UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

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

FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2017

☐ 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.)
1801 BAYBERRY COURT, SUITE 101 RICHMOND, VIRGINIA	23226
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES)	(ZIP CODE)

(804) 435-1171

(REGISTRANT’S TELEPHONE NUMBER, INCLUDING AREA CODE)

100 SOUTH MAIN STREET

KILMARNOCK, VIRGINIA 22482

(FORMER NAME, FORMER ADDRESS, AND FORMER FISCAL YEAR, IF CHANGED SINCE LAST REPORT)

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

Indicate by check mark whether the registrant has submitted electronically 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).    ☒  yes    ☐  no

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

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

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

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

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

13,193,983 shares of common stock on October 31, 2017

FORM 10-Q

For the interim period ending September 30, 2017

INDEX

ITEM 1.     FINANCIAL STATEMENTS
CONSOLIDATED BALANCE SHEETS SEPTEMBER  30, 2017 (UNAUDITED) AND DECEMBER 31, 2016	3
CONSOLIDATED STATEMENTS OF INCOME FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER  30, 2017 AND 2016 (UNAUDITED)	4
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2017 AND 2016 (UNAUDITED)	5
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2017 (UNAUDITED)	5
CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE NINE MONTHS ENDED SEPTEMBER  30, 2017 AND 2016 (UNAUDITED)	6
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)	7
ITEM 2.      MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS	31
ITEM 3.      QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK	38
ITEM 4.     CONTROLS AND PROCEDURES	39
PART II - OTHER INFORMATION
ITEM 1.     LEGAL PROCEEDINGS	39
ITEM 1A.  RISK FACTORS	39
ITEM 2.      UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS	39
ITEM 3.     DEFAULTS UPON SENIOR SECURITIES	39
ITEM 4.     MINE SAFETY DISCLOSURES	39
ITEM 5.     OTHER INFORMATION	39
ITEM 6.     EXHIBITS	40

2

PART I – FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

BAY BANKS OF VIRGINIA, INC.    

CONSOLIDATED BALANCE SHEETS    

	September 30, 2017			December 31, 2016 (1)
(Dollars in thousands)	(unaudited)
ASSETS
Cash and due from banks	$	5,806		$	4,851
Interest-bearing deposits		46,060			7,945
Certificates of deposit		3,224			4,216
Federal funds sold		23,357			1,906
Securities available-for-sale, at fair value		71,893			51,173
Restricted securities		6,000			2,649
Loans receivable, net of allowance for loan losses of $4,920 and $3,863		739,708			381,537
Loans held for sale		162			276
Premises and equipment, net		17,472			10,844
Accrued interest receivable		2,905			1,372
Other real estate owned, net		5,159			2,494
Bank owned life insurance		18,641			9,869
Goodwill		8,968			2,808
Mortgage servicing rights		978			671
Core deposit intangible		3,209			—
Other assets		6,394			4,099
Total assets	$	959,936		$	486,710
LIABILITIES
Noninterest-bearing deposits	$	99,531		$	74,799
Savings and interest-bearing demand deposits		297,150			178,869
Time deposits		338,732			128,050
Total deposits		735,413			381,718
Securities sold under repurchase agreements		17,091			18,310
Federal Home Loan Bank advances		75,000			35,000
Subordinated debt, net of issuance costs		6,873			6,860
Other liabilities		7,771			3,117
Total liabilities		842,148			445,005
SHAREHOLDERS’ EQUITY
Common stock ($5 par value; authorized - 30,000,000 shares; outstanding - 13,193,983 and 4,774,856 shares, respectively)		65,970			23,874
Additional paid-in capital		37,099			2,872
Unearned employee stock ownership plan shares		(817	)		—
Retained earnings		16,412			16,194
Accumulated other comprehensive loss, net		(876	)		(1,235	)
Total shareholders’ equity		117,788			41,705
Total liabilities and shareholders’ equity	$	959,936		$	486,710

(1) Derived from the audited December 31, 2016 Consolidated Financial Statements

See Notes to Consolidated Financial Statements.

3

BAY BANKS OF VIRGINIA, INC.

CONSOLIDATED STATEMENTS OF INCOME

(unaudited)

	For the three months ended						For the nine months ended
(Dollars in thousands except per share amounts)	September 30, 2017			September 30, 2016			September 30, 2017			September 30, 2016
INTEREST INCOME
Loans, including fees	$	8,874		$	4,153		$	21,588		$	12,140
Securities:
Taxable		329			233			946			651
Tax-exempt		116			123			344			394
Federal funds sold		43			1			77			2
Interest-bearing deposit accounts		116			25			176			52
Certificates of deposit		18			20			55			62
Total interest income		9,496			4,555			23,186			13,301
INTEREST EXPENSE
Deposits		1,292			648			2,999			1,934
Federal funds purchased		—			1			10			2
Securities sold under repurchase agreements		5			4			12			10
Subordinated debt		118			118			354			354
FHLB advances		279			118			681			360
Total interest expense		1,694			889			4,056			2,660
Net interest income		7,802			3,666			19,130			10,641
Provision for loan losses		1,075			259			1,833			407
Net interest income after provision for loan losses		6,727			3,407			17,297			10,234
NON-INTEREST INCOME
Income from fiduciary activities		217			253			691			696
Service charges and fees on deposit accounts		238			212			696			667
VISA-related fees		11			48			59			153
Non-deposit product income		105			83			300			263
Other service charges and fees		201			152			556			449
Secondary market lending income		157			165			358			465
Increase in cash surrender value of life insurance		133			73			341			197
Net gains on sale of securities available for sale		—			180			2			290
Other real estate gains (losses)		(9	)		(6	)		(102	)		(94	)
Other income		17			178			169			194
Total non-interest income		1,070			1,338			3,070			3,280
NON-INTEREST EXPENSES
Salaries and employee benefits		3,687			1,881			9,832			5,751
Occupancy expense		811			445			1,943			1,344
Software maintenance		299			152			897			494
Bank franchise tax		141			82			359			203
VISA expense		—			20			35			81
Telecommunications expense		111			42			215			130
FDIC assessments		119			96			315			280
Foreclosure property expense		45			11			114			40
Consulting expense		58			87			209			216
Advertising and marketing		100			59			227			160
Directors’ fees		135			74			466			218
Audit and accounting fees		121			68			366			225
Merger expense		141			—			1,126			—
Intangible amortization		227			—			461			—
Other expense		787			548			2,274			1,739
Total non-interest expenses		6,782			3,565			18,839			10,881
Income before income taxes		1,015			1,180			1,528			2,633
Income tax expense		273			326			406			669
Net income	$	742		$	854		$	1,122		$	1,964
Basic Earnings Per Share
Average basic shares outstanding		10,488,227			4,774,856			8,175,431			4,774,856
Earnings per share, basic	$	0.07		$	0.18		$	0.14		$	0.41
Diluted Earnings Per Share
Average diluted shares outstanding		10,557,623			4,797,521			8,242,700			4,793,147
Earnings per share, diluted	$	0.07		$	0.18		$	0.14		$	0.41

See Notes to Consolidated Financial Statements.

4

BAY BANKS OF VIRGINIA, INC.

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(unaudited)

	For the three months ended						For the nine months ended
	September 30,						September 30,
(Dollars in thousands)	2017			2016			2017			2016
Net income	$	742		$	854		$	1,122		$	1,964
Other comprehensive income:
Unrealized gains on securities:
Unrealized holding gains arising during the period		59			—			545			895
Deferred tax expense		(20	)		—			(185	)		(305	)
Reclassification of net securities gains recognized in net income		—			(180	)		(2	)		(290	)
Deferred tax expense		—			62			1			99
Unrealized gains adjustment, net of tax		39			(118	)		359			399
Total other comprehensive income		39			(118	)		359			399
Comprehensive income	$	781		$	736		$	1,481		$	2,363

See Notes to Consolidated Financial Statements.

BAY BANKS OF VIRGINIA, INC.

CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY

(unaudited)

(Dollars in thousands, except share data or amounts)	Shares of Common Stock		Common Stock		Additional Paid-in Capital			Unearned Employee Stock Ownership Plan Shares			Retained Earnings			Accumulated Other Comprehensive Loss			Total Shareholders’ Equity
Nine Months ended September 30, 2017
Balance at beginning of period		4,774,856	$	23,874	$	2,872		$	—		$	16,194		$	(1,235	)	$	41,705
Net income		—		—		—			—			1,122			—			1,122
Other comprehensive income		—		—		—			—			—			359			359
Dividends declared of $0.04 per share for both quarters ending June 30, 2017 and September 30, 2017		—		—		—			—			(904	)		—			(904	)
Issuance of common stock in connection with Virginia BanCorp acquisition		4,586,221		22,931		20,225			(911	)		—			—			42,245
Shares issued via private placement net of $2.1 million of issuance costs		3,783,784		18,919		13,969			—			—			—			32,888
Stock options exercised		33,622		169		26			—			—			—			195
Restricted shares granted		15,500		77		(77	)		—			—			—			—
Stock-based compensation expense		—		—		84			94			—			—			178
Balance at end of period		13,193,983	$	65,970	$	37,099		$	(817	)	$	16,412		$	(876	)	$	117,788

See Notes to Consolidated Financial Statements.

5

BAY BANKS OF VIRGINIA, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

(unaudited)

	For the Nine Months Ended
	September 30,
(Dollars in thousands)	2017			2016
Cash Flows From Operating Activities
Net income	$	1,122		$	1,964
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization		1,041			791
Net premium amortization and discount accretion of securities		271			320
Amortization of core deposit intangible		461			—
Accretion of time deposits		(219	)		—
Amortization of subordinated debt issuance costs		13			12
Accretion of loan discount		(860	)		—
Provision for loan losses		1,833			407
Stock compensation expense		178			16
Deferred tax benefit		(8	)		(6	)
(Gains) on securities available-for-sale		2			(290	)
Increase in OREO valuation allowance		145			53
(Gain) loss on sale of other real estate		(44	)		41
Decrease in mortgage servicing rights		16			68
Loan originations for sale		(10,204	)		(14,232	)
Loan sales		10,438			14,378
Gain on sold loans		(120	)		(357	)
Gain on sale of VISA loan portfolio		—			(150	)
Increase in cash surrender value of life insurance		(342	)		(197	)
Decrease in accrued income and other assets		(137	)		123
Increase in other liabilities		1,160			643
Net cash provided by operating activities		4,370			3,584
Cash Flows From Investing Activities
Proceeds from maturities and principal paydowns of available-for-sale securities		3,093			2,907
Proceeds from sales and calls of available-for-sale securities		17,662			14,582
Maturities of certificates of deposit		992			1,240
Purchases of available-for-sale securities and certificates of deposit		(19,121	)		(15,356	)
Purchase of Life Insurance		—			(2,000	)
(Purchases) sales of restricted securities		(1,807	)		522
Increase in Federal Funds Sold		(21,451	)		(189	)
Proceeds from the sale of VISA loan portfolio		—			1,301
Loan (originations) and principal collections, net		(57,147	)		(20,277	)
Loan purchases		(34,037	)		(4,006	)
Cash acquired in the merger with Virginia Commonwealth		14,698			—
Proceeds from sale of other real estate		603			244
Proceeds from sale of equipment		9			—
Purchases of premises and equipment		(1,643	)		(168	)
Net cash used in investing activities		(97,705	)		(21,200	)
Cash Flows From Financing Activities
Net (decrease) increase in demand, savings, and other interest-bearing deposits		(2,527	)		17,593
Net increase in time deposits		88,512			524
Stock options exercised		195			—
Net (decrease) increase in securities sold under repurchase agreements		(1,219	)		5,823
Issuance of stock		32,888			—
Dividend paid		(376	)		—
Increase (decrease) in Federal Home Loan Bank advances		15,000			(15,000	)
Net cash provided by financing activities		132,849			8,940
Net increase in cash and due from banks		39,514			(8,676	)
Cash and cash equivalents (including interest-earning deposits) at beginning of period		12,796			20,299
Cash and cash equivalents (including interest-earning deposits) at end of period	$	51,866		$	11,623
Supplemental Schedule of Cash Flow Information
Cash paid for:
Interest	$	4,303		$	2,549
Income taxes		690			70
Non-cash investing and financing:
Unrealized gain on investment securities		545			605
Loans transferred to other real estate owned		259			1,348
Loans originated to facilitate sale of OREO		164			116
Changes in deferred taxes resulting from OCI transactions		184			206
Transfer of loans to held for sale		—			1,173
Business combination:
Assets acquired, net of cash acquired		315,845			—
Liabilities assumed		294,454			—
Net assets acquired, net of cash acquired		21,391			—
Unpaid dividends declared		527			—

See Notes to Consolidated Financial Statements.

