Bay Banks of Virginia (BAYK) 10-Q 2014 Q3 Quarterly report

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2014

¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

COMMISSION FILE NUMBER: 0-22955

BAY BANKS OF VIRGINIA, INC.

(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)

VIRGINIA	54-1838100
(STATE OR OTHER JURISDICTION OF INCORPORATION OR ORGANIZATION)	(I.R.S. EMPLOYER IDENTIFICATION NO.)
100 SOUTH MAIN STREET, KILMARNOCK, VA	22482
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES)	(ZIP CODE)

(804) 435-1171

(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 in Rule 12b-2 of the Exchange Act).    ¨  yes    x  no

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date:

4,817,856 shares of common stock on November 4, 2014

FORM 10-Q

For the interim period ending September 30, 2014.

INDEX

PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
CONSOLIDATED BALANCE SHEETS SEPTEMBER 30, 2014 (UNAUDITED) AND DECEMBER 31, 2013		3
CONSOLIDATED STATEMENTS OF INCOME FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2014 AND 2013 (UNAUDITED)		4
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2014 AND 2013 (UNAUDITED)		5
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2014 (UNAUDITED)		5
CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2014 AND 2013 (UNAUDITED)		6
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)		7
ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS		25
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK		31
ITEM 4. CONTROLS AND PROCEDURES		31
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS		31
ITEM 1A. RISK FACTORS		31
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS		31
ITEM 3. DEFAULTS UPON SENIOR SECURITIES		31
ITEM 4. MINE SAFETY DISCLOSURES		31
ITEM 5. OTHER INFORMATION	��	31
ITEM 6. EXHIBITS		32

2

PART I – FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

BAY BANKS OF VIRGINIA, INC.

CONSOLIDATED BALANCE SHEETS

	September 30, 2014			December 31, 2013 (1)
(Dollars in thousands)	(unaudited)
ASSETS
Cash and due from banks	$	4,341		$	6,789
Interest-bearing deposits		6,952			8,900
Federal funds sold		137			120
Securities available for sale, at fair value		36,519			38,522
Restricted securities		1,980			1,638
Loans receivable, net of allowance for loan losses of $3,151 and $2,925		270,980			247,912
Loans held for sale		—			196
Premises and equipment, net		10,868			10,620
Accrued interest receivable		1,060			1,124
Other real estate owned, net		2,839			3,897
Bank owned life insurance		7,284			5,129
Goodwill		2,808			2,808
Mortgage servicing rights		620			579
Other assets		2,346			2,901
Total assets	$	348,734		$	331,135
LIABILITIES
Noninterest-bearing deposits	$	60,334		$	57,805
Savings and interest-bearing demand deposits		118,189			114,056
Time deposits		97,382			96,486
Total deposits		275,905			268,347
Securities sold under repurchase agreements		6,978			9,118
Federal Home Loan Bank advances		25,000			15,000
Other liabilities		1,785			1,534
Total liabilities		309,668			293,999
SHAREHOLDERS’ EQUITY
Common stock ($5 par value; authorized - 10,000,000 shares; outstanding - 4,818,733 and 4,817,856 shares, respectively)		24,094			24,089
Additional paid-in capital		2,772			2,757
Retained earnings		12,695			11,463
Accumulated other comprehensive loss, net		(495	)		(1,173	)
Total shareholders’ equity		39,066			37,136
Total liabilities and shareholders’ equity	$	348,734		$	331,135

(1) Derived from the audited consolidated financial statements.

See Notes to Consolidated Financial Statements.

3

BAY BANKS OF VIRGINIA, INC.

CONSOLIDATED STATEMENTS OF INCOME

(unaudited)

	For the three months ended						For the nine months ended
(Dollars in thousands except per share amounts)	September 30, 2014			September 30, 2013			September 30, 2014			September 30, 2013
INTEREST INCOME
Loans, including fees	$	3,323		$	3,182		$	9,763		$	9,471
Securities:
Taxable		93			104			272	��		345
Tax-exempt		92			101			286			226
Interest-bearing deposit accounts		7			13			15			49
Total interest income		3,515			3,400			10,336			10,091
INTEREST EXPENSE
Deposits		456			582			1,363			1,814
Federal funds purchased		—			—			1			—
Securities sold under repurchase agreements		3			3			7			13
FHLB advances		76			103			261			348
Total interest expense		535			688			1,632			2,175
Net interest income		2,980			2,712			8,704			7,916
Provision for loan losses		190			304			452			566
Net interest income after provision for loan losses		2,790			2,408			8,252			7,350
NON-INTEREST INCOME
Income from fiduciary activities		193			166			580			493
Service charges and fees on deposit accounts		249			270			736			811
VISA-related fees		60			252			210			658
Other service charges and fees		343			399			850			875
Secondary market lending income		213			665			392			966
Increase in cash surrender value of life insurance		64			47			155			82
Net (losses) gains on sale of securities available for sale		(8	)		13			(25	)		284
Loss on securities with other-than-temporary impairment		—			—			—			(168	)
Portion of loss recognized in other comprehensive income		—			—			—			48
Net impairment recognized in income		—			—			—			(120	)
Other real estate losses		(60	)		(240	)		(279	)		(494	)
Net (losses) gains on sale of fixed assets		(2	)		165			136			165
Other income		18			8			52			34
Total non-interest income		1,070			1,745			2,807			3,754
NON-INTEREST EXPENSES
Salaries and employee benefits		1,653			1,604			4,837			4,941
Occupancy expense		356			324			1,068			984
Software maintenance		116			134			391			391
Bank franchise tax		47			44			141			132
VISA expense		26			213			134			558
Telephone expense		52			50			160			152
FDIC assessments		63			105			201			311
Foreclosure property expense		46			34			105			96
Consulting expense		75			98			244			143
Other expense		743			700			2,171			2,046
Total non-interest expenses		3,177			3,306			9,452			9,754
Net income before income taxes		683			847			1,607			1,350
Income tax expense		171			227			375			358
Net income	$	512		$	620		$	1,232		$	992
Basic Earnings Per Share
Average basic shares outstanding		4,818,733			4,817,856			4,818,454			4,816,523
Earnings per share, basic	$	0.11		$	0.13		$	0.26		$	0.21
Diluted Earnings Per Share
Average diluted shares outstanding		4,828,285			4,820,172			4,831,055			4,818,903
Earnings per share, diluted	$	0.11		$	0.13		$	0.26		$	0.21

See Notes to Consolidated Financial Statements.

4

BAY BANKS OF VIRGINIA, INC.

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(unaudited)

	For the three months ended						For the nine months ended
(Dollars in thousands)	September 30, 2014			September 30, 2013			September 30, 2014			September 30, 2013
Net income	$	512		$	620		$	1,232		$	992
Other comprehensive income (loss):
Unrealized gains (losses) on securities:
Unrealized holding gains (losses) arising during the period		177			(125	)		1,002			(1,442	)
Deferred tax (expense) benefit		(60	)		43			(340	)		490
Reclassification of net securities losses (gains) and impairments recognized in net income		8			(13	)		25			(164	)
Deferred tax (benefit) expense		(3	)		4			(9	)		56
Unrealized gains (losses) adjustment, net of tax		122			(91	)		678			(1,060	)
Defined benefit pension plan:
Net periodic pension (benefit) cost		(6	)		22			(17	)		67
Net pension gain (loss)		6			(22	)		17			(67	)
Deferred tax benefit		—			—			—			—
Defined benefit pension plan adjustment, net of tax		—			—			—			—
Post retirement benefit plan:
Net periodic cost		11			1			34			3
Net loss		(11	)		(1	)		(34	)		(3	)
Deferred tax benefit		—			—			—			—
Post retirement benefit plan adjustment, net of tax		—			—			—			—
Total other comprehensive income (loss)		122			(91	)		678			(1,060	)
Comprehensive income (loss)	$	634		$	529		$	1,910		$	(68	)

See Notes to Consolidated Financial Statements.

BAY BANKS OF VIRGINIA, INC.

CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY

(unaudited)

(Dollars in thousands, except share data or amounts)	Shares of Common Stock		Common Stock		Additional Paid-in Capital		Retained Earnings		Accumulated Other Comprehensive Loss			Total Shareholders’ Equity
Nine Months ended September 30, 2014
Balance at beginning of period		4,817,856	$	24,089	$	2,757	$	11,463	$	(1,173	)	$	37,136
Net income		—		—		—		1,232		—			1,232
Other comprehensive income		—		—		—		—		678			678
Stock-based compensation expense		877		5		15		—		—			20
Balance at end of period		4,818,733	$	24,094	$	2,772	$	12,695	$	(495	)	$	39,066

See Notes to Consolidated Financial Statements.

5

BAY BANKS OF VIRGINIA, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

	Nine Months Ended September 30,
	2014			2013
Cash Flows From Operating Activities
Net income	$	1,232		$	992
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation		573			567
Net amortization and accretion of securities		281			295
Provision for loan losses		452			566
Stock compensation expense		20			122
Deferred income tax benefit		—			(7	)
Loss (gain) on securities available-for-sale		25			(284	)
Impairment loss on securities available-for-sale		—			120
Increase in OREO valuation allowance		187			249
Loss on sale of other real estate		92			245
Gain on disposal of fixed assets		(136	)		(165	)
Mortgage servicing rights		(41	)		(535	)
Loan originations for sale to FNMA		(8,306	)		(19,118	)
Loan sales to FNMA		8,706			19,691
Gain on loans sold to FNMA		(204	)		(335	)
Increase in cash surrender value of life insurance		(155	)		(82	)
Decrease (increase) in accrued income and other assets		404			(226	)
(Decrease) increase in other liabilities		(99	)		881
Net cash provided by operating activities		3,031			2,976
Cash Flows From Investing Activities
Proceeds from maturities and principal paydowns of available-for-sale securities		3,888			2,774
Proceeds from sales and calls of available-for-sale securities		3,810			9,433
Purchase of bank owned life insurance		(2,000	)		(5,000	)
Purchases of available-for-sale securities		(4,974	)		(17,199	)
Purchases of restricted securities		(342	)		(38	)
Increase in federal funds sold		(17	)		(449	)
Loan (originations) and principal collections, net		(23,112	)		(13,018	)
Proceeds from sale of other real estate		371			1,076
Purchases of premises and equipment		(780	)		(402	)
Proceeds from the sale of premises and equipment		311			727
Net cash used in investing activities		(22,845	)		(22,096	)
Cash Flows From Financing Activities
Increase in demand, savings, and other interest-bearing deposits		6,662			4,006
Net increase (decrease) in time deposits		896			(7,217	)
Net (decrease) increase in securities sold under repurchase agreements		(2,140	)		2,971
Increase in Federal Home Loan Bank advances		10,000			—
Net cash provided by (used in) financing activities		15,418			(240	)
Net decrease in cash and due from banks		(4,396	)		(19,360	)
Cash and due from banks at beginning of period		15,689			39,924
Cash and due from banks at end of period	$	11,293		$	20,564
Supplemental Schedule of Cash Flow Information
Cash paid for:
Interest	$	1,665		$	2,159
Income taxes		341			212
Non-cash investing and financing:
Unrealized gain (loss) on investment securities		1,027			(1,606	)
Change in fair value of pension and post-retirement obligation		—			—
Loans transferred to other real estate owned		197			2,313
Loans originated to facilitate sale of OREO		605			204
Changes in deferred taxes resulting from OCI transactions		349			546

See Notes to Consolidated Financial Statements.

6

Notes to Consolidated Financial Statements (Unaudited)

Note 1: General

Bay Banks of Virginia, Inc. (the “Company”) owns 100% of the Bank of Lancaster (the “Bank”), 100% of Bay Trust Company, Inc. (the “Trust Company”) and 100% of Steptoes Holdings, LLC (“Steptoes Holdings”). The consolidated financial statements include the accounts of the Bank, the Trust Company, Steptoes Holdings and Bay Banks of Virginia, Inc.

The accounting and reporting policies of the Company conform to accounting principles generally accepted in the United States of America (“GAAP”) and to the general practices within the banking industry. In management’s opinion, all adjustments, consisting only of normal recurring adjustments necessary for a fair presentation of the consolidated financial statements, have been included. The results of operations for the interim periods are not necessarily indicative of the results to be expected for the full year or for any other interim periods. These consolidated financial statements should be read in conjunction with the consolidated financial statements and notes to the consolidated financial statements included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2013.

