UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

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

FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2013

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

COMMISSION FILE NUMBER: 0-22955

BAY BANKS OF VIRGINIA, INC.

(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)

VIRGINIA	54-1838100
(STATE OR OTHER JURISDICTION OF INCORPORATION OR ORGANIZATION)	(I.R.S. EMPLOYER IDENTIFICATION NO.)

100 SOUTH MAIN STREET, KILMARNOCK, VA 22482

(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE)

(804) 435-1171

(REGISTRANT’S TELEPHONE NUMBER, INCLUDING AREA CODE)

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

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    x  yes    ¨no

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

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

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

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

4,817,856 shares of common stock on August 7, 2013

FORM 10-Q

For the interim period ending June 30, 2013.

INDEX

PART I - FINANCIAL INFORMATION
ITEM 1.	FINANCIAL STATEMENTS
CONSOLIDATED BALANCE SHEETS JUNE 30, 2013 (UNAUDITED) AND DECEMBER 31, 2012		3
CONSOLIDATED STATEMENTS OF INCOME FOR THE THREE MONTHS AND SIX MONTHS ENDED JUNE  30, 2013 AND 2012 (UNAUDITED)		4
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME FOR THE THREE MONTHS AND SIX MONTHS ENDED JUNE 30, 2013 AND 2012 (UNAUDITED)		5
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY FOR THE SIX MONTHS ENDED JUNE 30, 2013 AND 2012 (UNAUDITED)		6
CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE SIX MONTHS ENDED JUNE  30, 2013 AND 2012 (UNAUDITED)		7
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS		8
ITEM 2.	MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS	26
ITEM 3.	QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK	35
ITEM 4.	CONTROLS AND PROCEDURES	35
PART II - OTHER INFORMATION
ITEM 1.	LEGAL PROCEEDINGS	35
ITEM 1A.	RISK FACTORS	35
ITEM 2.	UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS	35
ITEM 3.	DEFAULTS UPON SENIOR SECURITIES	35
ITEM 4.	MINE SAFETY DISCLOSURES	35
ITEM 5.	OTHER INFORMATION	36
ITEM 6.	EXHIBITS	36

2

PART I – FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

BAY BANKS OF VIRGINIA, INC.

CONSOLIDATED BALANCE SHEETS

	June 30, 2013			December 31, 2012  (1)
	(Unaudited)
ASSETS
Cash and due from banks	$	7,067,371		$	4,757,889
Interest-bearing deposits		28,499,652			35,166,448
Federal funds sold		303,900			48,009
Securities available for sale, at fair value		40,050,413			36,700,520
Restricted securities		1,623,350			1,584,700
Loans receivable, net of allowance for loan losses of $2,983,147 and $3,093,623		231,867,546			236,144,526
Premises and equipment, net		11,489,577			11,611,688
Accrued interest receivable		1,103,621			1,070,763
Other real estate owned, net		3,351,454			3,151,346
Bank owned life insurance		5,034,994			—
Goodwill		2,807,842			2,807,842
Other assets		2,116,204			1,753,945
Total assets	$	335,315,924		$	334,797,676
LIABILITIES
Noninterest-bearing deposits	$	54,800,212		$	50,467,907
Savings and interest-bearing demand deposits		114,311,014			117,954,879
Time deposits		102,063,440			106,751,785
Total deposits		271,174,666			275,174,571
Securities sold under repurchase agreements		11,355,400			6,459,839
Federal Home Loan Bank advances		15,000,000			15,000,000
Other liabilities		1,674,770			1,578,295
Total liabilities		299,204,836			298,212,705
SHAREHOLDERS’ EQUITY
Common stock ($5 par value; authorized -10,000,000 shares; outstanding - 4,817,856 and 4,810,856 shares, respectively)		24,089,280			24,054,280
Additional paid-in capital		2,757,450			2,670,021
Retained earnings		10,613,508			10,241,396
Accumulated other comprehensive loss, net		(1,349,150	)		(380,726	)
Total shareholders’ equity		36,111,088			36,584,971
Total liabilities and shareholders’ equity	$	335,315,924		$	334,797,676

(1) Derived from the audited consolidated financial statements.

See Notes to Consolidated Financial Statements.

3

BAY BANKS OF VIRGINIA, INC.

CONSOLIDATED STATEMENTS OF INCOME

(unaudited)

	For the three months ended					For the six months ended
	June 30, 2013			June 30, 2012		June 30, 2013			June 30, 2012
INTEREST INCOME
Loans, including fees	$	3,134,683		$	3,264,259	$	6,289,031		$	6,489,039
Securities:
Taxable		117,971			180,011		241,662			380,944
Tax-exempt		68,619			62,031		124,980			132,625
Federal funds sold		301			1,244		336			2,610
Interest-bearing deposit accounts		17,373			8,561		35,517			15,623
Total interest income		3,338,947			3,516,106		6,691,526			7,020,841
INTEREST EXPENSE
Deposits		600,750			716,967		1,231,288			1,466,121
Federal funds purchased		390			—		390			—
Securities sold under repurchase agreements		6,111			5,146		10,014			8,067
FHLB advances		105,949			140,923		245,149			281,847
Total interest expense		713,200			863,036		1,486,841			1,756,035
Net interest income		2,625,747			2,653,070		5,204,685			5,264,806
Provision for loan losses		179,000			546,661		262,000			642,685
Net interest income after provision for loan losses		2,446,747			2,106,409		4,942,685			4,622,121
NON-INTEREST INCOME
Income from fiduciary activities		161,865			157,688		327,114			317,842
Service charges and fees on deposit accounts		266,580			192,826		541,126			359,689
VISA-related fees		226,118			212,654		405,716			372,123
Other service charges and fees		241,764			255,685		475,221			444,795
Secondary market lending fees		168,446			121,687		300,732			198,895
Bank owned life insurance income		34,994			—		34,994			—
Net gains on sale of securities available for sale		267,773			493,955		270,714			502,816
Loss on securities with other-than-temporary impairment		(168,000	)		—		(168,000	)		—
Portion of loss recognized in other comprehensive income		48,000			—		48,000			—
Net impairment recognized in income		(120,000	)		—		(120,000	)		—
Net losses on other assets		—			—		—			(4,906	)
Other income		14,543			30,076		26,317			58,400
Total non-interest income		1,262,083			1,464,571		2,261,934			2,249,654
NON-INTEREST EXPENSES
Salaries and employee benefits		1,607,429			1,384,469		3,337,749			2,946,638
Occupancy expense		486,643			546,034		985,748			1,050,365
Bank franchise tax		43,935			42,990		87,870			85,980
VISA expense		191,035			176,944		345,477			308,104
Telephone expense		52,706			33,737		101,969			75,061
FDIC assessments		101,480			103,851		204,949			207,702
Debit card expense		19,220			60,445		37,181			115,849
Foreclosure property expense		38,243			62,532		61,492			105,786
Other real estate losses		239,809			255,796		253,899			323,849
Consulting expense		12,046			55,026		28,515			121,105
Other expense		625,670			740,276		1,256,200			1,303,872
Total non-interest expenses		3,418,216			3,462,100		6,701,049			6,644,311
Net income before income taxes		290,614			108,880		503,570			227,464
Income tax expense		58,593			11,830		131,458			24,787
Net income	$	232,021		$	97,050	$	372,112		$	202,677
Basic Earnings Per Share
Average basic shares outstanding		4,817,856			2,610,856		4,815,845			2,610,856
Earnings per share, basic	$	0.05		$	0.04	$	0.08		$	0.08
Diluted Earnings Per Share
Average diluted shares outstanding		4,820,014			2,613,877		4,818,258			2,612,816
Earnings per share, diluted	$	0.05		$	0.04	$	0.08		$	0.08

See Notes to Consolidated Financial Statements.

4

BAY BANKS OF VIRGINIA, INC..

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(unaudited)

	For the three months ended						For the six months ended
	June 30, 2013			June 30, 2012			June 30, 2013			June 30, 2012
Net income	$	232,021		$	97,050		$	372,112		$	202,677
Other comprehensive (loss) income:
Unrealized (losses) gains on securities available for sale:
Unrealized holding (losses) gains and arising during the period		(1,242,933	)		324,405			(1,316,595	)		215,917
Deferred tax benefit (expense)		422,597			(110,298	)		447,642			(73,412	)
Reclassification of net securities (gains) and impairments recognized in net income		(147,773	)		(493,955	)		(150,714	)		(502,816	)
Deferred tax benefit		50,243			167,945			51,243			170,957
Unrealized (losses) gains adjustment, net of tax		(917,866	)		(111,903	)		(968,424	)		(189,354	)
Defined benefit pension plan:
Net periodic pension cost		22,437			17,860			44,873			35,720
Net pension gain (loss)		(22,437	)		(17,860	)		(44,873	)		(35,720	)
Deferred tax benefit		—			—			—			—
Defined benefit pension plan adjustment, net of tax		—			—			—			—
Post retirement benefit plan:
Net periodic cost		1,124			736			2,248			1,471
Net gain (loss)		(1,124	)		(736	)		(2,248	)		(1,471	)
Deferred tax benefit		—			—			—			—
Post retirement benefit plan adjustment, net of tax		—			—			—			—
Total other comprehensive loss		(917,866	)		(111,903	)		(968,424	)		(189,354	)
Comprehensive (loss) income	$	(685,845	)	$	(14,853	)	$	(596,312	)	$	13,323

See Notes to Consolidated Financial Statements.

5

BAY BANKS OF VIRGINIA, INC.

CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY

	Shares of Common Stock		Common Stock		Additional Paid-in Capital		Retained Earnings		Accumulated Other Comprehensive Loss			Total Shareholders’ Equity
SIX MONTHS ENDED JUNE 30, 2013
(unaudited)
Balance at beginning of period		4,810,856	$	24,054,280	$	2,670,021	$	10,241,396	$	(380,726	)	$	36,584,971
Net income		—		—		—		372,112		—			372,112
Other comprehensive loss		—		—		—		—		(968,424	)		(968,424	)
Stock-based compensation		7,000		35,000		87,429		—		—			122,429
Balance at end of period		4,817,856	$	24,089,280	$	2,757,450	$	10,613,508	$	(1,349,150	)	$	36,111,088

See Notes to Consolidated Financial Statements.