6

Notes to Consolidated Financial Statements (Unaudited)

Note 1: General

Bay Banks of Virginia, Inc. (the “Company”) owns 100% of Virginia Commonwealth Bank, formerly named Bank of Lancaster (refer to Note 2) (the “Bank”), 100% of VCB Financial Group, Inc., formerly known as Bay Trust Company (“VCBFG”) and 100% of Steptoes Holdings, LLC (“Steptoes Holdings”). The consolidated financial statements include the accounts of the Bank, VCBFG, Steptoes Holdings and Bay Banks of Virginia, Inc. The September 30, 2017 consolidated financial statements presented herein reflect combined operations of the business combination of the Company and Virginia BanCorp Inc. effective April 1, 2017, and described further in Note 2.

The accounting and reporting policies of the Company conform to accounting principles generally accepted in the United States of America (“GAAP”) and to the general practices within the banking industry. In management’s opinion, all adjustments, consisting only of normal recurring adjustments necessary for a fair presentation of the consolidated financial statements, have been included. The results of operations for the interim periods are not necessarily indicative of the results to be expected for the full year or for any other interim periods. These consolidated financial statements should be read in conjunction with the consolidated financial statements and notes to the consolidated financial statements included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2016.

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

Note 2: Business Combination

On April 1, 2017, the Company and Virginia BanCorp Inc. (“Virginia BanCorp”), a bank holding company conducting substantially all of its operations through its subsidiary Virginia Commonwealth Bank, completed a merger pursuant to the Agreement and Plan of Merger, dated as of November 2, 2016, by and between the Company and Virginia BanCorp. The Company is the surviving corporation in the merger and the former shareholders of Virginia BanCorp received 1.178 shares of the Company’s common stock for each share of Virginia BanCorp common stock they owned immediately prior to the merger, for a total issuance of 4,586,221 shares of the Company’s common stock valued at approximately $42.2 million at the time of closing. As of the completion of the merger, the Company’s legacy shareholders owned approximately 51% of the outstanding common stock of the Company and Virginia BanCorp’s former shareholders owned approximately 49% of the outstanding common stock of the Company. After the merger of Virginia BanCorp with and into the Company, Virginia BanCorp’s subsidiary bank was merged with and into Bank of Lancaster, and immediately thereafter Bank of Lancaster changed its name to Virginia Commonwealth Bank. Bank operating systems are being consolidated and are expected to be completed during the fourth quarter of 2017.

The acquisition was accounted for using the acquisition method of accounting in accordance with Accounting Standards Codification 805, Business Combinations. Under this method, the assets and liabilities of Virginia BanCorp were recorded at their respective fair values as of April 1, 2017. Determining the fair value of assets and liabilities, particularly to the loan portfolio, is a complex process involving significant judgment regarding methods and assumptions used to calculate the estimated fair values. The fair values are preliminary and subject to refinement for up to one year after the acquisition date, as additional information relative to the acquisition date fair values becomes available. The Company recognized goodwill of $6.2 million in connection with the acquisition, none of which is deductible for income tax purposes.

7

The following table details the total consideration paid by the Company on April 1, 2017 in connection with the acquisition of Virginia BanCorp, the fair value of the assets acquired and liabilities assumed, and the resulting goodwill.

						As Recorded
	As Recorded		Fair Value			by the
(Dollars in thousands)	by VCB		Adjustments			Company
Consideration paid:
Bay Banks of Virginia, Inc. common stock						$	42,247
Identifiable assets acquired:
Cash and due from banks	$	2,356	$	—		$	2,356
Interest-bearing deposits		12,342		—			12,342
Securities available-for-sale		22,088		—			22,088
Restricted securities		1,543		—			1,543
Loans receivable		272,479		(59,907	)		212,572
Loans held for sale		—		55,648			55,648
Deferred income taxes		1,325		(500	)		825
Premises and equipment		3,333		2,703			6,036
Accrued interest receivable		1,253		(24	)		1,229
Other real estate owned		3,113		—			3,113
Core deposit intangible		—		3,670			3,670
Bank owned life insurance		8,430		—			8,430
Mortgage servicing rights		324		—			324
Other assets		367		—			367
Total identified assets acquired		328,953		1,590			330,543
Identifiable liabilities assumed:
Noninterest-bearing deposits		21,119		—			21,119
Savings and interest-bearing demand deposits		124,640		—			124,640
Time deposits		121,437		733			122,170
Federal Home Loan Bank advances		25,000		—			25,000
Other liabilities		1,525		—			1,525
Total identifiable liabilities assumed		293,721		733			294,454
Total identifiable assets assumed	$	35,232	$	857		$	36,089
Goodwill resulting from acquisition						$	6,158

Fair value of the major categories of assets acquired and liabilities assumed were determined as follows:

Loans

The acquired loans were recorded at fair value at the acquisition date of $268.2 million without carryover of Virginia BanCorp’s allowance for loan losses. Where loans exhibited characteristics of performance, fair value was determined based on a discounted cash flow analysis which included default estimates; loans without such characteristics, fair value was determined based on the estimated values of the underlying collateral. While estimating the amount and timing of both principal and interest cash flows expected to be collected, a market-based discount rate was applied. In this regard, the acquired loans were segregated into pools based on loan type and credit risk. Loan type was determined based on collateral type and purpose, industry segment and loan structure. Credit risk characteristics included risk rating groups pass, special mention, substandard, and doubtful and lien position. For valuation purposes, these pools were further disaggregated by maturity and pricing characteristics (e.g., fixed-rate, adjustable-rate, balloon maturities).

8

At April 1, 2017, the gross contractual amounts of receivable and the fair value for the purchased credit impaired loans (“PCI”) were $8.3 million, while the estimated cash flows not expected to be collected were approximately $7.4 million. Information about the PCI loan portfolio at April 1, 2017 is as follows:

(Dollars in thousands)	April 1, 2017
Contractual principal and interest due	$	8,303
Nonaccretable difference		869
Expected cash flows		7,434
Accretable yield		1,354
Purchased credit impaired loans - estimated fair value	$	6,080

Loans which totaled approximately $55.4 million which were acquired were held for sale as of June 30, 2017. Management decided to withdraw these loans from held for sale status and classify them back as held to maturity loans in the 3^rd quarter of 2017.

Premises and Equipment

The fair value of Virginia BanCorp premises, including land, buildings and improvements, was determined based upon appraisal by licensed appraisers. These appraisals were based upon the best and highest use of the property with final values determined based upon an analysis of the cost, sales comparison and income capitalization approaches for each property appraised. The fair value of premises and equipment resulted in a $2.7 million fair value adjustment. Land is not depreciated.

Core Deposit Intangible

The fair value of the core deposit intangible (“CDI”) was determined based on a combined discounted economic benefit and market approach. The economic benefit was calculated as the cost savings between maintaining the core deposit base and using an alternate funding source, such as Federal Home Loan Bank of Atlanta (“FHLB”) advances. The life of the deposit base and projected deposit attrition rates was determined using Virginia BanCorp’s historical deposit data. The CDI fair value was estimated at $3.7 million or 2.52% of acquired deposits, excluding time deposits. The CDI is being amortized over a weighted average life of 92 months using a sum-of-the-months method.

Time Deposits

The fair value adjustment of time deposits represents a premium over the value of the contractual repayments of fixed-maturity deposits using prevailing market interest rates for similar term certificates of deposit. The resulting estimated fair value adjustment of certificates of deposit ranging in maturity from one month to five years is a $733 thousand premium and is being amortized into income on a level-yield basis over the weighted average remaining life.

FHLB Advances

The fair value of FHLB advances was considered to be equivalent to Virginia BanCorp’s recorded book balance as the advances matured in April 30, 2017.

Deferred Tax Assets and Liabilities

Certain deferred tax assets and liabilities were carried over to the Company from Virginia BanCorp based on the Company’s ability to utilize them in the future. Additionally, deferred tax assets and liabilities were established for acquisition accounting fair value adjustments as the future amortization/accretion of these adjustments represent temporary differences between book income and taxable income.

Pro Forma Financial Information

The table below illustrates the unaudited pro forma revenue and net income of the combined entities had the acquisition taken place on January 1, 2016. The unaudited combined pro forma revenue and net income combines the historical results of Virginia BanCorp with the Company’s consolidated statements of income for the period listed below, and while certain adjustments were made for the estimated effect of certain fair value adjustments and other acquisition-related activity, they are not indicative of what would have occurred had the acquisition actually taken place on January 1, 2016. Acquisition related expenses of $141 thousand and $1.1 million were included in the Company’s actual consolidated statements of income for the three and nine months ended September 30, 2017, respectively, but were excluded from the unaudited pro forma information listed below. Legacy Virginia BanCorp incurred $174 thousand of merger related expenses during the first three months of 2017 which was also excluded from the unaudited pro forma information below. Additionally, the Company expects to achieve further operational cost savings and other efficiencies as a result of the acquisition which are not reflected in the unaudited pro forma amounts below:

	For the Three Months Ended				For the Nine Months Ended
(Dollars in thousand)	September 30, 2017		September 30, 2016		September 30, 2017		September 30, 2016
Net interest income	$	7,707	$	6,872	$	22,014	$	20,443
Net income		906		1,653		2,752		4,443

9

Impact of Certain Acquisition Accounting Adjustments

The net effect of the amortization and accretion of premiums and discounts associated with the Company’s acquisition accounting adjustments to assets acquired and liabilities assumed from Virginia BanCorp had the following impact on the consolidated statements of income for the three and nine months ended September 30, 2017.

	Three Months			Nine Months
	Ended			Ended
(Dollars in thousands)	September 30, 2017			September 30, 2017
Loans(1)	$	411		$	860
Core deposit intangible(2)		(226	)		(461	)
Time deposits(3)		103			219
Depreciation(4)		(10	)		(20	)
Net impact to income before income taxes	$	278		$	598

⁽¹⁾ Loan discount accretion is included in the “Loans, including fees” section of “Interest Income” in the consolidated statements of income.

⁽²⁾  Core deposit intangible premium amortization is included in “Other expense” section of “Non-Interest Expenses in the consolidated statements of income.

⁽³⁾  Time deposit premium amortization is included in the “Deposits” section of “Interest Expense” in the consolidated statements of income.

⁽⁴⁾  Depreciation on the fair value mark up of fixed assets is included in “Occupancy expense” section of “Non-Interest Expense” in the consolidated statements of income.