Certain amounts presented in the consolidated financial statements of prior periods have been reclassified to conform to current year presentations. The reclassifications had no effect on net income, net income per share or shareholders’ equity as previously reported.

Note 2: Significant Accounting Policies

Loans

The Company grants mortgage loans on real estate; commercial and industrial loans; and consumer and other loans to customers. A substantial portion of the loan portfolio is represented by mortgage loans on real estate. The ability of the Company’s debtors to honor their contracts is dependent upon the real estate and general economic conditions in the Company’s market areas.

Loans are reported at their recorded investment, which is the outstanding principal balance net of any unearned income, such as deferred fees and costs, and charge-offs. Interest on loans is recognized over the term of the loan and is calculated using the interest method on principal amounts outstanding. Loan origination fees and certain direct origination costs are deferred and recognized as an adjustment of the related loan yield over the contractual term of the loan, adjusted for early pay-offs, where applicable.

The accrual of interest is generally discontinued at the time a loan is 90 days or more past due, or earlier, if collection is uncertain based on an evaluation of the net realizable value of the collateral and the financial strength of the borrower. Payments received for loans no longer accruing interest are applied to the unpaid principal balance. Loans greater than 90 days past due may remain on accrual status if the credit is well-secured and in process of collection. Credit card loans and other personal loans are typically charged off no later than 180 days past due. Past due status is based on the contractual terms of the loan. In all cases, loans are charged off at an earlier date if collection of principal or interest is considered doubtful. Nonaccrual and past due policies are materially the same for all types of loans.

All interest accrued but not collected for loans that are placed on non-accrual or charged off is reversed against interest income. Any interest received on these loans is accounted for on the cash basis or cost recovery method until qualifying for return to accrual. Generally, a loan is returned to accrual status when all the principal and interest amounts contractually due are brought current and future payments are reasonably assured, or it becomes well secured and in the process of collection.

Allowance for loan losses (“ALL”)

The ALL reflects management’s judgment of probable loan losses inherent in the portfolio at the balance sheet date. Management uses a disciplined process and methodology to establish the ALL each quarter. To determine the total ALL, the Company estimates the reserves needed for each segment of the portfolio, including loans analyzed individually and homogenous pools of loans analyzed on a segmented basis. Considerations include historical experience, the nature and volume of the loan portfolio, adverse situations that may affect a borrower’s ability to repay, estimated value of any underlying collateral, prevailing local and national economic conditions, and internal policies and procedures including credit risk management and underwriting. This evaluation is inherently subjective, as it requires estimates that are susceptible to significant revision as additional information becomes available.

The ALL calculation methodology’s historical loss factor period is considered the length of a business cycle. The business cycle, upon which the historical loss factor is based, was believed to have begun in the fourth quarter of 2008. During the third quarter of 2013, management determined that the business cycle had ended given noticeable national economic improvement and local real estate market stabilization. The historical loss factor is now based on that business cycle of 19 quarters, compared to the previous averaging period that had been growing each quarter based on the business cycle that began in 2008. The change in methodology during the third quarter of 2013 produced an immaterial change in the ALL calculation.

Management employs a risk rating system to evaluate and consistently categorize loan portfolio credit risk. Loans assigned risk rating grades include all commercial loans not secured by real estate, commercial mortgages, residential mortgages greater than $1 million, smaller residential mortgages which are impaired, loans to real estate developers and contractors, consumer loans greater than $250 thousand with chronic delinquency, and troubled debt restructures. The grading analysis estimates the capability of the borrower to repay the contractual obligations of the loan agreements as scheduled. Risk grades are evaluated as new information becomes available for each borrowing relationship or at least quarterly. All other loans not specifically assigned a risk rating grade are monitored as a discrete pool of loans generally based on delinquency status. Risk rating categories are as follows:

7

Pass – Borrower is strong or sound and collateral securing the loan, if any, is adequate.

Watch – Borrower exhibits some signs of financial stress but is generally believed to be a satisfactory customer and collateral, if any, may be in excess of 90% of the loan balance.

Special Mention – Adverse trends in the borrower’s financial position are evident and warrant management’s close attention and any collateral may not be fully adequate to secure loan balance.

Substandard – A loan in this category has a well-defined weakness in the primary repayment source that jeopardizes the timely collection of the debt. There is a distinct possibility that a loss may result if the weakness is not corrected.

Doubtful – Default has already occurred and it is likely that foreclosure or repossession procedures have begun or will begin in the near future. Weaknesses make collection or liquidation in full, based on currently existing information, highly questionable and improbable.

Loss – Uncollectible and of such little value that continuance as a bankable asset is not warranted.

The ALL consists of specific, general, and unallocated components. The specific component is determined by identifying impaired loans (as described below) then evaluating each one to calculate the amount of impairment. Impaired loans measured for impairment generally include: (1) non-accruing Special mention, Substandard and Doubtful loans in excess of $250,000; (2) Substandard and Doubtful loans in excess of $500,000; (3) Special Mention loans in excess of $500,000 if any of the loans in the relationship are more than 30 days past due or if the borrower has filed for bankruptcy; and (4) all troubled debt restructurings (“TDRs”). A specific allowance arises when the discounted cash flows (or collateral value or observable market price) of the impaired loan is lower than the carrying value of that loan. The general component collectively evaluates smaller commercial loans, residential mortgages and consumer loans, grouped into segments and classes. Historical loss experience is calculated and applied to each segment or class, then adjusted for qualitative factors. Qualitative factors include changes in the local and national economic outlook, including unemployment, interest rates, inflation rates and real estate trends; the level and trend of past due and nonaccrual loans; strength of policies and procedures; and oversight of credit risk and quality of underwriting. These qualitative adjustments reflect management’s judgment of risks inherent in the segments. An unallocated component is maintained if needed to cover uncertainties that could affect management’s estimate of probable losses. The unallocated component of the allowance reflects the margin of imprecision inherent in the underlying assumptions used in the methodologies for estimating specific and general losses in the portfolio. Changes in the allowance for loan losses and the related provision expense can materially affect net income.

The specific component of the ALL calculation accounts for the loan loss reserve necessary on impaired loans. A loan is considered impaired when, based on current information and events, it is probable that the Company will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. Factors considered by management in determining impairment include payment status, collateral value, and the probability of collecting scheduled principal and interest payments when due. Loans that experience insignificant payment delays and payment shortfalls generally are not considered impaired. Management determines the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrower’s prior payment record, and the amount of the shortfall in relation to the principal and interest owed. Accrual of interest may or may not be discontinued for any given impaired loan. Impairment is measured by either the present value of expected future cash flows discounted at the loan’s effective interest rate, the loan’s obtainable market price, or the fair value of the collateral if the loan is collateral dependent. Because large groups of smaller balance homogeneous loans are collectively evaluated for impairment, the Company does not generally separately identify smaller balance individual consumer and residential loans for impairment disclosures, unless such loans are the subject of a troubled debt restructuring agreement.

The general component of the ALL calculation collectively evaluates groups of loans in segments or classes, as noted above. The segments are: (1) Mortgage loans on real estate; (2) Commercial and industrial loans; and (3) Consumer and other loans. The segment for Mortgage loans on real estate is disaggregated into the following classes: (1) Construction, land and land development; (2) Farmland; (3) Residential first mortgages; (4) Residential revolving and junior mortgages; (5) Commercial mortgages (non-owner-occupied); and (6) Commercial mortgages (owner-occupied). Every loan is assigned to a segment or a class. Loans in segment 1 are secured by real estate. Loans in segments 2 and 3 are secured by other types of collateral or are unsecured. A given segment or class may not reflect the purpose of a loan. For example, a business owner may provide his residence as collateral for a loan to his company, in which case the loan would be grouped in a residential mortgage class. Historical loss factors are calculated for the prior 19 quarters by segment and class, and then applied to the current balances in each segment and class. Finally, qualitative factors are applied to each segment and class.

Construction and development loans carry risks that the project will not be finished according to schedule or according to budget and the value of the collateral, at any point in time, may be less than the principal amount of the loan. These loans also bear the risk that the general contractor may face financial pressure unrelated to the project. Loans secured by land, farmland and residential mortgages carry the risk of continued credit-worthiness of the borrower and changes in value of the underlying real estate collateral. Commercial mortgages and commercial and industrial loans carry risks associated with the profitable operation of a business and its related cash flows. Additionally, commercial and industrial loans carry risks associated with the value of collateral other than real estate which may depreciate over time. Consumer loans carry risks associated with the continuing credit-worthiness of the borrower and are more likely than real estate loans to be adversely affected by divorce, unemployment, personal illness or bankruptcy of an individual. Consumer loans secured by automobiles carry risks associated with rapidly depreciating collateral. Consumer loans include credit cards.

The summation of the specific, general and unallocated components results in the total estimated ALL. Management may also include an unallocated component to cover uncertainties in the level of probable losses. This estimate is inherently subjective and actual losses could be greater or less than the estimates.

8

Additions to the ALL are made by charges to earnings through the provision for loan losses. Charge-offs result from credit exposures deemed to be uncollectible and the ALL is reduced by these. Recoveries of previously charged off amounts are credited back to the ALL. Charge-off policies are materially the same for all types of loans.

Mortgage servicing rights (“MSRs”)

MSRs are included on the consolidated balance sheet and recorded at fair value on an ongoing basis. Changes in the fair value of the MSRs are recorded in the results of operations. A fair value analysis of MSRs is performed on a quarterly basis.

Note 3: Amendments to the Accounting Standards Codification

In January 2014, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2014-04, “Receivables – Troubled Debt Restructurings by Creditors (Subtopic 310-4): Reclassification of Residential Real Estate Collateralized Consumer Mortgage Loans upon Foreclosure.” The amendment clarifies 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, either upon (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. The amendment also requires 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. Companies should apply this amendment for fiscal years and interim periods beginning after December 15, 2014. The Company adopted the new guidance during the first quarter of 2014. The adoption did not have a material impact on the Company’s consolidated financial statements. Disclosures are included in Note 6.

In May 2014, the FASB issued ASU 2014-09, “Revenue from Contracts with Customers” (Topic 606). The amendments in this ASU modify the guidance companies use to recognize revenue from contracts with customers for transfers of goods or services and transfers of nonfinancial assets, unless those contracts are within the scope of other standards. The ASU requires that entities apply a specific method to recognize revenue reflecting the consideration expected from customers in exchange for the transfer of goods and services. The guidance also requires new qualitative and quantitative disclosures, including information about contract balances and performance obligations. Entities are also required to disclose significant judgments and changes in judgments for determining the satisfaction of performance obligations. Most revenue associated with financial instruments, including interest and loan origination fees, is outside the scope of the guidance. This ASU is effective for annual periods and interim periods within those annual periods beginning after December 15, 2016, with early adoption prohibited. The Company is evaluating the impact that ASU 2014-09 will have on its consolidated financial statements.

Note 4: Securities

The aggregate amortized costs and fair values of the available-for-sale securities portfolio are as follows:

(Dollars in thousands) Available-for-sale securities September 30, 2014	Amortized Cost		Gross Unrealized Gains		Gross Unrealized (Losses)			Fair Value
U.S. Government agencies	$	11,452	$	7	$	(59	)	$	11,400
State and municipal obligations		23,255		189		(316	)		23,128
Certificates of deposits		1,984		9		(2	)		1,991
	$	36,691	$	205	$	(377	)	$	36,519
Available-for-sale securities December 31, 2013	Amortized Cost		Gross Unrealized Gains		Gross Unrealized (Losses)			Fair Value
U.S. Government agencies	$	9,383	$	11	$	(86	)	$	9,308
State and municipal obligations		27,690		109		(1,242	)		26,557
Certificates of deposits		1,736		9		—			1,745
Auction rate security		912		—		—			912
	$	39,721	$	129	$	(1,328	)	$	38,522

9

Gross realized gains and gross realized losses on sales and calls of securities were as follows:

	For the three months ended September 30,					For the nine months ended September 30,
(Dollars in thousands)	2014			2013		2014			2013
Gross realized gains	$	3		$	13	$	8		$	285
Gross realized losses		(11	)		—		(33	)		(1	)
Net realized (losses) gains	$	(8	)	$	13	$	(25	)	$	284
Aggregate proceeds	$	479		$	1,173	$	3,810		$	9,433

Average yields (taxable equivalent) on securities were 2.43% and 2.40% for the three months ended September 30, 2014 and 2013, respectively, and 2.39% and 2.28% for the nine months ended September 30, 2014 and 2013, respectively.

