BANK OF THE JAMES FINANCIAL GROUP INC annual report, FY2018

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Bank of the James Financial Group, Inc. — 2018 Form 10-K

Business context and reporting period. This annual report covers the fiscal year ended December 31, 2018, with comparisons to 2017. The Lynchburg, Virginia-based bank holding company operates primarily through Bank of the James, a community bank serving markets across Virginia. Community banking is the principal earnings source; mortgage banking originates residential loans for sale. The filing reports annual results, not standalone fourth-quarter results.

Financial performance and position

  • Profit: Net income was $5.302 million, or $1.21 per basic and diluted share, versus $2.922 million, or $0.67 per share, in 2017. Return on average assets improved to 0.81% from 0.49%; return on average equity rose to 9.74% from 5.64%.
  • Revenue and margins: Net interest income increased 12.1% to $23.176 million. Net interest margin was 3.75%, up from 3.67%. Total noninterest income was $5.235 million, compared with $4.727 million; gains on loan sales contributed $2.918 million. The efficiency ratio improved to 74.14% from 74.99%.
  • Expenses and taxes: Noninterest expense rose 10.6% to $21.064 million, with salaries and benefits up to $11.279 million. Income tax expense fell to $1.329 million from $2.438 million; the effective tax rate was 20.04% versus 45.49%.
  • Balance sheet and funding: Total assets increased 7.8% to $674.897 million. Net loans grew 7.9% to $530.016 million; deposits rose 7.9% to $612.043 million. Cash and cash equivalents were $50.325 million, up from $37.018 million. Capital notes totaled $5.0 million, bearing 4% interest and maturing in 2022. No bank borrowings under the disclosed credit facilities were outstanding at year-end.
  • Cash flow: Operating activities provided $8.573 million; investing activities used $38.766 million, including net loan growth and property and equipment purchases; financing activities provided $43.500 million, primarily from deposit growth. Cash and cash equivalents increased by $13.307 million.
  • Liquidity and capital: Management reported $103.052 million in liquid assets and $207.615 million of available nondeposit funding capacity, subject to collateral requirements. The Bank was categorized as well capitalized. Its year-end capital ratios included 11.00% common equity Tier 1, 11.00% Tier 1 risk-based, 11.81% total risk-based, and 9.25% Tier 1 leverage.

Material changes versus 2017

  • Net income increased $2.380 million. Management attributed the improvement chiefly to higher net interest income, lower provision for loan losses, and lower income tax expense, partly offset by higher noninterest expense.
  • The tax comparison was affected by a $871,000 deferred-tax-asset write-down recorded in 2017 following the reduction in the federal corporate tax rate. The 2018 tax rate also benefited from tax-exempt income, including bank-owned life insurance earnings and certain municipal securities.
  • Interest income increased to $26.971 million from $23.665 million, while interest expense rose to $3.795 million from $2.993 million as funding costs and interest-bearing liabilities increased.
  • Nonperforming assets declined to $5.369 million from $6.959 million. Nonaccrual loans fell to $2.939 million from $4.309 million, and net charge-offs decreased to $887,000 from $1.957 million. The allowance for loan losses declined to $4.581 million from $4.752 million.
  • Growth reflected loan and deposit expansion and market-area expansion. Commercial real estate loans were $289.171 million, about 54% of total loans.

Outlook, risks, and other notable items

  • Management described local economic conditions as favorable and expected loan demand to remain stable or increase through 2019. It anticipated continued favorable conditions but provided no quantified earnings or growth guidance. Management cautioned that interest-rate movements are difficult to predict.
  • The company planned further branch activity, including a Lexington branch and relocation of a Charlottesville office, subject to regulatory approval. It generally expected new branches to become profitable within 12 to 18 months, while acknowledging expansion costs and execution risks.
  • Mortgage originations increased to 555 loans totaling $115.331 million from 434 loans totaling $89.522 million. Management expected residential mortgage rates to remain relatively steady in 2019, but noted that higher rates could reduce refinancing and that tax-law changes could affect mortgage demand.
  • Key risks include geographic concentration in the Lynchburg/Region 2000 area; significant commercial real estate exposure and large individual loans; borrower and collateral deterioration; deposit pricing and interest-rate sensitivity; competition; branch expansion; cybersecurity and vendor disruptions; liquidity; and evolving regulation.
  • Available-for-sale securities had $2.842 million of gross unrealized losses at year-end, primarily attributed to higher interest rates. Management said it did not intend, and did not expect to be required, to sell the securities before recovery, but a sale at a loss could affect earnings or capital. Accumulated other comprehensive loss was $2.243 million.
  • Off-balance-sheet commitments included $129.485 million to extend credit and $2.972 million of standby letters of credit. Management did not anticipate material losses. The Bank also had $6.334 million in mortgage rate-lock commitments, with corresponding investor commitments to purchase loans that close.
  • The company adopted the new lease standard on January 1, 2019 and estimated an approximately $3.0 million increase in assets and liabilities. It was assessing the impact of the expected-credit-loss standard (CECL), effective for it in 2020.
  • The independent auditor gave an unqualified opinion on the financial statements. Management concluded internal control over financial reporting was effective; the auditor did not provide an attestation on internal controls.

Important facts for investors to verify

  • Whether loan growth, especially commercial real estate and commercial and industrial lending, is being matched by underwriting quality, collateral support, and adequate reserves.
  • Whether the improvement in earnings persists after separating recurring operating performance from the unusually high 2017 tax expense and the 2018 tax benefits.
  • How deposit costs, deposit mix, and competition affect net interest margin as interest rates and customer funding needs change.
  • The valuation and potential capital impact of unrealized securities losses, and the extent to which securities pledged for deposits or credit facilities limit liquidity.
  • Progress and costs of branch expansion, along with the availability of required regulatory approvals and collateral for disclosed funding capacity.
  • The company’s ability to maintain capital and dividends. The 2018 dividend was $0.24 per share; a fourth-quarter dividend of $0.06 per share was declared in January 2019, subject to the Bank’s regulatory and financial capacity to upstream funds.