Bank of the James Financial (BOTJ) 10-Q 2018 Q3 Quarterly report

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

Form10-Q

Quarterly Report Pursuant to Section 13 or 15(d)

of the Securities Exchange Act of 1934

For the Quarterly Period Ended September 30, 2018

BANK OF THE JAMES FINANCIAL GROUP, INC.

(Exact Name of Registrant as Specified in Its Charter)

Virginia	001-35402	20-0500300
(State or other jurisdiction of incorporation or organization)	(Commission file number)	(I.R.S. Employer Identification No.)
828 Main Street, Lynchburg, VA		24504
(Address of principal executive offices)		(Zip Code)

(434)846-2000

(Registrant’s telephone number, including area code)

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  ☒    No  ☐

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of RegulationS-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).    Yes  ☒    No  ☐

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, anon-accelerated filer, smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule12b-2 of the Exchange Act.

Large accelerated filer	☐	Accelerated filer	☐
Non-accelerated filer	☒	Smaller reporting company	☒
Emerging growth company	☐

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.  ☐

Indicate by check mark whether the registrant is a shell company (as defined by Rule12b-2 of the Exchange Act).    Yes  ☐    No  ☒

APPLICABLE ONLY TO CORPORATE ISSUERS

State the number of shares outstanding of each of the issuer’s classes of common equity, as of the latest practicable date: 4,378,436 shares of Common Stock, par value $2.14 per share, were outstanding at November 8, 2018.

Table of Contents

PART I – FINANCIAL INFORMATION		1
Item 1.	Consolidated Financial Statements	1
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results ofOperations	31
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	48
Item 4.	Controls and Procedures	48
PART II – OTHER INFORMATION		49
Item 1.	Legal Proceedings	49
Item 1A.	Risk Factors	49
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	49
Item 3.	Defaults Upon Senior Securities	49
Item 4.	Mine Safety Disclosures	49
Item 5.	Other Information	50
Item 6.	Exhibits	50
SIGNATURES		52

PART I – FINANCIAL INFORMATION

Item 1. Consolidated Financial Statements

Bank of the James Financial Group, Inc. and Subsidiaries

Consolidated Balance Sheets

(dollar amounts in thousands, except per share amounts) (2018 unaudited)

	September 30,			December 31,
	2018			2017
Assets
Cash and due from banks	$	25,849		$	20,267
Federal funds sold		24,615			16,751
Total cash and cash equivalents		50,464			37,018
Securitiesheld-to-maturity (fair value of $3,394 in 2018 and $5,619 in 2017)		3,703			5,713
Securitiesavailable-for-sale, at fair value		52,333			55,312
Restricted stock, at cost		1,462			1,505
Loans, net of allowance for loan losses of $4,561 in 2018 and 4,752 in 2017		524,104			491,022
Loans held for sale		2,529			2,626
Premises and equipment, net		12,080			12,055
Interest receivable		1,876			1,713
Cash value - bank owned life insurance		13,274			13,018
Other real estate owned		2,455			2,650
Income taxes receivable		1,315			1,366
Deferred tax asset, net		1,839			1,418
Other assets		1,004			925
Total assets	$	668,438		$	626,341
Liabilities and Stockholders’ Equity
Deposits
Noninterest bearing demand	$	89,844		$	74,102
NOW, money market and savings		329,870			307,987
Time		187,733			185,404
Total deposits		607,447			567,493
Capital notes		5,000			5,000
Interest payable		131			111
Other liabilities		2,743			2,072
Total liabilities	$	615,321		$	574,676
Commitments and Contingencies
Stockholders’ equity
Preferred stock; authorized 1,000,000 shares; none issued and outstanding	$	—		$	—
Common stock $2.14 par value; authorized 10,000,000 shares; issued and outstanding 4,378,436 as of September 30, 2018 and December 31, 2017		9,370			9,370
Additionalpaid-in-capital		31,495			31,495
Retained earnings		15,309			12,269
Accumulated other comprehensive (loss)		(3,057	)		(1,469	)
Total stockholders’ equity	$	53,117		$	51,665
Total liabilities and stockholders’ equity	$	668,438		$	626,341

1

See accompanying notes to these consolidated financial statements

Bank of the James Financial Group, Inc. and Subsidiaries

Consolidated Statements of Income

(dollar amounts in thousands, except per share amounts) (unaudited)

	For the Three Months				For the Nine Months
	Ended September 30,				Ended September 30,
	2018		2017		2018		2017
Interest Income
Loans	$	��6,460	$	5,683	$	18,329	$	16,336
Securities
US Government and agency obligations		187		131		571		365
Mortgage backed securities		62		71		196		214
Municipals - taxable		81		81		243		230
Municipals - tax exempt		2		7		5		28
Dividends		9		7		40		42
Other (Corporates)		23		24		70		81
Interest bearing deposits		60		21		151		53
Federal Funds sold		96		45		255		81
Total interest income		6,980		6,070		19,860		17,430
Interest Expense
Deposits
NOW, money market savings		261		186		684		530
Time Deposits		679		537		1,885		1,488
FHLB borrowings		—		—		17		—
Reverse repurchase agreements		—		13		—		13
Capital notes 4% due 1/24/2022		50		50		150		137
Total interest expense		990		786		2,736		2,168
Net interest income		5,990		5,284		17,124		15,262
Provision for loan losses		190		200		527		745
Net interest income after provision for loan losses		5,800		5,084		16,597		14,517
Noninterest income
Gain on sales of loans held for sale		767		694		2,260		1,663
Service charges, fees and commissions		547		479		1,476		1,377
Increase in cash value of life insurance		86		86		256		259
Other		20		9		55		42
Gain on sales and calls of securities, net		—		51		—		113
Total noninterest income		1,420		1,319		4,047		3,454
Noninterest expenses
Salaries and employee benefits		2,853		2,538		8,398		7,314
Occupancy		388		390		1,143		1,127
Equipment		414		360		1,191		1,146
Supplies		124		133		413		390
Professional, data processing, and other outside expenses		761		735		2,413		2,112
Marketing		165		212		492		596
Credit expense		241		155		478		456
Other real estate expenses		110		42		236		78
FDIC insurance expense		99		94		299		285
Other		310		255		805		733
Total noninterest expenses		5,465		4,914		15,868		14,237
Income before income taxes		1,755		1,489		4,776		3,734
Income tax expense		351		474		949		1,172
Net Income	$	1,404	$	1,015	$	3,827	$	2,562
Weighted average shares outstanding - basic		4,378,436		4,378,436		4,378,436		4,378,436
Weighted average shares outstanding - diluted		4,378,436		4,378,519		4,378,466		4,378,524
Earnings per common share - basic	$	0.32	$	0.23	$	0.87	$	0.59
Earnings per common share - diluted	$	0.32	$	0.23	$	0.87	$	0.59

2

See accompanying notes to these consolidated financial statements

Bank of the James Financial Group, Inc. and Subsidiaries

Consolidated Statements of Comprehensive Income

For the Three and Nine Months Ended September 30, 2018 and 2017

(dollar amounts in thousands) (unaudited)

	For the Three Months						For the Nine Months
	Ended September 30,						Ended September 30,
	2018			2017			2018			2017
Net Income	$	1,404		$	1,015		$	3,827		$	2,562
Other comprehensive (loss) income:
Unrealized (losses) gains on securitiesavailable-for-sale		(693	)		25			(2,009	)		1,019
Tax effect		144			(9	)		421			(347	)
Reclassification adjustment for gains included in net income (1)		—			(51	)		—			(113	)
Tax effect (2)		—			17			—			38
Other comprehensive (loss) income, net of tax		(549	)		(18	)		(1,588	)		597
Comprehensive income	$	855		$	997		$	2,239		$	3,159

(1) Gains are included in “gain on sales and calls of securities, net” on the consolidated statements of income.

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

3

See accompanying notes to these consolidated financial statements

Bank of the James Financial Group, Inc. and Subsidiaries

Consolidated Statements of Cash Flows

Nine Months Ended September 30, 2018 and 2017

(dollar amounts in thousands) (unaudited)

	For the Nine Months Ended September 30,
	2018			2017
Cash flows from operating activities
Net Income	$	3,827		$	2,562
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization		679			601
Net amortization and accretion of premiums and discounts on securities		312			280
(Gain) on sales ofavailable-for-sale securities		—			(113	)
(Gain) on sales of loans held for sale		(2,260	)		(1,663	)
Proceeds from sales of loans held for sale		89,949			63,271
Origination of loans held for sale		(87,592	)		(59,277	)
Provision for loan losses		527			745
Loss on sale of other real estate owned		39			—
Impairment of other real estate owned		160			60
(Increase) in cash value of life insurance		(256	)		(259	)
(Increase) in interest receivable		(163	)		(218	)
(Increase) decrease in other assets		(79	)		69
Decrease (increase) in income taxes receivable		51			(61	)
Increase in interest payable		20			12
Increase in other liabilities		671			355
Net cash provided by operating activities	$	5,885		$	6,364
Cash flows from investing activities
Proceeds from calls of securitiesheld-to-maturity	$	2,000		$	—
Purchases of securitiesavailable-for-sale		(998	)		(20,728	)
Proceeds from maturities, calls and paydowns of securitiesavailable-for-sale		1,666			2,655
Proceeds from sale of securitiesavailable-for-sale		—			9,941
(Purchase) of Federal Reserve Bank stock		—			(90	)
Redemption (purchase) of Federal Home Loan Bank stock		43			(42	)
Proceeds from sale of other real estate owned		846			515
Improvements to other real estate owned		—			(29	)
Origination of loans, net of principal collected		(34,459	)		(30,971	)
Proceeds from sale of other assets		—			1
Purchases of premises and equipment		(704	)		(1,574	)
Net cash (used in) investing activities	$	(31,606	)	$	(40,322	)
Cash flows from financing activities
Net increase in deposits	$	39,954		$	37,403
Dividends paid to common stockholders		(787	)		(788	)
Proceeds fom sale of 4% capital notes due 1/24/2022		—			5,000
Net cash provided by financing activities	$	39,167		$	41,615
Increase in cash and cash equivalents		13,446			7,657
Cash and cash equivalents at beginning of period	$	37,018		$	28,683
Cash and cash equivalents at end of period	$	50,464		$	36,340
Non cash transactions
Transfer of loans to other real estate owned	$	850		$	815
Unrealized (losses) gains on securitiesavailable-for-sale		(2,009	)		906
Cash transactions
Cash paid for interest	$	2,716		$	2,156
Cash paid for income taxes		975			1,275

4

See accompanying notes to these consolidated financial statements

Bank of the James Financial Group, Inc. and Subsidiaries

Consolidated Statements of Changes in Stockholders’ Equity

For the Nine Months Ended September 30, 2018 and 2017

(dollars in thousands, except per share amounts) (unaudited)

										Accumulated
					Additional					Other
	Shares		Common		Paid-in		Retained			Comprehensive
	Outstanding		Stock		Capital		Earnings			(Loss)			Total
Balance at December 31, 2016		4,378,436	$	9,370	$	31,495	$	10,156		$	(1,600	)	$	49,421
Net Income		—		—		—		2,562			—			2,562
Dividends paid on common stock ($0.18 per share)		—		—		—		(788	)		—			(788	)
Other comprehensive income		—		—		—		—			597			597
Balance at September 30, 2017		4,378,436	$	9,370	$	31,495	$	11,930		$	(1,003	)	$	51,792
Balance at December 31, 2017		4,378,436	$	9,370	$	31,495	$	12,269		$	(1,469	)	$	51,665
Net Income		—		—		—		3,827			—			3,827
Dividends paid on common stock ($0.18 per share)		—		—		—		(787	)		—			(787	)
Other comprehensive loss		—		—		—		—			(1,588	)		(1,588	)
Balance at September 30, 2018		4,378,436	$	9,370	$	31,495	$	15,309		$	(3,057	)	$	53,117

5

See accompanying notes to these consolidated financial statements

Notes to Consolidated Financial Statements

Note 1 – Basis of Presentation

The unaudited consolidated financial statements have been prepared by Bank of the James Financial Group, Inc. (“Financial” or the “Company”) pursuant to the rules and regulations of the Securities and Exchange Commission. In management’s opinion the accompanying financial statements, which unless otherwise noted are unaudited, reflect all adjustments, consisting solely of normal recurring accruals, necessary for a fair presentation of the financial information as of September 30, 2018 and for the three and nine months ended September 30, 2018 and 2017 in conformity with accounting principles generally accepted in the United States of America. Additional information concerning the organization and business of Financial, accounting policies followed, and other related information is contained in Financial’s Annual Report on Form10-K for the year ended December 31, 2017. These financial statements should be read in conjunction with the audited consolidated financial statements and footnotes for the year ended December 31, 2017 included in Financial’s Annual Report on Form10-K. Results for the three and nine month periods ended September 30, 2018 are not necessarily indicative of the results that may be expected for the year ending December 31, 2018.

Certain immaterial reclassifications have been made to prior period balances to conform to the current period presentation. Reclassifications had no effect on prior year net income or stockholders’ equity.

The Company’s primary market area consists of the area commonly referred to as Region 2000 which encompasses the seven jurisdictions of the Town of Altavista, Amherst County, Appomattox County, the Town of Bedford, Bedford County, Campbell County, and the City of Lynchburg. Recently, the Company has expanded into Charlottesville, Roanoke, and Harrisonburg.