Securities with a market value of $11.3 million and $12.9 million were pledged as collateral for repurchase agreements and for other purposes as required by law as of September 30, 2014 and December 31, 2013, respectively.

Securities in an unrealized loss position at September 30, 2014 and December 31, 2013, by duration of the unrealized loss, are shown below. The unrealized loss positions were directly related to interest rate movements as there is minimal credit risk exposure in these investments. All agency securities, states and municipal securities and certificates of deposit are investment grade or better and their losses are considered temporary. Management does not intend to sell the securities and does not expect to be required to sell the securities. Furthermore, all amortized cost bases are expected to be recovered. Bonds with unrealized loss positions at September 30, 2014 included 21 federal agencies and 36 municipals. Bonds with unrealized loss positions at December 31, 2013 included 15 federal agencies and 50 municipals. The tables are shown below.

	Less than 12 months				12 months or more				Total
(Dollars in thousands) September 30, 2014	Fair Value		Unrealized Loss		Fair Value		Unrealized Loss		Fair Value		Unrealized Loss
U.S. Government agencies	$	4,247	$	6	$	4,640	$	53	$	8,887	$	59
States and municipal obligations		153		1		10,979		315		11,132		316
Certificates of deposits		246		2		—		—		246		2
Total temporarily impaired securities	$	4,646	$	9	$	15,619	$	368	$	20,265	$	377
	Less than 12 months				12 months or more				Total
December 31, 2013	Fair Value		Unrealized Loss		Fair Value		Unrealized Loss		Fair Value		Unrealized Loss
U.S. Government agencies	$	4,808	$	66	$	1,462	$	20	$	6,270	$	86
States and municipal obligations		14,255		1,120		2,306		122		16,561		1,242
Total temporarily impaired securities	$	19,063	$	1,186	$	3,768	$	142	$	22,831	$	1,328

The Company’s investment in Federal Home Loan Bank of Atlanta (“FHLB”) stock totaled $1,421,400 and $1,079,800 at September 30, 2014 and December 31, 2013, respectively. The Company also had an investment in Federal Reserve Bank of Richmond (“FRB”) stock which totaled $382 thousand at both September 30, 2014 and December 31, 2013. The investments in both FHLB and FRB stock are required investments related to the Bank’s membership with the FHLB and FRB. These securities do not have a readily determinable fair value as their ownership is restricted, and they lack an active market for trading. Additionally, per charter relations to the FHLB and FRB stock, all repurchase transactions of such stock must occur at par. Accordingly, these securities are carried at cost, and are periodically evaluated for impairment. The Company’s determination as to whether its investment in FHLB and FRB stock is impaired is based on management’s assessment of the ultimate recoverability of its par value rather than recognizing temporary declines in its value. The determination of whether the decline affects the ultimate recoverability of the investments is influenced by available information regarding various factors. These factors include, among others, the significance of the decline in net assets of the issuing banks as compared to the capital stock amount reported by these banks, and the length of time a decline has persisted; commitments by such banks to make payments required by law or regulation and the level of such payments in relation to the operating performance of the issuing bank; and the overall liquidity position of the issuing bank. Based on its most recent analysis of publicly available information regarding the financial condition of the issuing banks, management concluded that no impairment existed in the carrying value of this stock.

10

Note 5: Loans

The following is a summary of the balances of loans:

(Dollars in thousands)	September 30, 2014			December 31, 2013
Mortgage loans on real estate:
Construction, Land and Land Development	$	35,553		$	31,839
Farmland		1,151			1,262
Commercial Mortgages (Non-Owner Occupied)		17,568			14,626
Commercial Mortgages (Owner Occupied)		32,672			34,177
Residential First Mortgages		124,425			114,458
Residential Revolving and Junior Mortgages		25,396			24,045
Commercial and Industrial loans		31,628			23,938
Consumer Loans		5,302			5,986
Total loans	$	273,695		$	250,331
Net unamortized deferred loans costs		436			506
Allowance for loan losses		(3,151	)		(2,925	)
Loans, net	$	270,980		$	247,912

The recorded investment in past due and non-accruing loans is shown in the following table. A loan past due by more than 90 days is generally placed on nonaccrual unless it is both well secured and in the process of collection.

(Dollars in thousands) Loans Past Due and Nonaccruals September 30, 2014	30-89 Days Past Due		90 Days or More Past Due and Still Accruing		Nonaccruals		Total Past Due and Nonaccruals		Current		Total Loans
Construction, Land and Land Development	$	294	$	—	$	832	$	1,126	$	34,427	$	35,553
Farmland		—		—		—		—		1,151		1,151
Commercial Mortgages (Non-Owner Occupied)		74		—		—		74		17,494		17,568
Commercial Mortgages (Owner Occupied)		—		—		571		571		32,101		32,672
Residential First Mortgages		1,886		—		402		2,288		122,137		124,425
Residential Revolving and Junior Mortgages		127		—		80		207		25,189		25,396
Commercial and Industrial		20		—		228		248		31,380		31,628
Consumer Loans		89		38		82		209		5,093		5,302
Total	$	2,490	$	38	$	2,195	$	4,723	$	268,972	$	273,695
Loans Past Due and Nonaccruals December 31, 2013	30-89 Days Past Due		90 Days or More Past Due and Still Accruing		Nonaccruals		Total Past Due and Nonaccruals		Current		Total Loans
Construction, Land and Land Development	$	65	$	—	$	854	$	919	$	30,920	$	31,839
Farmland		—		—		—		—		1,262		1,262
Commercial Mortgages (Non-Owner Occupied)		—		—		—		—		14,626		14,626
Commercial Mortgages (Owner Occupied)		—		—		427		427		33,750		34,177
Residential First Mortgages		668		—		1,083		1,751		112,707		114,458
Residential Revolving and Junior Mortgages		108		—		76		184		23,861		24,045
Commercial and Industrial		16		—		311		327		23,611		23,938
Consumer Loans		60		19		3		82		5,904		5,986
Total	$	917	$	19	$	2,754	$	3,690	$	246,641	$	250,331

11

Note 6: Allowance for Loan Losses

Allowance for Loan Losses

A disaggregation of and an analysis of the change in the allowance for loan losses by segment is shown below.

(Dollars in thousands)	Mortgage Loans on Real Estate			Commercial and Industrial			Consumer Loans			Total
For the Three Months Ended September 30, 2014
ALLOWANCE FOR LOAN LOSSES:
Beginning Balance	$	2,589		$	211		$	173		$	2,973
(Charge-offs)		(10	)		—			(22	)		(32	)
Recoveries		15			—			5			20
Provision		109			91			(10	)		190
Ending Balance	$	2,703		$	302		$	146		$	3,151
Individually evaluated for impairment	$	723		$	—		$	11		$	734
Collectively evaluated for impairment		1,980			302			135			2,417
	Mortgage Loans on Real Estate			Commercial and Industrial			Consumer Loans			Total
For the Three Months Ended September 30, 2013
ALLOWANCE FOR LOAN LOSSES:
Beginning Balance	$	2,461		$	250		$	272		$	2,983
(Charge-offs)		(264	)		—			(50	)		(314	)
Recoveries		4			2			0			6
Provision		225			61			18			304
Ending Balance	$	2,426		$	313		$	240		$	2,979
Individually evaluated for impairment	$	574		$	—		$	33		$	607
Collectively evaluated for impairment		1,852			313			207			2,372
(Dollars in thousands)	Mortgage Loans on Real Estate			Commercial and Industrial			Consumer Loans			Total
For the Nine Months Ended September 30, 2014
ALLOWANCE FOR LOAN LOSSES:
Beginning Balance	$	2,465		$	256		$	204		$	2,925
(Charge-offs)		(224	)		—			(43	)		(267	)
Recoveries		29			—			12			41
Provision		433			46			(27	)		452
Ending Balance	$	2,703		$	302		$	146		$	3,151
	Mortgage Loans on Real Estate			Commercial and Industrial			Consumer Loans			Total
For the Nine Months Ended September 30, 2013
ALLOWANCE FOR LOAN LOSSES:
Beginning Balance	$	2,579		$	262		$	252		$	3,093
(Charge-offs)		(629	)		(17	)		(105	)		(751	)
Recoveries		64			2			5			71
Provision		412			66			88			566
Ending Balance	$	2,426		$	313		$	240		$	2,979

12

Loan receivables evaluated for impairment individually and collectively by segment as of September 30, 2014 and December 31, 2013 are as follows:

(Dollars in thousands)	Mortgage Loans on Real Estate		Commercial and Industrial		Consumer Loans		Total
As of September 30, 2014
Individually evaluated for impairment	$	6,425	$	—	$	17	$	6,442
Collectively evaluated for impairment		230,340		31,628		5,285		267,253
Total Gross Loans	$	236,765	$	31,628	$	5,302	$	273,695
As of December 31, 2013
Individually evaluated for impairment	$	6,306	$	311	$	39	$	6,656
Collectively evaluated for impairment		214,101		23,627		5,947		243,675
Total Gross Loans	$	220,407	$	23,938	$	5,986	$	250,331

Internal Risk Rating Grades

Internal risk rating grades are generally assigned to commercial loans not secured by real estate, commercial mortgages, residential mortgages greater than $1 million, smaller residential mortgages which are impaired, loans to real estate developers and contractors, consumer loans greater than $250,000 with chronic delinquency, and TDRs, as shown in the following table. The grading analysis estimates the capability of the borrower to repay the contractual obligations of the loan agreements as scheduled. Risk grades (refer to Note 2) are evaluated as new information becomes available for each borrowing relationship or at least quarterly.

(Dollars in thousands) As of September 30, 2014 INTERNAL RISK RATING GRADES	Construction, Land and Land Development		Farmland		Commercial Mortgages (Non-Owner Occupied)		Commercial Mortgages (Owner Occupied)		Commercial and Industrial		Total
Grade:
Pass	$	29,485	$	1,151	$	13,079	$	23,176	$	28,291	$	95,182
Watch		3,371		—		4,151		4,424		2,383		14,329
Special mention		1,406		—		—		3,176		639		5,221
Substandard		1,291		—		338		1,896		315		3,840
Doubtful		—		—		—		—		—		—
Total	$	35,553	$	1,151	$	17,568	$	32,672	$	31,628	$	118,572
As of December 31, 2013 INTERNAL RISK RATING GRADES	Construction, Land and Land Development		Farmland		Commercial Mortgages (Non-Owner Occupied)		Commercial Mortgages (Owner Occupied)		Commercial and Industrial		Total
Grade:
Pass	$	25,616	$	1,262	$	9,083	$	23,984	$	20,309	$	80,254
Watch		3,493		—		5,204		7,429		2,743		18,869
Special mention		1,416		—		—		1,001		487		2,904
Substandard		1,314		—		339		1,763		399		3,815
Doubtful		—		—		—		—		—		—
Total	$	31,839	$	1,262	$	14,626	$	34,177	$	23,938	$	105,842

Loans not assigned internal risk rating grades are comprised of smaller residential mortgages and smaller consumer loans. Payment activity of these loans is reviewed monthly by management. However, some of these loans are graded when the borrower’s total exposure to the Bank exceeds the limits noted above. Loans are considered to be nonperforming when they are delinquent by 90 days or more or non-accruing and credit risk is primarily evaluated by delinquency status, as shown in the table below.