6

BAY BANKS OF VIRGINIA, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

(unaudited)

	For the six months ended June 30,
	2013			2012
Cash Flows From Operating Activities
Net income	$	372,112		$	202,677
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation		379,703			400,322
Net amortization and accretion of securities		197,264			126,999
Provision for loan losses		262,000			642,685
Stock-based compensation		122,429			2,925
Deferred income tax benefit		(7,259	)		—
Gain on securities available-for-sale		(270,714	)		(502,816	)
Other than temporary impairment on securities available-for-sale		120,000			—
Provision for real estate losses		16,090			111,094
Loss on sale of other real estate		237,809			212,755
Loss on disposal of fixed assets		—			4,906
(Increase) decrease in accrued income and other assets		(397,911	)		323,309
Increase in other liabilities		555,594			78,210
Net cash provided by operating activities		1,587,117			1,603,066
Cash Flows From Investing Activities
Proceeds from maturities and principal paydowns of available-for-sale securities		1,971,070			1,610,448
Proceeds from sales and calls of available-for-sale securities		8,259,602			9,849,763
Purchase of bank owned life insurance		(5,000,000	)		—
Purchases of available-for-sale securities		(15,094,424	)		(3,861,484	)
(Purchases) sales of restricted securities		(38,650	)		315,900
Decrease (increase) in overnight funds in other banks		6,666,796			(2,801,877	)
(Increase) decrease in federal funds sold		(255,891	)		1,906,080
Loan (originations) and principal collections, net		2,688,587			(6,695,008	)
Proceeds from sale of other real estate		887,210			674,550
Purchases of premises and equipment		(257,591	)		(59,947	)
Net cash (used) provided by investing activities		(173,291	)		938,425
Cash Flows From Financing Activities
Increase in demand, savings, and other interest-bearing deposits		688,440			4,973,377
Net (decrease) in time deposits		(4,688,345	)		(2,075,541	)
Net increase in securities sold under repurchase agreements		4,895,561			3,795,242
Net cash provided by financing activities		895,656			6,693,078
Net increase in cash and due from banks		2,309,482			9,234,569
Cash and due from banks at beginning of period		4,757,889			4,728,895
Cash and due from banks at end of period	$	7,067,371		$	13,963,464
Supplemental Schedule of Cash Flow Information
Cash paid for:
Interest	$	1,466,446		$	1,765,190
Income taxes		211,943			—
Non-cash investing and financing:
Unrealized loss on investment securities	$	(1,467,309	)	$	(286,900	)
Loans transferred to other real estate owned		1,326,393			1,403,983
Changes in deferred taxes resulting from OCI transactions		498,885			97,545

See Notes to Consolidated Financial Statements.

7

Notes to Consolidated Financial Statements

Note 1: General

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

The Company completed a private stock placement of 2,200,000 shares of its common stock for $4.25 per share at the end of the day on December 31, 2012, which materially increased the number of shares outstanding and the level of capital.

The accounting and reporting policies of the Company conform to accounting principles generally accepted in the United States of America (“GAAP”) and to the general practices within the banking industry. In management’s opinion, all adjustments, consisting only of normal recurring adjustments necessary for a fair presentation of the consolidated financial statements, have been included. The results of operations for the interim periods are not necessarily indicative of the results to be expected for the full year. These consolidated financial statements should be read in conjunction with the financial statements and notes to financial statements included in the Company’s 2012 Annual Report to Shareholders.

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

Note 2: Significant Accounting Policies

Other significant accounting policies are described in Note 1 of the Financial Statements contained within the Company’s 2012 annual report filed on Form 10-K.

The Loan and Allowance for loan losses policy is included here and intended to be read in conjunction with Notes 5 and 6.

Loans

The Company grants mortgage, commercial and consumer loans to customers. A substantial portion of the loan portfolio is represented by mortgage loans. The ability of the Company’s debtors to honor their contracts is dependent upon the general economic conditions in the Company’s market area.

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

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

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

Allowance for loan losses

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

During the third quarter of 2012, management enhanced the ALL calculation methodology by changing the historical loss factor period from six quarters to the length of a business cycle. This increased the historical loss period to 16 quarters, since the current business cycle is assumed to have begun in the fourth quarter of 2008. As the length of the current business cycle extends, so will the length of the historical loss factor period.

8

The allowance consists of specific, general, and unallocated components. The specific component generally evaluates large commercial and construction loans which are adversely risk rated, in bankruptcy, nonaccruing, or more than 30 days past due, to determine which are impaired. The scope of this evaluation can include commercial borrowers utilizing mortgages on their residences for their businesses. For those loans determined to be impaired, an allowance is established when the discounted cash flows (or collateral value or observable market price) of the impaired loan is lower than the carrying value of that loan. The general component collectively evaluates smaller commercial loans, residential mortgages and consumer loans, grouped into segments. Historical loss experience is calculated and applied to each segment, then adjusted for qualitative factors. Qualitative factors include changes in the local economic outlook, including unemployment, interest rates, inflation rates and real estate trends; the level and trend of past due and nonaccrual loans; strength of policies and procedures; and oversight of credit risk and quality of underwriting. These qualitative adjustments reflect management’s judgment of risks inherent in the segments. An unallocated component is maintained to cover uncertainties that could affect management’s estimate of probable losses. The unallocated component of the allowance reflects the margin of imprecision inherent in the underlying assumptions used in the methodologies for estimating specific and general losses in the portfolio. Changes in the allowance for loan losses and the related provision expense can materially affect net income.

Management employs a risk rating system to evaluate and consistently categorize loan portfolio credit risk. Loans assigned risk rating grades include all commercial loans, commercial loans secured by real estate (commercial mortgages), large residential loans secured by real estate (residential mortgages), loans to real estate developers and contractors, large consumer loans with chronic delinquency, and troubled debt restructures. Risk rating categories are as follows:

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

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

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

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

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

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

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

The general component of the ALL calculation collectively evaluates groups of loans in segments, as noted above. Segments are not disaggregated into classes. These segments are 1) Construction, land and land development; 2) Farmland; 3) Residential first mortgages; 4) Residential junior mortgages; 5) Commercial mortgages (non-owner-occupied); 6) Commercial mortgages (owner-occupied); 7) Commercial and industrial; and 8) Consumer. Every loan is assigned to a segment. Segments 1 through 6 are secured by real estate. Segments 7 and 8 are secured by other types of collateral or are unsecured. A given segment may not reflect the purpose of a loan. For example, a business owner may provide his residence as collateral for a loan to his company, in which case the loan would be grouped in a residential mortgage segment.

9

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

Additions to the allowance for loan losses are made by charges to earnings through the provision for loan losses. Credit exposures deemed to be uncollectible are charged against the allowance for loan losses. Recoveries of previously charged off amounts are credited to the allowance for loan losses. Charge-off policies are materially the same for all types of loans.

In situations where, for economic or legal reasons related to a borrower’s financial condition, management may grant a concession to the borrower that it would not otherwise consider, the related loan is classified as a troubled debt restructuring. Management strives to identify borrowers in financial difficulty early and work with them to modify their loan to more affordable terms before their loan reaches nonaccrual status. These modified terms may include rate reductions, principal forgiveness, payment forbearance and other actions intended to minimize the economic loss and to avoid foreclosure or repossession of the collateral. In cases where borrowers are granted new terms that provide for a reduction of either interest or principal, management measures any impairment on the restructuring as noted above for impaired loans.

Note 3: Amendments to the Accounting Standards Codification

In December 2011, the Financial Accounting Standards (“FASB”) issued Accounting Standards Update “(ASU”) 2011-11, “Balance Sheet (Topic 210) – Disclosures about Offsetting Assets and Liabilities.” This ASU requires entities to disclose both gross information and net information about both instruments and transactions eligible for offset in the balance sheet and instruments and transactions subject to an agreement similar to a master netting arrangement. An entity is required to apply the amendments for annual reporting periods beginning on or after January 1, 2013, and interim periods within those annual periods. An entity should provide the disclosures required by those amendments retrospectively for all comparative periods presented. The adoption of the new guidance did not have a material impact on the Company’s consolidated financial statements.

In July 2012, the FASB issued ASU 2012-02, “Intangibles – Goodwill and Other (Topic 350): Testing Indefinite-Lived Intangible Assets for Impairment.” The amendments in this ASU apply to all entities that have indefinite-lived intangible assets, other than goodwill, reported in their financial statements. The amendments in this ASU provide an entity with the option to make a qualitative assessment about the likelihood that an indefinite-lived intangible asset is impaired to determine whether it should perform a quantitative impairment test. The amendments also enhance the consistency of impairment testing guidance among long-lived asset categories by permitting an entity to assess qualitative factors to determine whether it is necessary to calculate the asset’s fair value when testing an indefinite-lived intangible asset for impairment. The amendments are effective for annual and interim impairment tests performed for fiscal years beginning after September 15, 2012. Early adoption is permitted. The adoption of the new guidance did not have a material impact on the Company’s consolidated financial statements.

In January 2013, the FASB issued ASU 2013-01, “Balance Sheet (Topic 210): Clarifying the Scope of Disclosures about Offsetting Assets and Liabilities.” The amendments in this ASU clarify the scope for derivatives accounted for in accordance with Topic 815, Derivatives and Hedging, including bifurcated embedded derivatives, repurchase agreements and reverse repurchase agreements and securities borrowing and securities lending transactions that are either offset or subject to netting arrangements. An entity is required to apply the amendments for fiscal years, and interim periods within those years, beginning on or after January 1, 2013. The adoption of the new guidance did not have a material impact on the Company’s consolidated financial statements.

In February 2013, the FASB issued ASU 2013-02, “Comprehensive Income (Topic 220): Reporting of Amounts Reclassified Out of Accumulated Other Comprehensive Income.” The amendments in this ASU require an entity to present (either on the face of the statement where net income is presented or in the notes) the effects on the line items of net income of significant amounts reclassified out of accumulated other comprehensive income. In addition, the amendments require a cross-reference to other disclosures currently required for other reclassification items to be reclassified directly to net income in their entirety in the same reporting period. Companies should apply these amendments for fiscal years, and interim periods within those years, beginning on or after December 15, 2012. The Company has included the required disclosures from ASU 2013-02 in the consolidated financial statements.

10

Note 4: Securities

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

Available-for-sale securities June 30, 2013 (unaudited)	Amortized Cost		Gross Unrealized Gains		Gross Unrealized (Losses)			Fair Value
U.S. Government agencies	$	9,690,312	$	15,727	$	(43,701	)	$	9,662,338
State and municipal obligations		28,339,387		113,600		(1,086,313	)		27,366,674
Certificates of deposits		1,985,000		7,440		(3,039	)		1,989,401
Auction rate securities		1,080,000		—		(48,000	)		1,032,000
	$	41,094,699	$	136,767	$	(1,181,053	)	$	40,050,413

Available-for-sale securities December 31, 2012	Amortized Cost		Gross Unrealized Gains		Gross Unrealized (Losses)			Fair Value
U.S. Government agencies	$	9,411,627	$	78,178	$	(25,990	)	$	9,463,815
State and municipal obligations		23,480,871		412,759		(44,102	)		23,849,528
Certificates of deposits		1,985,000		3,271		(1,094	)		1,987,177
Auction rate securities		1,400,000		—		—			1,400,000
	$	36,277,498	$	494,208	$	(71,186	)	$	36,700,520

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

	For the three months ended June 30,				For the six months ended June 30,
	2013		2012		2013			2012
Gross realized gains	$	267,773	$	493,955	$	272,295		$	504,644
Gross realized losses		—		—		(1,581	)		(1,828	)
Net realized gains (losses)	$	267,773	$	493,955	$	270,714		$	502,816

Average yields on securities were 2.27% and 2.83% for the three months ended June 30, 2013 and 2012, respectively; and 2.22% and 2.90% for the six months ended June 30, 2013 and 2012, respectively.

The aggregate amortized cost and market values of the investment securities portfolio by contractual maturity at June 30, 2013 are show below:

	Amortized Cost		Fair Value
Due one year or less	$	4,007,574	$	4,013,758
Due after one year through five years		18,430,486		18,415,158
Due after five years through ten years		13,291,387		12,629,823
Due after ten years		5,365,252		4,991,674
	$	41,094,699	$	40,050,413

Securities with a market value of $12.3 million were pledged as collateral for repurchase agreements and for other purposes as required by law as of June 30, 2013. The market value of pledged securities at December 31, 2012 was $8.1 million.