Financial’s critical accounting policies include the evaluation of the allowance for loan losses which is based on management’s estimate of an amount that is adequate to absorb probable losses inherent in the loan portfolio of Bank of the James (the “Bank”), Financial’s wholly-owned subsidiary. The allowance for loan losses is established through a provision for loan losses based on available information including the composition of the loan portfolio, historical loan losses, specific impaired loans, availability and quality of collateral, age of the various portfolios, changes in local economic conditions, and loan performance and quality of the portfolio. Different assumptions used in evaluating the adequacy of the Bank’s allowance for loan losses could result in material changes in Financial’s financial condition and results of operations. The Bank’s policy with respect to the methodology for determining the allowance for loan losses involves a higher degree of complexity and requires management to make subjective judgments that often require assumptions or estimates about uncertain matters. This critical policy and its assumptions are periodically reviewed with the Board of Directors.

Financial also considers valuation of other real estate owned (OREO) a critical accounting policy. OREO consists of properties acquired through foreclosure or deed in lieu of foreclosure. These properties are carried at fair value less estimated costs to sell at the date of foreclosure. Losses from the acquisition of property in full or partial satisfaction of loans are charged against the allowance for loan losses. Subsequent write-downs, if any, are charged against expense. Gains and losses on the sales of foreclosed properties are included in determining net income in the year of the sale. Operating costs after acquisition are expensed.

6

Note 2 – Use of Estimates

The consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States of America which require management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates.

Note 3 – Earnings Per Common Share (EPS)

The following is a summary of the earnings per share calculation for the three and nine months ended September 30, 2018 and 2017.

	Three Months Ended September 30,				Nine Months Ended September 30,
	2018		2017		2018		2017
Net income	$	1,404,000	$	1,015,000	$	3,827,000	$	2,562,000
Weighted average number of shares		4,378,436		4,378,436		4,378,436		4,378,436
Options effect of incremental shares		—		83		30		88
Weighted average diluted shares		4,378,436		4,378,519		4,378,466		4,378,524
Basic EPS (weighted avg shares)	$	0.32	$	0.23	$	0.87	$	0.59
Diluted EPS (Including Option Shares)	$	0.32	$	0.23	$	0.87	$	0.59

No option shares were excluded in calculating diluted earnings per share for any of the periods presented.

Note 4 – Stock Based Compensation

Accounting standards require companies to recognize the cost of employee services received in exchange for awards of equity instruments, such as stock options and restricted stock, based on the fair value of those awards at the date of grant.

7

Note 4 – Stock Based Compensation (continued)

Stock option plan activity for the nine months ended September 30, 2018 is summarized below:

	Shares			Weighted Average Exercise Price		Weighted Average Remaining Contractual Life (in years)		Intrinsic Value
Options outstanding, January 1, 2018		636		$	12.79
Granted		—			—
Exercised		—			—
Forfeited		(636	)		12.79
Options outstanding, September 30, 2018		—		$	—		—	$	—
Options exercisable, September 30, 2018		—		$	—		—	$	—

Intrinsic value is calculated by subtracting the exercise price of option shares from the market price of underlying shares as of September 30, 2018 and multiplying that amount by the number of options outstanding. No intrinsic value exists where the exercise price is greater than the market price on a given date.

All compensation expense related to the foregoing stock option plan has been recognized. The Company’s ability to grant additional options shares under the 1999 Plan has expired and no options remain outstanding from the 1999 Plan.

At the annual meeting of shareholders held on May 15, 2018, the shareholders approved the Bank of the James Financial Group, Inc. 2018 Equity Incentive Plan (the “2018 Incentive Plan”). The 2018 Incentive Plan permits the issuance of up to 250,000 shares of common stock for awards to key employees of the Company and its subsidiaries in the form of stock options, restricted stock, restricted stock units, stock awards and performance units. To date the Company has not awarded any equity compensation under the 2018 Incentive Plan.

Note 5 – Fair Value Measurements

Determination of Fair Value

The Company uses fair value measurements to record fair value adjustments to certain assets and liabilities and to determine fair value disclosures. In accordance with the Fair Value Measurements and Disclosures topic of FASB ASC, the fair value of a financial instrument is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. Fair value is best determined based upon quoted market prices. However, in many instances, there are no quoted market prices for the Company’s various financial instruments. In cases where quoted market prices are not available, fair values are based on estimates using present value or other valuation techniques. Those techniques are significantly affected by the assumptions used, including the discount rate and estimates of future cash flows. Accordingly, the fair value estimates may not be realized in an immediate settlement of the instrument.

The fair value guidance provides a consistent definition of fair value, which focuses on exit price in an orderly transaction (that is, not a forced liquidation or distressed sale) between market participants at the measurement date under current market conditions. If there has been a significant decrease in the volume

8

Note 5 – Fair Value Measurements (continued)

and level of activity for the asset or liability, a change in valuation technique or the use of multiple valuation techniques may be appropriate. In such instances, determining the price at which willing market participants would transact at the measurement date under current market conditions depends on the facts and circumstances and requires the use of significant judgment. The fair value is a reasonable point within the range that is most representative of fair value under current market conditions.

Fair Value Hierarchy

In accordance with this guidance, the Company groups its financial assets and financial liabilities generally measured at fair value in three levels, based on the markets in which the assets and liabilities are traded and the reliability of the assumptions used to determine fair value.

• Level 1 inputs to the valuation methodology are quoted prices (unadjusted) for identical assets or liabilities in active markets.

• Level 2 inputs to the valuation methodology include quoted prices for similar assets and liabilities in active markets, and inputs that are observable for the asset or liability, either directly or indirectly, for substantially the full term of the financial instrument.

• Level 3 inputs to the valuation methodology are unobservable and significant to the fair value measurement.

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

Fair Value on a Recurring Basis

SecuritiesAvailable-for-Sale

Fair values of securities, excluding restricted investments in Federal Reserve Bank stock, Federal Home Loan Bank stock, and Community Bankers’ Bank stock are based on quoted prices available in an active market. If quoted prices are available, these securities are classified within Level 1 of the valuation hierarchy. Level 1 securities would include highly liquid government bonds, mortgage products and exchange traded equities. If quoted market prices are not available, then fair values are estimated by using pricing models, quoted prices of securities with similar characteristics, or discounted cash flow.

Level 2 securities would include U.S. agency securities, mortgage-backed agency securities, obligations of states and political subdivisions and certain corporate, asset backed and other securities. In certain cases where there is limited activity or less transparency around inputs to the valuation, securities are classified within Level 3 of the valuation hierarchy. Currently, all of the Company’s securities are considered to be Level 2 securities.

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

9

Note 5 – Fair Value Measurements (continued)

			Carrying Value at September 30, 2018 (in thousands)
Description	Balance as of September 30, 2018		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
US Treasuries	$	1,780	$	—	$	1,780	$	—
US agency obligations		22,712		—		22,712		—
Mortgage-backed securities		12,225		—		12,225		—
Municipals		11,851		—		11,851		—
Corporates		3,765		—		3,765		—
Totalavailable-for-sale securities	$	52,333	$	—	$	52,333	$	—
			Carrying Value at December 31, 2017 (in thousands)
Description	Balance as of December 31, 2017		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
US Treasuries	$	1,858	$		$	1,858	$
US agency obligations		23,850		—		23,850		—
Mortgage-backed securities		13,388		—		13,388		—
Municipals		12,274		—		12,274		—
Corporates		3,942		—		3,942		—
Totalavailable-for-sale securities	$	55,312	$	—	$	55,312	$	—

Fair Value on aNon-recurring Basis

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 when due. The measurement of loss associated with impaired loans can be based on either the observable market price of the loan or the fair value of the collateral. Fair value is measured based on the value of the collateral securing the loans. Collateral may be in the form of real estate or business assets including equipment, inventory, and accounts receivable. The vast majority of the collateral is real estate. The value of real estate collateral is determined utilizing an income or market valuation approach based on an appraisal conducted by an independent, licensed appraiser outside of the Bank using observable market data (Level 2). However, in situations where the collateral is a house or building in the process of construction, the appraisal is more than 12 months old, management has determined the fair value of the collateral is further impaired below the appraised value, or the appraisal is not based solely on market comparables adjusted for observable inputs, the value is considered Level 3. The value of business equipment is based upon an outside appraisal if deemed significant, or the net book value on the applicable business’ financial statements if not considered significant using observable market data. Likewise, values for inventory and accounts receivables collateral are based on financial statement balances or aging reports (Level 3). Any fair value adjustments are recorded in the period incurred as provision for loan losses on the Consolidated Statements of Income.

10

Note 5 – Fair Value Measurements (continued)

Loans held for sale

Loans held for sale are carried at cost which approximates estimated fair value. These loans currently consist ofone-to-four family residential loans originated for sale in the secondary market. Fair value is based on the price secondary markets are currently offering for similar loans using observable market data which is not materially different than cost due to the short duration between origination and sale (Level 2). As such, the Company records fair value adjustments on a nonrecurring basis. No nonrecurring fair value adjustments were recorded on loans held for sale during the period ended September 30, 2018. Gains and losses on the sale of loans are recorded within gains on sales of loans held for sale, net on the Consolidated Statements of Income.

Other real estate owned

Certain assets such as other real estate owned (OREO) are measured at fair value less cost to sell. We believe that the fair value component in its valuation follows the provisions of ASC 820.

Real estate acquired through foreclosure is transferred to OREO. The measurement of loss associated with OREO is based on the fair value of the collateral compared to the unpaid loan balance and anticipated costs to sell the property. The value of OREO property is determined utilizing an income or market valuation approach based on an appraisal conducted by an independent, licensed appraiser outside of the Bank using observable market data (Level 2).

Any fair value adjustments are recorded in the period incurred and expensed against current earnings. However, in situations where the collateral is a house or building in the process of construction, the appraisal is more than 12 months old, management has determined the fair value of the collateral is further impaired below the appraised value, or the appraisal is not based solely on market comparables adjusted for observable inputes, the value is considered Level 3.

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

			Carrying Value at September 30, 2018
Description	Balance as of September 30, 2018		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Impaired loans*	$	1,857	$	—	$	—	$	1,857
Loans held for sale		2,529		—		2,529		—
Other real estate owned		2,455		—		—		2,455

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

			Carrying Value at December 31, 2017
Description	Balance as of December 31, 2017		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Impaired loans*	$	2,523	$	—	$	—	$	2,523
Loans held for sale		2,626		—		2,626		—
Other real estate owned		2,650		—		—		2,650

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

11

Note 5 – Fair Value Measurements (continued)

The following table sets forth information regarding the quantitative inputs used to value assets classified as Level 3:

	Quantitative information about Level 3 Fair Value Measurements for September 30, 2018 (dollars in thousands)
	Fair Value		Valuation Technique(s)	Unobservable Input	Range (Weighted Average)
Assets
Impaired loans	$	1,857	Discounted appraised value	Selling cost		0% - 10% (8%)
				Discount for lack of marketability and age of appraisal		0% - 20% (6%)
OREO		2,455	Discounted appraised value	Selling cost		0% - 10% (6%)
				Discount for lack of marketability and age of appraisal		0% - 25% (15%)
	Quantitative information about Level 3 Fair Value Measurements for December 31, 2017 (dollars in thousands)
	Fair Value		Valuation Technique(s)	Unobservable Input	Range (Weighted Average)
Assets
Impaired loans	$	2,523	Discounted appraised value	Selling cost		0% - 10% (8%)
				Discount for lack of marketability and age of appraisal		0% - 20% (6%)
OREO		2,650	Discounted appraised value	Selling cost		0% - 10% (6%)
				Discount for lack of marketability and age of appraisal		0% - 25% (15%)

12

Note 5 – Fair Value Measurements (continued)

The estimated fair values, and related carrying or notional amounts, of Financial’s financial instruments and their placement in the fair value hierarchy at September 30, 2018 and December 31, 2017 was as follows (in thousands):

			Fair Value Measurements at September 30, 2018 using
			Quoted Prices		Significant
			in Active		Other		Significant
			Markets for		Observable		Unobservable
	Carrying		Identical Assets		Inputs		Inputs
	Amounts		(Level 1)		(Level 2)		(Level 3)		Balance
Assets
Cash and due from banks	$	25,849	$	25,849	$	—	$	—	$	25,849
Fed funds sold		24,615		24,615		—		—		24,615
Securities
Available-for-sale		52,333		—		52,333		—		52,333
Held-to-maturity		3,703		—		3,394		—		3,394
Restricted stock		1,462				1,462		—		1,462
Loans, net (1)		524,104		—		—		511,788		511,788
Loans held for sale		2,529		—		2,529		—		2,529
Interest receivable		1,876		—		1,876		—		1,876
BOLI		13,274		—		13,274		—		13,274
Liabilities
Deposits	$	607,447	$	—	$	608,115	$	—	$	608,115
Capital notes		5,000		—		4,690		—		4,690
Interest payable		131		—		131		—		131
			Fair Value Measurements at December 31, 2017 using
			Quoted Prices		Significant
			in Active		Other		Significant
			Markets for		Observable		Unobservable
	Carrying		Identical Assets		Inputs		Inputs
	Amounts		(Level 1)		(Level 2)		(Level 3)		Balance
Assets
Cash and due from banks	$	20,267	$	20,267	$	—	$	—	$	20,267
Fed funds sold		16,751		16,751						16,751
Securities
Available-for-sale		55,312		—		55,312		—		55,312
Held-to-maturity		5,713		—		5,619		—		5,619
Restricted stock		1,505		—		1,505				1,505
Loans, net (1)		491,022		—		—		492,397		492,397
Loans held for sale		2,626		—		2,626		—		2,626
Interest receivable		1,713		—		1,713		—		1,713
BOLI		13,018		—		13,018		—		13,018
Liabilities
Deposits	$	567,493	$	—	$	568,224	$	—	$	568,224
Capital notes		5,000		—		5,310				5,310
Interest payable		111		—		111		—		111

(1) Carrying amount is net of unearned income and the Allowance. In accordance with the prospective adoption of ASUNo. 2016-01, the fair value of loans as of September 30, 2018 was measured using an exit price notion. The fair value of loans as of December 31, 2017 was measured using an entry price notion.