Note 3: Significant Accounting Policies

Loans

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

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

The accrual of interest is generally discontinued at the time a loan is 90 days or more past due, or earlier, if collection is uncertain based on an evaluation of the net realizable value of the collateral and the financial strength of the borrower. Payments received for loans no longer accruing interest are applied to the unpaid principal balance. Loans greater than 90 days past due may remain on accrual status if the credit is well-secured and in process of collection. 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 with the exception of PCI loans whose discount is being accreted to interest income.

All interest accrued but not collected for loans that are placed on non-accrual or charged off are reversed against interest income. Any subsequent 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.

Charge-off of Uncollectible Loans

As soon as any loan becomes uncollectible, the loan will be charged down or charged off as follows:

• If unsecured, the loan must be charged off in full.

• If secured, the outstanding principal balance of the loan should be charged down to the net realizable value of the collateral.

Loans should be considered uncollectible when:

• No regularly scheduled payment has been made within four months, or

• The loan is unsecured, the borrower files for bankruptcy protection and there is no other (guarantor, etc.) support from an entity outside of the bankruptcy proceedings.

10

Allowance for loan losses (“ALL”)

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

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

Risk rating categories are as follows:

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. Any collateral may not be fully adequate to secure the loan balance.

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

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

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

The ALL consists of specific and general components. The specific component is determined by identifying impaired loans (as described below) then evaluating each one to calculate the amount of impairment. Impaired loans measured for impairment generally include (1) all loans risk rated Special Mention or worse with balances of $400 thousand or more or where the borrower has filed for bankruptcy; and (2) all loans classified as a TDR . A specific allowance arises when the discounted cash flows (or collateral value or observable market price) of the impaired loan is lower than the carrying value of that loan. The general component collectively evaluates any loans not identified as impaired, which are typically smaller commercial loans, residential mortgages and consumer loans, grouped into segments and classes. Historical loss experience is calculated and applied to each segment or class, then adjusted for qualitative factors. Qualitative factors include changes in local and national economic indicators, such as unemployment rates, interest rates, gross domestic product growth and real estate market trends; the level of past due and nonaccrual loans; risk ratings on individual loans; strength of credit policies and procedures; loan officer experience; borrower credit scores; and other intrinsic risks related to the types and geographic locations of loans. These qualitative adjustments reflect management’s judgment of risks inherent in the segments. An unallocated component is maintained if needed to cover uncertainties that could affect management’s estimate of probable losses. Changes in the allowance for loan losses and the related provision expense can materially affect net income.

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

11

The general component of the ALL calculation collectively evaluates groups of loans in segments and classes, as noted above. The segments are: (1) Mortgage loans on real estate; (2) Commercial and industrial loans; and (3) Consumer and other loans. The segment for Mortgage loans on real estate is disaggregated into the following classes: (1) Construction, land and land development; (2) Farmland; (3) Residential first mortgages; (4) Residential revolving and junior mortgages; (5) Commercial mortgages (non-owner-occupied); and (6) Commercial mortgages (owner-occupied). Loans in segment 1 are secured by real estate. Loans in segments 2 and 3 are secured by other types of collateral or are unsecured. A given segment or class may not reflect the purpose of a loan. For example, a business owner may provide his residence as collateral for a loan to his company, in which case the loan would be grouped in a residential mortgage class. Historical loss factors are calculated for the prior 20 quarters by segment and class, and then applied to the current balances in each segment and class. Finally, qualitative factors are applied to each segment and class.

Construction and development loans carry risks that the project will not be finished according to schedule or according to budget and the value of the collateral, at any point in time, may be less than the principal amount of the loan. These loans also bear the risk that the general contractor may face financial pressure unrelated to the project. Loans secured by land, farmland and residential mortgages carry the risk of continued credit-worthiness of the borrower and changes in value of the underlying real estate collateral. Commercial mortgages and commercial and industrial loans carry risks associated with the profitable operation of a business and its related cash flows. Additionally, commercial and industrial loans carry risks associated with the value of collateral other than real estate which may depreciate over time. Consumer loans carry risks associated with the continuing credit-worthiness of the borrower and are more likely than real estate loans to be adversely affected by divorce, unemployment, personal illness or bankruptcy of an individual. Consumer loans secured by automobiles carry risks associated with rapidly depreciating collateral. Consumer loans have historically included credit cards, which are unsecured. The credit card portfolio was sold to an unaffiliated third party in the third quarter of 2016.

The summation of the specific and general components results in the total estimated ALL. This estimate is inherently subjective and actual losses could be greater or less than the estimates.

An ALL calculation is also performed on purchased performing loans. A comparison is then made to the remaining unaccreted discount associated with the purchase of those loans. If the ALL related to these loans exceeds the remaining unaccreted discount, that difference is added to the ALL that applies to non-purchased loans. See below for more information related to Loans Purchased in a Business Combination.

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

Loans Acquired in a Business Combination

The Company accounts for loans acquired in a business combination in accordance with the Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) Topic 805, “Business Combinations.” Accordingly, acquired loans are segregated between PCI loans and purchased performing loans (“PPL”) and are recorded at fair value on the date of acquisition without the carryover of the related allowance for loan losses.

PCI loans are those for which there is evidence of credit deterioration since origination and for which it is probable at the date of acquisition that the Company will not collect all contractually required principal and interest payments. When determining fair market value, PCI loans were aggregated into pools of loans based on common characteristics as of the date of acquisition such as loan type, date of origination, and evidence of credit quality deterioration such as internal risk grades and past due and nonaccrual status. The Company estimates the amount and timing of expected cash flows for each loan or pool, and the expected cash flows in excess of amount paid is recorded as interest income over the remaining life of the loan or pool (accretable yield). These estimates include certain prepayment assumptions based on the nature of each loan pool. The excess of the loan’s or pool’s contractual principal and interest over expected cash flows is not recorded (nonaccretable difference). Over the life of the loan or pool, expected cash flows continue to be estimated. If the present value of expected cash flows is less than the carrying amount, a loss is recorded as a provision for loan losses. If the present value of expected cash flows is greater than the carrying amount, it is recognized as part of future interest income.

Loans not designated PCI loans as of the acquisition date are designated purchased performing loans. The Company accounts for purchased performing loans using the contractual cash flows method of recognizing discount accretion based on the acquired loans’ contractual cash flows. Purchased performing loans are recorded at fair value, including a credit discount. The fair value discount is accreted as an adjustment to yield over the estimated lives of the loans. There is no allowance for loan losses established at the acquisition date for purchased performing or PCI loans. A provision for loan losses is recorded for any deterioration in these loans subsequent to the acquisition.

Employee Stock Ownership Plan (“ESOP”)

The Company currently has two ESOPs for the benefit of all eligible employees. Shares held by the legacy ESOP of the former Bank of Lancaster employees are considered outstanding for purposes of computing earnings per share as they are fully allocated.    Unearned ESOP shares in the ESOP acquired in the merger (“new ESOP”), are shown as a reduction of shareholders’ equity. The unearned ESOP shares are not included in basic or diluted earnings per share calculation as discussed in Note 9.

The use of dividends paid on allocated ESOP shares are at the discretion of the Company. Dividends on unallocated ESOP shares, if paid, are considered to be compensation expense. The Company recognizes compensation cost equal to the fair value of the ESOP shares during the periods in which they are committed to be released. The Company recognizes a tax deduction equal to the cost of shares released. The unearned ESOP shares are pledged to a third party to collateralize a direct loan to the ESOP. The loan is guaranteed by the Company and is recorded on the Company’s consolidated balance sheets.

12

It is anticipated that the Company will make contributions to the new ESOP in amounts necessary to amortize the third-party loans over a nine year period. See note 12.

Note 4: Amendments to the Accounting Standards Codification

In March 2017, the FASB issued Accounting Standards Update (“ASU”) No. 2017-09, “Compensation – Stock Compensation (Topic 718).” The amendments in this Update provide guidance about which changes to the terms or conditions of a share-based payment award require an entity to apply modification accounting in Topic 718. An entity should account for the effects of a modification unless all the following are met: 1) The fair value (or calculated value or intrinsic value, if such an alternative measurement method is used) of the modified award is the same as the fair value (or calculated value or intrinsic value, if such an alternative measurement method is used) of the original award immediately before the original award is modified. If the modification does not affect any of the inputs to the valuation technique that the entity uses to value the award, the entity is not required to estimate the value immediately before and after the modification; 2) The vesting conditions of the modified award are the same as the vesting conditions of the original award immediately before the original award is modified; and 3) The classification of the modified award as an equity instrument or a liability instrument is the same as the classification of the original award immediately before the original award is modified. The current disclosure requirements in Topic 718 apply regardless of whether an entity is required to apply modification accounting under the amendments in this Update. ASU 2017-09 will be effective for annual periods and interim periods beginning after December 15, 2017. Early adoption is permitted. The Company is currently assessing the impact that ASU 2017-09 will have on its consolidated financial statements and disclosures.

In March 2017, the FASB issued Accounting Standards Update No. 2017-08, “Receivables—Nonrefundable Fees and Other Costs (Subtopic 310-20), Premium Amortization on Purchased Callable Debt Securities.” The amendments in this ASU shorten the amortization period for certain callable debt securities purchased at a premium. Upon adoption of the standard, premiums on these qualifying callable debt securities will be amortized to the earliest call date. Discounts on purchased debt securities will continue to be accreted to maturity. The amendments are effective for fiscal years beginning after December 15, 2018, and interim periods within those fiscal years. Early adoption is permitted, including adoption in an interim period. Upon transition, entities should apply the guidance on a modified retrospective basis, with a cumulative-effect adjustment to retained earnings as of the beginning of the period of adoption and provide the disclosures required for a change in accounting principle. The Company is currently assessing the impact that ASU 2017-08 will have on its consolidated financial statements and disclosures.

In March 2017, the FASB issued ASU 2017-07, “Compensation – Retirement Benefits (Topic 715): Improving the Presentation of Net Periodic Pension Cost and Net Periodic Postretirement Benefit Cost.” This ASU intends to improve the presentation of net periodic pension cost and net periodic postretirement benefit costs in the income statement and to narrow the amounts eligible for capitalization in assets. ASU 2017-07 will be effective for the Company for fiscal years beginning after December 15, 2017. The Company expects to adopt ASU 2017-07 in the first quarter of 2018. The Company is evaluating the impact of the standard and does not expect the guidance to have a material effect on its financial statements.

In January 2017, the FASB issued ASU 2017-03, Accounting Changes and Error Corrections (Topic 250) and Investments - Equity Method and Joint Ventures (Topic 323): Amendments to SEC Paragraphs Pursuant to Staff Announcements at the September 22, 2016 and November 17, 2016 EITF Meetings. This ASU requires Securities and Exchange Commission (“SEC”) registrants to disclose the effect that recently issued accounting standards will have on their financial statements when adopted in a future period. In cases where a registrant cannot reasonably estimate the impact of the adoption, additional qualitative disclosures should be considered to assist the reader in assessing the significance of the standard’s impact on its financial statements. The Company adopted ASU 2017-03 in the first quarter of 2017. The adoption of the standard resulted in enhanced disclosures regarding the impact that recently issued accounting standards adopted in a future period will have on the Company’s financial statements and disclosures.