(Dollars in thousands) As of September 30, 2014 PAYMENT ACTIVITY STATUS	Residential First Mortgages (1)		Residential Revolving and Junior Mortgages (2)		Consumer Loans (3)		Total
Performing	$	124,023	$	25,316	$	5,182	$	154,521
Nonperforming		402		80		120		602
Total	$	124,425	$	25,396	$	5,302	$	155,123
As of December 31, 2013 PAYMENT ACTIVITY STATUS	Residential First Mortgages (4)		Residential Revolving and Junior Mortgages (5)		Consumer Loans (6)		Total
Performing	$	113,375	$	23,969	$	5,964	$	143,308
Nonperforming		1,083		76		22		1,181
Total	$	114,458	$	24,045	$	5,986	$	144,489

13

(1) Residential First Mortgages which have been assigned a risk rating grade of Substandard totaled $2.5 million as of September 30, 2014.

(2) Residential Revolving and Junior Mortgages which have been assigned a risk rating grade of Substandard totaled $219 thousand as of September 30, 2014.

(3) Consumer Loans which have been assigned a risk rating grade of Substandard totaled $6 thousand as of September 30, 2014.

(4) Residential First Mortgages which have been assigned a risk rating grade of Substandard totaled $2.6 million as of December 31, 2013.

(5) Residential Revolving and Junior Mortgages which have been assigned a risk rating grade of Substandard totaled $216 thousand as of December 31, 2013.

(6) Consumer Loans which have been assigned a risk rating grade of Substandard totaled $9 thousand as of December 31, 2013.

Impaired Loans

The following tables show the Company’s recorded investment and the customers’ unpaid principal balances for impaired loans, with the associated allowance amount, if applicable, as of September 30, 2014 and December 31, 2013, along with the average recorded investment and interest income recognized for the three and nine months ended September 30, 2014 and 2013.

	As of September 30, 2014						As of December 31, 2013
(Dollars in thousands) IMPAIRED LOANS	Recorded Investment		Customers’ Unpaid Principal Balance		Related Allowance		Recorded Investment		Customers’ Unpaid Principal Balance		Related Allowance
With no related allowance:
Construction, land & land development	$	451	$	452	$	—	$	453	$	453	$	—
Residential First Mortgages		1,037		1,051		—		1,053		1,057		—
Residential Revolving and Junior Mortgages (1)		—		—		—		—		—		—
Commercial Mortgages (Non-owner occupied)		264		264		—		264		264		—
Commercial Mortgages (Owner occupied)		1,899		1,924		—		1,831		1,840		—
Commercial & industrial		—		—		—		311		311		—
Consumer (2)		6		6		—		—		—		—
		3,657		3,697		—		3,912		3,925		—
With an allowance recorded:
Construction, land & land development		423		447		205		151		156		51
Residential First Mortgages		2,178		2,178		435		2,198		2,198		409
Residential Revolving and Junior Mortgages (1)		173		173		83		251		879		173
Commercial Mortgages (Non-owner occupied)		—		—		—		—		—		—
Commercial Mortgages (Owner occupied)		—		—		—		105		105		1
Commercial & industrial		—		—		—		—		—		—
Consumer (2)		11		11		11		39		39		33
		2,785		2,809		734		2,744		3,377		667
Total Impaired Loans:
Construction, land & land development		874		899		205		604		609		51
Residential First Mortgages		3,215		3,229		435		3,251		3,255		409
Residential Revolving and Junior Mortgages (1)		173		173		83		251		879		173
Commercial Mortgages (Non-owner occupied)		264		264		—		264		264		—
Commercial Mortgages (Owner occupied)		1,899		1,924		—		1,936		1,945		1
Commercial & industrial		—		—		—		311		311		—
Consumer (2)		17		17		11		39		39		33
	$	6,442	$	6,506	$	734	$	6,656	$	7,302	$	667

(1) Junior mortgages include equity lines.

(2) Includes credit cards.

14

	For the Three Months Ended September 30, 2014				For the Three Months Ended September 30, 2013
(Dollars in thousands)	Average Recorded Investment		Interest Income Recognized		Average Recorded Investment		Interest Income Recognized
With no related allowance:
Construction, land & land development	$	451	$	1	$	233	$	7
Residential First Mortgages		1,038		10		2,402		27
Residential Revolving and Junior Mortgages (1)		—		—		98		1
Commercial Mortgages (Non-owner occupied)		264		4		132		4
Commercial Mortgages (Owner occupied)		1,905		19		1,805		30
Consumer (2)		6		—		—		—
		3,664		34		4,670		69
With an allowance recorded:
Construction, land & land development		426		1		—		—
Residential First Mortgages		2,181		26		2,051		34
Residential Revolving and Junior Mortgages (1)		173		2		267		2
Commercial Mortgages (Non-owner occupied)		—		—		—		—
Commercial Mortgages (Owner occupied)		—		—		—		—
Consumer (2)		21		1		56		1
		2,801		30		2,374		37
Total
Construction, land & land development		877		2		233		7
Residential First Mortgages		3,219		36		4,453		61
Residential Revolving and Junior Mortgages (1)		173		2		365		3
Commercial Mortgages (Non-owner occupied)		264		4		132		4
Commercial Mortgages (Owner occupied)		1,905		19		1,805		30
Consumer (2)		27		1		56		1
	$	6,465	$	64	$	7,044	$	106

(1) Junior mortgages include equity lines.

(2) Includes credit cards.

15

	For the Nine Months Ended September 30, 2014				For the Nine Months Ended September 30, 2013
(Dollars in thousands)	Average Recorded Investment		Interest Income Recognized		Average Recorded Investment		Interest Income Recognized
With no related allowance:
Construction, land & land development	$	452	$	2	$	123	$	7
Residential First Mortgages		1,043		31		1,930		69
Residential Revolving and Junior Mortgages (1)		—		—		98		1
Commercial Mortgages (Non-owner occupied)		264		12		66		4
Commercial Mortgages (Owner occupied)		1,917		61		1,547		47
Consumer (2)		7		—		—		—
		3,683		106		3,764		128
With an allowance recorded:
Construction, land & land development		288		2		—		—
Residential First Mortgages		2,187		74		1,899		85
Residential Revolving and Junior Mortgages (1)		174		7		255		6
Commercial Mortgages (Non-owner occupied)		—		—		—		—
Commercial Mortgages (Owner occupied)		—		—		—		—
Consumer (2)		26		2		64		4
		2,675		85		2,218		95
Total
Construction, land & land development		740		4		123		7
Residential First Mortgages		3,230		105		3,829		154
Residential Revolving and Junior Mortgages (1)		174		7		353		7
Commercial Mortgages (Non-owner occupied)		264		12		66		4
Commercial Mortgages (Owner occupied)		1,917		61		1,547		47
Consumer (2)		33		2		64		4
	$	6,358	$	191	$	5,982	$	223

(1) Junior mortgages include equity lines.

(2) Includes credit cards.

Smaller non-accruing loans and non-accruing loans that are not graded because they are included in homogenous pools generally do not meet the criteria for impairment testing, and are therefore excluded from impaired loan disclosures. At September 30, 2014 and December 31, 2013, non-accruing loans excluded from impaired loan disclosure totaled $793 thousand and $724 thousand, respectively. If interest on these non-accruing loans had been accrued, such income would have approximated $11 thousand and $12 thousand during the three months ended September 30, 2014 and 2013, respectively, and $23 thousand and $26 thousand during the nine months ended September 30, 2014 and 2013, respectively.

Loan Modifications

Loans modified as TDRs are considered impaired and are individually evaluated for the amount of impairment in the ALL. The following table presents, by segments of loans, information related to loans modified as TDRs during the three and nine months ended September 30, 2014 and 2013.

16

For the three months ended

For the three months ended

September 30, 2014

September 30, 2013

Pre-Modification

Post-Modification

Pre-Modification

Post-Modification

(Dollars in thousands)

Outstanding

Outstanding

Outstanding

Outstanding

Number of

Recorded

Recorded

Number of

Recorded

Recorded

TROUBLED DEBT RESTRUCTURINGS

Loans

Investment

Investment

Loans

Investment

Investment

Construction, land & land development (1)

—

$

—

$

—

2

$

45

$

45

Consumer (2)

—

—

—

1

8

8

(1) Modifications were an extension of the loan terms.

(2) Modifications were capitalization of the interest.

			For the nine months ended						For the nine months ended
			September 30, 2014						September 30, 2013
			Pre-Modification		Post-Modification				Pre-Modification		Post-Modification
			Outstanding		Outstanding				Outstanding		Outstanding
	Number of		Recorded		Recorded		Number of		Recorded		Recorded
TROUBLED DEBT RESTRUCTURINGS	Loans		Investment		Investment		Loans		Investment		Investment
Construction, land & land development (1)		—	$	—	$	—		2	$	45	$	45
Residenital first mortages (2)		—		—		—		1		207		205
Consumer (2)		—		—		—		1		8		8

(1) Modifications were an extension of the loan terms.

(2) Modifications were capitalization of the interest.

(Dollars in thousands)	For the nine months ended				For the nine months ended
	September 30, 2014				September 30, 2013
TROUBLED DEBT RESTRUCTURINGS	Number of		Recorded		Number of		Recorded
THAT SUBSEQUENTLY DEFAULTED	Loans		Investment		Loans		Investment
Residential First Mortgages		—	$	—		1	$	106
Residential revolving and junior mortgages		1		75		—		—

No troubled debt restructurings which occurred in the previous twelve months subsequently defaulted in either the third quarter of 2014 or 2013.

Foreclosures

The table below details the properties included in other real estate owned (“OREO”) as of September 30, 2014 and December 31, 2013. There were no collateralized consumer residential mortgage loans in the process of foreclosure as of September 30, 2014.

	As of September 30, 2014				As of December 31, 2013
	No. of		Carrying		No. of		Carrying
(Dollars in thousands)	Properties		Value		Properties		Value
Residential		10	$	1,593		11	$	2,442
Land lots		13		601		14		684
Convenience store		2		234		2		239
Restaurant		1		107		1		107
Commerical properties		1		304		2		425
Total		27	$	2,839		30	$	3,897

Note 7: Earnings per share

The following table shows the weighted average number of shares used in computing earnings per share and the effect on the weighted average number of shares of dilutive potential common stock.

	For the Three Months Ended								For the Nine Months Ended
	September 30, 2014				September 30, 2013				September 30, 2014				September 30, 2013
	Average		Per share		Average		Per share		Average		Per share		Average		Per share
	Shares		Amount		Shares		Amount		Shares		Amount		Shares		Amount
Basic earnings per share		4,818,733	$	0.11		4,817,856	$	0.13		4,818,454	$	0.26		4,816,523	$	0.21
Effect of dilutive securities:
Stock options		9,552				2,316				12,601				2,380
Diluted earnings per share		4,828,285	$	0.11		4,820,172	$	0.13		4,831,055	$	0.26		4,818,903	$	0.21

For the three months ended September 30, 2014 and 2013, options on 68,828 and 170,215 shares, respectively, were not included in computing diluted earnings per share because their effects were anti-dilutive. For the nine months ended September 30, 2014 and 2013, options on 68,828 and 170,215 shares, respectively, were not included in computing diluted earnings per share because their effects were anti-dilutive.

17

Note 8: Stock-Based Compensation

On June 28, 2013, the Company registered with the Securities and Exchange Commission a new stock-based compensation plan, which superseded all other plans. There are 377,123 shares available for grant under this plan at September 30, 2014.

Stock-based compensation expense related to stock awards during the three month periods ended September 30, 2014 and 2013 was zero and $(4) thousand, respectively, and during the nine month periods ended September 30, 2014 and 2013 was $20 thousand and $122 thousand, respectively. Compensation expense for stock options is the estimated fair value of options on the date granted using the Black-Scholes Model amortized on a straight-line basis over the vesting period of the award. There was no unrecognized compensation expense related to stock options as of September 30, 2014.

Options for a total of 7,000 shares were granted and vested during the nine months ended September 30, 2014. The fair value of options granted during the nine months ended September 30, 2014 was $2.75. Options for a total of 89,500 shares were granted and vested during the nine months ended September 30, 2013. The fair value of options granted during the nine months ended September 30, 2013 was $1.03 and $1.08.