11

Securities in an unrealized loss position at June 30, 2013 and December 31, 2012, by duration of the unrealized loss, are shown below. The unrealized loss positions were directly related to interest rate movements as there is minimal credit risk exposure in these investments. All securities are investment grade or better and all losses are considered temporary. Management does not intend to sell the securities and does not expect to be required to sell the securities. Furthermore, we do expect to recover the entire amortized cost basis. Bonds with unrealized loss positions at June 30, 2013 included two certificates of deposit, 39 municipals and 12 federal agencies. Bonds with unrealized loss positions at December 31, 2012 included three certificates of deposit, 10 municipals and two federal agencies. The tables are shown below.

	Less than 12 months				12 months or more				Total
June 30, 2013 (unaudited)	Fair Value		Unrealized Loss		Fair Value		Unrealized Loss		Fair Value		Unrealized Loss
U.S. Government agencies	$	5,367,622	$	43,701	$	—	$	—	$	5,367,622	$	43,701
States and municipal obligations		13,379,481		1,077,115		1,026,974		9,198		14,406,455		1,086,313
Certificates of deposits		492,961		3,039		—		—		492,961		3,039
Auction rate securities		1,032,000		48,000		—		—		1,032,000		48,000
Total temporarily impaired securities	$	20,272,064	$	1,171,855	$	1,026,974	$	9,198	$	21,299,038	$	1,181,053

	Less than 12 months				12 months or more				Total
December 31, 2012	Fair Value		Unrealized Loss		Fair Value		Unrealized Loss		Fair Value		Unrealized Loss
U.S. Government agencies	$	1,080,438	$	25,990	$	—	$	—	$	1,080,438	$	25,990
States and municipal obligations		2,863,106		37,731		1,037,825		6,371		3,900,931		44,102
Certificates of deposits		742,906		1,094		—		—		742,906		1,094
Auction rate securities		—		—		—		—		—		—
Total temporarily impaired securities	$	4,686,450	$	64,815	$	1,037,825	$	6,371	$	5,724,275	$	71,186

The following table summarized cumulative credit related other-than-temporary impairment losses recognized on one debt security held by the Company:

	For the three and six months ended June 30, 2013
Balance, beginning of the period	$	—
Impairment losses recognized during the period		120,000
Realized losses from sales		—
Balance, end of period	$	120,000

The Company holds $1.2 million face amount South Carolina Student Loan Corporation auction rate securities. During the second quarter of 2013, the South Carolina Student Loan Corporation made a tender and exchange offer with regards to these auction rate securities with the provision that 50% of the security holders were required for the tender offer to be consummated. The tender offer was not accepted by the required 50% of security holders. As a result of the tender and exchange offer, the Company determined that the value of the auction rate securities were other-than-temporarily-impaired. The market value of the securities was estimated based on Level 3 inputs (refer to Note 11). The Company recognized an other-than-temporary impairment charge of $120 thousand in income, plus a $48 thousand unrealized loss component with $31,680 in accumulated other comprehensive income related to this security in the second quarter of 2013.

The Company’s investment in Federal Home Loan Bank of Atlanta (“FHLB”) stock totaled $1.1 million at June 30, 2013 and $1.1 million at December 31, 2012. The investment in FHLB stock is a required investment related to the Company’s membership with FHLB. This investment is carried at cost since there is no ready market and historically redemption has been made at par. The Company does not consider this investment to be other-than-temporarily impaired at June 30, 2013 and no impairment has been recognized. FHLB stock is shown in the restricted securities line item on the consolidated balance sheets and is not a part of the available for sale securities portfolio.

12

Note 5: Loans

The following is a summary of the balances of loans:

	June 30, 2013			December 31, 2012
	(unaudited)
Mortgage loans on real estate:
Construction, Land and Land Development	$	27,485,747		$	29,024,294
Farmland		1,348,947			1,442,757
Commercial Mortgages (Non-Owner Occupied)		13,536,438			13,420,551
Commercial Mortgages (Owner Occupied)		34,168,786			33,634,384
Residential First Mortgages		107,447,034			107,555,694
Residential Revolving and Junior Mortgages		27,229,262			26,982,512
Commercial and Industrial loans		17,072,727			20,524,547
Consumer Loans		6,561,752			6,653,410
Total loans	$	234,850,693		$	239,238,149
Allowance for loan losses		(2,983,147	)		(3,093,623	)
Loans, net	$	231,867,546		$	236,144,526

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

Loans Past Due and Nonaccruals June 30, 2013 (unaudited)	30-89 Days Past Due		90 Days or More Past Due and Still Accruing		Nonaccruals		Total Past Due and Nonaccruals		Current		Total Loans
Construction, Land and Land Development	$	176,569	$	—	$	848,496	$	1,025,065	$	26,460,682	$	27,485,747
Farmland		—		—		—		—		1,348,947		1,348,947
Commercial Mortgages (Non-Owner Occupied)		—		—		—		—		13,536,438		13,536,438
Commercial Mortgages (Owner Occupied)		—		—		167,980		167,980		34,000,806		34,168,786
Residential First Mortgages		1,233,737		302		482,254		1,716,293		105,730,741		107,447,034
Residential Revolving and Junior Mortgages		40,869		19,830		943,967		1,004,666		26,224,596		27,229,262
Commercial and Industrial		9,560		—		—		9,560		17,063,167		17,072,727
Consumer Loans		56,464		24,942		3,588		84,994		6,476,758		6,561,752
Total	$	1,517,199	$	45,074	$	2,446,285	$	4,008,558	$	230,842,135	$	234,850,693

Loans Past Due and Nonaccruals December 31, 2012	30-89 Days Past Due		90 Days or More Past Due and Still Accruing		Nonaccruals		Total Past Due and Nonaccruals		Current		Total Loans
Construction, Land and Land Development	$	230,866	$	—	$	655,397	$	886,263	$	28,138,031	$	29,024,294
Farmland		—		—		—		—		1,442,757		1,442,757
Commercial Mortgages (Non-Owner Occupied)		—		—		318,418		318,418		13,102,133		13,420,551
Commercial Mortgages (Owner Occupied)		—		71,254		819,467		890,721		32,743,663		33,634,384
Residential First Mortgages		761,981		502		2,677,788		3,440,271		104,115,423		107,555,694
Residential Revolving and Junior Mortgages		18,081		—		1,257,915		1,275,996		25,706,516		26,982,512
Commercial and Industrial		100,886		50,075		—		150,961		20,373,586		20,524,547
Consumer Loans		12,193		3,688		1,479		17,360		6,636,050		6,653,410
Total	$	1,124,007	$	125,519	$	5,730,464	$	6,979,990	$	232,258,159	$	239,238,149

Nonaccruals that are not 90 days or more past due are $926,553 at June 30, 2013 and $2,831,579 at December 31, 2012.

13

Note 6: Allowance for Loan Losses

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

Allowance for Loan Losses by Portfolio Segment for the six months ended June 30, 2013 (unaudited) are as follows:

	Construction, Land and Land Development		Farmland		Commercial Mortgages (Non Owner Occupied)			Commercial Mortgages (Owner Occupied)			Residential First Mortgages			Residential Revolving and Junior Mortgages		Commercial and Industrial			Consumer Loans			Unallocated			Total
ALLOWANCE FOR LOAN LOSSES:
Beginning Balance	$	191,882	$	2,000	$	106,000		$	545,084		$	1,209,454		$	517,253	$	262,000		$	252,210		$	7,740		$	3,093,623
(Charge-offs)		—		—		—			—			(365,012	)		—		(16,897	)		(54,888	)					(436,797	)
Recoveries		16,852		—		18,889			—			24,360			—		35			4,185						64,321
Provision		19,015		—		(40,889	)		(116,276	)		180,687			152,170		4,862			64,703			(2,272	)		262,000
Ending Balance	$	227,749	$	2,000	$	84,000		$	428,808		$	1,049,489		$	669,423	$	250,000		$	266,210		$	5,468		$	2,983,147
Individually evaluated for impairment	$	25,749	$	—	$	—		$	114,808		$	312,489		$	306,423	$	—		$	72,210		$	—		$	831,679
Collectively evaluated for impairment	$	202,000	$	2,000	$	84,000		$	314,000		$	737,000		$	363,000	$	250,000		$	194,000		$	5,468		$	2,151,468
LOAN RECEIVABLES:
Ending Balance:
Individually evaluated for impairment	$	213,070	$	—	$	—		$	1,287,682		$	3,811,380		$	1,451,118	$	—		$	72,210					$	6,835,460
Collectively evaluated for impairment		27,272,677		1,348,947		13,536,438			32,881,104			103,635,654			25,778,144		17,072,727			6,489,542						228,015,233
Total Gross Loans	$	27,485,747	$	1,348,947	$	13,536,438		$	34,168,786		$	107,447,034		$	27,229,262	$	17,072,727		$	6,561,752					$	234,850,693

Provision is negative for the Commercial Mortgages segments due mainly to a reduction in the total level of allowance required for these segments.

14

Allowance for Loan Losses by Portfolio Segment for the six months ended June 30, 2012 (unaudited) are as follows:

	Construction, Land and Land Development			Farmland		Commercial Mortgages (Non Owner Occupied)			Commercial Mortgages (Owner Occupied)			Residential First Mortgages			Residential Revolving and Junior Mortgages			Commercial and Industrial			Consumer Loans			Unallocated		Total
ALLOWANCE FOR LOAN LOSSES:
Beginning Balance	$	190,500		$	—	$	88,000		$	554,318		$	1,161,551		$	719,121		$	281,650		$	185,000		$	8,401	$	3,188,541
(Charge-offs)		(57,660	)		—		(283,569	)		—			(203,544	)		(32,674	)		(185,427	)		(75,381	)				(838,255	)
Recoveries		—			—		285,084			—			—			—			10,869			52,034					347,987
Provision		41,031			1,000		(515	)		(179,522	)		277,334			(76,007	)		180,740			99,557			299,067		642,685
Ending Balance	$	173,871		$	1,000	$	89,000		$	374,796		$	1,235,341		$	610,440		$	287,832		$	261,210		$	307,468	$	3,340,958
Individually evaluated for impairment	$	117,871		$	—	$	—		$	140,796		$	843,341		$	431,440		$	176,832		$	94,210		$	—	$	1,804,490
Collectively evaluated for impairment	$	56,000		$	1,000	$	89,000		$	234,000		$	392,000		$	179,000		$	111,000		$	167,000		$	307,468	$	1,536,468
LOAN RECEIVABLES:
Ending Balance:
Individually evaluated for impairment	$	406,378		$	—	$	—		$	1,603,830		$	4,025,871		$	1,760,201		$	513,008		$	94,210				$	8,403,498
Collectively evaluated for impairment		28,175,959			1,484,981		20,884,287			24,459,675			106,094,232			27,040,397			17,803,774			7,143,776					233,087,081
Total Gross Loans	$	28,582,337		$	1,484,981	$	20,884,287		$	26,063,505		$	110,120,103		$	28,800,598		$	18,316,782		$	7,237,986				$	241,490,579

Provision is negative for the Commercial Mortgages (Non Owner Occupied) segment due mainly to net recoveries received. Provision is negative for the Commercial Mortgages (Owner Occupied) and Residential Junior Mortgages segments due to a reduction in the total level of allowance required for these segments.