In June 2016, the FASB issued ASU 2016-13, Financial Instruments – Credit Losses (Topic 326), which is new guidance for the accounting for credit losses on instruments within its scope. It introduces a new model for current expected credit losses (“CECL”) which will apply to financial assets subject to credit losses and measured at amortized cost and certain off-balance sheet credit exposures. This will include loans, held-to-maturity debt securities, loan commitments, financial guarantees, net investments in leases, reinsurance and trade receivables. The CECL model requires an entity to estimate the credit losses expected over the life of an exposure (or pool of exposures). The estimate of expected credit losses should consider historical information, current information and reasonable and supportable forecasts, including estimates of prepayments. In addition, ASU 2016-13 replaces the current available-for-sale debt securities other-than-temporary impairment model with an estimate of expected credit losses only when the fair value falls below the amortized cost of the asset. Credit losses on available-for-sale debt securities will be limited to the difference between the security’s amortized cost basis and its fair value. The available-for-sale debt security model will also require the use of an allowance to record estimated credit losses and subsequent recoveries. The ASU also addresses purchased financial assets with credit deterioration. Disclosure requirements are expanded regarding an entity’s assumptions, models and methods for estimating the ALL. The ASU is effective for interim and annual reporting periods beginning after December 15, 2019. The Company is evaluating the impact that ASU 2016-13 will have on its consolidated financial statements. Periodic historical loan data is being accumulated which will allow for migration analysis of risk ratings, past due and non-accrual status, plus other various individual loan characteristics.

13

In March 2016, the FASB issued ASU 2016-09, “Compensation – Stock Compensation (Topic 718): Improvements to Employee Shares-Based Payment Accounting.” The amendments in this ASU simplify several aspects of the accounting for share-based payment award transactions including: (1) income tax consequences; (2) classification of awards as either equity or liabilities; (3) diluted earnings per share; and (4) classification on the statement of cash flows. The amendments are effective for public companies for annual periods beginning after December 15, 2016, and interim periods within those annual periods. The adoption of ASU 2016-09 did not have a material impact on the Company’s consolidated financial statements.

In February 2016, the FASB issued ASU 2016-02, Leases (Topic 842). This ASU increases transparency and comparability among organizations by recognizing lease assets and lease liabilities on the balance sheet and requiring more disclosures related to leasing transactions. ASU 2016-02 will be effective for the Company for the fiscal years beginning after December 15, 2018, with early adoption permitted. The Company expects to adopt ASU 2016-02 in the first quarter of 2019. The Company is evaluating the impact of the standard and expects a minimal increase in assets and liabilities; however, the Company does not expect the guidance to have a material effect on its financial statements.

In January 2016, the FASB issued ASU 2016-01, Financial Instruments – Overall (Subtopic 825-10) which requires equity investments, other than those accounted for using the equity method, to be measured at fair value through earnings. There will no longer be an available-for-sale classification measured (changes in fair value reported in other comprehensive income) for equity securities with readily determinable fair values. The cost method is also eliminated for equity instruments without a readily determinable fair value. For these investments, companies can elect to record the investment at cost, less impairment, plus or minus subsequent adjustments for observable price changes. This election only applies to equity investments that do not qualify for the net asset value practical expedient. Public companies will be required to use the exit price when measuring the fair value of financial instruments measured at amortized cost for disclosure purposes. In addition, the ASU requires financial assets and financial liabilities to be presented separately in the notes to the financial statements, grouped by measurement category and form of financial asset. The classification and measurement guidance is effective for periods beginning after December 15, 2017. The Company’s primary available-for sale investments are debt securities and are therefore not included in the scope of ASU 2016-01. The Company is continuing to evaluate the impact that ASU 2016-01 will have on its consolidated financial statements.

In May 2014, the FASB issued ASU 2014-09, Revenue from Contracts with Customers (Topic 606). The amendments in this ASU modify the guidance companies use to recognize revenue from contracts with customers for transfers of goods or services and transfers of nonfinancial assets, unless those contracts are within the scope of other standards. The ASU requires that entities apply a specific method to recognize revenue reflecting the consideration expected from customers in exchange for the transfer of goods and services. The guidance also requires new qualitative and quantitative disclosures, including information about contract balances and performance obligations. Entities are also required to disclose significant judgments and changes in judgments for determining the satisfaction of performance obligations. In August 2015, the FASB issued ASU 2014-09 changing the effective date for ASU 2014-09 to annual reporting periods beginning after December 15, 2017 from December 15, 2016. The Company’s primary source of revenue is interest income from loans and their fees and investments. As these items are outside the scope of the guidance, this income is not expected to be impacted by implementation of ASU 2014-09. The Company is still reviewing other sources of income such as fiduciary fees, secondary market lending fees and other deposit account fees to evaluate the impact of ASU 2014-09.    The Company continues to evaluate the impact that ASU 2014-09 will have on its consolidated financial statements.

Note 5: Securities

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

(Dollars in thousands)
			Gross		Gross
Available-for-sale securities	Amortized		Unrealized		Unrealized			Fair
September 30, 2017	Cost		Gains		(Losses)			Value
Corporate bonds	$	6,696	$	22	$	(1	)	$	6,717
U.S. Government agencies		44,194		77		(298	)		43,973
State and municipal obligations		21,211		186		(194	)		21,203
	$	72,101	$	285	$	(493	)	$	71,893
			Gross		Gross
Available-for-sale securities	Amortized		Unrealized		Unrealized			Fair
December 31, 2016	Cost		Gains		(Losses)			Value
Corporate bonds	$	7,695	$	14	$	(5	)	$	7,704
U.S. Government agencies		25,668		53		(408	)		25,313
State and municipal obligations		18,566		49		(459	)		18,156
	$	51,929	$	116	$	(872	)	$	51,173

14

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

	For the three months ended				For the nine months ended
	September 30,				September 30,
(Dollars in thousands)	2017		2016		2017			2016
Gross realized gains	$	—	$	180	$	7		$	300
Gross realized losses		—		—		(5	)		(10	)
Net realized gains	$	0	$	180	$	2		$	290
Aggregate proceeds	$	0	$	4,984	$	17,662		$	14,582

Average yields (taxable equivalent) on securities were 2.58% and 3.10% for the three months ended September 30, 2017 and 2016, respectively, and 3.26% and 3.07% for the nine months ended September 30, 2017 and 2016, respectively.

Securities with a market value of $19.5 million and $19.1 million were pledged as collateral for repurchase agreements and for other purposes as required by law as of September 30, 2017 and December 31, 2016, respectively. As of September 30, 2017 and December 31, 2016, all the securities pledged to repurchase agreements were state and municipal obligations. All the repurchase agreements had remaining contractual maturities that were overnight and continuous. Securities sold under repurchase agreements were $17.1 million and $18.3 million as of September 30, 2017 and December 31, 2016, respectively, and included in liabilities on the consolidated balance sheets. The securities pledged to each agreement are reviewed daily and can be changed at the option of the Bank with minimal risk of loss due to fair value.

Securities in an unrealized loss position at September 30, 2017 and December 31, 2016, by duration of the unrealized loss, are shown below. The unrealized loss positions were directly related to interest rate movements as there is minimal credit risk exposure in these investments. All agency securities, and states and municipal securities, are investment grade or better and their losses are considered temporary. Management does not intend to sell the securities and does not expect to be required to sell the securities. Furthermore, all amortized cost bases are expected to be recovered. Bonds with unrealized loss positions at September 30, 2017 included 40 federal agencies, one corporate bond and 21 municipals. Bonds with unrealized loss positions at December 31, 2016 included 37 federal agencies, one corporate bond and 39 municipals. The tables are shown below.

(Dollars in thousands)	Less than 12 months					12 months or more					Total
	Fair		Unrealized			Fair		Unrealized			Fair		Unrealized
September 30, 2017	Value		Loss			Value		Loss			Value		Loss
Corporate bonds	$	499	$	(1	)	$	—	$	—		$	499	$	(1	)
U.S. Government agencies		23,120		(134	)		7,296		(164	)		30,416		(298	)
States and municipal obligations		4,613		(70	)		3,448		(124	)		8,061		(194	)
Total temporarily impaired securities	$	28,232	$	(205	)	$	10,744	$	(288	)	$	38,976	$	(493	)
	Less than 12 months					12 months or more					Total
	Fair		Unrealized			Fair		Unrealized			Fair		Unrealized
December 31, 2016	Value		Loss			Value		Loss			Value		Loss
Corporate bonds	$	995	$	(5	)	$	—	$	—		$	995	$	(5	)
U.S. Government agencies		20,933		(396	)		1,308		(12	)		22,241		(408	)
States and municipal obligations		12,888		(459	)		—		—			12,888		(459	)
Total temporarily impaired securities	$	34,816	$	(860	)	$	1,308	$	(12	)	$	36,124	$	(872	)

The Company’s investment in FHLB stock totaled $3.9 million and $1.9 million at September 30, 2017 and December 31, 2016, respectively. The Company also had an investment in Federal Reserve Bank of Richmond (“FRB”) stock which totaled $1.9 million and $580 thousand at September 30, 2017 and December 31, 2016, respectively. The investments in both FHLB and FRB stock are required investments related to the Bank’s membership with the FHLB and FRB. These securities do not have a readily determinable fair value as their ownership is restricted, and they lack an active market for trading. Additionally, per charter provisions related to the FHLB and FRB stock, all repurchase transactions of such stock must occur at par. Accordingly, these securities are carried at cost, and are periodically evaluated for impairment. The Company’s determination as to whether its investment in FHLB and FRB stock is impaired is based on management’s assessment of the ultimate recoverability of its par value rather than recognizing temporary declines in its value. The determination of whether the decline affects the ultimate recoverability of the investments is influenced by available information regarding various factors. These factors include, among others, the significance of the decline in net assets of the issuing banks as compared to the capital stock amount reported by these banks, and the length of time a decline has persisted; commitments by such banks to make payments required by law or regulation and the level of such payments in relation to the operating performance of the issuing bank; and the overall liquidity position of the issuing bank. Based on its most recent analysis of publicly available information regarding the financial condition of the issuing banks, management concluded that no impairment existed in the carrying value of FHLB and FRB stock.

15

Note 6: Low Income Housing Tax Credits

The Company had investments in three separate housing equity funds at September 30, 2017. The general purpose of these funds is to encourage and assist participants in investing in low-income residential rental properties located in the Commonwealth of Virginia, develop and implement strategies to maintain projects as low-income housing, deliver federal low income housing tax credits to investors, allocate tax losses and other possible tax benefits to investors, and to preserve and protect project assets. The investments in these funds were recorded as other assets on the consolidated balance sheets and were $1.4 million as of September 30, 2017. These investments and related tax benefits have expected terms through 2030. Tax credits and other tax benefits recognized related to these investments during the three and nine months ended September 30, 2017 were $17 thousand and $51 thousand, respectively. Total projected tax benefits for 2017 are estimated at $81 thousand, based on the most recent quarterly estimates received from the funds. Additional capital calls expected for the funds totaled $1.5 million at September 30, 2017 and are included in other liabilities on the consolidated balance sheets.

Note 7: Loans

The following is a summary of the balances of loans:

(Dollars in thousands)	September 30, 2017			December 31, 2016
Mortgage loans on real estate:
Construction, Land and Land Development	$	63,046		$	39,818
Farmland		936			1,023
Commercial Mortgages (Non-Owner Occupied)		141,954			35,343
Commercial Mortgages (Owner Occupied)		73,615			41,825
Residential First Mortgages		269,017			194,007
Residential Revolving and Junior Mortgages		46,193			26,425
Commercial and Industrial loans		99,637			43,024
Consumer loans		48,640			3,544
Total loans		743,038			385,009
Net unamortized deferred loan costs and purchased discounts		1,590			391
Allowance for loan losses		(4,920	)		(3,863	)
Loans, net	$	739,708		$	381,537

The recorded investment in past due and non-accruing loans is shown in the following table. A loan past due by more than 90 days is generally placed on nonaccrual unless it is both well secured and in the process of collection. PCI loans are included in the aging schedule as current because they are considered to be accruing due to the existence of the accretable yield and not based on consideration given to contractual interest payments.