13

Note 5 – Fair Value Measurements (continued)

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

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

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

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

Note 6 – Capital Notes

On January 25, 2017, Financial closed a private placement of unregistered debt securities (the “2017 Offering”) pursuant to which Financial issued $5,000,000 in principal of notes (the “2017 Notes”). The 2017 Notes bear interest at the rate of 4% per year with interest payable quarterly in arrears. The 2017 Notes are to mature on January 24, 2022, but are subject to prepayment in whole or in part on or after January 24, 2018 at Financial’s sole discretion on 30 days written notice to the holders. Of the proceeds, $3,000,000 was injected into the Bank as equity capital in March 2017. It is anticipated the remaining $2,000,000 will remain at the holding company level for debt service on the 2017 Notes.

14

Note 7 - Securities

The following tables summarize the Bank’s holdings for both securitiesheld-to-maturity and securitiesavailable-for-sale as of September 30, 2018 and December 31, 2017 (amounts in thousands):

	September 30, 2018
	Amortized		Gross Unrealized
	Costs		Gains		(Losses)			Fair Value
Held-to-Maturity
US agency obligations	$	3,703	$	—	$	(309	)	$	3,394
Available-for-Sale
US Treasuries		1,960		—		(180	)		1,780
US agency obligations		24,747		5		(2,040	)		22,712
Mortgage-backed securities		12,941		—		(716	)		12,225
Municipals		12,448		—		(597	)		11,851
Corporates		4,106		—		(341	)		3,765
	$	56,202	$	5	$	(3,874	)	$	52,333
	December 31, 2017
	Amortized		Gross Unrealized
	Costs		Gains		(Losses)			Fair Value
Held-to-Maturity
US agency obligations	$	5,713	$	8	$	(102	)	$	5,619
Available-for-Sale
US Treasuries		1,956		—		(98	)		1,858
US agency obligations		24,881		5		(1,036	)		23,850
Mortgage-backed securities		13,662		2		(276	)		13,388
Municipals		12,556		16		(298	)		12,274
Corporates		4,117		—		(175	)		3,942
	$	57,172	$	23	$	(1,883	)	$	55,312

15

Note 7 – Securities (continued)

The following tables show the gross unrealized losses and fair value of the Bank’s investments with unrealized losses that are not deemed to be other-than-temporarily impaired, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position, at September 30, 2018 and December 31, 2017 (amounts in thousands):

	Less than 12 months				More than 12 months				Total
September 30, 2018	Fair Value		Unrealized Losses		Fair Value		Unrealized Losses		Fair Value		Unrealized Losses
Description of securities
Held-to-maturity
US agency obligations	$	2,435	$	200	$	1,268	$	109	$	3,703	$	309
Available-for-sale
US Treasuries		—		—		1,780		180		1,780		180
US agency obligations		6,241		379		16,471		1,661		22,712		2,040
Mortgage-backed securities		949		41		11,276		675		12,225		716
Municipals		—		—		11,851		597		11,851		597
Corporates		—		—		3,765		341		3,765		341
Total	$	7,190	$	420	$	45,143	$	3,454	$	52,333	$	3,874
	Less than 12 months				More than 12 months				Total
December 31, 2017	Fair Value		Unrealized Losses		Fair Value		Unrealized Losses		Fair Value		Unrealized Losses
Description of securities
Held-to-maturity
US agency obligations	$	2,367	$	70	$	1,243	$	32	$	3,610	$	102
Available-for-sale
US Treasuries		—		—		1,858		98		1,858		98
US agency obligations		11,465		215		12,379		821		23,844		1,036
Mortgage-backed securities		2,802		26		9,712		250		12,514		276
Municipals		4,823		41		5,644		257		10,467		298
Corporates		—		—		3,942		175		3,942		175
Total	$	19,090	$	282	$	33,535	$	1,601	$	52,625	$	1,883

Management evaluates securities for other-than-temporary impairment at least on a quarterly basis, and may do so more frequently when economic or market concerns warrant such evaluation. Consideration is given to (1) the length of time and the extent to which the fair value has been less than cost, (2) the financial condition and near-term prospects of the issuer, (3) the intent of Financial, if any, to sell the security; (4) whether Financial more likely than not will be required to sell the security before recovering its cost; and (5) whether Financial does not expect to recover the security’s entire amortized cost basis (even if Financial does not intend to sell the security).

16

Note 7 – Securities (continued)

At September 30, 2018, the Company did not consider the unrealized losses as other-than-temporary losses due to the nature of the securities involved. As of September 30, 2018, the Bank owned 60 securities in an unrealized loss position that were being evaluated for other than temporary impairment. Ten of these securities were S&P rated AAA, 47 were rated AA, two were rated A, and one was rated BBB+. As of September 30, 2018, 34 of these securities were direct obligations of the U.S. government or government sponsored entities, 21 were municipal issues, and five were investments in domestic corporate issued securities.

Based on the analysis performed by management as mandated by the Bank’s investment policy, management believes the default risk to be minimal. Because management does not intend to sell and it is likely that management will not be required to sell the securities prior to their anticipated recovery, and the decline in fair value is largely due to change in interest rates and other market conditions, no declines currently are deemed to be other-than-temporary.

There were no gross gains on sales ofavailable-for-sale securities during the three and nine month periods ended September 30, 2018 compared to $51 and $113 for the same respective periods in 2017. There were no losses on sales ofavailable-for-sale securities and no sales ofheld-to-maturity securities during the three and nine month periods ended September 30, 2018 and 2017.

Note 8 – Business Segments

The Company has two reportable business segments: (i) a traditional full service community banking segment and, (ii) a mortgage loan origination business. The community banking business segment includes Bank of the James which provides loans, deposits, investments and insurance to retail and commercial customers throughout Region 2000 and other areas within Central Virginia. The mortgage segment provides a variety of mortgage loan products principally within Region 2000. Mortgage loans are originated and sold in the secondary market through purchase commitments from investors with servicing released. Because of thepre-arranged purchase commitments, there is minimal risk to the Company.

Both of the Company’s reportable segments are service based. The mortgage business is a gain on sale business while the Bank’s primary source of revenue is net interest income. The Bank also provides a referral network for the mortgage origination business. The mortgage business may also be in a position to refer its customers to the Bank for banking services when appropriate.

17

Note 8 – Business Segments (continued)

Information about reportable business segments and reconciliation of such information to the consolidated financial statements for the three and nine months ended September 30, 2018 and 2017 was as follows (dollars in thousands):

Business Segments

	Community
	Banking		Mortgage		Total
Nine months ended September 30, 2018
Net interest income	$	17,124	$	—	$	17,124
Provision for loan losses		527		—		527
Net interest income after provision for loan losses		16,597		—		16,597
Noninterest income		1,785		2,262		4,047
Noninterest expenses		14,023		1,845		15,868
Income before income taxes		4,359		417		4,776
Income tax expense		891		58		949
Net income	$	3,468	$	359	$	3,827
Total assets	$	665,698	$	2,740	$	668,438
Nine months ended September 30, 2017
Net interest income	$	15,262	$	—	$	15,262
Provision for loan losses		745		—		745
Net interest income after provision for loan losses		14,517		—		14,517
Noninterest income		1,791		1,663		3,454
Noninterest expenses		12,880		1,357		14,237
Income before income taxes		3,428		306		3,734
Income tax expense		1,068		104		1,172
Net income	$	2,360	$	202	$	2,562
Total assets	$	617,720	$	1,616	$	619,336
	Community
	Banking		Mortgage		Total
Three months ended September 30, 2018
Net interest income	$	5,990	$	—	$	5,990
Provision for loan losses		190		—		190
Net interest income after provision for loan losses		5,800		—		5,800
Noninterest income		653		767		1,420
Noninterest expenses		4,816		649		5,465
Income before income taxes		1,637		118		1,755
Income tax expense		345		6		351
Net income	$	1,292	$	112	$	1,404
Total assets	$	665,698	$	2,740	$	668,438
Three months ended September 30, 2017
Net interest income	$	5,284	$	—	$	5,284
Provision for loan losses		200		—		200
Net interest income after provision for loan losses		5,084		—		5,084
Noninterest income		625		694		1,319
Noninterest expenses		4,321		593		4,914
Income before income taxes		1,388		101		1,489
Income tax expense		438		36		474
Net income	$	950	$	65	$	1,015
Total assets	$	617,720	$	1,616	$	619,336

18

Note 9 – Loans, allowance for loan losses and OREO

Management has an established methodology used to determine the adequacy of the allowance for loan losses that assesses the risks and losses inherent in the loan portfolio. For purposes of determining the allowance for loan losses, the Bank has segmented certain loans in the portfolio by product type. Within these segments, the Bank hassub-segmented its portfolio into classes, based on the associated risks. The classifications set forth below do not correspond directly to the classifications set forth in the call report (Form FFIEC 041). Management has determined that the classifications set forth below are more appropriate for use in identifying and managing risk in the loan portfolio.

Loan Segments:		Loan Classes:
	Commercial		Commercial and industrial loans
	Commercial real estate		Commercial mortgages – owner occupied
			Commercial mortgages –non-owner occupied
			Commercial construction
	Consumer		Consumer unsecured
			Consumer secured
	Residential		Residential mortgages
			Residential consumer construction

A summary of loans, net is as follows (dollars in thousands):

	As of:
	September 30, 2018		December 31, 2017
Commercial	$	94,520	$	96,127
Commercial real estate		283,715		251,807
Consumer		84,692		83,746
Residential		65,738		64,094
Total loans (1)		528,665		495,774
Less allowance for loan losses		4,561		4,752
Net loans	$	524,104	$	491,022

(1) Includes net deferred costs and premiums of $583 and $940 as of September 30, 2018 and December 31, 2017, respectively.

The Bank’s internal risk rating system is in place to grade commercial and commercial real estate loans. Category ratings are reviewed periodically by lenders and the credit review area of the Bank based on the borrower’s individual situation. Additionally, internal and external monitoring and review of credits are conducted on an annual basis.

19

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

Below is a summary and definition of the Bank’s risk rating categories:

RATING 1	Excellent
RATING 2	Above Average
RATING 3	Satisfactory
RATING 4	Acceptable / Low Satisfactory
RATING 5	Monitor
RATING 6	Special Mention
RATING 7	Substandard
RATING 8	Doubtful
RATING 9	Loss

We segregate loans into the above categories based on the following criteria and we review the characteristics of each rating at least annually, generally during the first quarter. The characteristics of these ratings are as follows:

• “Pass.” These are loans having risk ratings of 1 through 4. Pass loans are to persons or business entities with an acceptable financial condition, appropriate collateral margins, appropriate cash flow to service the existing loan, and an appropriate leverage ratio. The borrower has paid all obligations as agreed and it is expected that this type of payment history will continue. When necessary, acceptable personal guarantors support the loan.

• “Monitor.” These are loans having a risk rating of 5. Monitor loans have currently acceptable risk but may have the potential for a specific defined weakness in the borrower’s operations and the borrower’s ability to generate positive cash flow on a sustained basis. The borrower’s recent payment history may currently or in the future be characterized by late payments. The Bank’s risk exposure is mitigated by collateral supporting the loan. The collateral is considered to be well-margined, well maintained, accessible and readily marketable.

• “Special Mention.” These are loans having a risk rating of 6. Special Mention loans have weaknesses that deserve management’s close attention. If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the asset or in the bank’s credit position at some future date. Special Mention loans are not adversely classified and do not expose an institution to sufficient risk to warrant adverse classification. These loans do warrant more than routine monitoring due to a weakness caused by adverse events.

• “Substandard.” These are loans having a risk rating of 7. Substandard loans are considered to have specific and well-defined weaknesses that jeopardize the viability of the Bank’s credit extension. The payment history for the loan has been inconsistent and the expected or projected primary repayment source may be inadequate to service the loan. The estimated net liquidation value of the collateral pledged and/or ability of the personal guarantor(s) to pay the loan may not adequately protect the Bank. There is a distinct possibility that the Bank will sustain some loss if the deficiencies associated with the loan are not corrected in the near term. A substandard loan would not automatically meet our definition of impaired unless the loan is significantly past due and the borrower’s performance and financial condition provides evidence that it is probable that the Bank will be unable to collect all amounts due.

• “Doubtful.” These are loans having a risk rating of 8. Doubtful rated loans have all the weaknesses inherent in a loan that is classified substandard but with the added characteristic that the weaknesses make collection or liquidation in full, on the basis of currently existing facts, conditions, and values, highly questionable and improbable. The possibility of loss is extremely high.

20

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

• “Loss.” These are loans having a risk rating of 9. Loss rated loans are not considered collectible under normal circumstances and there is no realistic expectation for any future payment on the loan. Loss rated loans are fully charged off.

Loans onNon-Accrual Status
(dollars in thousands)
	As of
	September 30, 2018		December 31, 2017
Commercial	$	700	$	727
Commercial Real Estate:
Commercial Mortgages-Owner Occupied		317		1,465
CommercialMortgages-Non-Owner Occupied		37		468
Commercial Construction		—		—
Consumer
Consumer Unsecured		—		—
Consumer Secured		89		566
Residential:
Residential Mortgages		405		1,025
Residential Consumer Construction		800		58
Totals	$	2,348	$	4,309

We also classify other real estate owned (OREO) as a nonperforming asset. OREO represents real property owned by the Bank either through purchase at foreclosure or received from the borrower through a deed in lieu of foreclosure. OREO decreased to $2,455 on September 30, 2018 from $2,650 on December 31, 2017. The following table represents the changes in OREO balance during the nine months ended September 30, 2018 and year ended December 31, 2017.

