | $ | 172,117 |  |  | $ | 71,165 |  |  | $ | 46,095 |  |  | $ | 345,180 |

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

|  | Three months ended March 31, (in thousands) |
|  | 2014 |  |  | 2013 |
Balance, beginning of period |  | $ | 5,186 |  |  | $ | 5,535 |
Provision for loan losses |  |  | 55 |  |  |  | 235 |
Loans charged off |  |  | (4 | ) |  |  | (186 | )
Recoveries of loans charged off |  |  | 24 |  |  |  | 22 |
Net charge offs |  |  | 20 |  |  |  | (164 | )
Balance, end of period |  | $ | 5,261 |  |  | $ | 5,606 |

The Bank’s 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 borrower’s individual situation. Additionally, internal and external monitoring and review of credits are conducted on an annual basis.

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Below is a summary and definition of the Bank’s 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 borrower’s operations and the borrower’s ability to generate positive cash flow on a sustained basis. The borrower’s recent payment history may currently or in the future be characterized by late payments. The Bank’s 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 management’s close attention. If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the asset or in the bank’s 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 Bank’s 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 borrower’s performance and financial condition provides evidence that it is probable that the Bank will be unable to collect all amounts due.

• |  | “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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The decrease in the percentage of the allowance for loan loss reserve to total loans as of March 31, 2014 to 1.48% as compared to 1.50% as of December 31, 2013 is a direct result of the increase in the average balances in the loan portfolio. The overall balance in the allowance for loan loss increased from $5,186,000 as of December 31, 2013 to $5,261,000 as of March 31, 2014. This increase is a result of the slight increase in non-performing loans and OREO previously discussed above. The loan loss reserve is determined as discussed above.

In the three months ended March 31, 2014, the Bank’s recoveries exceeded its charge offs by $20,000. In the comparable period in 2013, charge offs exceeded recoveries by $164,000. Charged off loans, which are loans that management deems uncollectible, are written against the loan loss reserve and constitute a realized loss. While a charged off loan may subsequently be collected, such recoveries generally are realized over an extended period of time.

Income Taxes

For the three months ended March 31, 2014, Financial had an income tax expense of $302,000, as compared to $331,000 for the three months ended March 31, 2013. This represents an effective tax rate of 29.99% the for the three month period ended March 31, 2014 and 29.58% for the three month period ended March 31, 2013.