			90 Days or
	30-89		More Past				Total Past
	Days		Due and				Due and				Total
(Dollars in thousands)	Past Due		Still Accruing		Nonaccruals		Nonaccruals		Current		Loans
September 30, 2017
Mortgage Loans on Real Estate:
Construction, Land and Land Development	$	267	$	—	$	632	$	899	$	62,147	$	63,046
Farmland		—		—		—		—		936		936
Commercial Mortgages (Non-Owner Occupied)		452		—		—		452		141,502		141,954
Commercial Mortgages (Owner Occupied)		243		—		1,717		1,960		71,655		73,615
Residential First Mortgages		1,621		—		1,318		2,939		266,078		269,017
Residential Revolving and Junior Mortgages		1,173		—		885		2,058		44,135		46,193
Commercial and Industrial		15		—		110		125		99,512		99,637
Consumer loans		449		3		137		589		48,051		48,640
Total	$	4,220	$	3	$	4,799	$	9,022	$	734,016	$	743,038
			90 Days or
	30-89		More Past				Total Past
	Days		Due and				Due and				Total
	Past Due		Still Accruing		Nonaccruals		Nonaccruals		Current		Loans
December 31, 2016
Mortgage Loans on Real Estate:
Construction, Land and Land Development	$	—	$	—	$	623	$	623	$	39,195	$	39,818
Farmland		57		—		—		57		966		1,023
Commercial Mortgages (Non-Owner Occupied)		—		—		—		—		35,343		35,343
Commercial Mortgages (Owner Occupied)		188		—		2,270		2,458		39,367		41,825
Residential First Mortgages		1,546		—		2,155		3,701		190,306		194,007
Residential Revolving and Junior Mortgages		480		—		160		640		25,785		26,425
Commercial and Industrial		408		—		92		500		42,524		43,024
Consumer loans		—		—		—		—		3,544		3,544
Total	$	2,679	$	—	$	5,300	$	7,979	$	377,030	$	385,009

16

The following table includes an aging analysis, based upon contractual terms, of the recorded investment of PCI loans as of September 30, 2017, included in the table above.

			90 Days or
	30-89		More Past				Total Past
	Days		Due and				Due and				Total
(Dollars in thousands)	Past Due		Still Accruing		Nonaccruals		Nonaccruals		Current		Loans
September 30, 2017
Mortgage Loans on Real Estate:
Construction, Land and Land Development	$	0	$	—	$	0	$	0	$	1,413	$	1,413
Commercial Mortgages (Non-Owner Occupied)		—		—		—		—		182		182
Commercial Mortgages (Owner Occupied)		133		37		—		170		168		338
Residential First Mortgages		—		144		—		144		3,697		3,841
Residential Revolving and Junior Mortgages		—		19		—		19		31		50
Consumer loans		5		—		—		5		69		74
Total	$	138	$	200	$	0	$	338	$	5,560	$	5,898

The total outstanding balance of PCI loans as September 30, 2017 was $6.7 million

Note 8: Allowance for Loan Losses

Loans Evaluated for Impairment

Loan receivables evaluated for impairment individually and collectively by segment as of September 30, 2017 and December 31, 2016 are as follows:

	Mortgage		Commercial		Consumer
	Loans		and		and Other
(Dollars in thousands)	on Real Estate		Industrial		Loans		Total
As of September 30, 2017
Loans individually evaluated for impairment	$	9,592	$	92	$	—	$	9,684
Loans collectively evaluated for impairment		579,344		99,545		48,567		727,456
Loans acquired with deteriorated credit quality		5,825		—		73		5,898
Total Gross Loans	$	594,761	$	99,637	$	48,640	$	743,038
As of December 31, 2016
Loans individually evaluated for impairment	$	10,323	$	92	$	—	$	10,415
Loans collectively evaluated for impairment		328,118		42,932		3,544		374,594
Total Gross Loans	$	338,441	$	43,024	$	3,544	$	385,009

Allowance for Loan Losses

The allowance for loan losses disaggregated based on loan receivables evaluated for impairment individually and collectively by segment as of September 30, 2017 and December 31, 2016 are as follows:

	Mortgage		Commercial
	Loans		and		Consumer
(Dollars in thousands)	on Real Estate		Industrial		Loans		Total
As of September 30, 2017
Loans individually evaluated for impairment	$	982	$	92	$	—	$	1,074
Loans collectively evaluated for impairment		2,855		421		570		3,846
Loans acquired with deteriorated credit quality		—		—		—		—
Total allowance for loan losses	$	3,837	$	513	$	570	$	4,920
	Mortgage		Commercial
		Loans		and		Consumer
		on Real Estate		Industrial		Loans		Total
As of December 31, 2016
Loans individually evaluated for impairment	$	803	$	92	$	—	$	895
Loans collectively evaluated for impairment		2,515		401		52		2,968
Total allowance for loan losses	$	3,318	$	493	$	52	$	3,863

17

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

	Mortgage			Commercial
	Loans on			and			Consumer
(Dollars in thousands)	Real Estate			Industrial			Loans			Total
For the Three Months Ended September 30, 2017
ALLOWANCE FOR LOAN LOSSES:
Beginning Balance	$	3,686		$	456		$	99		$	4,241
(Charge-offs)		(75	)		—			(366	)		(441	)
Recoveries		10			1			34			45
Provision (recovery)		216			56			803			1,075
Ending Balance	$	3,837		$	513		$	570		$	4,920
	Mortgage			Commercial
	Loans on			and			Consumer
	Real Estate			Industrial			Loans			Total
For the Three Months Ended September 30, 2016
ALLOWANCE FOR LOAN LOSSES:
Beginning Balance	$	2,995		$	435		$	117		$	3,547
Reclassification of allowance related to sold loans							$	(27	)	$	(27	)
(Charge-offs)		(46	)		—			(10	)		(56	)
Recoveries		15			—			3			18
Provision (recovery)		244			45			(30	)		259
Ending Balance	$	3,208		$	480		$	53		$	3,741
	Mortgage			Commercial
	Loans on			and			Consumer
(Dollars in thousands)	Real Estate			Industrial			Loans			Total
For the Nine Months Ended September 30, 2017
ALLOWANCE FOR LOAN LOSSES:
Beginning Balance	$	3,318		$	493		$	52		$	3,863
(Charge-offs)		(348	)		—			(567	)		(915	)
Recoveries		98			2			39			139
Provision (recovery)		769			18			1,046			1,833
Ending Balance	$	3,837		$	513		$	570		$	4,920
	Mortgage			Commercial
	Loans on			and			Consumer
	Real Estate			Industrial			Loans			Total
For the Nine Months Ended September 30, 2016
ALLOWANCE FOR LOAN LOSSES:
Beginning Balance	$	3,502		$	599		$	122		$	4,223
Reclassification of allowance related to sold loans	$	—		$	—		$	(27	)	$	(27	)
(Charge-offs)		(702	)		(158	)		(41	)		(901	)
Recoveries		25			5			9			39
Provision (recovery)		383			34			(10	)		407
Ending Balance	$	3,208		$	480		$	53		$	3,741

Purchased Impaired Loans

The following table presents the changes in the accretable yield for purchased impaired loans (refer to Note 3) since acquisition on April 1, 2017 through September 30, 2017 (in thousands):

	September 30,
	2017
Balance at acquisition, April 1, 2017	$	1,354
Accretion		(179	)
Reclassifications from nonaccretable balance, net		—
Other changes, net		—
Balance as of September 30, 2017	$	1,175

18

As of September 30, 2017 there was no allowance on PCI loans.

Internal Risk Rating Grades

Internal risk rating grades are generally assigned to commercial loans not secured by real estate, commercial mortgages, residential mortgages greater than $1 million, smaller residential mortgages which are impaired, loans to real estate developers and contractors, consumer loans greater than $250,000 with chronic delinquency, and TDRs, as shown in the following table. The grading analysis estimates the capability of the borrower to repay the contractual obligations of the loan agreements as scheduled. Risk grades (refer to Note 3) are evaluated as new information becomes available for each borrowing relationship or at least quarterly. All loan portfolios acquired in the merger are risk graded using loan risk grading software that employs a variety of algorithms based on detailed account characteristics to include borrower’s payment history on a total relationship basis as well as loan to value exposure. For non-homogenous loans, management reviews these resulting grade assignments and makes adjustments to the final grade where appropriate based on an assessment of additional external information that may affect a particular loan. The Bank is in the process of adopting the new risk grading system over its entire loan portfolio including the Bank’s legacy loans and expects to fully utilize it after core system conversion.

	Construction,						Residential		Commercial		Commercial
	Land and				Residential		Revolving		Mortgages		Mortgages		Commercial
	Land				First		and Junior		(Non-Owner		(Owner		and
(Dollars in thousands)	Development		Farmland		Mortgage		Mortgage		Occupied)		Occupied)		Industrial		Consumer		Total
As of September 30, 2017
Grade:
Pass	$	52,108	$	936	$	43,370	$	20,276	$	137,028	$	58,894	$	95,599	$	45,154	$	453,365
Watch		7,290		—		1,252		33		4,472		12,106		3,927		77		29,157
Special mention		175		—		—		—		—		249		—		—		424
Substandard		3,473		—		1,482		50		454		2,366		111		165		8,101
Doubtful		—		—		—		—		—		—		—		—		—
Total	$	63,046	$	936	$	46,104	$	20,359	$	141,954	$	73,615	$	99,637	$	45,396	$	491,047
	Construction,				Commercial		Commercial
	Land and				Mortgages		Mortgages		Commercial
	Land				(Non-Owner		(Owner		and
	Development		Farmland		Occupied)		Occupied)		Industrial		Total
As of December 31, 2016
Grade:
Pass	$	32,009	$	1,023	$	30,639	$	31,191	$	40,841	$	135,703
Watch		5,795		—		4,184		6,652		1,891		18,522
Special mention		180		—		272		1,453		125		2,030
Substandard		1,834		—		248		2,529		167		4,778
Doubtful		—		—		—		—		—		—
Total	$	39,818	$	1,023	$	35,343	$	41,825	$	43,024	$	161,033

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

			Residential
	Residential		Revolving
	First		and Junior		Consumer
(Dollars in thousands)	Mortgages (1)		Mortgages (2)		Loans (3)		Total
As of September 30, 2017
PAYMENT ACTIVITY STATUS
Performing	$	221,629	$	24,949	$	3,244	$	249,822
Nonperforming		1,284		885		—		2,169
Total	$	222,913	$	25,834	$	3,244	$	251,991
			Residential
	Residential		Revolving
	First		and Junior		Consumer
	Mortgages (4)		Mortgages (5)		Loans (6)		Total
As of December 31, 2016
PAYMENT ACTIVITY STATUS
Performing	$	191,852	$	26,265	$	3,544	$	221,661
Nonperforming		2,155		160		—		2,315
Total	$	194,007	$	26,425	$	3,544	$	223,976

(1) Residential First Mortgages which have been assigned a risk rating grade of Substandard totaled $2.2 million as of September 30, 2017.

(2) Residential Revolving and Junior Mortgages which have been assigned a risk rating grade of Substandard totaled $927 thousand as of September 30, 2017.

(3) No Consumer Loans had been assigned a risk rating grade of Substandard as of December 31, 2017.

(4) Residential First Mortgages which have been assigned a risk rating grade of Substandard totaled $3.3 million as of December 31, 2016.

(5) Residential Revolving and Junior Mortgages which have been assigned a risk rating grade of Substandard totaled $1.1 million as of December 31, 2016.

(6) No Consumer Loans had been assigned a risk rating grade of Substandard as of December 31, 2016.