OREO Changes
(dollars in thousands)
	Nine months ended September 30, 2018			Year ended December 31, 2017
Balance at the beginning of the year (net)	$	2,650		$	2,370
Transfers from loans		850			815
Capitalized costs		—			40
Valuation adjustments		(160	)		(60	)
Sales proceeds		(846	)		(514	)
Gain (loss) on disposition		(39	)		(1	)
Balance at the end of the period (net)	$	2,455		$	2,650

At September 30, 2018 and December 31, 2017, the Company had $0 of consumer mortgage loans secured by residential real estate for which foreclosure was in process. The Company held four residential real estate properties carried on the books in other real estate owned at a value of $180 as of September 30, 2018 and three residential real estate properties carried on the books at a value of $520 in other real estate owned as of December 31, 2017.

21

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

	Impaired Loans
	(dollars in thousands)
	As of and For the Nine months Ended September 30, 2018
			Unpaid				Average		Interest
	Recorded		Principal		Related		Recorded		Income
2018	Investment		Balance		Allowance		Investment		Recognized
With No Related Allowance Recorded:
Commercial	$	790	$	989	$	—	$	858	$	18
Commercial Real Estate
Commercial Mortgages-Owner Occupied		1,841		1,934		—		2,134		100
Commercial MortgageNon-Owner Occupied		132		132		—		404		6
Commercial Construction		—		—		—		—		—
Consumer
Consumer Unsecured		100		100		—		50		6
Consumer Secured		85		85		—		182		4
Residential
Residential Mortgages		1,066		1,134		—		1,323		39
Residential Consumer Construction		800		820		—		400		23
With An Allowance Recorded:
Commercial	$	237	$	645	$	133	$	277	$	1
Commercial Real Estate
Commercial Mortgages-Owner Occupied		498		498		62		582		22
Commercial MortgageNon-Owner Occupied		71		71		5		72		4
Commercial Construction		—		—		—		85		—
Consumer
Consumer Unsecured		1		1		1		2		—
Consumer Secured		106		106		106		267		5
Residential
Residential Mortgages		145		153		38		148		3
Residential Consumer Construction		—		—		—		—		—
Totals:
Commercial	$	1,027	$	1,634	$	133	$	1,135	$	19
Commercial Real Estate
Commercial Mortgages-Owner Occupied		2,339		2,432		62		2,716		122
Commercial MortgageNon-Owner Occupied		203		203		5		476		10
Commercial Construction		—		—		—		85		—
Consumer
Consumer Unsecured		101		101		1		52		6
Consumer Secured		191		191		106		449		9
Residential
Residential Mortgages		1,211		1,287		38		1,471		42
Residential Consumer Construction		800		820		—		400		23
	$	5,872	$	6,668	$	345	$	6,784	$	231

22

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

	Impaired Loans
	(dollars in thousands)
	As of and For the Year Ended December 31, 2017
			Unpaid				Average		Interest
	Recorded		Principal		Related		Recorded		Income
2017	Investment		Balance		Allowance		Investment		Recognized
With No Related Allowance Recorded:
Commercial	$	925	$	1,505	$	—	$	812	$	54
Commercial Real Estate
Commercial Mortgages-Owner Occupied		2,427		2,539		—		2,723		179
Commercial MortgageNon-Owner Occupied		675		690		—		512		30
Commercial Construction		—		—		—		—		—
Consumer
Consumer Unsecured		—		—		—		—		—
Consumer Secured		279		283		—		149		11
Residential
Residential Mortgages		1,580		1,673		—		1,568		63
Residential Consumer Construction		—		—		—		—		—
With An Allowance Recorded:
Commercial	$	317	$	323	$	112	$	919	$	16
Commercial Real Estate
Commercial Mortgages-Owner Occupied		665		665		93		1,126		39
Commercial MortgageNon-Owner Occupied		73		73		18		74		5
Commercial Construction		169		695		79		169		—
Consumer
Consumer Unsecured		2		2		2		1		—
Consumer Secured		427		445		255		269		11
Residential
Residential Mortgages		151		178		4		425		3
Residential Consumer Construction		—		—		—		—		—
Totals:
Commercial	$	1,242	$	1,828	$	112	$	1,731	$	70
Commercial Real Estate
Commercial Mortgages-Owner Occupied		3,092		3,204		93		3,849		218
Commercial MortgageNon-Owner Occupied		748		763		18		586		35
Commercial Construction		169		695		79		169		—
Consumer
Consumer Unsecured		2		2		2		1		—
Consumer Secured		706		728		255		418		22
Residential
Residential Mortgages		1,731		1,851		4		1,993		66
Residential Consumer Construction		—		—		—		—		—
	$	7,690	$	9,071	$	563	$	8,747	$	411

23

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

	Allowance for Loan Losses and Recorded Investment in Loans (dollars in thousands) As of and For the Nine months Ended September 30, 2018
				Commercial
2018	Commercial			Real Estate			Consumer			Residential			Total
Allowance for Loan Losses:
Beginning Balance	$	1,264		$	1,738		$	1,172		$	578		$	4,752
Charge-offs		(320	)		(144	)		(403	)		(12	)		(879	)
Recoveries		102			4			55			—			161
Provision		292			81			93			61			527
Ending Balance	$	1,338		$	1,679		$	917		$	627		$	4,561
Ending Balance: Individually evaluated for impairment	$	133		$	67		$	107		$	38		$	345
Ending Balance: Collectively evaluated for impairment		1,205			1,612			810			589			4,216
Totals:	$	1,338		$	1,679		$	917		$	627		$	4,561
Loans:
Ending Balance: Individually evaluated for impairment	$	1,027		$	2,542		$	292		$	2,011		$	5,872
Ending Balance: Collectively evaluated for impairment		93,493			281,173			84,400			63,727			522,793
Totals:	$	94,520		$	283,715		$	84,692		$	65,738		$	528,665

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

	Allowance for Loan Losses and Recorded Investment in Loans (dollars in thousands) As of and For the Year Ended December 31, 2017
				Commercial
2017	Commercial			Real Estate			Consumer			Residential			Total
Allowance for Loan Losses:
Beginning Balance	$	2,192		$	2,109		$	954		$	461		$	5,716
Charge-offs		(1,652	)		(91	)		(246	)		(105	)		(2,094	)
Recoveries		6			41			51			39			137
Provision		718			(321	)		413			183			993
Ending Balance	$	1,264		$	1,738		$	1,172		$	578		$	4,752
Ending Balance: Individually evaluated for impairment	$	112		$	190		$	257		$	4		$	563
Ending Balance: Collectively evaluated for impairment		1,152			1,548			915			574			4,189
Totals:	$	1,264		$	1,738		$	1,172		$	578		$	4,752
Loans:
Ending Balance: Individually evaluated for impairment	$	1,242		$	4,009		$	708		$	1,731		$	7,690
Ending Balance: Collectively evaluated for impairment		94,885			247,798			83,038			62,363			488,084
Totals:	$	96,127		$	251,807		$	83,746		$	64,094		$	495,774

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

	Age Analysis of Past Due Loans as of
	September 30, 2018
	(dollars in thousands)
					Greater								Recorded Investment
	30-59 Days		60-89 Days		than		Total Past				Total		> 90 Days &
2018	Past Due		Past Due		90 Days		Due		Current		Loans		Accruing
Commercial	$	86	$	315	$	571	$	972	$	93,548	$	94,520	$	—
Commercial Real Estate:
Commercial Mortgages-Owner Occupied		769		192		317		1,278		102,371		103,649		—
Commercial Mortgages-Non-Owner Occupied		724		—		—		724		164,284		165,008		—
Commercial Construction		—		—		—		—		15,058		15,058		—
Consumer:
Consumer Unsecured		6		—		—		6		8,273		8,279		—
Consumer Secured		229		4		—		233		76,180		76,413		—
Residential:
Residential Mortgages		1,503		198		343		2,044		54,649		56,693		—
Residential Consumer Construction		—		—		800		800		8,245		9,045		—
Total	$	3,317	$	709	$	2,031	$	6,057	$	522,608	$	528,665	$	—
	Age Analysis of Past Due Loans as of
	December 31, 2017
	(dollars in thousands)
					Greater								Recorded Investment
	30-59 Days		60-89 Days		than		Total Past				Total		> 90 Days &
2017	Past Due		Past Due		90 Days		Due		Current		Loans		Accruing
Commercial	$	320	$	—	$	250	$	570	$	95,557	$	96,127	$	—
Commercial Real Estate:
Commercial Mortgages-Owner Occupied		904		64		177		1,145		92,504		93,649		—
CommercialMortgages-Non-Owner Occupied		—		361		299		660		138,101		138,761		—
Commercial Construction		—		—		169		169		19,228		19,397		—
Consumer:
Consumer Unsecured		3		—		—		3		6,977		6,980		—
Consumer Secured		245		139		462		846		75,920		76,766		—
Residential:
Residential Mortgages		706		414		532		1,652		51,545		53,197		—
Residential Consumer Construction		—		—		58		58		10,839		10,897		—
Total	$	2,178	$	978	$	1,947	$	5,103	$	490,671	$	495,774	$	—

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

		Credit Quality Information - by Class September 30, 2018
		(dollars in thousands)
2018		Pass		Monitor		Special Mention		Substandard		Doubtful		Totals
Commercial		$	92,127	$	752	$	528	$	1,113	$	—	$	94,520
Commercial Real Estate:
CommercialMortgages-Owner Occupied			95,544		1,482		4,284		2,339		—		103,649
CommercialMortgages-Non Owner Occupied			162,798		1,574		335		301		—		165,008
Commercial Construction			15,058		—		—		—		—		15,058
Consumer
Consumer Unsecured			8,168		—		10		101		—		8,279
Consumer Secured			76,064		—		89		260		—		76,413
Residential:
Residential Mortgages			55,203		—		—		1,490		—		56,693
Residential Consumer Construction			8,245		—		—		800		—		9,045
Totals		$	513,207	$	3,808	$	5,246	$	6,404	$	—	$	528,665
		Credit Quality Information - by Class December 31, 2017
		(dollars in thousands)
2017		Pass		Monitor		Special Mention		Substandard		Doubtful		Totals
Commercial		$	93,571	$	1,217	$	4	$	1,335	$	—		96,127
Commercial Real Estate:
Commercial Mortgages-Owner Occupied			83,834		2,926		3,734		3,155		—		93,649
CommercialMortgages-Non Owner Occupied			135,855		1,898		152		856		—		138,761
Commercial Construction			18,423		—		805		169		—		19,397
Consumer
Consumer Unsecured			6,978		—		—		2		—		6,980
Consumer Secured			75,774		90		—		902		—		76,766
Residential:
Residential Mortgages			50,816		—		241		2,140		—		53,197
Residential Consumer Construction	��		10,839		—		—		58		—		10,897
Totals		$	476,090	$	6,131	$	4,936	$	8,617	$	—	$	495,774

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

Troubled Debt Restructurings (TDR)

There were no loan modifications that would have been classified as TDRs during the three and nine months ended September 30, 2018 and 2017.

There were no loan modifications classified as TDRs within the last twelve months that defaulted during the three and nine months ended September 30, 2018 and 2017.

At September 30, 2018 and December 31, 2017, the Bank had no outstanding commitments to disburse additional funds on loans classified as TDRs.

Note 10 – Revenue Recognition

On January 1, 2018, the Company adopted ASUNo. 2014-09“Revenue from Contracts with Customers” (Topic 606)and all subsequent ASUs that modified Topic 606. The implementation of the new standard did not have a material impact on the measurement or recognition of revenue; as such, a cumulative effect adjustment to opening retained earnings was not deemed necessary. Results for reporting periods beginning after January 1, 2018 are presented under Topic 606, while prior period amounts were not adjusted and continue to be reported in accordance with our historic accounting under Topic 605.

Topic 606 does not apply to revenue associated with financial instruments, including revenue from loans and securities. Topic 606 is applicable to noninterest revenue streams such as deposit related fees, interchange fees, merchant income, and annuity and insurance commissions. However, the recognition of these revenue streams did not change significantly upon adoption of Topic 606. Substantially all of the Company’s revenue is generated from contracts with customers. Noninterest revenue streamsin-scope of Topic 606 are discussed below.

Service Charges on Deposit Accounts

Service charges on deposit accounts consist of account analysis fees (i.e., net fees earned on analyzed business checking accounts), monthly service fees, check orders, and other deposit account related fees. The Company’s performance obligation for account analysis fees and monthly service fees is generally satisfied, and the related revenue recognized, over the period in which the service is provided. Check orders and other deposit account related fees are largely transactional based, and therefore, the Company’s performance obligation is satisfied, and related revenue recognized, at a point in time. Payment for service charges on deposit accounts is primarily received immediately or at the end of the month through a direct charge to customers’ accounts.

Fees, Exchange, and Other Service Charges

Fees, exchange, and other service charges are primarily comprised of debit and credit card income, ATM fees, merchant services income, treasury services income and other service charges. Debit and credit card income is primarily comprised of interchange fees earned whenever the Company’s debit and credit cards are processed through card payment networks such as Visa. ATM fees are primarily generated when a Company cardholder uses anon-Company ATM or anon-Company cardholder uses a Company ATM. Merchant services income mainly represents fees charged to merchants to process their debit and credit card transactions, in addition to account management fees. Treasury services income primarily represents fees charged to customers for sweep, positive pay and lockbox services. Other service charges include revenue from processing wire transfers, bill pay service, cashier’s checks, and other services. The Company’s

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Note 10 – Revenue Recognition (continued)

performance obligation for fees, exchange, and other service charges are largely satisfied, and related revenue recognized, when the services are rendered or upon completion. Payment is typically received immediately or at the end of the month.