The variables used in these calculations of the fair value of the options are as follows:

	For the nine months ended September 30,
	2014			2013
Risk free interest rate (5 year Treasury)		1.74	%		0.86	%
Expected dividend yield		0	%		3.6	%
Expected term (years)		5			5
Expected volatility		51.4	%		33.8	%

Stock option activity for the nine months ended September 30, 2014 (unaudited) is summarized below:

	Shares			Weighted Average Exercise Price		Weighted Average Remaining Contractual Life (in years)		Aggregate Intrinsic Value (1)
Options outstanding, January 1, 2014		191,002		$	7.35		6.8
Granted		7,000			5.99
Forfeited		—			—
Exercised		—			—
Expired		(7,239	)		14.65
Options outstanding and exercisable, September 30, 2014		190,763		$	7.02		6.4	$	24,896

(1) The aggregate intrinsic value of a stock option in the table above represents the total pre-tax intrinsic value (the amount by which the current market value of the underlying stock exceeds the exercise price of the option) that would have been received by the option holders had all option holders exercised their options on September 30, 2014. This amount changes based on changes in the market value of the Company’s common stock.

In the first quarter of 2014, 877 shares of restricted stock were granted to an executive officer of the Bank. Early in October 2014, the executive officer left the Bank. The shares were forfeited and the compensation expense recognized to date was reversed in October 2014.

Note 9: Employee Benefit Plans

The Company has a non-contributory, defined benefit pension plan for full-time employees who were over 21 years of age and vested in the plan as of December 31, 2012, when the plan was frozen. Each participant’s account balance grows based on monthly interest credits. The Company funds pension costs in accordance with the funding provisions of the Employee Retirement Income Security Act.

The Company sponsors a postretirement benefit plan covering current and future retirees who acquire age 55 and 10 years of service or age 65 and 5 years of service. The post-retirement benefit plan provides coverage toward a retiree’s eligible medical and life insurance benefits expenses. The plan is unfunded and funded as benefits are due.

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Components of Net Periodic (Benefit) Cost

(Dollars in thousands)	Pension Benefits						Post-Retirement Benefits
Three months ended September 30,	2014			2013			2014		2013
Service cost	$	—		$	—		$	4	$	6
Interest cost		36			36			7		7
Expected return on plan assets		(51	)		(54	)		—		—
Amortization of unrecognized net loss		9			22			—		1
Remaining amortization of unrecognized net loss due to settlements		—			62			—		—
Amortization of transition obligation		—			—			—		1
Net periodic (benefit) cost	$	(6	)	$	66		$	11	$	15
(Dollars in thousands)	Pension Benefits						Post-Retirement Benefits
Nine months ended September 30,	2014			2013			2014		2013
Service cost	$	—		$	—		$	12	$	17
Interest cost		106			107			22		23
Expected return on plan assets		(151	)		(161	)		—		—
Amortization of unrecognized net loss		28			68			—		3
Remaining amortization of unrecognized net loss due to settlements		—			62			—		—
Amortization of transition obligation		—			—			—		2
Net periodic (benefit) cost	$	(17	)	$	76		$	34	$	45

The Company expects to make no contribution to its pension plan and $3 thousand to its post-retirement benefit plan during the remainder of 2014. The Company has contributed $8 thousand toward the post-retirement plan during the first nine months of 2014.

Note 10: Long Term Debt

On September 30, 2014, the Bank had FHLB debt consisting of four advances (see table below). The $10 million advance was restructured during the second quarter of 2013 to extend the maturity and reduce the interest rate from 4.23% to a three month LIBOR-based floating rate advance. A $5 million advance with an interest rate of 2.69%, matured in May 2014 and was replaced with a new $5 million three month LIBOR-based floating rate advance. Two additional $5 million advances were drawn in June 2014. Both were fixed rate advances.

The four advances are shown in the following table.

					Current			Maturity
Description	Balance		Originated		Interest Rate			Date
Adjustable Rate Hybrid	$	10,000,000		4/12/2013		2.61360	%		4/13/2020
Adjustable Rate Credit		5,000,000		5/20/2014		0.23210	%		5/20/2015
Fixed Rate Credit		5,000,000		6/18/2014		0.26000	%		6/18/2015
Fixed Rate Credit		5,000,000		6/26/2014		0.26000	%		6/26/2015
	$	25,000,000

Advances on the FHLB lines are secured by a blanket lien on qualified 1 to 4 family residential real estate loans. Immediate available credit, as of September 30, 2014, was $40.7 million against a total line of credit is $67.7 million.

Note 11: Fair Value Measurements

The Company uses fair value to record certain assets and liabilities and to determine fair value disclosures. Authoritative accounting guidance clarifies that fair value of certain assets and liabilities is an exit price, representing the amount that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants.

Authoritative accounting guidance specifies a hierarchy of valuation techniques based on whether the inputs to those valuation techniques are observable or unobservable. Observable inputs reflect market data obtained from independent sources, while unobservable inputs reflect the Company’s market assumptions. The three levels of the fair value hierarchy based on these two types of inputs are as follows:

Level 1 –	Valuation is based on quoted prices in active markets for identical assets and liabilities.
Level 2 –	Valuation is based on observable inputs including quoted prices in active markets for similar assets and liabilities, quoted prices for identical or similar assets and liabilities in less active markets, and model-based valuation techniques for which significant assumptions can be derived primarily from or corroborated by observable data in the market.
Level 3 –	Valuation is based on model-based techniques that use one or more significant inputs or assumptions that are unobservable in the market.

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The following describes the valuation techniques used by the Company to measure certain financial assets and liabilities recorded at fair value on a recurring basis in the financial statements:

Securities available-for-sale: Securities available-for-sale are recorded at fair value on a recurring basis. Fair value measurement is based upon quoted market prices, when available (Level 1). If quoted market prices are not available, fair values are measured utilizing independent valuation techniques of identical or similar securities for which significant assumptions are derived primarily from or corroborated by observable market data. Third party vendors compile prices from various sources and may determine the fair value of identical or similar securities by using pricing models that consider observable market data (Level 2). 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.

Defined benefit plan assets: Defined benefit plan assets are recorded at fair value on an annual basis at year end.

Mortgage servicing rights: MSRs are recorded at fair value on a recurring basis, with changes in fair value recorded in the result of operations. A valuation model, which utilizes a discounted cash flow analysis using interest rates and prepayment assumptions currently quoted for comparable instruments and a discount rate, is used to determine fair value. MSRs are classified as Level 3.

The following table presents the balances of financial assets and liabilities measured at fair value on a recurring basis as of September 30, 2014 and December 31, 2013:

(Dollars in thousands)			Fair Value Measurements at September 30, 2014 Using
Description	Balance		Level 1		Level 2		Level 3
Securities available-for-sale:
U. S. Government agencies	$	11,400	$	—	$	11,400	$	—
State and municipal obligations		23,128		—		23,128		—
Certificates of deposit		1,991		—		1,991		—
Total securities available-for-sale:	$	36,519	$	—	$	36,519	$	—
Mortgage servicing rights	$	620	$	—	$	—	$	620
Defined benefit plan assets:
Cash and cash equivalents	$	3	$	3	$	—	$	—
Mutual funds - fixed income		1,129		1,129		—		—
Mutual funds - equity		1,712		1,712		—		—
Total defined benefit plan assets	$	2,844	$	2,844	$	—	$	—
			Fair Value Measurements at December 31, 2013 Using
Description	Balance		Level 1		Level 2		Level 3
Securities available-for-sale:
U. S. Government agencies	$	9,308	$	—	$	9,308	$	—
State and municipal obligations		26,557		—		26,557		—
Certificates of deposit		1,745		—		1,745		—
Auction rate securities		912		—		—		912
Total securities available-for-sale:	$	38,522	$	—	$	37,610	$	912
Mortgage servicing rights	$	579	$	—	$	—	$	579
Defined benefit plan assets:
Cash and cash equivalents	$	3	$	3	$	—	$	—
Mutual funds - fixed income		1,070		1,070		—		—
Mutual funds - equity		1,747		1,747		—		—
Total defined benefit plan assets	$	2,820	$	2,820	$	—	$	—

20

The reconciliation of items using Level 3 inputs is as follows:

(Dollars in thousands)	Auction Rate Security			MSRs
Balance, January 1, 2014	$	912		$	579
Impairments		—			—
Fair value adjustments		—			41
Sales		(912	)		—
Balance, September 30, 2014	$	—		$	620

Certain assets are measured at fair value on a nonrecurring basis in accordance with GAAP. Adjustments to the fair value of these assets usually result from the application of lower-of-cost-or-market accounting or write-downs of individual assets.

The following describes the valuation techniques used by the Company to measure certain assets recorded at fair value on a nonrecurring basis in the financial statements:

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. Collateral may be in the form of real estate or business assets including equipment, inventory, and accounts receivable. Any given loan may have multiple types of collateral. The vast majority of the collateral is real estate. The value of real estate collateral is determined utilizing a market valuation approach based on an appraisal conducted by an independent, licensed appraiser outside of the Company using observable market data (Level 2). However, if the collateral value is significantly adjusted due to differences in the comparable properties, or is discounted by the Company because of marketability, 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. Likewise, values for inventory and accounts receivables collateral are based on financial statement balances or aging reports (Level 3). Impaired loans allocated to the ALL are measured at fair value on a nonrecurring basis. Any fair value adjustments are recorded in the period incurred as provision for loan losses on the Consolidated Statements of Income.

Other Real Estate Owned: OREO is measured at fair value less estimated costs to sell, based on an appraisal conducted by an independent, licensed appraiser outside of the Company. If the collateral value is significantly adjusted due to differences in the comparable properties, or is discounted by the Company because of marketability, then the fair value is considered Level 3. OREO is measured at fair value on a nonrecurring basis. The initial fair value of OREO is based on an appraisal done at the time of foreclosure. Subsequent fair value adjustments are recorded in the period incurred and included in other noninterest income on the Consolidated Statements of Income.

The following table summarizes the Company’s assets that were measured at fair value on a nonrecurring basis at the end of the respective period.

			Fair Value Measurements at September 30, 2014 Using
(Dollars in thousands)	Balance as of
Description	September 30, 2014		Level 1		Level 2		Level 3
Impaired Loans, net	$	2,051	$	—	$	—	$	2,051
Other real estate owned, net		2,839		—		—		2,839
			Fair Value Measurements at December 31, 2013 Using
	Balance as of
Description	December 31, 2013		Level 1		Level 2		Level 3
Impaired Loans, net	$	2,077	$	—	$	—	$	2,077
Other real estate owned, net		3,897		—		—		3,897

The following table displays quantitative information about Level 3 Fair Value Measurements as of September 30, 2014:

	Balance as of		Valuation		Unobservable		Range (Weighted
(Dollars in thousands)	September 30, 2014		Technique		Input		Average)
Impaired Loans, net	$	2,051		Discounted appraised value		Selling Cost		10% - 20% (10%)
						Lack of Marketability		25% - 75% (56%)
Other real estate owned, net		2,839		Discounted appraised value		Selling Cost		3% - 13% (5%)
						Lack of Marketability		7% - 20% (11%)

The following table displays quantitative information about Level 3 Fair Value Measurements as of December 31, 2013:

	Balance as of		Valuation		Unobservable		Range (Weighted
(Dollars in thousands)	December 31, 2013		Technique		Input		Average)
Impaired Loans, net	$	2,077		Discounted appraised value		Selling Cost		10% - 20% (10%)
						Lack of Marketability		25% - 100% (54%)
Other real estate owned, net		3,897		Discounted appraised value		Selling Cost		3% - 13% (6%)
						Lack of Marketability		7% - 30% (15%)

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The estimated fair values of financial instruments are shown in the following table. The carrying amounts in the table are included in the balance sheet under the applicable captions.