19

Impaired Loans

The following tables show the Company’s recorded investment and the customers’ unpaid principal balances for impaired loans, excluding purchased impaired loans, with the associated allowance amount, if applicable, as of September 30, 2017 and December 31, 2016, along with the average recorded investment and interest income recognized for the three and nine months ended September 30, 2017 and 2016, respectively.

	As of September 30, 2017						As of December 31, 2016
	Recorded		Customers’ Unpaid		Related		Recorded		Customers’ Unpaid		Related
(Dollars in thousands)	Investment		Principal Balance		Allowance		Investment		Principal Balance		Allowance
IMPAIRED LOANS
With no related allowance:
Construction, Land and Land Development	$	367	$	449	$	—	$	1,531	$	1,539	$	—
Residential First Mortgages		1,407		1,502		—		2,112		2,176		—
Residential Revolving and Junior Mortgages (1)		481		491		—		995		999		—
Commercial Mortgages (Non-owner occupied)		248		248		—		248		248		—
Commercial Mortgages (Owner occupied)		1,027		985		—		1,860		2,178		—
Commercial and Industrial		—		—		—		—		—		—
		3,530		3,675		—		6,746		7,140		—
With an allowance recorded:
Construction, Land and Land Development		1,312		1,365		142		243		286		145
Residential First Mortgages		1,922		1,922		367		1,951		1,951		367
Residential Revolving and Junior Mortgages (1)		1,479		1,491		334		544		546		199
Commercial Mortgages (Non-owner occupied)		—		—		—		—		—		—
Commercial Mortgages (Owner occupied)		1,355		1,399		139		839		854		92
Commercial and Industrial		92		101		92		92		101		92
		6,160		6,278		1,074		3,669		3,738		895
Total Impaired Loans:
Construction, Land and Land Development		1,679		1,814		142		1,774		1,825		145
Residential First Mortgages		3,329		3,424		367		4,063		4,127		367
Residential Revolving and Junior Mortgages (1)		1,960		1,982		334		1,539		1,545		199
Commercial Mortgages (Non-owner occupied)		248		248		—		248		248		—
Commercial Mortgages (Owner occupied)		2,382		2,384		139		2,699		3,032		92
Commercial and Industrial		92		101		92		92		101		92
	$	9,690	$	9,953	$	1,074	$	10,415	$	10,878	$	895

Notes:

(1) Junior mortgages include equity lines.

20

	For the three months ended								For the nine months ended
	September 30, 2017				September 30, 2016				September 30, 2017				September 30, 2016
	Average		Interest		Average		Interest		Average		Interest		Average		Interest
	Recorded		Income		Recorded		Income		Recorded		Income		Recorded		Income
(Dollars in thousands)	Investment		Recognized		Investment		Recognized		Investment		Recognized		Investment		Recognized
With no related allowance:
Construction, land and land development	$	367	$	—	$	1,533	$	14	$	385	$	—	$	1,262	$	41
Residential First Mortgages		1,425		4		2,618		4		1,439		15		2,432		9
Residential Revolving and Junior Mortgages (1)		482		5		951		9		485		7		739		30
Commercial Mortgages (Non-owner occupied)		248		4		248		4		248		11		252		11
Commercial Mortgages (Owner occupied)		1,030		5		2,104		9		1,102		16		1,982		26
Commercial and Industrial		—		—		—		—		—		—		—		—
		3,552		18		7,454		40		3,659		49		6,667		117
With an allowance recorded:
Construction, land and land development		1,315		15		250		1		1,323		44		255		3
Residential First Mortgages		1,928		23		1,965		24		1,937		71		1,956		66
Residential Revolving and Junior Mortgages (1)		1,389		11		234		—		1,345		38		209		4
Commercial Mortgages (Non-owner occupied)		—		—		—		—		—		—		—		—
Commercial Mortgages (Owner occupied)		1,372		4		686		5		1,381		19		691		17
Commercial and Industrial		92		—		92		—		92		—		105		1
		6,096		53		3,227		30		6,078		172		3,216		91
Total
Construction, land and land development		1,682		15		1,783		15		1,708		44		1,517		44
Residential First Mortgages		3,353		27		4,583		28		3,376		86		4,388		75
Residential Revolving and Junior Mortgages (1)		1,871		16		1,185		9		1,830		45		948		34
Commercial Mortgages (Non-owner occupied)		248		4		248		4		248		11		252		11
Commercial Mortgages (Owner occupied)		2,402		9		2,790		14		2,483		35		2,673		43
Commercial and Industrial		92		—		92		—		92		—		105		1
	$	9,648	$	71	$	10,681	$	70	$	9,737	$	221	$	9,883	$	208

(1) Junior mortgages include equity lines.

Smaller non-accruing loans and non-accruing loans that are not graded because they are included in homogenous pools generally do not meet the criteria for impairment testing, and are therefore excluded from impaired loan disclosures. At September 30, 2017 and December 31, 2016, non-accruing loans excluded from impaired loan disclosure totaled $726 thousand and $465 thousand, respectively. If interest on these non-accruing loans had been accrued, such income would have totaled $4 thousand and $1 thousand during the three months ended September 30, 2017 and 2016, respectively, and $9 thousand and $3 thousand during the nine months ended September 30, 2017 and 2016, respectively.

Loan Modifications

Loans modified as TDRs are considered impaired and are individually evaluated for the amount of impairment in the ALL. No TDRs subsequently defaulted in the first nine months 2017 and one loan subsequently defaulted in the first nine months of 2016. The following table presents, by segments of loans, information related to loans modified as TDRs.

For the three months ended

For the three months ended

September 30, 2017

September 30, 2016

Pre-Modification

Post-Modification

Pre-Modification

Post-Modification

(Dollars in thousands)

Outstanding

Outstanding

Outstanding

Outstanding

Number of

Recorded

Recorded

Number of

Recorded

Recorded

TROUBLED DEBT RESTRUCTURINGS

Loans

Investment

Investment

Loans

Investment

Investment

Residential first mortgages (1)

—

$

—

$

—

0

$

0

$

0

(1)    Modification was a capitalization of interest.

For the nine months ended

For the nine months ended

September 30, 2017

September 30, 2016

Pre-Modification

Post-Modification

Pre-Modification

Post-Modification

(Dollars in thousands)

Outstanding

Outstanding

Outstanding

Outstanding

Number of

Recorded

Recorded

Number of

Recorded

Recorded

TROUBLED DEBT RESTRUCTURINGS

Loans

Investment

Investment

Loans

Investment

Investment

Residential first mortgages (1)

—

$

—

$

—

1

$

244

$

244

(1)    Modification was a capitalization of interest.

21

Other Real Estate Owned

The table below details the properties included in other real estate owned (“OREO”) as of September 30, 2017 and December 31, 2016. There was one collateralized consumer land loan from one borrower valued at $93 thousand in the process of foreclosure as of September 30, 2017.

	As of September 30, 2017				As of December 31, 2016
	No. of		Carrying		No. of		Carrying
(Dollars in thousands)	Properties		Value		Properties		Value
Residential		4	$	889		2	$	891
Land lots		17		3,089		7		547
Convenience store		1		55		1		59
Restaurant		1		55		1		55
Commerical properties		5		1,071		3		942
Total		28	$	5,159		14	$	2,494

Included in other assets as of September 30, 2017 and December 31, 2016, is one residential property purchased in 2013 from a related party with a value of $708 thousand and a former branch, which was closed April 30, 2015, with a value of $403 thousand.

Note 9: 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. Basic earnings per share amounts are computed by dividing the net income (the numerator) by the weighted average number of common shares outstanding (the denominator). Diluted earnings per share amounts assume the conversion, exercise or issuance of all potential common stock instruments unless the effect is to reduce the loss or increase the income per common share from continuing operations. For both computations, the weighted average number of unearned ESOP shares purchased by the ESOP, which have not been allocated to participant accounts, as well as unearned restricted shares, are not assumed to be outstanding. The weighted average unearned ESOP shares which were excluded from the computation were 136,376 and 104,510 for the three and nine months ended September 30, 2017, respectively.

Capital Raise

At the end of August 2017, the Company announced the completion of a $35 million capital raise offered to certain existing shareholders, institutional investors and other accredited investors, raising $32.9 million in common equity net of offering expenses. In the capital raise the Company sold 3,783,784 shares of its common stock at an offering price of $9.25 per share.

	Three months ended								Nine months ended
	September 30, 2017				September 30, 2016				September 30, 2017				September 30, 2016
	Average		Per share		Average		Per share		Average		Per share		Average		Per share
	Shares		Amount		Shares		Amount		Shares		Amount		Shares		Amount
Basic earnings per share		10,488,227	$	0.07		4,774,856	$	0.18		8,175,431	$	0.14		4,774,856	$	0.41
Effect of dilutive securities:
Stock options		69,396				22,665				67,269				18,291
Diluted earnings per share		10,557,623	$	0.07		4,797,521	$	0.18		8,242,700	$	0.14		4,793,147	$	0.41

For the three months ended September 30, 2017 and 2016, options on 11,258 and 33,451 shares, respectively, were not included in computing diluted earnings per share because their effects were anti-dilutive. For the nine months ended September 30, 2017 and 2016, options on 21,258 and 47,041 shares, respectively, were not included in computing diluted earnings per share because their effects were anti-dilutive.

Note 10: Stock-Based Compensation

On June 28, 2013, the Company registered with the SEC a stock-based compensation plan, which superseded all other plans. There are 309,709 shares available for grant under this plan at September 30, 2017.

There was no stock-based compensation expense related to stock option awards for the three months ended September 30, 2017 and 2016. For the nine months ended September 30, 2017 and 2016, stock-based compensation expense related to stock option awards was $24 thousand and $16 thousand, respectively. Compensation expense for stock options is the estimated fair value of options on the date granted using the Black-Scholes Model amortized on a straight-line basis over the vesting period of the award. There was no unrecognized compensation expense related to stock options as of September 30, 2017.

22

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

	For the nine months ended September 30,
	2017	2016
Risk free interest rate (5 year Treasury)	1.78% - 1.93%	1.49%
Expected dividend yield	0%	0%
Expected term (years)	5	5
Expected volatility	17.2% - 21.7%	40.1%

Stock option activity for the nine months ended September 30, 2017 is summarized below:

						Weighted
						Average
				Weighted Average		Remaining		Aggregate
				Exercise		Contractual		Intrinsic
	Shares			Price		Life (in years)		Value (1)
Options outstanding, January 1, 2017		218,300		$	6.35		5.9
Granted		13,000			8.54
Forfeited		(1,195	)		8.43
Exercised		(33,622	)		5.75
Expired		(9,625	)		13.76
Options outstanding and exercisable, September 30, 2017		186,858		$	6.22		5.7	$	635,628

(1) The aggregate intrinsic value of a stock option in the table above represents the total pre-tax intrinsic value (the amount by which the current market value of the underlying stock exceeds the exercise price of the option) that would have been received by the option holders had all option holders exercised their options on September 30, 2017. This amount changes based on changes in the market value of the Company’s common stock.

In the first nine months of 2017, 15,500 shares of restricted stock were granted to four executives. Total unvested restricted shares were 10,500 as of September 30, 2017 and zero as of December 31, 2016. Stock based compensation related to restricted stock awards was $60 thousand and zero as of the nine months ended September 30, 2017 and 2016, respectively.