Other

Other noninterest income consists of other recurring revenue streams such as commissions from sales of mutual funds and other investments, safety deposit box rental fees, and other miscellaneous revenue streams. Commissions from the sale of mutual funds and other investments are recognized on trade date, which is when the Company has satisfied its performance obligation. The Company also receives periodic service fees (i.e., trailers) from mutual fund companies typically based on a percentage of net asset value. Trailer revenue is recorded over time, usually monthly or quarterly, as net asset value is determined. Safe deposit box rental fees are charged to the customer on an annual basis and recognized upon receipt of payment. The Company determined that since rentals and renewals occur fairly consistently over time, revenue is recognized on a basis consistent with the duration of the performance obligation.

Note 11 – Recent accounting pronouncements

In February 2016, the FASB issued ASUNo. 2016-02, “Leases (Topic 842).” Among other things, in the amendments in ASU2016-02, lessees will be required to recognize the following for all leases (with the exception of short-term leases) at the commencement date: (1) A lease liability, which is a lessee‘s obligation to make lease payments arising from a lease, measured on a discounted basis; and (2) Aright-of-use asset, which is an asset that represents the lessee’s right to use, or control the use of, a specified asset for the lease term. Under the new guidance, lessor accounting is largely unchanged. Certain targeted improvements were made to align, where necessary, lessor accounting with the lessee accounting model and Topic 606, Revenue from Contracts with Customers. The amendments in this ASU are effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. Early application is permitted upon issuance. Lessees (for capital and operating leases) and lessors (for sales-type, direct financing, and operating leases) must apply a modified retrospective transition approach for leases existing at, or entered into after, the beginning of the earliest comparative period presented in the financial statements. The modified retrospective approach would not require any transition accounting for leases that expired before the earliest comparative period presented. Lessees and lessors may not apply a full retrospective transition approach. The FASB made subsequent amendments to Topic 842 in July 2018 through ASU2018-10 (“Codification Improvements to Topic 842, Leases.”) and ASU2018-11 (“Leases (Topic 842): Targeted Improvements.”) Among these amendments is the provision in ASU2018-11 that provides entities with an additional (and optional) transition method to adopt the new leases standard. Under this new transition method, an entity initially applies the new leases standard at the adoption date and recognizes a cumulative-effect adjustment to the opening balance of retained earnings in the period of adoption. Consequently, an entity’s reporting for the comparative periods presented in the financial statements in which it adopts the new leases standard will continue to be in accordance with current GAAP (Topic 840, Leases). The Company is currently assessing the impact that ASU2016-02 (as amended) will have on its consolidated financial statements The Company has gathered and is in the process of analyzing lease data to determine the impact that ASU2016-02 will have on its consolidated financial statements.

In June 2016, the FASB issued ASUNo. 2016-13, “Financial Instruments – Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments.” The amendments in this ASU, among other things, require the measurement of all expected credit losses for financial assets held at the reporting date based on historical experience, current conditions, and reasonable and supportable forecasts. Financial institutions and other organizations will now use forward-looking information to better inform their credit loss estimates. Many of the loss estimation techniques applied today will still be permitted, although the

29

Note 11 – Recent accounting pronouncements (continued)

inputs to those techniques will change to reflect the full amount of expected credit losses. In addition, the ASU amends the accounting for credit losses onavailable-for-sale debt securities and purchased financial assets with credit deterioration. The amendments in this ASU are effective for SEC filers for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2019. The Company is currently assessing the impact that ASU2016-13 will have on its consolidated financial statements.The Company has been in discussions with its core processor to coordinate its plans for implementation.

In March 2017, the FASB issued ASU2017-08, “Receivables—Nonrefundable Fees and Other Costs (Subtopic310-20), Premium Amortization on Purchased Callable Debt Securities.” The amendments in this ASU shorten the amortization period for certain callable debt securities purchased at a premium. Upon adoption of the standard, premiums on these qualifying callable debt securities will be amortized to the earliest call date. Discounts on purchased debt securities will continue to be accreted to maturity. The amendments are effective for fiscal years beginning after December 15, 2018, and interim periods within those fiscal years. Early adoption is permitted, including adoption in an interim period. Upon transition, entities should apply the guidance on a modified retrospective basis, with a cumulative-effect adjustment to retained earnings as of the beginning of the period of adoption and provide the disclosures required for a change in accounting principle. The Company does not expect the adoption of ASU2017-08 to have a material impact on its consolidated financial statements. The Bank/Company is currently assessing the impact that ASU2017-08 will have on its consolidated financial statements.

In June 2018, the FASB issued ASU2018-07, “Compensation- Stock Compensation (Topic 718): Improvements to Nonemployee Share-Based Payment Accounting.” The amendments expand the scope of Topic 718 to include share-based payments issued tonon-employees for goods or services, which were previously excluded. The amendments will align the accounting for share-based payments to nonemployees and employees more similarly. The amendments are effective for fiscal years beginning after December 15, 2018, and interim periods within those fiscal years. Early adoption is permitted. The Company does not expect the adoption of ASU2018-07 to have a material impact on its consolidated financial statements.

In August 2018, the FASB issued ASU2018-13, “Fair Value Measurement (Topic 820): Disclosure Framework—Changes to the Disclosure Requirements for Fair Value Measurement.” The amendments modify the disclosure requirements in Topic 820 to add disclosures regarding changes in unrealized gains and losses, the range and weighted average of significant unobservable inputs used to develop Level 3 fair value measurements and the narrative description of measurement uncertainty. Certain disclosure requirements in Topic 820 are also removed or modified. The amendments are effective for fiscal years beginning after December 15, 2019, and interim periods within those fiscal years. Certain of the amendments are to be applied prospectively while others are to be applied retrospectively. Early adoption is permitted. The Company does not expect the adoption of ASU2018-13 to have a material impact on its consolidated financial statements.

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

CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS

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

GENERAL

Critical Accounting Policies

Bank of the James Financial Group, Inc.’s (“Financial”) financial statements are prepared in accordance with accounting principles generally accepted in the United States (GAAP). The financial information contained within our statements is, to a significant extent, based on measures of the financial effects of transactions and events that have already occurred. A variety of factors could affect the ultimate value that is obtained either when earning income, recognizing an expense, recovering an asset or relieving a liability. We use historical loss ratios as one factor in determining the inherent loss that may be present in our loan portfolio. Actual losses could differ significantly from the historical factors that we use in estimating risk. In addition, GAAP itself may change from one previously acceptable method to another method. Although the economics of our transactions would be the same, the timing of events that would impact our transactions could change.

Financial’s critical accounting policies include the evaluation of the allowance for loan losses which is based on management’s estimate of an amount that is adequate to absorb probable losses inherent in the loan portfolio of the Bank. The allowance for loan losses is established through a provision for loan loss based on available information including the composition of the loan portfolio, historical loan losses, specific impaired loans, availability and quality of collateral, age of the various portfolios, changes in local economic conditions, and loan performance and quality of the portfolio. Different assumptions used in evaluating the adequacy of the Bank’s allowance for loan losses could result in material changes in Financial’s financial condition and results of operations.

The allowance is based on two basic principles of accounting: (i) ASC 450 “Contingencies”, which requires that losses be accrued when they are probable of occurring and are reasonably estimable and (ii) ASC 310 “Impairment of a Loan”, which requires that losses on impaired loans be accrued based on the differences between the value of collateral, present value of future cash flows or values that are observable in the secondary market and the loan balance. Guidelines for determining allowances for loan losses are also provided in the SEC Staff Accounting Bulletin No. 102 – “Selected Loan Loss Allowance

31

Methodology and Documentation Issues” and the Federal Financial Institutions Examination Council’s interagency guidance, “Interagency Policy Statement on the Allowance for Loan and Lease Losses” (the “FFIEC Policy Statement”).

The Bank’s policy with respect to the methodology for determining the allowance for loan losses involves a higher degree of complexity and requires management to make subjective judgments that often require assumptions or estimates about uncertain matters. This critical policy and its assumptions are periodically reviewed with the Board of Directors.

See “Management Discussion and Analysis Results of Operations – Allowance for Loan Losses and Loan Loss Reserve” below for further discussion of the allowance for loan losses.

Financial also considers valuation of other real estate owned (OREO) a critical accounting policy. OREO consists of properties acquired through foreclosure or deed in lieu of foreclosure. These properties are carried at fair value less estimated costs to sell at the date of foreclosure. Losses from the acquisition of property in full or partial satisfaction of loans are charged against the allowance for loan losses. Subsequent write-downs, if any, are charged against expense. Gains and losses on the sales of foreclosed properties are included in determining net income in the year of the sale. Operating costs after acquisition are expensed.

Overview

Financial is a bank holding company headquartered in Lynchburg, Virginia. Our primary business is retail banking which we conduct through our wholly-owned subsidiary, Bank of the James (which we refer to as the “Bank”). We conduct three other business activities: mortgage banking through the Bank’s Mortgage division (which we refer to as “Mortgage division”), investment services through the Bank’s Investment division (which we refer to as “Investment division”), and insurance activities through BOTJ Insurance, Inc., a subsidiary of the Bank, (which we refer to as “Insurance business”). Of these three other business activities, only the Mortgage division is material to the Bank’s results and operations.

The Bank is a Virginia banking corporation headquartered in Lynchburg, Virginia. The Bank was incorporated under the laws of the Commonwealth of Virginia as a state chartered bank in 1998 and began banking operations in July 1999. The Bank was organized to engage in general retail and commercial banking business. The Bank is a community-oriented financial institution that provides varied banking services to individuals, small andmedium-sized businesses, and professional concerns. Historically, our primary market area has been the Central Virginia, Region 2000 area, which encompasses the seven jurisdictions of the Town of Altavista, Amherst County, Appomattox County, the Town of Bedford, Bedford County, Campbell County, and the City of Lynchburg. Recently the Bank has begun to expand to other areas in Virginia, specifically Roanoke, Charlottesville, and Harrisonburg. The Bank strives to provide its customers with products comparable to statewide regional banks located in its market area, while maintaining the prompt response time and level of service of a community bank. Management believes this operating strategy has particular appeal in the Bank’s market areas.

The Bank’s principal office is located at 828 Main Street, Lynchburg, Virginia 24504 and its telephone number is (434)846-2000. The Bank also maintains a website at www.bankofthejames.bank.

Our operating results depend primarily upon the Bank’s net interest income, which is determined by the difference between (i) interest and dividend income on earning assets, which consist primarily of loans, investment securities and other investments, and (ii) interest expense on interest-bearing liabilities, which consist principally of deposits and other borrowings. The Bank’s net income also is affected by its provision for loan losses, as well as the level of itsnon-interest income, including loan fees and service charges, and itsnon-interest expenses, including salaries and employee benefits, occupancy expense, data processing expenses, Federal Deposit Insurance Corporation premiums, expense in complying with the Sarbanes-Oxley Act of 2002, miscellaneous other expenses, franchise taxes, and income taxes.

32

The Bank intends to enhance its profitability by increasing its market share in our service areas, providing additional services to its customers, and controlling costs.

The Bank services its banking customers through the following locations in Virginia:

Full Service Branches

• The main office located at 828 Main Street in Lynchburg (the “Main Street Office”),

• A branch located at 615 Church Street in Lynchburg (the “Church Street Branch”),

• A branch located at 5204 Fort Avenue in Lynchburg (the “Fort Avenue Branch”),

• A branch located at 4698 South Amherst Highway in Amherst County (the “Madison Heights Branch”),

• A branch located at 17000 Forest Road in Forest (the “Forest Branch”),

• A branch located at 4935 Boonsboro Road, Suites C and D in Lynchburg (the “Boonsboro Branch”),

• A branch located at 164 South Main Street, Amherst, Virginia (the “Amherst Branch”),

• A branch located at 1405 Ole Dominion Boulevard in the Town of Bedford, Virginia, located off of Independence Boulevard (the “Bedford Branch”),

• A branch located at 1110 Main Street, Altavista, Virginia (the “Altavista Branch”),

• A branch located at 1391 South High Street, Harrisonburg, VA (the “Harrisonburg Branch”),

• A branch located at 1745 Confederate Blvd, Appomattox, VA (the “Appomattox Branch”),

• A branch located at 225 Merchant Walk Avenue, Charlottesville, VA (the “5^th Street Station Branch”), and

• A branch located at 3562 Electric Road, Roanoke, VA (the “Roanoke Branch”).

Limited Service Branches

• Westminster-Canterbury facilities located at 501 VES Road, Lynchburg, Virginia,

• Westminster-Canterbury facilities located at 250 Pantops Mountain Road, Charlottesville, Virginia,

• Luxor Office Park LLC, 1430 Rolkin Court Suite 203, Charlottesville, Virginia (the “Charlottesville Branch”).

33

Loan Production Offices

• Residential mortgage loan production office located at the Forest Branch,

• Commercial, consumer and mortgage loan production office located at the Charlottesville Branch.

The Investment division and the Insurance business operate primarily out of offices located at the Church Street Branch.

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

Subject to regulatory approval, the Bank anticipates opening additional branches during the next two fiscal years. Although numerous factors could influence the Bank’s expansion plans, the following discussion provides a general overview of the additional branch locations that the Bank currently is considering, including the following properties that we own and are holding for expansion:

• Real property located in the Timberlake Road area of Campbell County (Lynchburg), Virginia. The Timberlake property is not suitable for its intended use as a branch bank. Management anticipates that it will be necessary to raze the current structures and replace it with appropriate new construction.