15

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

As of June 30, 2013 (unaudited) INTERNAL RISK RATING GRADES	Construction, Land and Land Development		Farmland		Commercial Mortgages (Non-Owner Occupied)		Commercial Mortgages (Owner Occupied)		Commercial and Industrial		Total
Grade:
Pass	$	19,972,838	$	1,348,947	$	7,431,155	$	24,558,663	$	13,816,470	$	67,128,073
Watch		4,707,724		—		3,463,685		6,673,758		2,279,990		17,125,157
Special mention		1,330,659		—		2,301,952		335,292		800,293		4,768,196
Substandard		1,274,526		—		339,646		2,601,073		175,974		4,391,219
Doubtful		200,000		—		—		—		—		200,000
Total	$	27,485,747	$	1,348,947	$	13,536,438	$	34,168,786	$	17,072,727	$	93,612,645

As of December 31, 2012 INTERNAL RISK RATING GRADES	Construction, Land and Land Development		Farmland		Commercial Mortgages (Non-Owner Occupied)		Commercial Mortgages (Owner Occupied)		Commercial and Industrial		Total
Grade:
Pass	$	21,877,355	$	1,442,757	$	7,362,289	$	23,974,131	$	16,418,910	$	71,075,442
Watch		4,746,266		—		2,824,575		6,680,142		2,866,739		17,117,722
Special mention		1,162,388		—		2,574,371		338,902		759,554		4,835,215
Substandard		1,038,285		—		659,316		2,641,209		479,344		4,818,154
Doubtful		200,000		—		—		—		—		200,000
Total	$	29,024,294	$	1,442,757	$	13,420,551	$	33,634,384	$	20,524,547	$	98,046,533

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

As of June 30, 2013 (unaudited) PAYMENT ACTIVITY STATUS	Residential First Mortgages (1)		Residential Revolving and Junior Mortgages (2)		Consumer Loans (3)		Total
Performing	$	106,964,478	$	26,265,465	$	6,533,222	$	139,763,165
Nonperforming		482,556		963,797		28,530		1,474,883
Total	$	107,447,034	$	27,229,262	$	6,561,752	$	141,238,048

As of December 31, 2012 PAYMENT ACTIVITY STATUS	Residential First Mortgages (4)		Residential Revolving and Junior Mortgages (5)		Consumer Loans (6)		Total
Performing	$	104,877,404	$	25,724,597	$	6,648,243	$	137,250,244
Nonperforming		2,678,290		1,257,915		5,167		3,941,372
Total	$	107,555,694	$	26,982,512	$	6,653,410	$	141,191,616

(1) Residential First Mortgages which have been assigned a risk rating grade of Substandard totaled $3,492,695 as of June 30, 2013.

(2) Residential Revolving and Junior Mortgages which have been assigned a risk rating grade of Substandard totaled $398,902 and Doubtful totaled $836,759 as of June 30, 2013.

(3) Consumer Loans which have been assigned a risk rating grade of Substandard totaled $93,387 as of June 30, 2013.

(4) Residential First Mortgages which have been assigned a risk rating grade of Substandard totaled $4,676,938 as of December 31, 2012.

(5) Residential Revolving and Junior Mortgages which have been assigned a risk rating grade of Substandard totaled $536,019 and Doubtful totaled $847,581 as of December 31, 2012.

(6) Consumer Loans which have been assigned a risk rating grade of Substandard totaled $75,409 as of December 31, 2012.

16

The following table shows the Company’s recorded investment and the customers’ unpaid principal balances for impaired loans, with the associated allowance amount, if applicable. Also shown are the average recorded investments in impaired loans and the related amount of interest recognized and collected during the time the loans were impaired.

	As of June 30, 2013						For the six months ended June 30, 2013
IMPAIRED LOANS	Recorded Investment		Customers’ Unpaid Principal Balance		Related Allowance		Average Recorded Investment		Interest Income Recognized		Interest Income Collected
(unaudited)
With no related allowance:
Construction, land & land development	$	13,070	$	13,705	$	—	$	13,419	$	—	$	—
Farmland		—		—		—		—		—		—
Residential First Mortgages		1,968,483		1,968,483		—		1,887,449		32,818		27,206
Residential Revolving and Junior Mortgages (1)		331,386		331,386		—		331,268		10,697		4,474
Commercial Mortgages (Non-owner occupied)		—		—		—		—		—		—
Commercial Mortgages (Owner occupied)		750,910		755,856		—		753,824		14,835		14,745
Commercial & industrial		—		—		—		—		—		—
Consumer (2)		—		—		—		—		—		—
	$	3,063,849	$	3,069,430	$	—	$	2,985,960	$	58,350	$	46,425
With an allowance recorded:
Construction, land & land development	$	200,000	$	200,000	$	25,749	$	200,000	$	—	$	—
Farmland		—		—		—		—		—		—
Residential First Mortgages		1,842,897		1,842,897		312,489		1,847,289		50,385		50,320
Residential Revolving and Junior Mortgages (1)		1,119,732		1,942,054		306,423		1,067,665		3,771		4,154
Commercial Mortgages (Non-owner occupied)		—		—		—		—		—		—
Commercial Mortgages (Owner occupied)		536,772		536,772		114,808		535,706		2,722		—
Commercial & industrial		—		—		—		—		—		—
Consumer (2)		72,210		72,210		72,210		73,106		3,077		3,090
	$	3,771,611	$	4,593,933	$	831,679	$	3,723,766	$	59,955	$	57,564
Total Impaired Loans:
Construction, land & land development	$	213,070	$	213,705	$	25,749	$	213,419	$	—	$	—
Farmland		—		—		—		—		—		—
Residential First Mortgages		3,811,380		3,811,380		312,489		3,734,738		83,203		77,526
Residential Revolving and Junior Mortgages (1)		1,451,118		2,273,440		306,423		1,398,933		14,468		8,628
Commercial Mortgages (Non-owner occupied)		—		—		—		—		—		—
Commercial Mortgages (Owner occupied)		1,287,682		1,292,628		114,808		1,289,530		17,557		14,745
Commercial & industrial		—		—		—		—		—		—
Consumer (2)		72,210		72,210		72,210		73,106		3,077		3,090
	$	6,835,460	$	7,663,363	$	831,679	$	6,709,726	$	118,305	$	103,989

(1) Junior mortgages include equity lines

(2) Includes credit cards

	As of December 31, 2012						For the twelve months ended December 31, 2012
IMPAIRED LOANS	Recorded Investment		Customers’ Unpaid Principal Balance		Related Allowance		Average Recorded Investment		Interest Income Recognized		Interest Income Collected
With no related allowance:
Construction, land & land development	$	213,768	$	213,914	$	—	$	202,754	$	162	$	130
Farmland		—		—		—		—		—		—
Residential First Mortgages		1,495,910		1,495,910		—		1,372,196		44,756		59,727
Residential Junior Mortgages (1)		971,654		1,785,259		—		1,380,596		3,750		2,488
Commercial Mortgages (Non-owner occupied)		—		—		—		—		—		—
Commercial Mortgages (Owner occupied)		758,391		758,391		—		429,600		30,518		34,754
Commercial & industrial		—		—		—		—		—		—
Consumer (2)		—		—		—		—		—		—
	$	3,439,723	$	4,253,474	$	—	$	3,385,145	$	79,186	$	97,099
With an allowance recorded:
Construction, land & land development	$	61,882	$	65,566	$	25,882	$	63,761	$	—	$	—
Farmland		—		—		—		—		—		—
Residential First Mortgages		2,782,380		2,807,875		467,454		1,803,730		90.030		82,370
Residential Junior Mortgages (1)		365,107		381,452		101,253		310,726		1,953		1,205
Commercial Mortgages (Non-owner occupied)		—		—		—		—		—		—
Commercial Mortgages (Owner occupied)		858,610		858,610		165,084		863,479		15,900		11,961
Commercial & industrial		—		—		—		—		—		—
Consumer (2)		73,978		73,978		74,210		67,322		8,385		8,678
	$	4,141,957	$	4,187,481	$	833,883	$	3,109,017	$	116,268	$	104,214
Total Impaired Loans:
Construction, land & land development	$	275,650	$	279,480	$	25,882	$	266,515	$	162	$	130
Farmland		—		—		—		—		—		—
Residential First Mortgages		4,278,290		4,303,785		467,454		3,175,925		134,786		142,097
Residential Junior Mortgages (1)		1,336,761		2,166,711		101,253		1,691,321		5,703		3,693
Commercial Mortgages (Non-owner occupied)		—		—		—		—		—		—
Commercial Mortgages (Owner occupied)		1,617,001		1,617,001		165,084		1,293,079		46,418		46,715
Commercial & industrial		—		—		—		—		—		—
Consumer (2)		73,978		73,978		74,210		67,322		8,385		8,678
	$	7,581,680	$	8,440,955	$	833,883	$	6,494,162	$	195,454	$	201,313

(1) Junior mortgages include equity lines

(2) Includes credit cards

Smaller nonaccruing loans and nonaccruing loans that are not graded because they are included in homogenous pools generally do not meet the criteria for impairment testing, and are therefore excluded from impaired loan disclosures. At June 30, 2013 and December 31, 2012, nonaccruing loans excluded from impaired loan disclosure totaled $1,121,268 and $721,951, respectively. If interest on these nonaccruing loans had been accrued, such income would have approximated $19,680 during the six months ended June 30, 2013 and $16,139 for the twelve months ended December 31, 2012.

Loans modified as TDR’s are considered impaired and are individually evaluated for the amount of impairment in the ALL. The following table presents, by segments of loans, information related to loans modified as TDRs during the six months ended June 30, 2013 and 2012. There were no loans modified as TDR’s within 12 months prior to a default that subsequently defaulted (i.e. 90 days or more past due following a modification) during the six months ended June 30, 2013. There were 12 loans, with balances totaling $3.8 million, modified as TDRs within 12 months prior to a default that subsequently defaulted during the six months ended June 30, 2012.

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TROUBLED DEBT RESTRUCTURINGS	For the six months ended June 30, 2013 (unaudited)
	Number of Loans		Pre-Modification Outstanding Recorded Investment		Post-Modification Outstanding Recorded Investment
Residential First Mortgages (1)		2	$	314,889	$	314,665

	For the six months ended June 30, 2012 (unaudited)
	Number of Loans		Pre-Modification Outstanding Recorded Investment		Post-Modification Outstanding Recorded Investment
Commercial Mortgage (Owner Occupied) (2)		1	$	479,115	$	479,115
Residential First Mortgage (3)		1		650,113		650,113
Consumer Loan (3)		1		94,210		94,210

(1) These two loans were modified in the first quarter of 2013.

(2) This loan was modified in the second quarter of 2012.

(3) These two loans were modified in the first quarter of 2012.

Note 7: Earnings per share

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

	Three Months Ended								Six Months Ended
	June 30, 2013				June 30, 2012				June 30, 2013				June 30, 2012
(Unaudited)	Average Shares		Per share Amount		Average Shares		Per share Amount		Average Shares		Per share Amount		Average Shares		Per share Amount
Basic earnings per share		4,817,856	$	0.05		2,610,856	$	0.04		4,815,845	$	0.08		2,610,856	$	0.08
Effect of dilutive securities:
Stock options		2,158				3,021				2,413				1,960
Diluted earnings per share		4,820,014	$	0.05		2,613,877	$	0.04		4,818,258	$	0.08		2,612,816	$	0.08

For the three months ended June 30, 2013 and 2012, options on 177,871 and 107,727 shares, respectively, were not included in computing diluted earnings per share because their effects were anti-dilutive. For the six months ended June 30, 2013 and 2012, options on 177,871 and 122,056 shares, respectively, were not included in computing diluted earnings per share because their effects were anti-dilutive.