Note 11: Employee Benefit Plans

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

The Company sponsors a post-retirement benefit plan covering current and future retirees who acquire age 55 and 10 years of service or age 65 and five 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

(Dollars in thousands)	Pension Benefits						Post-Retirement Benefits
Nine months ended September 30,	2017			2016			2017			2016
Service cost	$	—		$	—		$	15		$	17
Interest cost		93			101			15			21
Expected return on plan assets		(135	)		(142	)		—			—
Settlement loss		39			21			—			—
Amortization of net gain		—			—			(6	)		—
Recognized net actuarial loss		57			58			—			—
Net periodic cost	$	54		$	38		$	24		$	38

The Company expects to make no contribution to its pension plan and $1 thousand to its post-retirement benefit plan during the remainder of 2017. The Company has contributed $5 thousand towards the post-retirement plan during the first nine months of 2017.

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Note 12: Long Term Debt

FHLB Debt

As of September 30, 2017, the Bank had $75 million of outstanding FHLB debt, consisting of six advances. As of December 31, 2016, five advances totaling $35.0 million were outstanding. The $50.0 million advance that matured on October 2, 2017, 2017 and the $5.0 million daily rate advance were combined together and replaced with a $55.0 million fixed rate advance with an interest rate of 1.16% maturing on November 1, 2017. The $5.0 million fixed rate credit that was to mature on October 17, 2017 was replaced with a daily rate advance with an interest rate of 1.16% maturing on November 1, 2017.

The six advances are shown in the following table.

					Current		Maturity
Description	Balance (000’s)		Originated		Interest Rate		Date
Adjustable Rate Hybrid	$	10,000		4/12/2013		3.68350		4/13/2020
Fixed Rate Credit		5,000		1/17/2017		0.91000		10/17/2017
Fixed Rate Credit		5,000		1/20/2017		0.99500		12/20/2017
Daily Rate Credit		5,000		5/30/2017		1.32000		5/30/2018
Fixed Rate Credit		50,000		9/1/2017		1.15000		10/2/2017
	$	75,000

Advances on the FHLB lines are secured by a blanket lien on qualified 1 to 4 family residential real estate loans. Immediate available credit, as of September 30, 2017, was $134.8 million against a total line of credit of $215.8 million.

As of September 30, 2017 and December 31, 2016, the Company had $75.0 million and $35.0 million, respectively, in FHLB debt outstanding with a weighted average interest rate of 1.47% and 1.49%, respectively.

Subordinated Debt

On May 28, 2015, the Company issued an aggregate of $7,000,000 of subordinated notes (the “Notes”). The Notes have a maturity date of May 28, 2025. The Notes bear interest, payable on the 1st of March and September of each year, commencing September 1, 2015, at a fixed interest rate of 6.50% per year. The Notes are not convertible into common stock or preferred stock, and are not callable by the holders. The Company has the right to redeem the Notes, in whole or in part, without premium or penalty, at any interest payment date on or after May 28, 2020 and prior to the maturity date, but in all cases in a principal amount with integral multiples of $1,000, plus interest accrued and unpaid through the date of redemption. If an event of default occurs, such as the bankruptcy of the Company, the holder of a Note may declare the principal amount of the Note to be due and immediately payable. The Notes are unsecured, subordinated obligations of the Company and will rank junior in right of payment to the Company’s existing and future senior indebtedness. The Notes qualify as Tier 2 capital for regulatory reporting.

(Dollars in thousands)	Balance as of
	September 30, 2017
6.5% Subordinated Debt	$	7,000
Less: Issuance costs		(127	)
	$	6,873

ESOP Debt

Acquired in the merger was $911 thousand of debt secured by unissued shares of stock in the Company’s ESOP plan. The four fixed rate amortizing notes each carry an interest rate of 3.25% with maturity dates ranging from March 1, 2019 to November 1, 2026. The unearned ESOP shares are pledged to a third party to collateralize a direct loan to the ESOP.

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Note 13: 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.

Mortgage servicing rights “(MSR”): The Bank currently owns MSRs from two portfolios, one serviced for Fannie Mae (“FNMA”) and one serviced for Freddie Mac (“FHLMC”).

The MSR for the portfolio serviced for FNMA is recorded at fair value on a recurring basis, with changes in fair value recorded in the results of operations. A model is used to determine fair value, which establishes pools of performing loans, calculates cash flows for each pool and applies a discount rate to each pool. Loans are segregated into 14 pools based on each loan’s term and seasoning (age). All loans have fixed interest rates. Cash flows are then estimated by utilizing assumed service costs and prepayment speeds. Monthly service costs were assumed to be $6.33 per loan as of September 30, 2017 and $6.00 per loan as of December 31, 2016. Prepayment speeds are determined primarily based on the average interest rate of the loans in each pool. The prepayment scale used is the Public Securities Association (“PSA”) model, where “100% PSA” means prepayments are zero in the first month, then increase by 0.2% of the loan balance each month until reaching 6.0% in month 30. Thereafter, the 100% PSA model assumes an annual prepayment of 6.0% of the remaining loan balance. The average PSA speed assumption in the fair value model is 153% and 150% as of September 30, 2017 and December 31, 2016, respectively. A discount rate of 14.0% was then applied to each pool both as of September 30, 2017 and December 31, 2016. This discount rate is intended to represent the estimated market yield for the highest quality grade of comparable servicing. This MSR is classified as Level 3.

Similarly, the MSR for the portfolio serviced for FHLMC is recorded at fair value on a recurring basis, with changes in fair value recorded in the results of operations. This MSR was acquired by the Bank as part of the merger with Virginia BanCorp effective April 1, 2017. A model is used to determine fair value, which establishes pools of performing loans, calculates cash flows for each pool and applies a discount rate to each. Loans are segregated into five pools based on each loan’s term and coupon strata. All loans have fixed interest rates. Cash flows are then estimated by utilizing assumed service costs and prepayment speeds. Monthly service costs were assumed to be $7.95 per loan as of September 30, 2017. Prepayment speeds are determined primarily based on the average interest rate and seasoning of the loans in each pool. The prepayment scale used is the PSA model as described above. The average PSA speed assumption in the fair value model is 202.19% as of September 30, 2017. The PSA speeds are converted to a constant prepayment rate (“CPR”) and then adjusted by applying betas in order to reflect the prepayment speeds of the portfolio based on historical payment behavior. As of September 30, 2017, an average CPR of 7.51% was applied based on the prior three years of history. Utilizing observed market prices in the secondary market, an average price of 103.59% was effectively applied in determining the market discount rate to be applied to the portfolio’s servicing cash flows. This rate is intended to represent the estimated market yield for the highest quality grade of comparable servicing. This MSR is classified as Level 3.

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The following table presents the balances of financial assets and liabilities measured at fair value on a recurring basis as of

September 30, 2017 and December 31, 2016:

(Dollars in thousands)			Fair Value Measurements at September 30, 2017 Using
Description	Balance		Level 1		Level 2		Level 3
Securities available-for-sale:
Corporate bonds	$	6,717	$	—	$	—	$	6,717
U. S. Government agencies		43,973		—		43,973		—
State and municipal obligations		21,203		—		21,203		—
Total securities available-for-sale:	$	71,893	$	—	$	65,176	$	6,717
Mortgage servicing rights	$	978	$	—	$	—	$	978
Defined benefit plan assets:
Cash and cash equivalents	$	2	$	2	$	—	$	—
Mutual funds - fixed income		987		987		—		—
Mutual funds - equity		1,543		1,543		—		—
Total defined benefit plan assets	$	2,532	$	2,532	$	—	$	—
			Fair Value Measurements at December 31, 2016 Using
Description	Balance		Level 1		Level 2		Level 3
Securities available-for-sale:
Corporate bonds	$	7,704	$	—	$	—	$	7,704
U. S. Government agencies		25,313		—		25,313		—
State and municipal obligations		18,156		—		18,156		—
Total securities available-for-sale:	$	51,173	$	—	$	43,469	$	7,704
Mortgage servicing rights	$	671	$	—	$	—	$	671
Defined benefit plan assets:
Mutual funds - fixed income	$	1,041	$	1,041	$	—	$	—
Mutual funds - equity		1,649		1,649		—		—
Total defined benefit plan assets	$	2,690	$	2,690	$	—	$	—

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

				Corporate
(Dollars in thousands)	MSRs			Bonds
Balance, January 1, 2017	$	671		$	7,704
Purchases		—			—
Acquired in merger		324			—
Impairments		—			—
Fair value adjustments		(17	)		13
Sales		—			(1,000	)
Balance, September 30, 2017	$	978		$	6,717

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

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

Impaired Loans: Loans are designated as impaired when, in the judgment of management based on current information and events, it is probable that all amounts due according to the contractual terms of the loan agreement will not be collected. The measurement of loss associated with impaired loans can be based on either the observable market price of the loan or the fair value of the collateral. Collateral may be in the form of real estate or business assets including equipment, inventory, and accounts receivable. Any given loan may have multiple types of collateral. The vast majority of the collateral is real estate. The value of real estate collateral is determined utilizing a market valuation approach based on an appraisal conducted by an independent, licensed appraiser outside of the Company using observable market data (Level 2). However, if the collateral value is significantly adjusted due to differences in the comparable properties, or is discounted by the Company because of marketability, then the fair value is considered Level 3. The value of business equipment is based upon an outside

26

appraisal if deemed significant, or the net book value on the applicable business’ financial statements if not considered significant. Likewise, values for inventory and accounts receivables collateral are based on financial statement balances or aging reports (Level 3). Impaired loans allocated to the ALL are measured at fair value on a nonrecurring basis. Any fair value adjustments are recorded in the period incurred as provision for loan losses on the Consolidated Statements of Income.

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

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

			Fair Value Measurements at September 30, 2017 Using
(Dollars in thousands)	Balance as of
Description	September 30, 2017		Level 1		Level 2		Level 3
Impaired Loans, net	$	5,086	$	—	$	—	$	5,086
Other real estate owned, net		5,159		—		—		5,159
			Fair Value Measurements at December 31, 2016 Using
	Balance as of
Description	December 31, 2016		Level 1		Level 2		Level 3
Impaired Loans, net	$	2,774	$	—	$	—	$	2,774
Other real estate owned, net		2,494		—		—		2,494

The following table displays quantitative information about Level 3 Fair Value Measurements as of September 30, 2017:

							Range
	Balance as of		Valuation		Unobservable		(Weighted
(Dollars in thousands)	September 30, 2017		Technique		Input		Average)
Impaired Loans, net	$	5,086		Discounted appraised value		Selling Cost		10% - 100% (20%)
						Lack of Marketability		50% - 75% (55%)
Other real estate owned, net		5,159		Discounted appraised value		Selling Cost		3% - 13% (7%)
						Lack of Marketability		10% - 20% (11%)
The following table displays quantitative information about Level 3 Fair Value Measurements as of December 31, 2016:
							Range
	Balance as of		Valuation		Unobservable		(Weighted
(Dollars in thousands)	December 31, 2016		Technique		Input		Average)
Impaired Loans, net	$	2,774		Discounted appraised value		Selling Cost		10% - 20% (16%)
						Lack of Marketability		50% (50%)
Other real estate owned, net		2,494		Discounted appraised value		Selling Cost		3% - 13% (5%)
						Lack of Marketability		10% - 20% (11%)