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Schedule I

Net Interest Margin Analysis

Average Balance Sheets

For the Quarter Ended March 31, 2014 and 2013

|  | 2014 |  |  | 2013 |
|  | Average Balance Sheet |  |  | Interest Income/ Expense |  |  | Average Rates Earned/ Paid |  |  | Average Balance Sheet |  |  | Interest Income/ Expense |  |  | Average Rates Earned/ Paid |
ASSETS |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Loans, including fees (1) (2) |  | $ | 348,611 |  |  | $ | 4,180 |  |  |  | 4.86 | % |  | $ | 326,992 |  |  | $ | 4,154 |  |  |  | 5.15 | %
Loans held for sale |  |  | 634 |  |  |  | 8 |  |  |  | 5.12 | % |  |  | 964 |  |  |  | 9 |  |  |  | 3.79 | %
Federal funds sold |  |  | 922 |  |  |  | 3 |  |  |  | 1.32 | % |  |  | 8,544 |  |  |  | 7 |  |  |  | 0.33 | %
Securities (3) |  |  | 51,287 |  |  |  | 373 |  |  |  | 2.94 | % |  |  | 53,003 |  |  |  | 398 |  |  |  | 3.04 | %
Federal agency equities |  |  | 1,295 |  |  |  | 6 |  |  |  | 1.88 | % |  |  | 1,410 |  |  |  | 5 |  |  |  | 1.44 | %
CBB equity |  |  | 116 |  |  |  | — |  |  |  | — |  |  |  | 116 |  |  |  | — |  |  |  | — |
Total earning assets |  |  | 402,865 |  |  |  | 4,570 |  |  |  | 4.60 | % |  |  | 391,029 |  |  |  | 4,573 |  |  |  | 4.74 | %
Allowance for loan losses |  |  | (5,219 | ) |  |  |  |  |  |  |  |  |  |  | (5,561 | ) |  |  |  |  |  |  |  |
Non-earning assets |  |  | 42,178 |  |  |  |  |  |  |  |  |  |  |  | 43,963 |  |  |  |  |  |  |  |  |
Total assets |  | $ | 439,824 |  |  |  |  |  |  |  |  |  |  | $ | 429,431 |  |  |  |  |  |  |  |  |
LIABILITIES AND STOCKHOLDERS’ EQUITY |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Deposits |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Demand interest bearing |  | $ | 96,660 |  |  | $ | 52 |  |  |  | 0.22 | % |  | $ | 91,069 |  |  | $ | 53 |  |  |  | 0.24 | %
Savings |  |  | 129,925 |  |  |  | 66 |  |  |  | 0.21 | % |  |  | 137,317 |  |  |  | 71 |  |  |  | 0.21 | %
Time deposits |  |  | 98,166 |  |  |  | 301 |  |  |  | 1.24 | % |  |  | 93,018 |  |  |  | 323 |  |  |  | 1.41 | %
Total interest bearing deposits |  |  | 324,751 |  |  |  | 419 |  |  |  | 0.52 | % |  |  | 321,404 |  |  |  | 447 |  |  |  | 0.56 | %
Other borrowed funds |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Fed funds purchased |  |  | 766 |  |  |  | 2 |  |  |  | 1.06 | % |  |  | — |  |  |  | — |  |  |  | — |
Repurchase agreements |  |  | 900 |  |  |  | 1 |  |  |  | 0.45 | % |  |  | — |  |  |  | — |  |  |  | — |
Other borrowings |  |  | 2,000 |  |  |  | 19 |  |  |  | 3.65 | % |  |  | 2,000 |  |  |  | 19 |  |  |  | 3.85 | %
Capital Notes |  |  | 10,000 |  |  |  | 150 |  |  |  | 6.00 | % |  |  | 10,000 |  |  |  | 150 |  |  |  | 6.00 | %
Total interest-bearing liabilities |  |  | 338,417 |  |  |  | 591 |  |  |  | 0.71 | % |  |  | 333,404 |  |  |  | 616 |  |  |  | 0.75 | %
Non-interest bearing deposits |  |  | 68,422 |  |  |  |  |  |  |  |  |  |  |  | 66,595 |  |  |  |  |  |  |  |  |
Other liabilities |  |  | 843 |  |  |  |  |  |  |  |  |  |  |  | 443 |  |  |  |  |  |  |  |  |
Total liabilities |  |  | 407,682 |  |  |  |  |  |  |  |  |  |  |  | 400,442 |  |  |  |  |  |  |  |  |
Stockholders’ equity |  |  | 32,142 |  |  |  |  |  |  |  |  |  |  |  | 28,989 |  |  |  |  |  |  |  |  |
Total liabilities and Stockholders’ equity |  | $ | 439,824 |  |  |  |  |  |  |  |  |  |  | $ | 429,431 |  |  |  |  |  |  |  |  |
Net interest income |  |  |  |  |  | $ | 3,979 |  |  |  |  |  |  |  |  |  |  | $ | 3,956 |  |  |  |  |
Net interest margin |  |  |  |  |  |  |  |  |  |  | 4.01 | % |  |  |  |  |  |  |  |  |  |  | 4.10 | %
Interest spread |  |  |  |  |  |  |  |  |  |  | 3.89 | % |  |  |  |  |  |  |  |  |  |  | 3.99 | %

(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.