Note 8: Stock-Based Compensation

On June 28, 2013, the Company registered a new stock-based compensation plan, which superseded all other plans in terms of the ability of the Company to grant stock-based compensation. There are 385,000 shares available for grant under this plan at June 30, 2013.

Stock-based compensation expense related to stock awards during the six-month periods ended June 30, 2013 and June 30, 2012 was $122,429 and $2,925, respectively. There was no unrecognized compensation expense related to stock options as of June 30, 2013. A total of 89,500 options were granted during the six months ended June 30, 2013. Compensation expense for stock options is the estimated fair value of options granted using the Black-Scholes Model amortized on a straight-line basis over the vesting period of the award. The fair value of options granted under the former 2003 Incentive Stock Option Plan and the former 2008 Non-Employee Directors Stock Option Plan during the six months ended June 30, 2013 was $1.08, respectively. The variables used in these calculations include the historical dividend yield of 3.6%, expected life of the options of five years, expected stock price volatility of 33.8%, and a risk-free interest rate of 0.86%, which is assumed to be the rate on 5-year U.S. Treasury bonds.

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Stock option plan activity for the six months ended June 30, 2013 (unaudited) is summarized below:

	Shares			Weighted Average Exercise Price		Weighted Average Remaining Contractual Life (in years)		Aggregate Intrinsic Value (1)
Options outstanding, January 1		120,617		$	9.51		5.4
Granted		89,500			5.25
Forfeited		—			—
Exercised		—			—
Expired		(7,596	)		13.80
Options outstanding, June 30		202,521		$	7.46		7.2	$	9,425
Options exercisable, June 30		202,521		$	7.46		7.2	$	9,425

(1) The aggregate intrinsic value of a stock option in the table above represents the total pre-tax intrinsic value (the amount by which the current market value of the underlying stock exceeds the exercise price of the option) that would have been received by the option holders had all option holders exercised their options on June 30, 2013. This amount changes based on changes in the market value of the Company’s common stock.

As of February 21, 2013, a total of 7,000 shares of the Company’s common stock were awarded to the Chief Executive Officer, the Executive Vice President and the Chief Financial Officer. These shares vested immediately and $36,750 in compensation expense was recognized on that date.

Note 9: Employee Benefit Plans

The Company has a non-contributory, defined benefit pension plan for all full-time employees over 21 years of age. Under this cash balance plan, until December 31, 2012, the account balance for each participant will grow each year with annual pay credits based on age and years of service and monthly interest credits based on an amount established each year by the Company’s Board of Directors. Effective December 31, 2012, this plan was frozen to new participants. Annual pay credits have been discontinued, but each participant’s account balance will continue to grow based on monthly interest credits. The Company funds pension costs in accordance with the funding provisions of the Employee Retirement Income Security Act.

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

Components of Net Periodic Benefit Cost

(Unaudited)

	Pension Benefits						Post Retirement Benefits
Six months ended June 30,	2013			2012			2013		2012
Service cost	$	—		$	127,142		$	11,475	$	13,001
Interest cost		71,630			89,149			14,953		14,978
Expected return on plan assets		(107,331	)		(160,932	)		—		—
Amortization of unrecognized prior service cost		—			(26,981	)		—		—
Amortization of unrecognized net loss		44,873			35,720			2,248		1,457
Amortization of transition obligation		—			112,313			1,457		1,471
Net periodic benefit cost	$	9,172		$	176,411		$	30,133	$	30,907

The Company expects to make no contribution to its pension plan and $23,945 to its post-retirement benefit plan in 2013. The Company has contributed $7,984 toward the post-retirement plan during the first six months of 2013.

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Note 10: Long Term Debt

On June 30, 2013, the Bank had FHLB debt consisting of two advances (see table below). The $10 million advance was restructured during the second quarter of 2013 to extend the maturity and reduce the interest rate from 4.23% to a three month LIBOR-based floating rate advance.

Advances on the FHLB lines are secured by a blanket lien on qualified 1 to 4 family residential real estate loans with a lendable collateral value of $52.3 million. Immediate available credit, as of June 30, 2013, was $35.4 million. With additional collateral, the total line of credit is worth $65.6 million, with $48.6 million available.

The two advances are shown in the following table.

Description	Balance		Acquired		Current Interest Rate			Maturity Date
Adjustable Rate Hybrid	$	10,000,000		4/12/2013		2.38	%		4/13/2020
Fixed Rate Hybrid		5,000,000		5/20/2011		2.69	%		5/20/2014
	$	15,000,000

Note 11: Fair Value Measurements

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

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

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

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

Securities available for sale: Securities available for sale are recorded at fair value on a recurring basis. Fair value measurement is based upon quoted market prices, when available (Level 1). If quoted market prices are not available, fair values are measured utilizing independent valuation techniques of identical or similar securities for which significant assumptions are derived primarily from or corroborated by observable market data. Third party vendors compile prices from various sources and may determine the fair value of identical or similar securities by using pricing models that consider observable market data (Level 2). In certain cases where there is limited activity or less transparency around inputs to the valuation, securities are classified within Level 3 of the valuation hierarchy.

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

20

The following table presents the balances of financial assets and liabilities measured at fair value on a recurring basis as of June 30, 2013 and December 31, 2012:

			Fair Value Measurements at June 30, 2013 Using
Description	Balance		Level 1		Level 2		Level 3
	(unaudited)
Securities available for sale:
U. S. Government agencies	$	9,662,338	$	—	$	9,662,338	$	—
State and municipal obligations		27,366,674		—		27,366,674		—
Certificates of deposit		1,989,401		—		1,989,401		—
Auction rate security		1,032,000		—		—		1,032,000
Total securities available for sale	$	40,050,413	$	—	$	39,018,413	$	1,032,000

				Fair Value Measurements at December  31, 2012 Using
Description	Balance			Level 1			Level 2		Level 3
Securities available for sale:
U. S. Government agencies	$	9,463,815		$	—		$	9,463,815	$	—
State and municipal obligations		23,849,528			—			23,849,528		—
Certificates of deposit		1,987,177			—			1,987,177		—
Auction rate security		1,400,000			—			—		1,400,000
Total securities available for sale	$	36,700,520		$	—		$	35,300,520	$	1,400,000
Defined benefit plan assets:
Cash and cash equivalents		(5,539	)		(5,539	)		—		—
Mutual funds - fixed income		1,091,176			1,091,176			—		—
Mutual funds - equity		1,759,171			1,759,171			—		—
Total defined benefit plan assets	$	2,844,808		$	2,844,808		$	—	$	—

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

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

Impaired Loans: Loans are designated as impaired when, in the judgment of management based on current information and events, it is probable that all amounts due according to the contractual terms of the loan agreement will not be collected. The measurement of loss associated with impaired loans can be based on either the observable market price of the loan or the fair value of the collateral. Collateral may be in the form of real estate or business assets including equipment, inventory, and accounts receivable. The vast majority of the collateral is real estate. The value of real estate collateral is determined utilizing a market valuation approach based on an appraisal conducted by an independent, licensed appraiser outside of the Company using observable market data (Level 2). However, if the collateral value is significantly adjusted due to differences in the comparable properties, or is discounted by the Company because of marketability, then the fair value is considered Level 3. The value of business equipment is based upon an outside appraisal if deemed significant, or the net book value on the applicable business’ financial statements if not considered significant. Likewise, values for inventory and accounts receivables collateral are based on financial statement balances or aging reports (Level 3). Impaired loans allocated to the Allowance for Loan Losses are measured at fair value on a nonrecurring basis. Any fair value adjustments are recorded in the period incurred as provision for loan losses on the Consolidated Statements of Income.

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

21

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

			Fair Value Measurements at June 30, 2013 Using
Description	Balance		Level 1		Level 2		Level 3
	(unaudited)
Impaired Loans, net	$	2,939,932	$	—	$	—	$	2,939,932
Other real estate owned, net		3,351,454		—		—		3,351,454

			Fair Value Measurements at December 31, 2012 Using
Description	Balance		Level 1		Level 2		Level 3
Impaired Loans, net	$	3,308,074	$	—	$	—	$	3,308,074
Other real estate owned, net		3,151,346		—		—		3,151,346

The following table displays quantitative information about Level 3 Fair Value Measurements as of June 30, 2013:

Description	Balance		Valuation Technique		Unobservable Input		Range (Weighted Average)
	(unaudited)
Impaired Loans, net	$	2,939,932		Discounted appraised value		Selling Cost	10% - 20% (11%)
						Lack of Marketability	0% - 100% (32%)
Other real estate owned, net		3,351,454		Discounted appraised value		Selling Cost	6% - 13% (6%)
						Lack of Marketability	10% - 30% (19%)

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

22

				Fair Value Measurements at June 30, 2013 Using
Description	Balance as of     June 30, 2013			Level 1		Level 2		Level 3
Financial Assets:		(unaudited	)
Cash and due from banks	$	7,067,371		$	7,067,371	$	—	$	—
Interest-bearing deposits		28,499,652			28,499,652		—		—
Federal funds sold		303,900			303,900		—		—
Securities available-for-sale		40,050,413			—		39,018,413		1,032,000
Restricted securities		1,623,350			—		—		1,623,350
Loans, net		231,867,546			—		—		236,404,000
Accrued interest receivable		1,103,621			—		1,103,621		—
Financial Liabilities:
Non-interest-bearing deposits	$	54,800,212		$	54,800,212	$	—	$	—
Savings and other interest-bearing deposits		114,311,014			—		114,311,014		—
Time deposits		102,063,440			—		—		104,264,000
Securities sold under repurchase agreements		11,355,400			—		11,355,400		—
FHLB advances		15,000,000			—		16,128,428		—
Accrued interest payable		177,207			—		177,207		—

			Fair Value Measurements at December 31, 2012 Using
Description	Balance as of  December 31,2012		Level 1		Level 2		Level 3
Financial Assets:
Cash and due from banks	$	4,757,889	$	4,757,889	$	—	$	—
Interest-bearing deposits		35,166,448		35,166,448		—		—
Federal funds sold		48,009		48,009		—		—
Securities available-for-sale		36,700,520		—		35,300,520		1,400,000
Restricted securities		1,584,700		—		—		1,584,700
Loans, net		236,144,526		—		—		244,708,821
Accrued interest receivable		1,070,763		—		1,070,763		—
Financial Liabilities:
Non-interest-bearing deposits	$	50,467,907	$	50,467,907	$	—	$	—
Savings and other interest-bearing deposits		117,954,879		—		117,954,879		—
Time deposits		106,751,785		—		—		109,449,974
Securities sold under repurchase agreements		6,459,839		—		6,459,839		—
FHLB advances		15,000,000		—		16,483,342		—
Accrued interest payable		156,812		—		156,812		—

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

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

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

Time deposits are presented at estimated fair value using interest rates offered for deposits of similar remaining maturities.

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

23

The fair value of commitments to extend credit is estimated using the fees currently charged to enter similar agreements, taking into account the remaining terms of the agreements and the present credit worthiness of the counter parties. For fixed-rate loan commitments, fair value also considers the difference between current levels of interest rates and the committed rates. The fair value of standby letters of credit is based on fees currently charged for similar agreements or on the estimated cost to terminate them or otherwise settle the obligations with the counter parties at the reporting date. At June 30, 2013 and December 31, 2012, the fair value of loan commitments and standby letters of credit was immaterial. Therefore, they are not included in the table above.