			Fair Value Measurements at September 30, 2014 Using
(Dollars in thousands)	Balance as of
Description	September 30, 2014		Level 1		Level 2		Level 3
Financial Assets:
Cash and due from banks	$	4,341	$	4,341	$	—	$	—
Interest-bearing deposits		6,952		6,952		—		—
Federal funds sold		137		137		—		—
Securities available-for-sale		36,519		—		36,519		—
Restricted securities		1,980		—		—		1,980
Loans, net		270,980		—		—		275,571
Accrued interest receivable		1,060		—		1,060		—
Mortgage servicing rights		620		—		—		620
Financial Liabilities:
Non-interest-bearing liabilities	$	60,334	$	60,334	$	—	$	—
Savings and other interest-bearing deposits		118,189		—		118,189		—
Time deposits		97,382		—		—		98,181
Securities sold under repurchase agreements		6,978		—		6,978		—
FHLB advances		25,000		—		25,939		—
Accrued interest payable		133		—		133		—
			Fair Value Measurements at December 31, 2013 Using
Description	Balance as of December 31,2013		Level 1		Level 2		Level 3
Financial Assets:
Cash and due from banks	$	6,789	$	6,789	$	—	$	—
Interest-bearing deposits		8,900		8,900		—		—
Federal funds sold		120		120		—		—
Securities available-for-sale		38,522		—		37,610		912
Restricted securities		1,638		—		—		1,638
Loans, net		247,912		—		—		253,139
Loans held for sale		196		—		—		196
Accrued interest receivable		1,124		—		1,124		—
Mortgage servicing rights		579		—		—		579
Financial Liabilities:
Non-interest-bearing liabilities	$	57,805	$	57,805	$	—	$	—
Savings and other interest-bearing deposits		114,056		—		114,056		—
Time deposits		96,486		—		—		98,049
Securities sold under repurchase agreements		9,118		—		9,118		—
FHLB advances		15,000		—		15,923		—
Accrued interest payable		167		—		167		—

The carrying amounts of cash and due from banks, interest-bearing deposits, federal funds sold or purchased, accrued interest, loans held for sale and non-interest-bearing deposits, are payable on demand, or are of such short duration that carrying value approximates market value.

Securities available-for-sale are carried at the fair values measured utilizing independent valuation techniques of identical or similar securities for which significant assumptions are derived primarily from or corroborated by observable market data. Therefore carrying value equals market value. The carrying value of restricted securities approximates fair value based on the redemption provisions of the issuer.

MSRs are carried at fair value. A valuation model, which utilizes a discounted cash flow analysis using interest rates and prepayment assumptions currently quoted for comparable instruments and a discount rate, is used to determine fair value.

The fair value of performing loans is estimated by discounting the future cash flows using the current rates at which similar loans would be made to borrowers with similar remaining maturities. This calculation ignores loan fees and certain factors affecting the interest rates charged on various loans such as the borrower’s creditworthiness and compensating balances and dissimilar types of real estate held as collateral. The fair value of impaired loans is measured as described within the Impaired Loans section of this note. The fair value of loans does not consider the lack of liquidity and uncertainty in the market that would affect the valuation.

22

Time deposits are presented at estimated fair value by discounting the future cash flows using interest rates offered for deposits of similar remaining maturities.

The fair value of the FHLB advances is estimated by discounting the future cash flows using the current interest rates offered for similar advances.

The fair value of commitments to extend credit is estimated using the fees currently charged to enter similar agreements, taking into account the remaining terms of the agreements and the present credit worthiness of the counter parties. For fixed-rate loan commitments, fair value also considers the difference between current levels of interest rates and the committed rates. The fair value of standby letters of credit is based on fees currently charged for similar agreements or on the estimated cost to terminate them or otherwise settle the obligations with the counter parties at the reporting date. At September 30, 2014 and December 31, 2013, the fair value of loan commitments and standby letters of credit was immaterial and therefore, they are not included in the table above.

The Company 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 value of the Company’s financial instruments will change when interest rate levels change and that change may be either favorable or unfavorable to the Company. 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. 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 the Company’s overall interest rate risk.

Note 12: Changes in Accumulated Other Comprehensive Income (Loss)

The balances in accumulated other comprehensive income (loss) are shown in the following tables:

(Dollars in thousands)	Net Unrealized Gains (Losses) on Securities			Pension and Post-retirement Benefit Plans			Accumulated Other Comprehensive Income (Loss)
Balance July 1, 2014	$	(235	)	$	(382	)	$	(617	)
Change in net unrealized holding gains on securities, before reclassification, net of tax expense of $60		117			—			117
Reclassification for previously unrealized net losses recognized in income, net of tax benefit of $3		5			—			5
Balance September 30, 2014	$	(113	)	$	(382	)	$	(495	)
	Net Unrealized Gains (Losses) on Securities			Pension and Post-retirement Benefit Plans			Accumulated Other Comprehensive Income (Loss)
Balance July 1, 2013	$	(689	)	$	(660	)	$	(1,349	)
Change in net unrealized holding losses on securities, before reclassification, net of tax benefit of $43		(83	)		—			(83	)
Reclassification for previously unrealized net gains recognized in income, net of tax benefit of $4		(9	)		—			(9	)
Balance September 30, 2013	$	(781	)	$	(660	)	$	(1,441	)
	Net Unrealized Gains (Losses) on Securities			Pension and Post-retirement Benefit Plans			Accumulated Other Comprehensive Income (Loss)
Balance January 1, 2014	$	(791	)	$	(382	)	$	(1,173	)
Change in net unrealized holding losses on securities, before reclassification, net of tax expense of $340		662			—			662
Reclassification for previously unrealized net losses recognized in income, net of tax benefit of $9		16			—			16
Balance September 30, 2014	$	(113	)	$	(382	)	$	(495	)

23

	Net Unrealized Gains (Losses) on Securities			Pension and Post-retirement Benefit Plans			Accumulated Other Comprehensive Income (Loss)
Balance January 1, 2013	$	279		$	(660	)	$	(381	)
Change in net unrealized holding losses on securities, before reclassification, net of tax benefit of $490		(952	)		—			(952	)
Reclassification for previously unrealized net gains and impairment losses recognized in income, net of tax of $56		(108	)		—			(108	)
Balance September 30, 2013	$	(781	)	$	(660	)	$	(1,441	)

Reclassification for previously unrealized (losses) gains and impairments on securities are reported in the Consolidated Statements of Income as follows. No unrealized gains (losses) on pension and post-employment related costs were reclassified to the Consolidated Statements of Income in the three and nine months ended September 30, 2014 and 2013.

Accumulated Other Comprehensive Income (Loss)

Reclassification for the Three Months Ended

Holding (Losses) Gains on Securities

(In thousands)	September 30, 2014			September 30, 2013
Net (losses) gains on sale of securities available-for-securities	$	(8	)	$	13
Tax benefit (expense)		3			(4	)
Impact on net income	$	(5	)	$	9

Accumulated Other Comprehensive Income (Loss)

Reclassification for the Nine Months Ended

Holding Gains (Losses) on Securities

(In thousands)	September 30, 2014			September 30, 2013
Net (losses) gains on sale of securities available-for-securities	$	(25	)	$	284
Loss on securities with other-than-temporary impairment		—			(120	)
Tax benefit (expense)		9			(56	)
Impact on net income	$	(16	)	$	108

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ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS

OF OPERATIONS

The following discussion is intended to assist in understanding the results of operations and the financial condition of Bay Banks of Virginia, Inc. This discussion should be read in conjunction with the above consolidated financial statements and the notes thereto.

STATEMENT REGARDING FORWARD-LOOKING STATEMENTS

This report contains statements concerning the Company’s expectations, plans, objectives, future financial performance and other statements that are not historical facts. These statements may constitute “forward-looking statements” as defined by federal securities laws. These statements may address issues that involve estimates and assumptions made by management, risks and uncertainties, and actual results could differ materially from historical results or those anticipated by such statements. Factors that could have a material adverse effect on the operations and future prospects of the Company include, but are not limited to, changes in interest rates, general economic conditions, the legislative/regulatory climate, monetary and fiscal policies of the U.S. Government, including policies of the U.S. Treasury and the Board of Governors of the Federal Reserve System, the quality or composition of the loan or investment portfolios, demand for loan products, deposit flows, competition, expansion activities, demand for financial services in the Company’s market area and accounting principles, policies and guidelines. These risks and uncertainties should be considered in evaluating the forward-looking statements contained herein, and readers are cautioned not to place undue reliance on such statements, which speak only as of the date they are made.

EXECUTIVE SUMMARY

Results through September 30, 2014 are highlighted by growth in loans and continued improvements in earnings. The capital position remains solid. Core earnings and growth remain priorities. Return on average assets is up to 0.49% for the first nine months of 2014 compared to 0.40% for the same period in 2013. Return on average equity is up to 4.32% from 3.63% for the same time period comparison.

In September 2014, the Bank received approval from federal and state banking regulators to open a second branch office in Richmond, and opened the branch in November of 2014. A third Richmond location was purchased early in October 2014, and plans are to open it in mid-2015. This will give the Bank a total of three offices in the growing Richmond market. Total assets have grown by $17.6 million, or 5.3%, during the first nine months of 2014.

The in-house loan portfolio grew by $23.3 million, or 9.3%, in the first nine months of 2014. Loans originated and sold to Fannie Mae generated growth of $4.8 million in the portfolio of loans serviced for Fannie Mae since December 31, 2013. The servicing portfolio totals $63.8 million as of September 30, 2014 compared to $58.9 million as of December 31, 2013 and $57.9 million as of September 30, 2013.

The net interest margin increased to 3.82% for the third quarter of 2014 compared to 3.60% for the same period in 2013. As this low-rate climate continues, loan yields continue to decline, but increased loan balances have resulted in increased interest income. The refinance of our $10 million FHLB advance in April 2013, plus the maturity and replacement of a $5 million FHLB advance in May 2014, resulted in an average FHLB advance cost of 1.21% for the third quarter of 2014 compared to 2.70% for the third quarter of 2013. Two new $5 million advances acquired in June 2014, during this low-rate environment, will further reduce the average cost of FHLB advances and cost of funds going forward. Scheduled maturities of time deposits continue to reduce both costs of funds and interest expense. Maturities of time deposits are typically renewed at lower rates, leave the Bank or transfer into lower-cost checking or savings accounts.

Along with growth in the loan portfolio, these margin improvements were a major contributor to the 24.2% increase in earnings for the nine months ended September 30, 2014 compared to the same period in 2013. Net interest income improved by $268 thousand and $788 thousand for the year over year three-month and nine-month comparisons, respectively, ended September 30, 2014 compared to September 30, 2013.

Asset quality improved, with nonperforming assets down to 1.45% of total assets as of September 30, 2014 from 2.01% as of December 31, 2013. OREO balances are down to $2.8 million as of September 30, 2014 compared to $3.9 million as of December 31, 2013. Non-accruing loan balances are down to $2.2 million as of September 30, 2014 as compared to $2.8 million at December 31, 2013.

Annualized net loan charge-offs against the ALL are down to 0.12% of total loans during the first nine months of 2014 compared to 0.38% during the first nine months of 2013.

During the first quarter of 2014, the Company sold a troubled investment for which an impairment loss was recognized in 2013. In addition, during the first quarter of 2014, the Company sold its former Heathsville, Virginia, branch office recognizing a gain of approximately $138 thousand.

Finally, the Company’s core capital levels and regulatory ratios remain well above what is considered “well capitalized” by the Company’s regulators. The Company took no Troubled Asset Relief Program (“TARP”) or Small Business Lending Fund (“SBLF”) investments from the U.S. Treasury.

For more information, visit the Company’s website at www.baybanks.com. Information contained on the Company’s website is not a part of this report.

25

EARNINGS SUMMATION

For the three months ended September 30, 2014 and 2013, net income was $512 thousand and $620 thousand, respectively, a decrease of $108 thousand or 17.4% from 2013 to 2014. Diluted earnings per average share for the three months ended September 30, 2014 and 2013 were $0.11 and $0.13, respectively. Return on average assets was 0.59% for the three months ended September 30, 2014 compared to 0.74% for the three months ended September 30, 2013. The annualized return on average equity was 5.29% and 6.82% for the three months ended September 30, 2014 and 2013, respectively. During the third quarter of 2013, the Company recognized a mortgage servicing rights asset that directly increased pretax earnings by $535 thousand and a gain of $165 thousand on the sale of the Bay Trust office.

For the nine months ended September 30, 2014 and 2013, net income was $1.2 million and $992 thousand, respectively, an increase of $240 thousand or 24.2% from 2013 to 2014. Diluted earnings per average share for the nine months ended September 30, 2014 and 2013 were $0.26 and $0.21, respectively. Annualized return on average assets was 0.44% at September 30, 2014 compared to 0.40% at September 30, 2013. The annualized return on average equity was 3.83% and 3.60% at September 30, 2014 and 2013, respectively.