• Real property located at 5 Village Highway (near the intersection of Routes 501 and 24) in Rustburg, Virginia. The structure on the property has been demolished and removed. The Bank does not anticipate opening a branch at this location prior to 2019.

• Real property located at 45 South Main Street, Lexington, Virginia. The Bank does not anticipate opening a branch at this location prior to 2019.

• Real property located at 550 Water Street, Charlottesville, Virginia. The Bank intends to relocate the Charlottesville Branch mentioned above to this location in 2019.

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

Although the Bank cannot predict with certainty the financial impact of each new branch, management generally anticipates that each new branch will become profitable within 12 to 18 months of operation.

Except as set forth herein, the Bank does not expect to purchase any significant property or equipment in the upcoming 12 months. Future branch openings are subject to regulatory approval.

OFF-BALANCE SHEET ARRANGEMENTS

The Bank is a party to various financial instruments withoff-balance sheet risk in the normal course of business to meet the financing needs of our customers. These financial instruments include commitments to extend credit and standby letters of credit. Such commitments involve, to varying degrees, elements of credit risk and interest rate risk in excess of the amount recognized in the balance sheets and could impact the overall liquidity and capital resources to the extent customers accept and/or use these commitments.

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

	September 30, 2018 (in thousands)
Commitments to extend credit	$	117,426
Letters of Credit		2,596
Total	$	120,022

Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Because many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The amount of collateral obtained, if deemed necessary by the Bank upon extension of credit, is based on the Bank’s credit evaluation of the customer.

Standby letters of credit are conditional commitments issued by the Bank to guarantee the performance of a customer to a third party. Those letters of credit are primarily issued to support public and private borrowing arrangements. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loans to customers. The amount of collateral obtained, if deemed necessary by the Bank upon extension of credit, is based on the Bank’s credit evaluation of the customer.

The Bank has rate lock commitments to originate mortgage loans through its Mortgage Division. The Bank has entered into corresponding commitments with third party investors to sell each of these loans that close. No other obligation exists. As a result of these contractual relationships with these investors, the Bank is not exposed to losses nor will it realize gains related to its rate lock commitments due to changes in interest rates.

SUMMARY OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following discussion represents management’s discussion and analysis of the financial condition of Financial as of September 30, 2018 and December 31, 2017 and the results of operations of Financial for the three and nine month periods ended September 30, 2018 and 2017. This discussion should be read in conjunction with the financial statements included elsewhere herein.

All financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America.

Financial Condition Summary

September 30, 2018 as Compared to December 31, 2017

Total assets were $668,438,000 on September 30, 2018 compared with $626,341,000 at December 31, 2017, an increase of 6.72%. The increase in total assets was primarily funded from the growth in deposits.

Total deposits increased from $567,493,000 as of December 31, 2017 to $607,447,000 on September 30, 2018, an increase of 7.04%. The increase resulted in large part from increases innon-interest bearing demand deposits and an increase in NOW, money market, and savings accounts. NOW, money market, and savings deposits increased from $307,987,000 on December 31, 2017 to $329,870,000 on September 30, 2018. Noninterest bearing demand deposits increased from $74,102,000 on December 31, 2017 to $89,844,000 on September 30, 2018. Time deposits increased slightly from $185,404,000 on December 31, 2017 to $187,733,000 on September 30, 2018.

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Total loans, excluding loans held for sale, increased to $528,665,000 on September 30, 2018 from $495,774,000 on December 31, 2017. Loans, excluding loans held for sale and net of deferred fees and costs and the allowance for loan losses, increased to $524,104,000 on September 30, 2018 from $491,022,000 on December 31, 2017, an increase of 6.74%. The following summarizes the position of the Bank’s loan portfolio as of the dates indicated by dollar amount and percentages (dollar amounts in thousands):

	September 30, 2018					December 31, 2017
	Amount		Percentage			Amount		Percentage
Commercial	$	94,520		17.88	%	$	96,127		19.39	%
Commercial Real Estate		283,715		53.67	%		251,807		50.79	%
Consumer		84,692		16.02	%		83,746		16.89	%
Residential		65,738		12.43	%		64,094		12.93	%
Total loans	$	528,665		100.00	%	$	495,774		100.00	%

Total nonperforming assets, which consist ofnon-accrual loans, loans past due 90 days or more and still accruing, and other real estate owned (“OREO”) decreased to $4,803,000 on September 30, 2018 from $6,959,000 on December 31, 2017. OREO decreased to $2,455,000 on September 30, 2018 from $2,650,000 on December 31, 2017. This decrease was due in large part to a downward adjustment of the carrying value of certain OREO resulting from a change in appraised value and the Bank’s ability to sell OREO properties during the nine months ended September 30, 2018 and was offset in part by new foreclosures during the period.Non-performing loans decreased from $4,309,000 at December 31, 2017 to $2,348,000 at September 30, 2018. As discussed in more detail below under “Results of Operations—Allowance for Loan Losses,” management has provided for the anticipated losses on these loans in the allowance for loan losses. Loan payments received onnon-accrual loans are first applied to principal. When a loan is placed onnon-accrual status there are several negative implications. First, all interest accrued but unpaid at the time of the classification is reversed and deducted from the interest income totals for the Bank. Second, accruals of interest are discontinued until it becomes certain that both principal and interest can be repaid. Third, there may be actual losses that necessitate additional provisions for loan losses charged against earnings.

OREO represents real property acquired by the Bank for debts previously contracted, including through foreclosure or deeds in lieu of foreclosure. On December 31, 2017, the Bank was carrying seven OREO properties on its books at a value of $2,650,000. During the nine months ended September 30, 2018, the Bank acquired nine additional OREO properties and disposed of six OREO properties, and as of September 30, 2018 the Bank is carrying ten OREO properties at a value of $2,455,000. The OREO properties are available for sale and are being actively marketed.

The Bank had loans in the amount of $428,000 at September 30, 2018 classified as performing Troubled Debt Restructurings (“TDRs”) as compared to $440,000 at December 31, 2017. None of these TDRs were included innon-accrual loans. These loans have had their original terms modified to facilitate payment by the borrower. The loans have been classified as TDRs primarily due to a change to interest only payments and the maturity of these modified loans is primarily less than one year.

Cash and cash equivalents increased to $50,464,000 on September 30, 2018 from $37,018,000 on December 31, 2017. Cash and cash equivalents consist of cash due from correspondents, cash in vault, and overnight investments (including federal funds sold). The increase in cash and cash equivalents was due primarily to an increase in deposits. Cash and cash equivalents are subject to routine fluctuations in deposits, including fluctuations in transactional accounts and professional settlement accounts.

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Securitiesheld-to-maturity decreased to $3,703,000 on September 30, 2018 from $5,713,000 on December 31, 2017. This decrease resulted from the call of a security with a par value of $2,000,000 during the quarter. Securitiesavailable-for-sale, which are carried on the balance sheet at fair market value, decreased to $52,333,000 on September 30, 2018, from $55,312,000 on December 31, 2017. The decrease resulted from the normal amortization of and principal payments on mortgage-backed securities in theavailable-for-sale portfolio along with a decrease in fair value related to an increase in interest rates. During the nine months ended September 30, 2018 the Bank received $1,666,000 in proceeds from calls, maturities, and paydowns of securitiesavailable-for-sale and $0 in proceeds from the sale of securitiesavailable-for-sale. The Bank purchased $998,000 in securitiesavailable-for sale during the same period.

Financial’s investment in Federal Home Loan Bank of Atlanta (FHLBA) stock totaled $564,000 at September 30, 2018 and $607,000 at December 31, 2017, a decrease of $43,000. This decrease is attributable to the FHLBA’s redemption of stock as a result of the repayment of a $10,000,000 advance earlier this year. FHLBA stock is generally viewed as a long-term investment and because there is no market for the stock other than other Federal Home Loan Banks or member institutions, FHLBA stock is viewed as a restricted security. Therefore, when evaluating FHLBA stock for impairment, its value is based on the ultimate recoverability of the par value rather than by recognizing temporary declines in value.

Liquidity and Capital

At September 30, 2018, Financial, on a consolidated basis, had liquid assets of $102,797,000 in the form of cash, interest-bearing and noninterest-bearing deposits with banks, andavailable-for-sale investments. Of this amount, approximately $16,611,000 (representing current book value) of theavailable-for-sale securities are pledged as collateral with $8,169,000 pledged as security for public deposits, and $8,442,000 pledged as security on a line of credit the Bank may draw on from time to time to meet liquidity needs. This line of credit currently has a zero balance. Management believes that liquid assets were adequate at Septmeber 30, 2018. Management anticipates that additional liquidity will be provided by the growth in deposit accounts and loan repayments at the Bank. In addition, if additional liquidity is needed, the Bank has the ability to purchase federal funds on the open market, borrow from the FHLBA using loans or investments within the Bank’s portfolio as collateral, and to borrow from the Federal Reserve Bank’s discount window.

Management is not aware of any trends, events or uncertainties that are reasonably likely to have a material negative impact on Financial’s short-term or long-term liquidity. Based in part on recent loan growth, the Bank is monitoring liquidity to ensure it is able to fund future loans.

On January 25, 2017, Financial closed a private placement of unregistered debt securities (the “2017 Offering”) pursuant to which Financial issued $5,000,000 in principal of notes (the “2017 Notes”). The 2017 Notes bear interest at the rate of 4% per year with interest payable quarterly in arrears. The 2017 Notes are to mature on January 24, 2022, but are subject to prepayment in whole or in part on or after January 24, 2018 at Financial’s sole discretion on 30 days written notice to the holders. Of the proceeds, $3,000,000 was injected into the Bank as equity capital in March 2017. The Company left the remaining $2,000,000 at the holding company level for debt service on the 2017 Notes and other general corporate purposes.

At September 30, 2018, the Bank had a leverage ratio of approximately 9.20%, a Tier 1 risk-based capital ratio and a CET1 ratio of approximately 11.36% and a total risk-based capital ratio of approximately 12.22%. As of September 30, 2018 and December 31, 2017 the Bank’s regulatory capital

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levels exceeded those established for well-capitalized institutions. The following table sets forth the minimum capital requirements and the Bank’s capital position as of September 30, 2018 and December 31, 2017:

Bank Level Only Capital Ratios

	September 30,		December 31,
Analysis of Capital (in 000’s)	2018		2017
Tier 1 capital
Common Stock	$	3,742	$	3,742
Surplus		22,325		22,325
Retained earnings		34,816		31,069
Total Tier 1 capital	$	60,883	$	57,136
Common Equity Tier 1 Capital (CET1)	$	60,883	$	57,136
Tier 2 capital
Allowance for loan losses	$	4,561	$	4,752
Total Tier 2 capital:	$	4,561	$	4,752
Total risk-based capital	$	65,444	$	61,888
Risk weighted assets	$	535,709	$	513,419
Average total assets	$	662,097	$	626,422

	Actual						Regulatory Benchmarks
							For Capital			For Well
	September 30,			December 31,			Adequacy			Capitalized
	2018			2017			Purposes (1)			Purposes
Capital Ratios:
Tier 1 capital to average total assets		9.20	%		9.12	%		4.00	%		5.00	%
Common Equity Tier 1 Ratio		11.36	%		11.13	%		7.00	%		6.50	%
Tier 1 risk-based capital ratio		11.36	%		11.13	%		8.50	%		8.00	%
Total risk-based capital ratio		12.22	%		12.05	%		10.50	%		10.00	%

(1) Includes the capital conservation buffer after fullphase-in.

The above tables set forth the capital position and analysis for the Bank only. Because total assets on a consolidated basis are less than $3,000,000,000, Financial is not subject to the consolidated capital requirements imposed by the Bank Holding Company Act. Consequently, Financial does not calculate its financial ratios on a consolidated basis. If calculated, the capital ratios for the Company on a consolidated basis at September 30, 2018 would be slightly lower than those of the Bank because proceeds from the sale of the capital notes were contributed to the Bank and counted as equity at the Bank level.

In July 2013, the Federal Reserve Board approved a final rule establishing a regulatory capital framework for smaller, less complex financial institutions. The rule implements in the United States the Basel III regulatory capital reforms from the Basel Committee on Banking Supervision and certain changes required by the Dodd-Frank Wall Street Reform and Consumer Protection Act. Thephase-in period for this rule began in January 2015. Under the final rule, minimum requirements were increased for both the quantity and quality of capital held by banking organizations. The rule included a new minimum ratio of common equity Tier 1 capital to risk-weighted assets of 4.5% and a common equity Tier 1 capital conservation buffer of 2.5% of risk-weighted assets that applies to all supervised financial institutions. The capital conservation buffer began itsphase-in on January 1, 2016 at 0.625% and increases by an additional 0.625% annually until it reaches 2.5% on January 1, 2019. This will result in an effective Tier 1 capital ratio of 8.5% upon full implementation. The capital conservation buffer will limit capital distributions, stock redemptions, and certain discretionary bonuses. Beginning January 1,

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2016, failure to maintain the capital conservation buffer will limit the ability of the Bank and Financial to pay dividends, repurchase shares or pay discretionary bonuses. The rule also raised the minimum ratio of Tier 1 capital to risk-weighted assets from 4% to 6% and includes a minimum leverage ratio of 4% for all banking organizations.