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

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

Changes in accumulated other comprehensive income (loss) (“AOCI”) balances, including amounts reclassified out of AOCI, are shown in the following table.

	Net Unrealized Gains (Losses) on Securities			Pension and Post-retirement Benefit Plans			Accumulated Other Comprehensive Income (Loss)
Three months ended June 30, 2013 (unaudited)
Beginning balance	$	228,637		$	(659,921	)	$	(431,284	)
Change in net unrealized holding gains on securities, before reclassifications, net of tax benefit of $422,597		(820,336	)		—			(820,336	)
Reclassification for previously unrealized net (gains) and impairments on securities recognized in net income, net of tax of $50,243		(97,530	)		—			(97,530	)
Balance at June 30, 2013	$	(689,229	)	$	(659,921	)	$	(1,349,150	)
Three months ended June 30, 2012 (unaudited)
Beginning balance	$	683,279		$	(315,391	)	$	367,888
Change in net unrealized holding gains on securities, before reclassifications, net of tax of $110,298		214,107			—			214,107
Reclassification for previously unrealized net (gains) on securities recognized in net income, net of tax of $167,945		(326,010	)		—			(326,010	)
Balance at June 30, 2012	$	571,376		$	(315,391	)	$	255,985

24

	Net Unrealized Gains (Losses) on Securities			Pension and Post-retirement Benefit Plans			Accumulated Other Comprehensive Income (Loss)
Six months ended June 30, 2013 (unaudited)
Beginning balance	$	279,195		$	(659,921	)	$	(380,726	)
Change in net unrealized holding gains on securities, before reclassifications, net of tax benefit of $447,642		(868,953	)		—			(789,753	)
Reclassification for previously unrealized net (gains) and impairments on securities recognized in net income, net of tax of $51,243		(99,471	)		—			(178,671	)
Balance at June 30, 2013	$	(689,229	)	$	(659,921	)	$	(1,349,150	)
Six months ended June 30, 2012 (unaudited)
Beginning balance	$	760,730		$	(315,391	)	$	445,339
Change in net unrealized holding gains on securities, before reclassifications, net of tax of $73,412		142,505			—			142,505
Reclassification for previously unrealized net (gains) on securities recognized in net income, net of tax of $170,957		(331,859	)		—			(331,859	)
Balance at June 30, 2012	$	571,376		$	(315,391	)	$	255,985

Reclassification for previously unrealized gains and impairments on securities are reported in the consolidated statements of income as “Gains on sale of securities available for sale” and “net impairment recognized in income” with the corresponding income tax effect being reflected as a component of income tax expense. During the six months ended June 30, 2013 and 2012, the Company reported net gains on sales of securities of $270,714 and $502,816, respectively; the tax effect of these transactions was $92,043 and $170,957, respectively, which was included as a component of income tax expense. Similarly, for both the six-month and three-month period ended June 30, 2013, the Company recorded a net impairment loss on an other-than-temporarily-impaired security of $120,000, with a corresponding tax effect of $40,800 included as a component of income tax expense.

25

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

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

STATEMENT REGARDING FORWARD-LOOKING STATEMENTS

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

EXECUTIVE SUMMARY

Earnings more than doubled for the second quarter of 2013 compared to the second quarter of 2012 and nearly doubled for the first half of 2013 compared to the first half of 2012. This allowed earnings per share to remain at $0.08 for the six months ended June 30, 2013, even after we nearly doubled the number of shares outstanding as a result of our private placement of 2,200,000 shares of common stock in December 2012.

Our new residential loan production office in Hartfield, Virginia, is generating revenue and we remain confident that it will make a positive contribution to earnings within its first year of operation. This new office supported additional mortgage activity and contributed to the $102 thousand increase of secondary market lending fees in the first half of 2013 compared to the first half of 2012.

The quest for improved earnings continues with the purchase of $5.0 million of bank owned life insurance (“BOLI”), which has already contributed $35 thousand in tax free earnings. We expect BOLI to contribute $190 thousand in earnings on an annual basis. We also refinanced our $10 million FHLB advance in April, which has saved us $33 thousand so far in in 2013. We expect to save $157 thousand on an annual basis as a result of this refinance. The Overdraft Privilege Program we introduced last year continues to provide increased fee income from deposit accounts.

We have also recently announced the consolidation of three branch offices into two in Northumberland County. This follows ongoing performance reviews of our entire retail network, including an evaluation of each location for a number of criteria, including access and availability of services to affected customers, the proximity of other banking centers, profitability, transaction volumes and market dynamics. This review culminated in the approval of the consolidation of these branch offices by our board of directors. As a result, the Heathsville office will close on September 30, 2013, with deposits and other operations transferring to either the Burgess office or the Callao office. We expect a pretax earnings improvement of approximately $100 thousand on an annual basis due to the anticipated reduction in noninterest expenses. The Heathsville office will be marketed for sale. No impairment of the value of these premises is expected.

Asset quality continues to improve. Non-performing assets are now 2.5% of loans and OREO as of June 30, 2013 compared to 3.7% at December 31, 2012. They are down 35.1% to $5.8 million as of June 30, 2013 compared to $9.0 million as of December 31, 2012. OREO balances of $3.4 million as of June 30, 2013 have improved since March 31, 2013, but are still $200 thousand higher as compared to December 31, 2012. During the first half of 2013, seven OREO properties were sold and five were added through foreclosures. Non-accruing loan balances are down 57.3% to $2.4 million as of June 30, 2013 as compared to $5.7 million at December 31, 2012.

26

Annualized net loan charge-offs against the allowance for loan losses (“ALL”) are down to 0.32% of total loans during the first half of 2013 compared to 0.41% during the first half of 2012. This has resulted in corresponding reductions in provision for loan losses expense.

The net interest margin declined to 3.46% for the first half of 2013 compared to 3.60% for the same period in 2012. It has become increasingly difficult to reduce the cost of funds by the same or more than the reductions we are seeing in yields on loans and investments. As this historic low-rate climate continues, loan yields continue to decline, contributing to reduced interest income. In order to drive increases in interest income, the Bank’s main source of revenue, we are concentrating on loan growth via cautious expansion into new markets. Since June 30, 2013, loan balances have grown by more than $10.0 million. The refinance of the FHLB advance, noted above, and scheduled maturities of time deposits in 2013, will help to reduce our cost of funds. Maturities of time deposits are typically renewed at lower rates, leave the bank or transfer to a lower-cost checking or savings account.

Finally, our core capital levels and regulatory ratios remain substantially higher than what is considered “well capitalized” by our regulators, due in no small part to last fall’s successful capital raise. We took no Troubled Asset Relief Program (“TARP”) or Small Business Lending Fund (“SBLF”) investments from the U.S. Treasury. In July 2013, the FDIC and Federal Reserve approved a final rule to implement Basel III capital reforms, among other changes required by the Dodd-Frank Act. We expect the impact of these rules to be immaterial in the near term.

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

EARNINGS SUMMATION

For the three months ended June 30, 2013 and 2012, net income was $232 thousand and $97 thousand, respectively, an increase of $135 thousand or 139.1%. Diluted earnings per average share for the three months ended June 30, 2013 and 2012 were $0.05 and $0.04, respectively. Return on average assets was 0.28% for the three months ended June 30, 2013 compared to 0.12% for the three months ended June 30,2012. Return on average equity was 2.55% and 1.38% for the three months ended June 30, 2013 and 2012, respectively.

For the six months ended June 30, 2013 and 2012, net income was $372 thousand and $203 thousand, respectively, an increase of $169 thousand or 83.6%. Diluted earnings per average share for both the six months ended June 30, 2013 and 2012 were $0.08. Return on average assets was 0.22% for the six months ended June 30, 2013 compared to 0.13% for the six months ended June 30, 2012. Return on average equity was 2.05% and 1.45% for the six months ended June 30, 2013 and 2012, respectively.

RESULTS OF OPERATIONS

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

27

FOR THE THREE MONTHS ENDED JUNE 30, 2013 COMPARED TO THE THREE MONTHS ENDED JUNE 30, 2012

NET INTEREST INCOME

Net Interest Income Analysis (unaudited)	Average Balances, Income and Expense, Yields and Rates
(Fully taxable equivalent basis) (Dollars in Thousands)	Three months ended 6/30/2013							Three months ended 6/30/2012
	Average Balance		Income/ Expense		Yield/ Cost			Average Balance		Income/ Expense		Yield/ Cost
INTEREST EARNING ASSETS:
Taxable investments	$	25,015	$	118		1.89	%	$	27,482	$	180		2.62	%
Tax-exempt investments (1)		14,203		105		2.96	%		10,841		94		3.47	%
Total investments		39,218		223		2.27	%		38,323		274		2.86	%
Gross loans (2)		233,212		3,135		5.38	%		242,162		3,264		5.39	%
Interest-bearing deposits		29,305		17		0.23	%		13,561		9		0.27	%
Federal funds sold		1,391		—		0.09	%		2,308		1		0.09	%
Total Interest Earning Assets	$	303,126	$	3,375		4.45	%	$	296,354	$	3,548		4.79	%
INTEREST-BEARING LIABILITIES:
Savings deposits	$	46,762	$	23		0.20	%	$	47,939	$	39		0.33	%
NOW deposits		40,594		21		0.21	%		38,011		20		0.21	%
Time deposits => $100,000		45,894		255		2.23	%		51,525		296		2.30	%
Time deposits < $100,000		57,079		263		1.85	%		63,371		324		2.05	%
Money market deposit accounts		27,568		39		0.57	%		23,256		38		0.66	%
Total Deposits	$	217,897	$	601		1.11	%	$	224,102	$	717		1.28	%
Federal funds purchased	$	226	$	—		0.70	%	$	—	$	—		0.00	%
Securities sold under repurchase agreements		8,418		6		0.29	%		6,977		5		0.29	%
FHLB advances		15,000		106		2.87	%		15,000		141		3.77	%
Total Interest-Bearing Liabilities	$	241,541	$	713		1.18	%	$	246,079	$	863		1.41	%
Net interest income and net interest margin			$	2,662		3.51	%			$	2,685		3.62	%
Non-interest-bearing deposits	$	52,386		—		0.00	%	$	44,821		—		0.00	%
Total Cost of funds						0.97	%						1.19	%
Net interest rate spread						3.48	%						3.60	%

Notes:

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

(2) Includes Visa program and nonaccrual loans.

Interest income for the three months ended June 30, 2013, on a tax-equivalent basis, was $3.4 million, a decrease of $173 thousand from the second quarter of 2012, due mainly to reduced loan balances. Interest expense for the three months ended June 30, 2013, was $713 thousand, a decrease of $150 thousand from the second quarter of 2012, due mainly to reductions in both balances and costs of time deposits. Net interest income for the three months ended June 30, 2013, on a tax-equivalent basis, was $2.7 million, a decrease of $23 thousand, or 0.9%, from the second quarter of 2012. The annualized net interest margin was 3.51% for the three months ended June 30, 2013, down from 3.62% for the same period in 2012, due mainly to lower yields on investments. However, reductions in deposit costs and related interest expense have nearly mitigated the reduced interest income. Also, the mix of deposits continues to improve as lower cost balances in checking and money market accounts have increased while higher cost time deposit balances have declined. Further reductions in the cost of funds are anticipated as time deposits mature and are replaced at lower rates. As long as market rates remain low, this positive trend is expected to continue.