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| (1) | Item 3. Quantitative and Qualitative Disclosures About Market Risk

Not applicable

Item 4. Controls and Procedures

EVALUATION OF DISCLOSURE CONTROLS AND PROCEDURES

Financial’s management, including Financial’s principal executive officer and principal financial officer, have evaluated the effectiveness of the Company’s “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, Financial’s 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 SEC’s rules and forms, and (2) is accumulated and communicated to the Company’s 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 March 31, 2014, in the Company’s 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, including any corrective actions with regard to significant deficiencies and material weaknesses.

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.

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Item 1A. Risk Factors

Not applicable

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

Not applicable

Item 3. Defaults Upon Senior Securities

Not applicable

Item 4. Mine Safety Disclosures

Not applicable

Item 5. Other Information

Not applicable

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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 May 12, 2014
31.2 |  | Certification of J. Todd Scruggs Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002, dated May 12, 2014
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 May 12, 2014
101 |  | The following materials from Bank of the James Financial Group, Inc.’s Quarterly Report on Form 10-Q for the quarter ended March 31, 2014, formatted in eXtensible Business Reporting Language (XBRL): (i) Consolidated Balance Sheets (unaudited) as of March 31, 2014 and December 31, 2013; (ii) Consolidated Statements of Income (unaudited) for the Three Months Ended March 31, 2014 and 2013; (iii) Consolidated Statements of Comprehensive Income (unaudited) for the Three Months Ended March 31, 2014 and 2013 (iv) Consolidated Statements of Cash Flows (unaudited) for the Three Months Ended March 31, 2014 and 2013 (v) Unaudited Consolidated Statements of Changes in Stockholders’ Equity for the Three Months Ended March 31, 2014 and 2013; (vi) Notes to Unaudited Consolidated Financial Statements.*

* | Pursuant to Rule 406T of Regulation S-T, the Interactive Data Files on Exhibit 101 hereto are deemed not filed or part of a registration statement or prospectus for purposes of Sections 11 or 12 of the Securities Act of 1933, as amended, are deemed not filed for purposes of Section 18 of the Securities Exchange Act of 1934, as amended, and otherwise are not subject to liability under those sections.

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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.

|  |  |  | BANK OF THE JAMES FINANCIAL GROUP, INC.
Date: May 12, 2014 |  |  |  | By |  | /S/ Robert R. Chapman III
|  |  |  |  |  | Robert R. Chapman III, President
|  |  |  |  |  | (Principal Executive Officer)
Date: May 12, 2014 |  |  |  | By |  | /S/ J. Todd Scruggs
|  |  |  |  |  | J. Todd Scruggs, Secretary and Treasurer
|  |  |  |  |  | (Principal Financial Officer and Principal Accounting Officer)

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Index of 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 May 12, 2014
31.2 |  | Certification of J. Todd Scruggs Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002, dated May 12, 2014
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 May 12, 2014
101 |  | The following materials from Bank of the James Financial Group, Inc.’s Quarterly Report on Form 10-Q for the quarter ended March 31, 2014, formatted in eXtensible Business Reporting Language (XBRL): (i) Consolidated Balance Sheets (unaudited) as of March 31, 2014 and December 31, 2013; (ii) Consolidated Statements of Income (unaudited) for the Three Months Ended March 31, 2014 and 2013; (iii) Consolidated Statements of Comprehensive Income (unaudited) for the Three Months Ended March 31, 2014 and 2013 (iv) Consolidated Statements of Cash Flows (unaudited) for the Three Months Ended March 31, 2014 and 2013 (v) Unaudited Consolidated Statements of Changes in Stockholders’ Equity for the Three Months Ended March 31, 2014 and 2013; (vi) Notes to Unaudited Consolidated Financial Statements.*

* | Pursuant to Rule 406T of Regulation S-T, the Interactive Data Files on Exhibit 101 hereto are deemed not filed or part of a registration statement or prospectus for purposes of Sections 11 or 12 of the Securities Act of 1933, as amended, are deemed not filed for purposes of Section 18 of the Securities Exchange Act of 1934, as amended, and otherwise are not subject to liability under those sections.

49