RESULTS OF OPERATIONS

The principal source of earnings for the Company is net interest income. Net interest income is the amount by which interest income exceeds interest expense. The net interest margin is net interest income expressed as a percentage of interest-earning assets. Changes in the volume and mix of interest-earning assets and interest-bearing liabilities, the associated yields and rates, and the volume of non-performing assets have an effect on net interest income, the net interest margin, and net income.

FOR THE THREE MONTHS ENDED SEPTEMBER 30, 2014 COMPARED TO THE THREE MONTHS ENDED SEPTEMBER 30, 2013

NET INTEREST INCOME

Net Interest Income Analysis (Fully taxable equivalent basis)	Average Balances, Income and Expense, Yields and Rates
(Dollars in Thousands)	Three months ended 9/30/2014							Three months ended 9/30/2013
	Average		Income/					Average		Income/
	Balance		Expense		Yield/Cost			Balance		Expense		Yield/Cost
INTEREST EARNING ASSETS:
Taxable investments	$	20,684	$	94		1.81	%	$	23,144	$	103		1.78	%
Tax-exempt investments (1)		17,601		139		3.16	%		19,520		153		3.14	%
Total investments		38,285		233		2.43	%		42,664		256		2.40	%
Gross loans (2)		266,192		3,322		4.98	%		245,332		3,182		5.19	%
Interest-bearing deposits		12,034		7		0.23	%		18,313		13		0.28	%
Federal funds sold		287		—		0.05	%		451		—		0.17	%
Total Interest Earning Assets	$	316,798	$	3,562		4.50	%	$	306,760	$	3,451		4.50	%
INTEREST -BEARING LIABILITIES:
Savings deposits	$	42,464	$	16		0.15	%	$	45,490	$	18		0.16	%
NOW deposits		42,590		16		0.15	%		41,378		16		0.15	%
Time deposits => $100,000		45,463		194		1.69	%		45,194		254		2.23	%
Time deposits < $100,000		50,750		197		1.54	%		55,439		264		1.89	%
Money market deposit accounts		31,079		32		0.40	%		29,111		30		0.41	%
Total Deposits		212,346		455		0.85	%		216,612		582		1.07	%
Federal funds purchased		—		—		—			5		—		0.60	%
Securities sold under repurchase agreements		7,898		2		0.11	%		9,514		3		0.11	%
FHLB advances		25,000		76		1.21	%		15,000		102		2.70	%
Total Interest-Bearing Liabilities	$	245,244	$	533		0.86	%	$	241,131	$	687		1.13	%
Net interest income and net interest margin			$	3,029		3.82	%			$	2,764		3.60	%
Non-interest-bearing deposits	$	60,238		—		0.00	%	$	56,080		—		0.00	%
Total Cost of funds						0.70	%						0.92	%
Net interest rate spread						3.80	%						3.58	%

Notes:

(1) Income and yield assumes a federal tax rate of 34%.

(2) Includes loan fees, VISA program and nonaccrual loans.

Interest income for the three months ended September 30, 2014, on a tax-equivalent basis, was $3.6 million, an increase of $112 thousand from the third quarter of 2013. Interest expense for the three months ended September 30, 2014, was $533 thousand, a decrease of $154 thousand from the third quarter of 2013, due mainly to reductions in both balances and costs of time deposits, but also from the reduced cost of the FHLB advances. Net interest income for the three months ended September 30, 2014, on a tax-equivalent basis, was $3.0 million, an increase of $265 thousand from the third quarter of 2013. The annualized net interest margin was 3.82% and 3.60% for the three months ended September 30, 2014 and 2013, respectively. Further reductions in the cost of funds are anticipated as time deposits mature and are replaced at lower rates. As long as market rates remain low, this positive trend is expected to continue.

26

The net interest spread, which is the difference between the annualized yield on earning assets and the total cost of funds, increased to 3.80% for the three months ended September 30, 2014, compared to 3.58% for the three months ended September 30, 2013.

NON-INTEREST INCOME

Non-interest income for the three months ended September 30, 2014 decreased $675 thousand, or 38.7%, compared to the three months ended September 30, 2013. This decrease was primarily due to the recognition of mortgage servicing rights in 2013 of $535 thousand and a gain of $165 thousand on the sale of the Bay Trust building in 2013. Also, VISA-related fees declined by $192 thousand due to the assignment of merchant agreements to a third party, but mitigated by a similar reduction in VISA expense.

NON-INTEREST EXPENSE

For the three months ended September 30, 2014 and 2013, non-interest expenses totaled $3.2 million and $3.3 million, respectively. In the third quarter of 2014, VISA-related expense decreased $187 thousand due to the aforementioned assignment of merchant agreements to a third party. This decrease was partially offset by a $49 increase in salaries and benefits related to the ramp up of the Richmond offices.

FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2014 COMPARED TO THE NINE MONTHS ENDED SEPTEMBER 30, 2013

NET INTEREST INCOME

Net Interest Income Analysis (Fully taxable equivalent basis)	Average Balances, Income and Expense, Yields and Rates
(Dollars in Thousands)	Nine months ended 9/30/2014							Nine months ended 9/30/2013
	Average		Income/					Average		Income/
	Balance		Expense		Yield/Cost			Balance		Expense		Yield/ Cost
INTEREST EARNING ASSETS:
Taxable investments	$	20,840	$	272		1.74	%	$	24,965	$	345		1.84	%
Tax-exempt investments (1)		18,545		433		3.11	%		15,166		342		3.01	%
Total investments		39,385		705		2.39	%		40,131		687		2.28	%
Gross loans (2)		258,481		9,763		5.04	%		237,856		9,471		5.31	%
Interest-bearing deposits		8,213		16		0.25	%		26,759		49		0.24	%
Federal funds sold		301		—		0.06	%		682		1		0.20	%
Total Interest Earning Assets	$	306,380	$	10,484		4.56	%	$	305,428	$	10,208		4.46	%
INTEREST-BEARING LIABILITIES:
Savings deposits	$	43,454	$	50		0.15	%	$	46,095	$	71		0.20	%
NOW deposits		42,437		47		0.15	%		40,989		60		0.20	%
Time deposits => $100,000		40,931		524		1.71	%		46,110		769		2.23	%
Time deposits < $100,000		54,332		658		1.62	%		56,889		805		1.89	%
Money market deposit accounts		28,396		85		0.40	%		28,186		110		0.52	%
Total Deposits		209,550		1,364		0.87	%		218,269		1,815		1.11	%
Federal funds purchased		121		1		0.58	%		77		—		0.74	%
Securities sold under repurchase agreements		7,836		7		0.11	%		8,280		13		0.21	%
FHLB advances		18,667		261		1.87	%		15,000		347		3.09	%
Total Interest-Bearing Liabilities	$	236,174	$	1,633		0.92	%	$	241,626	$	2,175		1.20	%
Net interest income and net interest margin			$	8,851		3.85	%			$	8,033		3.51	%
Non-interest-bearing deposits	$	58,568		—		0.00	%	$	52,532		—		0.00	%
Total Cost of funds						0.74	%						0.98	%
Net interest rate spread						3.83	%						3.48	%

Notes:

(1) Income and yield assumes a federal tax rate of 34%.

(2) Includes loan fees, VISA program and nonaccrual loans.

Interest income for the nine months ended September 30, 2014, on a tax-equivalent basis, was $10.5 million, an increase of $276 thousand from the same period of 2013 due mainly to increased loan balances. Interest expense for the nine months ended September 30, 2014 was $1.6 million, a decrease of $542 thousand from the same period of 2013, due mainly to reductions in both balances and costs of time deposits, but also from the reduced cost of the FHLB advances. Net interest income for the nine months ended September 30, 2014, on a tax-equivalent basis, was $8.9 million, an increase of $818 thousand from the same period of 2013. The annualized net interest margin was 3.85% and 3.51% for the nine months ended September 30, 2014 and 2013, respectively. Further reductions in the cost of funds are anticipated as time deposits mature and are replaced at lower rates. As long as market rates remain low, this positive trend is expected to continue.

27

The net interest spread, which is the difference between the annualized yield on earning assets and the total cost of funds, increased to 3.83% for the nine months ended September 30, 2014, compared to 3.48% for the nine months ended September 30, 2013.

NON-INTEREST INCOME

Non-interest income for the nine months ended September 30, 2014 decreased $947 thousand, or 25.2%, compared to the nine months ended September 30, 2013. This decrease was primarily due to the recognition of mortgage servicing rights in 2013 of $535 thousand and VISA-related fees declined by $448 thousand due to the assignment of merchant agreements to a third party, which was offset by a similar reduction in expense.

NON-INTEREST EXPENSE

For the nine months ended September 30, 2014, non-interest expenses totaled $9.5 million, a decrease of $302 thousand, or 3.1%, compared to the same period in 2013. This decrease is primarily due to a reduction in VISA-related expense of $424 thousand, resulting from the aforementioned assignment of merchant agreements to a third party and $110 thousand reduction in FDIC assessments. These decreases were partially offset by increases in consulting expense of $101 thousand primarily related to accounting services.

AVERAGE INTEREST-EARNINGS ASSETS AND AVERAGE INTEREST-BEARING LIABILITIES

Average interest-earning assets increased 0.31% to $306.4 million for the nine months ended September 30, 2014, as compared to $305.4 million for the nine months ended September 30, 2013, as interest-bearing deposits were redeployed into higher yielding loans and bank-owned life insurance. Average interest-earning assets as a percent of total average assets were 91.6% for the nine months ended September 30, 2014 as compared to 91.2% for the same period in 2013. The loan portfolio, with $258.5 million in average balances as of September 30, 2014, is the largest category of interest-earning assets.

Average interest-bearing liabilities decreased 2.3% to $236.2 million for the nine months ended September 30, 2014, as compared to $241.6 million for the nine months ended September 30, 2013. The largest category of interest-bearing liabilities is time deposits, with combined average balances of $95.3 million for the nine months ended September 30, 2014, down from $103.0 million for the similar period in 2013.

ASSET QUALITY

In the first nine months of 2014, asset quality improved. Non-performing assets, which include OREO and non-performing loans, declined by $1.6 million to $5.1 million, or 1.45% of assets. This level also represents 1.85% of loans plus OREO.

Non-Performing Assets

(Dollars in thousands)	September 30, 2014			December 31, 2013
Loans past due 90 days or more and still accruing	$	38		$	19
Non-accruing loans		2,195			2,754
Total non-performing loans		2,233			2,773
Other real estate owned		2,839			3,897
Total non-performing assets	$	5,072		$	6,670
Allowance for loan losses	$	3,151		$	2,925
Allowance to non-performing loans		141.1	%		105.5	%
Non-performing assets to total assets		1.45	%		2.01	%

Non-performing loans, which include loans past due 90 days or more and still accruing, plus non-accruing loans, as a percentage of total loans, decreased to 0.82% as of September 30, 2014 compared to 1.1% as of December 31, 2013. Non-accruing loans totaled $2.2 million as of September 30, 2014, down from $2.8 million at year-end 2013.

Loans charged off during the first nine months of 2014, net of recoveries, totaled $227 thousand compared to $680 thousand for the first nine months of 2013. This represents a decline in the annualized net charge-off ratio to 0.12% for the first nine months of 2014 compared to 0.38% for the first nine months of 2013, reflecting an improvement in asset quality. The majority of the charge-offs were anticipated and specific reserves had been provided for them in the ALL. Management believes it is maintaining an adequate level of the ALL at 1.15% and 1.17% of total loans at September 30, 2014 and December 31, 2013, respectively.

Classified assets, which include loans with risk rating grades of substandard, doubtful and loss, plus OREO, decreased by $2.1 million during the first nine months of 2014 to $9.4 million, or 23.06% of Tier 1 capital plus the allowance for loan losses. Risk rating grades are assigned conservatively, causing some homogenous loans, such as residential mortgages, to fall into the pool of adversely risk rated loans and thereby evaluated for impairment, even though they may be performing as agreed and therefore not impaired.