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The net interest spread, which is the difference between the annualized yield on earning assets and the annualized cost of funds, decreased to 3.48% for the three months ended June 30, 2013, compared to 3.60% for the three months ended June 30, 2012.

NON-INTEREST INCOME

Non-interest income for the three months ended June 30, 2013 decreased $202 thousand, or 13.8%, compared to the three months ended June 30, 2012. The decrease was primarily due to reduced gains on the sales of securities of $226 thousand and a credit impairment write-down of $120 thousand on a debt security with other-than-temporary impairment (refer to Note 4). These declines were partially offset by increases in other areas. Service charges and fees on deposit accounts increased by $74 thousand, a result of the Bank’s new Overdraft Privilege Program. Overdraft fees have increased to $198 thousand for the second quarter of 2013 compared to $143 thousand for the similar period in 2012. Fees from sales of mortgages into the secondary market increased by $47 thousand, which was driven exclusively by increased loan sales to Fannie Mae. Income from Investment Advantage increased by $34 thousand. Investment Advantage contributes the majority of income to other service charges and fees, and since income from Investment Advantage is commission-based, increases in investment activity will cause increases in the Company’s income. Finally, the Bank’s acquisition of bank owned life insurance in April contributed an additional $35 thousand.

Income from fiduciary activities increased $4 thousand to $162 thousand for the second quarter of 2013 compared to the same period in 2012. The Company’s fiduciary income is derived from the operations of its subsidiary, Bay Trust Company, which offers a broad range of trust and related fiduciary services. Among these are estate settlement and testamentary trusts, revocable and irrevocable personal trusts, managed agency, custodial accounts, and rollover IRAs, both self-directed and managed. Fiduciary income is largely affected by changes in the performance of the stock and bond market, which directly impacts the market value of the accounts upon which fees are earned and therefore the levels of this fee income.

NON-INTEREST EXPENSE

For the three months ended June 30, 2013, non-interest expenses totaled $3.4 million, a decrease of $44 thousand, or 1.3%, compared to the same period in 2012. The largest component of non-interest expense is salaries and benefits, which increased by $223 thousand, due mainly to $108 thousand in severance expenses related to early retirements in the month of June, 2013, plus $52 thousand related to positioning the Company for growth as positions that were eliminated in 2012 are replaced with positions that generate new revenue. Also reflected in salaries and benefits, during the three months ended June 30, 2012, is a $46 thousand reversal of accrued Employee Stock Ownership Plan and Pension Plan costs which was made as a result of the decision to freeze these plans effective December 31, 2012.

Increases in salary and benefits expense were partially offset by the following expense decreases:

• Occupancy expense decreased by $59 thousand for the second quarter of 2013 compared to the similar period in 2012, due mainly to reductions in building maintenance and software contract expense.

• OREO costs, including losses on OREO, which was reclassified into non-interest expense from non-interest income, have improved by $40 thousand.

• Consulting expense decreased $43 thousand, a result of earnings enhancement projects in process during the second quarter of 2012, which are now complete.

• Other expense decreased $115 thousand primarily due to the defalcation investigation completed in 2012.

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FOR THE SIX MONTHS ENDED JUNE 30, 2013 COMPARED TO THE SIX MONTHS ENDED JUNE 30, 2012

NET INTEREST INCOME

Net Interest Income Analysis (unaudited)	Average Balances, Income and Expense, Yields and Rates
(Fully taxable equivalent basis) (Dollars in Thousands)	Six months ended 6/30/2013							Six months ended 6/30/2012
	Average Balance		Income/ Expense		Yield/ Cost			Average Balance		Income/ Expense		Yield/ Cost
INTEREST EARNING ASSETS:
Taxable investments	$	25,875	$	242		1.87	%	$	28,769	$	381		2.65	%
Tax-exempt investments (1)		12,989		189		2.91	%		11,331		202		3.55	%
Total investments		38,864		431		2.22	%		40,100		583		2.91	%
Gross loans (2)		234,117		6,289		5.37	%		240,739		6,489		5.40	%
Interest-bearing deposits		30,982		36		0.23	%		12,844		16		0.24	%
Federal funds sold		797		—		0.09	%		2,366		3		0.22	%
Total Interest Earning Assets	$	304,760	$	6,756		4.43	%	$	296,049	$	7,091		4.79	%
INTEREST-BEARING LIABILITIES:
Savings deposits	$	46,397	$	52		0.23	%	$	47,838	$	101		0.43	%
NOW deposits		40,795		44		0.22	%		38,137		40		0.21	%
Time deposits => $100,000		46,567		514		2.23	%		51,687		593		2.31	%
Time deposits < $100,000		57,614		541		1.89	%		63,789		657		2.08	%
Money market deposit accounts		27,723		80		0.58	%		23,000		74		0.65	%
Total Deposits	$	219,096	$	1,231		1.13	%	$	224,451	$	1,465		1.32	%
Federal funds purchased	$	113	$	—		0.70	%	$	—	$	—		0.00	%
Securities sold under repurchase agreements		7,663		10		0.26	%		6,060		8		0.27	%
FHLB advances		15,000		245		3.29	%		15,000		282		3.78	%
Total Interest-Bearing Liabilities	$	241,872	$	1,486		1.24	%	$	245,511	$	1,755		1.44	%
Net interest income and net interest margin			$	5,270		3.46	%			$	5,336		3.60	%
Non-interest-bearing deposits	$	50,758		—		0.00	%	$	44,555		—		0.00	%
Total Cost of funds						1.02	%						1.21	%
Net interest rate spread						3.41	%						3.58	%

Notes:

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

(2) Includes Visa program and nonaccrual loans.

Interest income for the six months ended June 30, 2013, on a fully tax-equivalent basis, was $6.8 million, a decrease of $335 thousand from the first six months of 2012, due primarily to reduced loan balances, but also from lower yields on investments. Interest expense for the six months ended June 30, 2013, was $1.5 million, a decrease of $269 thousand compared to the first six months of 2012, due primarily to reduced balances and costs of time deposits. Net interest income for the six months ended June 30, 2013, on a fully tax-equivalent basis, was $5.3 million, declining $66 thousand, or 1.2%, from the first six months of 2012. The annualized net interest margin was 3.46% for the six months ended June 30, 2013, down from 3.60% for the same period in 2012. The main reason for the decrease is lower yields on investments. However, reductions in deposit costs and related interest expense have helped to mitigate the reduced interest income. Also, the mix of deposits continues to improve as lower cost balances in checking and money market accounts have increased while higher cost time deposit balances have declined. Further reductions in the cost of funds are anticipated as time deposits mature and are replaced at lower rates. As long as market rates remain low, this positive trend is expected to continue.

30

The net interest spread, which is the difference between the annualized yield on earning assets and the annualized cost of funds, declined to 3.42% for the six months ended June 30, 2013, compared to 3.58% for the six months ended June 30, 2012.

NON-INTEREST INCOME

Non-interest income for the six months ended June 30, 2013 increased by $12 thousand, or 0.5%, compared to the six months ended June 30, 2012. The main driver was a $181 thousand increase in service charges and fees, a direct result of the Bank’s new Overdraft Privilege Program, where fees have increased to $404 thousand for the first six months of 2013 compared to $252 thousand for the similar period in 2012. Fees from sales of mortgages into the secondary market increased $102 thousand, which was driven exclusively by increased loan sales to Fannie Mae. Income from Investment Advantage increased by $11 thousand. Investment Advantage generates the majority of income to other service charges and fees, and since income from Investment Advantage is commission-based, increases in investment activity will cause increases in the Company’s income. VISA^® related fees increased by $34 thousand to $406 thousand in the first six months of 2013 compared to the similar period in 2012. Gains from sales of investment securities declined by $232 thousand in the first six months of 2013 compared to the similar period in 2012 and in the second quarter of 2013, the Bank recorded a credit impairment write-down of $120 thousand on a debt security with other-than-temporary impairment (refer to Note 4).

Income from fiduciary activities increased by $9 thousand to $327 thousand for the first six months of 2013 compared to the same period in 2012. The Company’s fiduciary income is derived from the operations of its subsidiary, Bay Trust Company, which offers a broad range of trust and related fiduciary services. Among these are estate settlement and testamentary trusts, revocable and irrevocable personal trusts, managed agency, custodial accounts, and rollover IRAs, both self-directed and managed. Fiduciary income is largely affected by changes in the performance of the stock and bond market, which directly impacts the market value of the accounts upon which fees are earned and therefore the levels of this fee income.

NON-INTEREST EXPENSE

For the six months ended June 30, 2013, non-interest expenses totaled $6.7 million, an increase of $57 thousand, or 0.9%, compared to $6.6 million for the same period in 2012. The largest component of non-interest expense is salaries and benefits, which increased by $391 thousand, due mainly to $176 thousand in additional salaries as we position the Company for growth by replacing positions eliminated in 2012 with positions that generate new revenue. Another $69 thousand is related to reduced wage credits for the origination of mortgage loans. Finally, $123 thousand of the increase is a result of stock-based compensation paid to key management during the first quarter of 2013. Severance expenses totals were similar in the two periods.

Increases in salary and benefits expense were partially offset by the following expense decreases:

• Occupancy expense decreased by $65 thousand for the first half of 2013 compared to the similar period in 2012, a result of decreased building maintenance expense and software contract expense.

• OREO costs, including losses on OREO, which was reclassified into non-interest expense from non-interest income, have improved by $110 thousand.

• Consulting expense decreased $93 thousand, due to earnings enhancement projects in process during the first half of 2012, which are now complete.

• Other expense decreased $48 thousand primarily due to the defalcation investigation completed in 2012.

AVERAGE INTEREST-EARNINGS ASSETS AND AVERAGE INTEREST-BEARING LIABILITIES

Average interest-earning assets increased 2.9% to $304.8 million for the six months ended June 30, 2013, as compared to $296.0 million for the six months ended June 30, 2012, a result of higher interest-bearing deposit balances in the Bank’s account at the Federal Reserve Bank of Richmond, which was driven by receipt of cash from the issuance of new capital in December 2012, declines in loan balances, and increases in non-interest bearing checking accounts. Average interest-earning assets as a percent of total average assets was 92.1% for the six months ended June 30, 2013 as compared to 92.6% for the same period in 2012. The loan portfolio, with $234.1 million in average balances as of June 30, 2013, is the largest category of interest-earning assets.

Average interest-bearing liabilities decreased 1.5% to $241.9 million for the six months ended June 30, 2013, as compared to $245.5 million for the six months ended June 30, 2012. The largest category of interest-bearing liabilities is time deposits, with combined average balances of $104.2 million for the six months ended June 30, 2013, down from $115.5 million for the similar period in 2012.

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ASSET QUALITY

In the first six months of 2013, asset quality continued to improve. Classified assets declined by $509 thousand during the first six months of 2013 to $13.8 million, or 35.8% of Tier 1 capital plus the allowance for loan losses. Non-performing assets, excluding performing TDRs, declined by $3.2 million to $5.8 million, or 1.7% of assets.

As of June 30, 2013, loans valued at $6.8 million were considered impaired, whereas $7.6 million were considered impaired as of December 31, 2012. Between December 31, 2012 and June 30, 2013, two loans were identified as impaired, two were dispensed through foreclosures and charge-offs and one was resolved. Management has reviewed the impaired credits and the underlying collateral and expects no additional losses above those which are specifically reserved in the ALL.