Results of Operations

Comparison of the Three and Nine Months Ended September 30, 2018 and 2017

Earnings Summary

Financial had net income including all operating segments of $1,404,000 and $3,827,000 for the three and nine months ended September 30, 2018, compared to $1,015,000 and $2,562,000 for the comparable periods in 2017. Basic and diluted earnings per common share for the three and nine months ended September 30, 2018 were $0.32 and $0.87, compared to basic and diluted earnings per share of $0.23 and $0.59 for the three and nine months ended September 30, 2017.

The increase in net income for the three and nine months ended September 30, 2018 as compared to the prior year was due primarily to an increase in interest income andnon-interest income and was partially offset by an increase in interest expense andnon-interest expense.Non-interest expense increased in large part because of the Bank’s continued emphasis on growth in Charlottesville, Harrisonburg, and Roanoke. These efforts resulted in increases in OREO, personnel, professional, data processing, and other outside expenses.

Also as discussed below underIncome Taxes, the reduction in both income tax expense and the effective rate due to the passage of the Tax and Jobs Act of 2017 contributed to the increase in net income for the three and nine months ended September 30, 2018 as compared to the same periods in 2017.

These operating results represent an annualized return on average stockholders’ equity of 10.13% and 9.49% for the three and nine months ended September 30, 2018, compared with 7.75% and 6.65% for the three and nine months ended September 30, 2017. This increase for the three and nine months was a direct result of the increase in net income. The Company had an annualized return on average assets of 0.84% and 0.79% for the three and nine months ended September 30, 2018 compared with 0.66% and 0.58% for the same periods in 2017. The increase for the three and nine months ended September 30, 2018 largely resulted from an increase in net income.

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

Interest Income, Interest Expense, and Net Interest Income

Interest income increased to $6,980,000 and $19,860,000 for the three and nine months ended September 30, 2018 from $6,070,000 and $17,430,000 for the same periods in 2017, increases of 14.99% and 13.94%, respectively. Interest income increased primarily because of increased balances in the loan portfolio and increases in interest rates tied to floating rate loans. The average rate received on earning assets increased from 4.20% and 4.20% to 4.43% and 4.32% for the three and nine months ended September 30, 2018 from the comparable periods in 2017. The rate on total average earning assets increased for the three and nine months ended September 30, 2018 as compared to the three and nine months ended September 30, 2017 primarily because of multiple short term rate increases by the FOMC, which, as noted above, resulted in an increase in the rates paid by borrowers on floating rate loans.

Interest expense increased to $990,000 and $2,736,000 for the three and nine months ended September 30, 2018 from $786,000 and $2,168,000 for the same periods in 2017, increases of 25.95% and 26.20%. The increase in interest expense resulted primarily from an increase on the rates paid on and balances of deposits. The Bank’s average rate paid on interest bearing deposits was 0.73% and 0.71% during the three and nine month periods ended September 30, 2018 as compared to 0.67% and 0.64% for the same periods in 2017.

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The fundamental source of the Bank’s net revenue is net interest income, which is determined by the difference between (i) interest and dividend income on interest earning assets, which consist primarily of loans, investment securities and other investments, and (ii) interest expense on interest-bearing liabilities, which consist principally of deposits and other borrowings. Net interest income for the three and nine months ended September 30, 2018 was $5,990,000 and $17,124,000 as compared to $5,284,000 and $15,262,000 for the same periods in 2017, increases of 13.36% and 12.20%. The increase in net interest income for the three and nine months ended September 30, 2018 as compared with the comparable periods in 2017 primarily is attributable to the increase in interest income resulting from increased loan balances and the previously discussed increase in short term rates by the FOMC. The net interest margin was 3.80% and 3.73% for the three and nine months ended September 30, 2018 as compared with 3.65% and 3.68% for the same periods in 2017.

Financial’s net interest margin analysis and average balance sheets are shown in Schedule I below.

Non-Interest Income

Non-interest income is comprised primarily of fees and charges on transactional deposit accounts, gains on sales of mortgage loans held for sale, commissions on sales of investments and the Bank’s ownership interest in a title insurance agency.Non-interest income increased to $1,420,000 and $4,047,000 for the three and nine months ended September 30, 2018 from $1,319,000 and $3,454,000 for the three and nine months ended September 30, 2017.

This increase for the three and nine months ended September 30, 2018 as compared to the same periods last year was due primarily due to an increase in gains on sales of loans held for sale from $694,000 and $1,663,000 for the three and nine months ended September 30, 2017 to $767,000 and $2,260,000 for the periods ended September 30, 2018. In addition, there was a slight increase in service charges, fees, and commissions from the comparable three and nine month periods ended September 30, 2017.

The Bank, through its Mortgage division, originates both conforming andnon-conforming consumer residential mortgage loans in the markets we serve. As part of the Bank’s overall risk management strategy, all of the loans originated and closed by the Mortgage division are presold to major national mortgage banking or financial institutions. The Mortgage division assumes, except in limited circumstances such as first payment default, no credit or interest rate risk on these mortgages.

Purchase mortgage originations totaled $23,785,000 and $65,271,000, or 83.02% and 74.52% of the total mortgage loans originated in the three and nine months ended September 30, 2018 as compared to $16,861,000 and $39,016,000, or 67.00% and 65.82%% of the total mortgage loans originated in the same periods in 2017. The increase in the volume of purchase mortgage originations for the three and nine months of 2018 resulted from the Bank’s increased presence in the Charlottesville, Harrisonburg, Roanoke, and recently, Blacksburg markets as well as continually favorable longer-term interest rates. However, despite the increase in longer-term rates, refinancing activity, while reduced, continued primarily due to the relatively low interest rate environment as compared to long-term historical interest rate levels. Management anticipates that purchase mortgage originations going forward will represent a majority of mortgage originations as they have in the recent past.

Management anticipates that residential mortgage rates will continue to trend upward during the remainder of 2018. Management expects that the Mortgage division’s reputation in Region 2000, steady residential real estate inventory and the recent hiring of additional mortgage loan originators in Roanoke, Harrisonburg and Charlottesville, and Blacksburg, will result in strong mortgage originations through the

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remainder of 2018. In addition, Management believes that regulatory pressure may result in a decreased number of competitors to the Mortgage division and this could result in an increase in market share. Management also believes that in the event that interest rates rise, revenue from the mortgage segment could be under pressure.

Our Investment division provides brokerage services through an agreement with a third-party broker-dealer. Pursuant to this arrangement, the third party broker-dealer operates a service center adjacent to one of the branches of the Bank. The center is staffed by two dual employees of the Bank and the broker-dealer. Investment receives commissions on transactions generated and in some cases ongoing management fees such as mutual fund12b-1 fees. The Investment division’s financial impact on our consolidated revenue has been immaterial. Although management cannot predict the financial impact of Investment with certainty, management anticipates the Investment division’s impact on noninterest income will remain immaterial in 2018.

The Bank provides insurance and annuity products to Bank customers and others, through the Bank’s Insurance subsidiary. The Bank has three employees that are licensed to sell insurance products through Insurance. Insurance generates minimal revenue and its financial impact on our consolidated revenue has been immaterial. Management anticipates that Insurance’s impact on noninterest income will remain immaterial in 2018.

Non-Interest Expense

Non-interest expense for the three and nine months ended September 30, 2018 increased to $5,465,000 and $15,868,000 from $4,914,000 and $14,237,000, increases of 11.21% and 11.46% from the comparable periods in 2017. This increase resulted from increases for personnel expense primarily related to the expansion into Charlottesville, Harrisonburg, and Roanoke, as well as increases in professional fees, data processing and outside expenses, and other real estate expense. Total personnel expense was $2,853,000 and $8,398,000 for the three and nine month periods ended September 30, 2018 as compared to $2,538,000 and $7,314,000 for the same periods in 2017.

Allowance and Provision for Loan Losses

The allowance for loan losses represents an amount that, in our judgment, will be adequate to absorb probable losses inherent in the loan portfolio. The provision for loan losses increases the allowance, and loans charged off, net of recoveries, reduce the allowance. The provision for the allowance for loan losses is charged to earnings to bring the total allowance to a level deemed appropriate by management and is based upon two components – specific impairment and general reserves. As discussed below, loans having a risk rating of 7 or below that are significantly past due, and the borrower’s performance and financial condition provide evidence that it is probable that the Bank will be unable to collect all amounts when due as well as all TDRs, are evaluated for specific impairment. The general reserve component is based on an evaluation of general economic conditions, actual and expected credit losses, and loan performance measures. Based on the application of the loan loss calculation, the Bank provided $190,000 and $527,000 to the allowance for loan losses for the three and nine month periods ended September 30, 2018. This compares to provisions of $200,000 and $745,000 for the comparable periods in 2017, representing decreases of 5.00% and 29.26%.

Charged-off loans, which are loans that management deems uncollectible, are charged against the allowance for loan losses and constitute a realized loss.Charged-off loans were $324,000 and $879,000 for the three and nine months ended September 30, 2018 as compared to $325,000 and $551,000 for the comparable periods in 2017. While a charged off loan may subsequently be collected, such recoveries generally are realized over an extended period of time. In the three and nine months ended September 30, 2018, the Bank had recoveries ofcharged-off loans of $7,000 and $161,000 as compared with $13,000 and $110,000 for the comparable periods in 2017.

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In light of the current economic environment, management continues its ongoing assessment of specific impairment in the Bank’s loan portfolio. As set forth in the tables below, the Bank’s allowance arising from the specific impairment evaluation as of September 30, 2018 decreased slightly as compared to December 31, 2017.

As shown in the table below, the total balance in the allowance decreased, from $4,752,000 as of December 31, 2017 to $4,561,000 on September 30, 2018. The allowance for loan losses as a percent of loans decreased to 0.86% as of September 30, 2018 from 0.96% as of December 31, 2017 due to an increase in the Bank’s loan balances and the slight decrease in the reserve. Increased loan balances during the nine months led to an increase in the balance of the general reserve as of September 30, 2018 as compared to December 31, 2017, but this increase was more than offset by a decrease in specific reserves when comparing the same periods. The allowance for loan losses as a percent of unimpaired loans decreased slightly to 0.81% as of September 30, 2018 from 0.86% as of December 31, 2017 due to consumer segment charge-offs during the nine months ended September 30, 2018 and an overall increase in total loan balances. This decrease was partially offset by a slight increase in the general reserves associated with the commercial, commercial real estate and residential segments. Management believes that the current allowance for loan losses is adequate.

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

	Allowance for Loan Losses and Recorded Investment in Loans
	(dollars in thousands)
	As of and For the Nine Months Ended September 30, 2018
2018	Commercial			Commercial Real Estate			Consumer			Residential			Total
Allowance for Loan Losses:
Beginning Balance	$	1,264		$	1,738		$	1,172		$	578		$	4,752
Charge-offs		(320	)		(144	)		(403	)		(12	)		(879	)
Recoveries		102			4			55			—			161
Provision		292			81			93			61			527
Ending Balance	$	1,338		$	1,679		$	917		$	627		$	4,561
Ending Balance: Individually evaluated for impairment	$	133		$	67		$	107		$	38		$	345
Ending Balance: Collectively evaluated for impairment		1,205			1,612			810			589			4,216
Totals:	$	1,338		$	1,679		$	917		$	627		$	4,561
Loans:
Ending Balance: Individually evaluated for impairment	$	1,027		$	2,542		$	292		$	2,011		$	5,872
Ending Balance: Collectively evaluated for impairment		93,493			281,173			84,400			63,727			522,793
Totals:	$	94,520		$	283,715		$	84,692		$	65,738		$	528,665

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	Allowance for Loan Losses and Recorded Investment in Loans (dollars in thousands)
	As of and For the Year Ended December 31, 2017
2017	Commercial			Commercial Real Estate			Consumer			Residential			Total
Allowance for Loan Losses:
Beginning Balance	$	2,192		$	2,109		$	954		$	461		$	5,716
Charge-offs		(1,652	)		(91	)		(246	)		(105	)		(2,094	)
Recoveries		6			41			51			39			137
Provision		718			(321	)(1)		413			183			993
Ending Balance	$	1,264		$	1,738		$	1,172		$	578		$	4,752
Ending Balance: Individually evaluated for impairment	$	112		$	190		$	257		$	4		$	563
Ending Balance: Collectively evaluated for impairment		1,152			1,548			915			574			4,189
Totals:	$	1,264		$	1,738		$	1,172		$	578		$	4,752
Loans:
Ending Balance: Individually evaluated for impairment	$	1,242		$	4,009		$	708		$	1,731		$	7,690
Ending Balance: Collectively evaluated for impairment		94,885			247,798			83,038			62,363			488,084
Totals:	$	96,127		$	251,807		$	83,746		$	64,094		$	495,774

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

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

	Three months ended September 30, (in thousands)						Nine months ended September 30, (in thousands)
	2018			2017			2018			2017
Balance, beginning of period	$	4,688		$	6,132		$	4,752		$	5,716
Provision for loan losses		190			200			527			745
Loans charged off		(324	)		(325	)		(879	)		(551	)
Recoveries of loans charged off		7			13			161			110
Net (charge offs)		(317	)		(312	)		(718	)		(441	)
Balance, end of period	$	4,561		$	6,020		$	4,561		$	6,020

No nonaccrual loans were excluded from the impaired loan disclosures at September 30, 2018 and December 31, 2017. If interest on these loans had been accrued, such income cumulatively would have approximated $150,000 and $472,000 on September 30, 2018 and December 31, 2017, respectively. Loan payments received on nonaccrual loans are applied to principal. When a loan is placed on nonaccrual status there are several negative implications. First, all interest accrued but unpaid at the time of the classification is deducted from the interest income totals for the Bank. Second, accruals of interest are discontinued until it becomes certain that both principal and interest can be repaid. Third, there may be actual losses that necessitate additional provisions for credit losses charged against earnings.