As of September 30, 2014, loans valued at $6.4 million were considered impaired, whereas $6.7 million were considered impaired as of December 31, 2013. Between December 31, 2013 and September 30, 2014, two loans were identified as impaired, one was dispensed through foreclosure and charged-off, and one was moved into the pool of loans for collective evaluation of impairment due to a large paydown. Management has reviewed the impaired credits and the underlying collateral and expects no additional losses above those which are specifically reserved in ALL.

28

FINANCIAL CONDITION

Total assets increased to $348.7 million as of September 30, 2014 compared to $331.1 million as of December 31, 2013. Cash and due from banks, which produces no income, was $4.3 million and $6.8 million on September 30, 2014 and December 31, 2013, respectively. Interest-bearing deposits at other banks, which is mainly the Bank’s cash on deposit at the Federal Reserve Bank of Richmond, has decreased by $1.9 million since year end 2013.

During the nine months ended September 30, 2014, gross loans increased by $23.4 million or 9.3%, to $273.7 million from $250.3 million at year-end 2013. The largest components of this increase were $10.0 million related to residential first mortgages, $7.7 million related to commercial and industrial loans and $3.7 million related to construction loans.

The Bank had $2.8 million of OREO at September 30, 2014 and $3.9 million at December 31, 2013. As of September 30, 2014, OREO consists of 10 residences, 13 lots, two former convenience stores, one former restaurant and one commercial business property. During the first nine months of 2014, three properties with a total book value of $197 thousand from two borrowers were added through foreclosures, and six properties with a total book value of $1.1 million were sold. There were $160 thousand of write-downs of OREO properties during the first nine months of 2014, compared to $249 thousand for the same period in 2013. All properties maintained as OREO are valued at the lesser of cost or fair value less estimated costs to sell and are actively marketed.

In March 2014, the Company sold a former branch in Heathsville, Virginia for $311 thousand and recognized a gain of $138 thousand on the sale. The branch was included in other assets as of December 31, 2013.

As of September 30, 2014, securities available-for-sale at fair value totaled $36.5 million as compared to $38.5 million on December 31, 2013. This represents a net decrease of $2.0 million or 5.2% for the nine months. The decrease in securities available-for-sale is primarily the result of the redeployment of cash from maturing securities into higher-yielding loans and in bank owned life insurance and the sale of a troubled asset with a fair value of $912 thousand. An impairment loss was recognized on this asset in 2013 and therefore, no gain or loss was recognized on the sale of the asset as its carrying value equaled its fair value at the time of sale. As of September 30, 2014, available-for-sale securities represented 10.5% of total assets and 11.9% of earning assets. All securities in the Company’s investment portfolio are classified as available-for-sale and marked to market on a monthly basis. These unrealized gains or losses, net of tax, are booked as an adjustment to shareholders’ equity, and are not realized as an adjustment to earnings until the securities are actually sold or an other than temporary impairment occurs.

In the second quarter of 2013, the Company purchased $5.0 million of bank owned life insurance in order to offset the cost of employee benefits. During the second quarter of 2014, the Company purchased an additional $2.0 million of such insurance. The bank owned life insurance’s carrying value as of September 30, 2014 was $7.3 million.

As of September 30, 2014, total deposits were $275.9 million compared to $268.3 million at year-end 2013. This represents an increase in balances of $7.6 million or 2.8% during the nine months. The increase consisted of $896 thousand increase in time deposit balances, $4.1 million in savings and interest-bearing demand deposits and $2.5 million in non-interest bearing deposits.

To support loan growth, $10.0 million of new FHLB advances were drawn during the second quarter of 2014 plus $3.0 million in a brokered money market accounting during the third quarter of 2014. The Bank has also accumulated $2.5 million of time deposits through an internet listing service during 2014.

As of September 30, 2014, securities sold under repurchase agreements decreased $2.1 thousand to $7.0 million from $9.1 million at December 31, 2013. This decrease was the result of normal seasonality for these customers.

LIQUIDITY

Liquidity represents an institution’s ability to meet present and future financial obligations (such as commitments to fund loans) through either the sale or maturity of existing assets or the acquisition of additional funds through liability management. Liquid assets include cash, interest-bearing deposits with other banks, federal funds sold and investments and loans maturing within one year. The Company’s ability to obtain deposits and purchase funds at favorable rates are major factors for liquidity. Management believes that the Company maintains overall liquidity that is sufficient to satisfy its depositors’ requirements and to meet its customers’ credit needs.

At September 30, 2014, cash totaled $4.3 million, federal funds sold totaled $137 thousand, interest-bearing deposits totaled $7.0 million, and securities and loans maturing in one year or less totaled $26.7 million. This results in a liquidity ratio as of September 30, 2014 of 10.9% as compared to 12.9% as of December 31, 2013. The Company determines this ratio by dividing the sum of cash and cash equivalents, investment securities maturing in one year or less, loans maturing in one year or less and federal funds sold, by total assets. The Bank has a formal liquidity management policy and contingency plan, which includes periodic evaluation of cash flow projections.

In addition, the Company has a line of credit with the FHLB of $67.7 million, with $40.7 million available, plus federal funds lines of credit with correspondent banks totaling $20.3 million.

29

CAPITAL RESOURCES

Capital resources represent funds, earned or obtained, over which a financial institution can exercise greater long-term control in comparison with deposits and borrowed funds. The adequacy of the Company’s capital is reviewed by management on an ongoing basis with reference to size, composition, quality of the Company’s resources and consistency with regulatory requirements and industry standards. Management seeks to maintain a capital structure that will assure an adequate level of capital to support anticipated asset growth and to absorb potential losses, yet allows management to effectively leverage its capital to maximize return to shareholders. The Company’s capital, also known as shareholders’ equity, is comprised mainly of outstanding common stock and retained earnings. Capital can be increased with securities offerings or through earnings.

Several factors impact shareholders’ equity, including net income and regulatory capital requirements. The Company’s capital resources are also impacted by net unrealized gains or losses on securities. The available-for-sale securities portfolio is marked to market monthly and unrealized gains or losses, net of taxes, are recognized as accumulated other comprehensive income (loss) on the balance sheets and statement of changes in shareholders’ equity. Another factor affecting accumulated other comprehensive income (loss) is changes in the market value of the Company’s pension and post-retirement benefit plans. The Company’s shareholders’ equity before accumulated other comprehensive loss was $39.6 million on September 30, 2014 compared to $38.3 million on December 31, 2013. Accumulated other comprehensive loss decreased $678 thousand between December 31, 2013 and September 30, 2014, primarily as a result of decreases in unrealized net losses in the investment portfolio.

Book value per share, before accumulated other comprehensive loss, on September 30, 2014, compared to December 31, 2013, increased to $8.21 from $7.96. Book value per share, including accumulated other comprehensive loss, increased to $8.11 on September 30, 2014 from $7.71 on December 31, 2013. No cash dividends were paid for the nine-month period ended September 30, 2014, nor for the comparable period ended September 30, 2013.

The Bank is subject to minimum regulatory capital ratios as defined by Federal Financial Institutions Examination Council guidelines. These ratios continue to be well in excess of regulatory minimums. As of September 30, 2014, the Bank maintained Tier 1 capital of $31.6 million, net risk weighted assets of $254.5 million, and Tier 2 capital of $3.2 million. On September 30, 2014, the Tier 1 leverage ratio was 9.26%, the Tier 1 capital to risk weighted assets ratio was 12.42%, and the total capital ratio to risk weighted assets ratio was 13.66%. Management is evaluating Basel III capital rules which will begin a phase-in period on January 1, 2015, and expects no detrimental effects.

OFF BALANCE SHEET COMMITMENTS

In the normal course of business, the Company offers various financial products to its customers to meet their credit and liquidity needs. These instruments may involve elements of liquidity, credit and interest rate risk in excess of the amount recognized in the Consolidated Balance Sheets. The Company’s exposure to credit loss in the event of nonperformance by the other party to the financial instruments for commitments to extend credit and standby-letters of credit is represented by the contractual amount of these instruments. Subject to its normal credit standards and risk monitoring procedures, the Company makes contractual commitments to extend credit. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since many of the commitments may expire without being completely drawn upon, the total commitment amounts do not necessarily represent future cash requirements. Conditional commitments are issued by the Company in the form of performance stand-by letters of credit, which guarantee the performance of a customer to a third-party. The credit risk of issuing letters of credit is essentially the same as that involved in extending loan facilities to customers.

Off Balance Sheet Arrangements

(Dollars in thousands)	September 30, 2014		December 31, 2013
Total Loan Commitments Outstanding	$	38,647	$	37,279
Standby-by Letters of Credit		380		329

The Company maintains liquidity and credit facilities with non-affiliated banks in excess of the total loan commitments and stand-by letters of credit. As these commitments are earning assets only upon takedown of the instrument by the customer, thereby increasing loan balances, management expects the revenue of the Company to be enhanced as these credit facilities are utilized.

There have been no material changes to the off balance sheet items disclosed in “Management’s Discussion and Analysis of Financial Condition and Results of Operation” in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2013.

CONTRACTUAL OBLIGATIONS

There have been no material changes outside the ordinary course of business to the contractual obligations disclosed in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2013.

30

RECENT ACCOUNTING PRONOUNCEMENTS

Refer to Note 3, Amendments to the Accounting Standards Codification, for information related to the adoption of new amendments to the Accounting Standards Codification.

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Not required.

ITEM 4. CONTROLS AND PROCEDURES

EVALUATION OF DISCLOSURE CONTROLS AND PROCEDURES

As of the end of the period to which this report relates, the Company has carried out an evaluation, under the supervision and with the participation of the Company’s management, including the Company’s Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of the Company’s disclosure controls and procedures pursuant to Rule 13a-14 of the Securities Exchange Act of 1934. In designing and evaluating its disclosure controls and procedures, management recognized that disclosure controls and procedures, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that objectives of the disclosure controls and procedures are met. The design of any disclosure controls and procedures is also based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential conditions. Based upon their evaluation, the Company’s Chief Executive Officer and Chief Financial Officer concluded that the Company’s disclosure controls and procedures are effective in timely alerting them to material information relating to the Company (including its consolidated subsidiaries) required to be included in the Company’s periodic Securities and Exchange Commission filings as of September 30, 2014.

CHANGES IN INTERNAL CONTROLS OVER FINANCIAL REPORTING

There was no change to the Company’s internal control over financial reporting during the nine months ended September 30, 2014 that materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.

PART II - OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

In the ordinary course of its operations, the Company is a party to various legal proceedings. Based upon information currently available, management believes that such legal proceedings, in the aggregate, will not have a material adverse effect on the business, financial condition, or results of operations of the Company.

ITEM 1A. RISK FACTORS

Not required.

ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

None to report.

ITEM 3. DEFAULT UPON SENIOR SECURITIES

None to report.

ITEM 4. MINE SAFETY DISCLOSURES

Not applicable.

ITEM 5.OTHER INFORMATION

None to report.

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ITEM 6. EXHIBITS

31.1	Certification Pursuant to 18 U.S.C. Section 1350 as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
31.2	Certification Pursuant to 18 U.S.C. Section 1350 as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
32.1	Certification Pursuant to 18 U.S.C. Section 1350 as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
101	The following materials from the Company’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2014, formatted in Extensible Business Reporting Language (XBRL): (i) Consolidated Balance Sheets as of September 30, 2014 and December 31, 2013, (ii) Consolidated Statements of Income for the three and nine months ended September 30, 2014 and 2013, (iii) Consolidated Statements of Comprehensive Income for the three and nine months ended September 30, 2014 and 2013, (iv) Consolidated Statements of Changes in Shareholders’ Equity for the nine months ended September 30, 2014, (v) Consolidated Statements of Cash Flows for the nine months ended September 30, 2014 and 2013, and (vi) Notes to Consolidated Financial Statements.

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

Bay Banks of Virginia, Inc.
(Registrant)
November 13, 2014	By:	/s/ Randal R. Greene
		Randal R. Greene
		President and Chief Executive Officer
		(Principal Executive Officer)
	By:	/s/ Deborah M. Evans
		Deborah M. Evans
		Treasurer and Chief Financial Officer
		(Principal Financial and Accounting Officer)

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