Risk rating grades are assigned conservatively, causing some homogenous loans, like residential mortgages, to fall into the pool of adversely risk rated loans and thereby evaluated for impairment, even though they may be performing as agreed and therefore not impaired.

Non-Performing Assets

(Dollars in Thousands)	June 30, 2013						December 31, 2012
	(unaudited)
(percentages are as a percent of total loans)	$			%			$			%
Loans past due 90 days or more and still accruing	$	45			0.02	%	$	126			0.1	%
Non-accruing loans		2,446			1.0	%		5,730			2.4	%
Total non-performing loans	$	2,491			1.1	%	$	5,856			2.4	%
Allowance for loan losses	$	2,983			1.27	%	$	3,094			1.29	%
Allowance to non-performing loans		119.8	%					52.8	%
(percentages are as a percent of total loans plus OREO)
Other real estate owned		3,351			1.4	%		3,151			1.3	%
Total non-performing assets	$	5,842			2.5	%	$	9,007			3.7	%

Non-performing loans, which include loans past due 90 days or more and still accruing, plus non-accruing loans, as a percentage of total loans, decreased to 1.1% as of June 30, 2013 compared to 2.4% as of December 31, 2012. Non-accruing loans totaled $2.5 million as of June 30, 2013, down from $5.9 million at year-end 2012. Non-performing assets, which include OREO in addition to non-performing loans, declined to 2.5% at June 30, 2013 as compared to 3.7% at December 31, 2012.

Loans charged off during the first six months of 2013, net of recoveries, totaled $372 thousand compared to $490 thousand for the first six months of 2012. This represents a decline in the annualized net charge-off ratio to 0.32% for the first six months of 2013 compared to 0.41% for the first six months of 2012, reflecting an improvement in asset quality. The majority of the charge-offs were anticipated and specific reserves had been provided for them in the ALL. Management is maintaining an adequate level of the ALL at 1.27% and 1.29% of total loans for June 30, 2013 and December 31, 2012, respectively.

FINANCIAL CONDITION

Total assets increased by 0.2% to $335.3 million during the six months ended June 30, 2013 from $334.8 million at December 31, 2012. Cash and due from banks, which produces no income, increased to $7.1 million on June 30, 2013 from $4.7 million at year-end 2012, a result of normal daily fluctuation in deposit transactions.

During the six months ended June 30, 2013, gross loans decreased by $4.4 million or 1.8%, to $234.9 million from $239.2 million at year-end 2012. The largest component of this decrease was a $3.5 million decline in Commercial and industrial loan balances, driven mainly by one large loan maturity.

The Bank had $3.4 million of OREO at June 30, 2013 and $3.2 million at December 31, 2012. As of June 30, 2013, OREO consists of nine residences, seventeen lots, two former convenience stores, a seafood house, one former nursery property and one commercial business property. The one piece of farmland owned at March 31, 2013, was subdivided into five lots during the second quarter. During the first six months of 2013, five properties with a total book value of $1.3 million from five borrowers were added through foreclosures, and seven properties with a total book value of $1.1 million were sold. Write-downs of book value on OREO properties totaled $16 thousand during the first six months of 2013, compared to $111 thousand for the same period in 2012. All properties maintained as OREO are valued at the lesser of carrying value or fair value less estimated costs to sell and are actively marketed.

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As of June 30, 2013, securities available for sale at fair value totaled $40.0 million as compared to $36.7 million on December 31, 2012. This represents a net increase of $3.3 million or 9.1% for the six months. As of June 30, 2013, these securities represented 11.9% of total assets and 13.1% of earning assets. All securities in the Company’s investment portfolio are classified as available-for-sale and marked to market on a monthly basis. These gains or losses, net of tax, are booked as an adjustment to shareholders’ equity, and are not realized as an adjustment to earnings until the securities are actually sold or an other than temporary impairment occurs. One security, with a fair value of $1.0 million, is deemed to be other than temporarily impaired by $120 thousand.

In the second quarter of 2013, the Company purchased $5.0 million of bank owned life insurance in order to offset the cost of employee benefits.

As of June 30, 2013, total deposits were $271.2 million compared to $275.2 million at year-end 2012. This represents a decrease in balances of $4.0 million or 1.5% during the six months. The main driver of the decline was $4.7 million of reductions in time deposit balances.

As of June 30, 2013, securities sold under repurchase agreements increased $4.9 million to $11.4 million from $6.5 million at December 31, 2012. This increase was the result of normal seasonality for these customers.

LIQUIDITY

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

At June 30, 2013, cash totaled $7.1 million, federal funds sold totaled $304 thousand, interest-bearing deposits totaled $28.5 million, and securities and loans maturing in one year or less totaled $23.5 million. This results in a liquidity ratio as of June 30, 2013 of 17.7% as compared to 18.6% as of December 31, 2012. The Company determines this ratio by dividing the sum of cash and cash equivalents, investment securities maturing in one year or less, loans maturing in one year or less and federal funds sold, by total assets. The Bank has a formal liquidity management policy and contingency plan. Given current economic uncertainty, management is maintaining a historically high level of liquidity.

In addition, as noted earlier, the Company has a line of credit with the FHLB of $65.6 million, plus federal funds lines of credit with correspondent banks totaling $20.3 million.

CAPITAL RESOURCES

Capital resources represent funds, earned or obtained, over which a financial institution can exercise greater long-term control in comparison with deposits and borrowed funds. The adequacy of the Company’s capital is reviewed by management on an ongoing basis with reference to size, composition, and quality of the Company’s resources and consistency with regulatory requirements and industry standards. Management seeks to maintain a capital structure that will assure an adequate level of capital to support anticipated asset growth and to absorb potential losses, yet allows management to effectively leverage its capital to maximize return to shareholders. The Company’s capital, also known as shareholders’ equity, is comprised mainly of outstanding common stock and retained earnings. Capital can be increased with securities offerings or through earnings. On December 31, 2012, the Company sold a total of 2,200,000 shares of its common stock at a purchase price of $4.25 per share to certain accredited investors in a private placement exempt from registration under the Securities Act of 1933 pursuant to Section 4(2) thereof and Rule 506 of Regulation D promulgated thereunder. The Company received gross proceeds of $9.35 million from such private placement. The Company has a formal capital policy and plan, and management believes that the capital level at June 30, 2013, which was enhanced by this successful private placement, supports plans for growth.

Several factors impact shareholders’ equity, including net income, and regulatory capital requirements. The Company’s capital resources are also impacted by net unrealized gains or losses on securities. The available-for-sale securities portfolio is marked to market monthly and unrealized gains or losses, net of taxes, are recognized as accumulated other comprehensive income (loss) on the balance sheets and statement of changes in shareholders’ equity. Another factor affecting accumulated other comprehensive

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income (loss) is changes in the market value of the Company’s pension and post-retirement benefit plans. Shareholders’ equity before accumulated other comprehensive income (loss) was $37.5 million on June 30, 2013 compared to $37.0 million on December 31, 2012. Accumulated other comprehensive loss increased $968 thousand between December 31, 2012 and June 30, 2013, a result of increases in unrealized losses in the investment portfolio due to increased market rates.

Book value per share, before accumulated other comprehensive loss, on June 30, 2013, compared to December 31, 2012, increased to $7.78 from $7.68. Book value per share, including accumulated other comprehensive loss, decreased to $7.50 from $7.60 on June 30, 2013 as compared to December 31, 2012. No cash dividends were paid for the six-month period ended June 30, 2013, nor for the comparable period ended June 30, 2012. Of the 10,000,000 common shares authorized, 4,817,856 were outstanding on June 30, 2013, up 7,000 shares from 4,810,856 on December 31, 2012, a result of stock awarded to the Company’s Chief Executive Officer, Executive Vice President and Chief Financial Officer.

The Bank is subject to minimum regulatory capital ratios as defined by Federal Financial Institutions Examination Council guidelines. These ratios continue to be well in excess of regulatory minimums. As of June 30, 2013, the Bank maintained Tier 1 capital of $29.8 million, net risk weighted assets of $225.3 million, and Tier 2 capital of $2.8 million. On June 30, 2013, the Tier 1 leverage ratio was 9.06%, the capital to risk weighted assets ratio was 13.23%, and the total capital ratio to risk weighted assets ratio was 14.48%.

OFF BALANCE SHEET COMMITMENTS

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

Off Balance Sheet Arrangements

(unaudited)	June 30, 2013		December 31, 2012
(Dollars in Thousands)
Total Loan Commitments Outstanding	$	31,881	$	30,459
Standby-by Letters of Credit		325		359

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

There have been no material changes to the off balance sheet items disclosed in “Management’s Discussion and Analysis of Financial Condition and Results of Operation” in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2012.

CONTRACTUAL OBLIGATIONS

There have been no material changes outside the ordinary course of business to the contractual obligations disclosed in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2012.

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RECENT ACCOUNTING PRONOUNCEMENTS

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

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Not required.

ITEM 4. CONTROLS AND PROCEDURES

EVALUATION OF DISCLOSURE CONTROLS AND PROCEDURES

As of the end of the period to which this report relates, the Company has carried out an evaluation, under the supervision and with the participation of the Company’s management, including the Company’s Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of the Company’s disclosure controls and procedures pursuant to Rule 13a-14 of the Securities Exchange Act of 1934. In designing and evaluating its disclosure controls and procedures, management recognized that disclosure controls and procedures, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that objectives of the disclosure controls and procedures are met. The design of any disclosure controls and procedures is also based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential conditions. Based upon their evaluation, the Company’s Chief Executive Officer and Chief Financial Officer concluded that the Company’s disclosure controls and procedures are effective in timely alerting them to material information relating to the Company (including its consolidated subsidiaries) required to be included in the Company’s periodic Securities and Exchange Commission filings as of June 30, 2013.

CHANGES IN INTERNAL CONTROLS OVER FINANCIAL REPORTING

There was no change to the Company’s internal control over financial reporting during the six months ended June 30, 2013 that materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.

PART II - OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

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

ITEM 1A. RISK FACTORS

Not required.

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

None to report.

ITEM 3. DEFAULT UPON SENIOR SECURITIES

None to report.

ITEM 4. MINE SAFETY DISCLOSURES

Not applicable.

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ITEM 5. OTHER INFORMATION

None to report.

ITEM 6. EXHIBITS

31.1	Certification Pursuant to 18 U.S.C. Section 1350 as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
31.2	Certification Pursuant to 18 U.S.C Section 1350 as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
32.1	Certification Pursuant to 18 U.S.C. Section 1350 as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
101	The following materials from the Company’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2013, formatted in Extensible Business Reporting Language (XBRL): (i) Consolidated Balance Sheets as of June 30, 2013 and December 31, 2012, (ii) Consolidated Statements of Income for the three and six months ended June 30, 2013 and 2012, (iii) Consolidated Statements of Changes in Shareholders’ Equity for the six months ended June 30, 2013, (iv) Consolidated Statements of Cash Flows for the six months ended June 30, 2013 and 2012, and (v) Notes to Consolidated Financial Statements. *

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

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SIGNATURES

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

	Bay Banks of Virginia, Inc.
	(Registrant)
August 14, 2013	By:	/s/ Randal R. Greene
		Randal R. Greene
		President and Chief Executive Officer
		(Principal Executive Officer)
	By:	/s/ Deborah M. Evans
		Deborah M. Evans
		Treasurer and Chief Financial Officer
		(Principal Financial and Accounting Officer)

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