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The Bank’s internal risk rating system is in place to grade commercial and commercial real estate loans. Category ratings are reviewed periodically by lenders and the credit review area of the Bank based on the borrower’s individual situation. Additionally, internal and external monitoring and review of credits are conducted on an annual basis.

Below is a summary and definition of the Bank’s risk rating categories:

RATING 1	Excellent
RATING 2	Above Average
RATING 3	Satisfactory
RATING 4	Acceptable / Low Satisfactory
RATING 5	Monitor
RATING 6	Special Mention
RATING 7	Substandard
RATING 8	Doubtful
RATING 9	Loss

We segregate loans into the above categories based on the following criteria and we review the characteristics of each rating at least annually, generally during the first quarter. The characteristics of these ratings are as follows:

• “Pass.” These are loans having risk ratings of 1 through 4. Pass loans are to persons or business entities with an acceptable financial condition, appropriate collateral margins, appropriate cash flow to service the existing loan, and an appropriate leverage ratio. The borrower has paid all obligations as agreed and it is expected that this type of payment history will continue. When necessary, acceptable personal guarantors support the loan.

• “Monitor.” These are loans having a risk rating of 5. Monitor loans have currently acceptable risk but may have the potential for a specific defined weakness in the borrower’s operations and the borrower’s ability to generate positive cash flow on a sustained basis. The borrower’s recent payment history may currently or in the future be characterized by late payments. The Bank’s risk exposure is mitigated by collateral supporting the loan. The collateral is considered to be well-margined, well maintained, accessible and readily marketable.

• “Special Mention.” These are loans having a risk rating of 6. Special Mention loans have weaknesses that deserve management’s close attention. If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the asset or in the bank’s credit position at some future date. Special Mention loans are not adversely classified and do not expose an institution to sufficient risk to warrant adverse classification. These loans do warrant more than routine monitoring due to a weakness caused by adverse events.

• “Substandard.” These are loans having a risk rating of 7. Substandard loans are considered to have specific and well-defined weaknesses that jeopardize the viability of the Bank’s credit extension. The payment history for the loan has been inconsistent and the expected or projected primary repayment source may be inadequate to service the loan. The estimated net liquidation value of the collateral pledged and/or ability of the personal guarantor(s) to pay the loan may not adequately protect the Bank. There is a distinct possibility that the Bank will sustain some loss if the deficiencies associated with the loan are not corrected in the near term. A substandard loan would not automatically meet our definition of impaired unless the loan is significantly past due and the borrower’s performance and financial condition provides evidence that it is probable that the Bank will be unable to collect all amounts due.

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• “Doubtful.” These are loans having a risk rating of 8. Doubtful rated loans have all the weaknesses inherent in a loan that is classified substandard but with the added characteristic that the weaknesses make collection or liquidation in full, on the basis of currently existing facts, conditions, and values, highly questionable and improbable. The possibility of loss is extremely high.

• “Loss.” These are loans having a risk rating of 9. Loss rated loans are not considered collectible under normal circumstances and there is no realistic expectation for any future payment on the loan. Loss rated loans are fully charged off.

Income Taxes

For the three and nine months ended September 30, 2018, Financial had an income tax expense of $351,000 and $949,000 as compared to $474,000 and $1,172,000 for the three and nine months ended September 30, 2017. This represents an effective tax rate of 20.00% and 19.87% for the three and nine months ended September 30, 2018 as compared with 31.83% and 31.39% for the three and nine months ended September 30, 2017. Our effective rate was lower than the statutory corporate tax rate in all periods because of federal income tax benefits resulting from the tax treatment of earnings on bank owned life insurance and certain tax free municipal securities. The decrease in the expense, despite an increase in net income, as well as the decrease in the effective rate from September 30, 2017 is due to the decrease in our applicable corporate income tax rate following the passage of the Tax and Jobs Act of 2017 from 34% in the 2017 periods to 21% in the 2018 periods.

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Schedule I

Net Interest Margin Analysis

Average Balance Sheets

For the Quarter Ended September 30, 2018 and 2017

(dollars in thousands)

	2018								2017
	Average Balance Sheet			Interest Income/ Expense		Average Rates Earned/ Paid			Average Balance Sheet			Interest Income/ Expense		Average Rates Earned/ Paid
ASSETS
Loans, including fees (1) (2)	$	527,566		$	6,424		4.83	%	$	493,179		$	5,654		4.55	%
Loans held for sale		3,134			36		4.56	%		3,169			29		3.63	%
Fed funds sold		20,148			96		1.89	%		14,570			45		1.23	%
Interest bearing bank balances		13,102			60		1.82	%		7,000			21		1.19	%
Securities (3)		60,281			355		2.36	%		54,791			318		2.30	%
Federal agency equities		1,346			9		2.65	%		1,389			7		2.00	%
CBB equity		116			—		—			116			—		—
Total earning assets		625,693			6,980		4.43	%		574,214			6,074		4.20	%
Allowance for loan losses		(4,622	)							(6,128	)
Non-earning assets		42,614								44,361
Total assets	$	663,685							$	612,447
LIABILITIES AND STOCKHOLDERS’ EQUITY
Deposits
Demand interest bearing	$	226,880		$	211		0.37	%	$	146,745		$	129		0.35	%
Savings		102,557			50		0.19	%		104,738			57		0.22	%
Time deposits		184,798			679		1.46	%		177,147			537		1.20	%
Total interest bearing deposits		514,235			940		0.73	%		428,630			723		0.67	%
Other borrowed funds
Repurchase agreements		—			—		—			2,880			13		1.79	%
Capital Notes		5,000			50		4.00	%		5,000			50		4.00	%
Total interest-bearing liabilities		519,235			990		0.76	%		436,510			786		0.71	%
Non-interest bearing deposits		88,314								122,999
Other liabilities		1,169								954
Total liabilities		608,718								560,463
Stockholders’ equity		54,967								51,984
Total liabilities and Stockholders’ equity	$	663,685							$	612,447
Net interest income				$	5,991							$	5,288
Net interest margin							3.80	%							3.65	%
Interest spread							3.67	%							3.49	%

(1) Net accretion or amortization of deferred loan fees and costs are included in interest income.

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

(3) The interest income and yields calculated on securities have been tax affected to reflect any tax exempt interest on municipal securities. Assumed income tax rates of 21% and 34% were used for the second quarter of 2018 and 2017, respectively.

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Net Interest Margin Analysis

Average Balance Sheets

For the Nine Months Ended September 30, 2018 and 2017

(dollars in thousands)

	2018								2017
	Average Balance Sheet			Interest Income/ Expense		Average Rates Earned/ Paid			Average Balance Sheet			Interest Income/ Expense		Average Rates Earned/ Paid
ASSETS
Loans, including fees (1) (2)	$	516,237		$	18,231		4.72	%	$	480,317		$	16,266		4.53	%
Loans held for sale		3,096			98		4.23	%		2,309			70		4.05	%
Federal funds sold		19,701			255		1.73	%		10,276			81		1.05	%
Interest bearing bank balances		12,418			151		1.63	%		7,000			53		1.01	%
Securities (3)		61,302			1,086		2.37	%		53,293			932		2.34	%
Federal agency equities		1,420			40		3.77	%		1,331			42		4.22	%
CBB equity		116			—		—			116			—		—
Total earning assets		614,290			19,861		4.32	%		554,642			17,444		4.20	%
Allowance for loan losses		(4,664	)							(5,862	)
Non-earning assets		41,863								44,194
Total assets	$	651,489							$	592,974
LIABILITIES AND STOCKHOLDERS’ EQUITY
Deposits
Demand interest bearing	$	198,319		$	537		0.36	%	$	143,087		$	357		0.33	%
Savings		103,032			147		0.19	%		107,044			173		0.22	%
Time deposits		183,460			1,885		1.37	%		170,206			1,488		1.17	%
Total interest bearing deposits		484,811			2,569		0.71	%		420,337			2,018		0.64	%
Other borrowed funds
Repurchase agreements		—			—		—			1,062			13		1.64	%
FHLB borrowings		1,136			17		2.00	%		—			—		—
Capital Notes		5,000			150		4.00	%		4,560			137		4.00	%
Total interest-bearing liabilities		490,947			2,736		0.75	%		425,959			2,168		0.68	%
Non-interest bearing deposits		105,508								114,866
Other liabilities		1,117								667
Total liabilities		597,572								541,492
Stockholders’ equity		53,917								51,482
Total liabilities and Stockholders’ equity	$	651,489							$	592,974
Net interest income				$	17,125							$	15,276
Net interest margin							3.73	%							3.68	%
Interest spread							3.57	%							3.52	%

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

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

(3) The interest income and yields calculated on securities have been tax affected to reflect any tax exempt interest on municipal securities. Assumed income tax rates of 21% and 34% were used for the first six months of 2018 and 2017, respectively.

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Item 3. Quantitative and Qualitative Disclosures About Market Risk

Not applicable

Item 4. Controls and Procedures

EVALUATION OF DISCLOSURE CONTROLS AND PROCEDURES

Financial’s management, including Financial’s principal executive officer and principal financial officer, have evaluated the effectiveness of the Company’s “disclosure controls and procedures,” as such term is defined in Rule13a-15(e) promulgated under the Securities Exchange Act of 1934, as amended, (the “Exchange Act”). Based upon their evaluation, the principal executive officer and principal financial officer concluded that, as of the end of the period covered by this report, Financial’s disclosure controls and procedures were effective for the purpose of ensuring that the information required to be disclosed in the reports that Financial files or submits under the Exchange Act with the Securities and Exchange Commission (the “SEC”) (1) is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and (2) is accumulated and communicated to the Company’s management, including its principal executive and principal financial officers, as appropriate to allow timely decisions regarding required disclosure.

There have been no significant changes during the quarter ended September 30, 2018, in the Company’s internal controls over financial reporting (as defined in Rules13a-15(e) and15d-15(e) of the Securities Exchange Act of 1934) or in other factors that could have significantly affected those controls subsequent to the date of our most recent evaluation of internal controls over financial reporting.

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PART II – OTHER INFORMATION

Item 1. Legal Proceedings

The Company is not involved in any pending legal proceedings at this time, other than routine litigation incidental to its business.

Item 1A. Risk Factors

For information regarding the Company’s risk factors, see Part I, Item 1A “Risk Factors” in the Company’s Annual Report on Form10-K for the year ended December 31, 2017, filed with the Securities and Exchange Commission on March 21, 2018. There have been no material changes from risk factors as previously disclosed in Part 1 Item 1A of the Company’s Form10-K for the year ended December 31, 2017.

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

Not applicable

Item 3. Defaults Upon Senior Securities

Not applicable

Item 4. Mine Safety Disclosures

Not applicable

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Item 5. Other Information

Not applicable

Item 6. Exhibits

Exhibit     No.	Description of Exhibit
31.1	Certification of Robert R. Chapman III Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002, dated November 9, 2018
31.2	Certification of J. Todd Scruggs Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002, dated November 9, 2018
32.1	Certification Pursuant To 18 U.S.C. Section 1350, As Adopted Pursuant To Section 906 Of The Sarbanes-Oxley Act Of 2002, dated November 9, 2018
101	The following materials from Bank of the James Financial Group, Inc.’s Quarterly Report on Form10-Q for the quarter ended June 30, 2018, formatted in eXtensible Business Reporting Language (XBRL): (i) Consolidated Balance Sheets (unaudited) as of September 30, 2018 and December 31, 2017; (ii) Consolidated Statements of Income (unaudited) for the three and nine months ended September 30, 2018 and 2017; (iii) Consolidated Statements of Comprehensive Income (unaudited) for the three and nine months ended September 30, 2018 and 2017 (iv) Consolidated Statements of Cash Flows (unaudited) for the nine months ended September 30, 2018 and 2017 (v) Consolidated Statements of Changes in Stockholders’ Equity (unaudited) for the nine months ended September 30, 2018 and 2017; (vi) Notes to Unaudited Consolidated Financial Statements.

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Index of Exhibits

Exhibit     No.	Description of Exhibit
31.1	Certification of Robert R. Chapman III Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002, dated November 9, 2018
31.2	Certification of J. Todd Scruggs Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002, dated November 9, 2018
32.1	Certification Pursuant To 18 U.S.C. Section 1350, As Adopted Pursuant To Section 906 Of The Sarbanes-Oxley Act Of 2002, dated November 9, 2018
101	The following materials from Bank of the James Financial Group, Inc.’s Quarterly Report on Form10-Q for the quarter ended September 30, 2018, formatted in eXtensible Business Reporting Language (XBRL): (i) Consolidated Balance Sheets (unaudited) as of September 30, 2018 and December 31, 2017; (ii) Consolidated Statements of Income (unaudited) for the three and nine months ended September 30, 2018 and 2017; (iii) Consolidated Statements of Comprehensive Income (unaudited) for the three and nine months ended September 30, 2018 and 2017 (iv) Consolidated Statements of Cash Flows (unaudited) for the nine months ended September 30, 2018 and 2017 (v) Consolidated Statements of Changes in Stockholders’ Equity (unaudited) for the nine months ended September 30, 2018 and 2017; (vi) Notes to Unaudited Consolidated Financial Statements.

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SIGNATURES

In accordance with the requirements of the Exchange Act, the registrant caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

	BANK OF THE JAMES FINANCIAL GROUP, INC.
Date: November 9, 2018	By	/S/ Robert R. Chapman III
		Robert R. Chapman III, President (Principal Executive Officer)
Date: November 9, 2018	By	/S/ J. Todd Scruggs
		J. Todd Scruggs, Secretary and Treasurer (Principal Financial Officer and Principal Accounting Officer)

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