27

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

					Fair Value Measurements at September 30, 2017 Using
(Dollars in thousands)	Balance as of		Fair Value as of
Description	September 30, 2017		September 30, 2017		Level 1		Level 2		Level 3
Financial Assets:
Cash and due from banks	$	5,806	$	5,806	$	5,806	$	—	$	—
Interest-bearing deposits		46,060		46,060		46,060		—		—
Certificates of deposit		3,224		3,224		—		3,224		—
Federal funds sold		23,357		23,357		23,357		—		—
Securities available-for-sale		71,893		71,893		—		65,176		6,717
Restricted securities		6,000		6,000		—		—		6,000
Loans, net		739,708		745,665		—		—		745,665
Loans held for sale		162		162		—		—		162
Accrued interest receivable		2,905		2,905		—		2,905		—
Bank owned life insurance		18,641		18,641		18,641		—		—
Mortgage servicing rights		978		978		—		—		978
Financial Liabilities:
Non-interest-bearing liabilities	$	99,531	$	99,531	$	99,531	$	—	$	—
Savings and other interest-bearing deposits		297,150		297,150		297,150		—		—
Time deposits		338,732		337,586		—		—		337,586
Securities sold under repurchase agreements		17,091		17,091		—		17,091		—
FHLB advances		75,000		75,520		—		75,520		—
Subordinated debt		6,873		7,000		—		—		7,000
Accrued interest payable		302		302		—		302		—
					Fair Value Measurements at December 31, 2016 Using
(Dollars in thousands)	Balance as of		Fair Value as of
Description	December 31, 2016		December 31, 2016		Level 1		Level 2		Level 3
Financial Assets:
Cash and due from banks	$	4,851	$	4,851	$	4,851	$	—	$	—
Interest-bearing deposits		7,945		7,945		7,945		—		—
Certificates of deposit		4,216		4,216		—		4,216		—
Federal funds sold		1,906		1,906		1,906		—		—
Securities available-for-sale		51,173		51,173		—		43,469		7,704
Restricted securities		2,649		2,649		—		—		2,649
Loans, net		381,537		384,468		—		—		384,468
Loans held for sale		276		276		—		—		276
Accrued interest receivable		1,372		1,372		—		1,372		—
Bank owned life insurance		9,869		9,869		9,869		—		—
Mortgage servicing rights		671		671		—		—		671
Financial Liabilities:
Non-interest-bearing liabilities	$	74,799	$	74,799	$	74,799	$	—	$	—
Savings and other interest-bearing deposits		178,869		178,869		—		178,869		—
Time deposits		128,050		127,497		—		—		127,497
Securities sold under repurchase agreements		18,310		18,310		—		18,310		—
FHLB advances		35,000		35,668		—		35,668		—
Subordinated debt		6,860		7,000		—		—		7,000
Accrued interest payable		331		331		—		331		—

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

Securities available-for-sale are carried at 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.

The carrying value of restricted securities approximates fair value based on the redemption provisions of the issuer.

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Bank owned life insurance is carried at its cash surrender value.

MSRs are carried at fair value. As described above, a valuation model is used to determine fair value. This model utilizes a discounted cash flow analysis with servicing costs and prepayment assumptions based on comparable instruments and a discount rate.

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 by discounting the future cash flows using interest rates offered for deposits of similar remaining maturities.

The fair value of the Company’s subordinated debt is estimated by utilizing observable market prices for comparable securities. Qualitative factors like asset quality, market factors and liquidity are also considered.

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

The fair value of commitments to extend credit is estimated using the fees currently charged to enter similar agreements, taking into account the remaining terms of the agreements and the present credit worthiness of the counter parties. For fixed-rate loan commitments, fair value also considers the difference between current levels of interest rates and the committed rates. The fair value of standby letters of credit is based on fees currently charged for similar agreements or on the estimated cost to terminate them or otherwise settle the obligations with the counter parties at the reporting date. At September 30, 2017 and December 31, 2016, the fair value of loan commitments and standby letters of credit was immaterial and therefore, they are not included in the table above.

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

Note 14: Changes in Accumulated Other Comprehensive Income (Loss)

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

	For the Three Months Ended September 30, 2017
	Net Unrealized			Pension and			Accumulated Other
	Gains (Losses)			Post-retirement			Comprehensive
(Dollars in thousands)	on Securities			Benefit Plans			Income (Loss)
Balance July 1, 2017	$	(200	)	$	(715	)	$	(915	)
Change in net unrealized holding gains on securities, before reclassification, net of tax expense of $20		39			—			39
Reclassification for previously unrealized net losses recognized in income, net of tax expense of $0		—			—			—
Balance September 30, 2017	$	(161	)	$	(715	)	$	(876	)
	For the Three Months Ended September 30, 2016
	Net Unrealized			Pension and			Accumulated Other
	Gains (Losses)			Post-retirement			Comprehensive
(Dollars in thousands)	on Securities			Benefit Plans			Income (Loss)
Balance July 1, 2016	$	624		$	(883	)	$	(259	)
Change in net unrealized holding gains on securities, before reclassification		—			—			—
Reclassification for previously unrealized net gains recognized in income, net of tax expense of $62		(118	)		—			(118	)
Balance September 30, 2016	$	506		$	(883	)	$	(377	)

29

	For the Nine Months Ended September 30, 2017
	Net Unrealized			Pension and			Accumulated Other
	Gains (Losses)			Post-retirement			Comprehensive
(Dollars in thousands)	on Securities			Benefit Plans			Income (Loss)
Balance January 1, 2017	$	(520	)	$	(715	)	$	(1,235	)
Change in net unrealized holding gains on securities, before reclassification, net of tax expense of $185		360			—			360
Reclassification for previously unrealized net losses recognized in income, net of tax expense of $1		(1	)		—			(1	)
Balance September 30, 2017	$	(161	)	$	(715	)	$	(876	)
	For the Nine Months Ended September 30, 2016
	Net Unrealized			Pension and			Accumulated Other
	Gains (Losses)			Post-retirement			Comprehensive
(Dollars in thousands)	on Securities			Benefit Plans			Income (Loss)
Balance January 1, 2016	$	107		$	(883	)	$	(776	)
Change in net unrealized holding gains on securities, before reclassification, net of tax expense of $305		590			—			590
Reclassification for previously unrealized net gains recognized in income, net of tax expense of $99		(191	)		—			(191	)
Balance September 30, 2016	$	506		$	(883	)	$	(377	)

Reclassification for previously unrealized gains (losses) and impairments on securities are reported in the Consolidated Statements of Income as follows. No unrealized gains (losses) on pension and post-employment related costs were reclassified to the Consolidated Statements of Income in the three and nine months ended September 30, 2017 and 2016.

Accumulated Other Comprehensive Income (Loss)

Reclassification for the Three Months Ended

Holding (Losses) Gains on Securities

(Dollars in thousands)	September 30, 2017		September 30, 2016
Net gains on sale of securities available-for-securities	$	—	$	180
Tax expense		—		(62	)
Impact on net income	$	—	$	118

Accumulated Other Comprehensive Income (Loss)

Reclassification for the Nine Months Ended

Holding (Losses) Gains on Securities

(Dollars in thousands)	September 30, 2017			September 30, 2016
Net gains on sale of securities available-for-securities	$	2		$	290
Tax expense		(1	)		(99	)
Impact on net income	$	1		$	191

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

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

STATEMENT REGARDING FORWARD-LOOKING STATEMENTS

This report contains statements concerning the Company’s expectations, plans, objectives, future financial performance and other statements that are not historical facts. These statements may constitute “forward-looking statements” as defined by federal securities laws. These statements may address issues that involve estimates and assumptions made by management, risks and uncertainties, and actual results could differ materially from historical results or those anticipated by such statements. These forward-looking statements include statements about the benefits of the merger between the Company and Virginia BanCorp, the Company’s plans, obligations, expectations and intentions and other statements that are not historical facts. Words such as “anticipates,” “believes,” “intends,” “should,” “expects,” “will,” and variations of similar expressions are intended to identify forward-looking statements. Factors that could have a material adverse effect on the operations and future prospects of the Company include, but are not limited to, disruptions to customer and employee relationships and business operations caused by the merger; the ability to implement integration plans associated with the transaction in which integration may be more difficult, time-consuming or costly than expected; the ability to achieve the cost savings and synergies contemplated by the merger within the expected timeframe, or at all; changes in interest rates, general economic conditions, the legislative/regulatory climate, monetary and fiscal policies of the U.S. Government, including policies of the U.S. Treasury and the Board of Governors of the Federal Reserve System; the quality or composition of the loan or investment portfolios; demand for loan products; deposit flows; competition; expansion activities; demand for financial services in the Company’s market area, accounting principles, policies and guidelines and the other factors detailed in the Company’s publicly filed documents, including its Annual Report on Form 10-K for the year ended December 31, 2016 and current report on Form 8-K filed with the SEC on September 1, 2017. 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

MERGER WITH VIRGINIA BANCORP

On April 1, 2017, the Company and Virginia BanCorp, a bank holding company conducting substantially all of its operations through its subsidiary Virginia Commonwealth Bank, completed a merger pursuant to the Agreement and Plan of Merger, dated as of November 2, 2016, by and between the Company and Virginia BanCorp. The Company is the surviving corporation in the merger, and the former shareholders of Virginia BanCorp received 1.178 shares of the Company’s common stock for each share of Virginia BanCorp common stock they owned immediately prior to the merger, for a total issuance of 4,586,221 shares of the Company’s common stock valued at approximately $43.2 million before the application of unearned ESOP shares. As of the completion of the merger, the Company’s legacy shareholders owned approximately 51% of the outstanding common stock of the Company and Virginia BanCorp’s former shareholders owned approximately 49% of the outstanding common stock of the Company.

After the merger of Virginia BanCorp with and into the Company, Virginia BanCorp’s subsidiary bank was merged with and into Bank of Lancaster, and immediately thereafter Bank of Lancaster changed its name to Virginia Commonwealth Bank. Bank operating systems are currently being consolidated, which is expected to be completed during the fourth quarter of 2017.

Pursuant to the merger, on April 1, 2017, the Company acquired approximately $330.5 million in assets including $268.2 million of loans, and assumed approximately $294.5 million in liabilities, including $25.0 million of debt. Merger-related costs during the first nine months of 2017 were $1.1 million, and accumulated merger-related costs including the fourth quarter of 2016 were $1.6 million. Annual cost savings of the combined companies are anticipated to be approximately 14% from combined 2016 levels.

GENERAL

Net earnings for the nine months ended September 30, 2017 and 2016 were $1.1 million and $2.0 million, respectively. This is a decrease of $842 thousand, or 42.9%, year over year. Net interest income grew by $8.5 million, non-interest income decreased by $210 thousand and provision for loan losses increased by $1.4 million primarily as a result of organic loan portfolio growth. Non-interest expenses increased by $8.0 million, or 73.1%, driven primarily by merger-related costs and increased operating expenses resulting from the Virginia BanCorp merger at the beginning of the second quarter of 2017, as well as strategic staffing and infrastructure investments in the Richmond market. Return on average assets decreased to 0.32% from 0.57% for the comparable prior-year period, and return on average equity decreased to 3.10% from 6.44%.

The loan portfolio grew by $358.2 million, or 93.9%, during the first nine months of 2017, inclusive of loans acquired in the merger amounting to $212.6 million. The portfolio of loans serviced for FNMA and FHLMC totaled $106.2 million as of September 30, 2017 (inclusive of $23.4 million acquired in the merger) compared to $82.3 million as of December 31, 2016 and $76.4 million as of September 30, 2016.

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The net interest margin improved to 3.72% for the first nine months of 2017 compared to 3.39% for the same period in 2016 due to an overall increase in loan and investment yields, partially offset by slightly decreased cost of funds. Loan growth was funded primarily by retail deposit growth and tactical FHLB advances.

Loans past due or non-accruing have increased by $1.0 million to $9.0 million at September 30, 2017. Asset quality remains stable with non-performing assets at 1.04% of total assets at September 30, 2017 compared to 1.70% at December 31, 2016.

Finally, the Bank’s core capital levels and regulatory ratios remain well above what is considered “well capitalized” by the Bank’s regulators.

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

EARNINGS SUMMATION

For the three months ended September 30, 2017 and 2016, net income was $742 thousand and $854 thousand, respectively, a decrease of $112 thousand or 13.1%. Diluted earnings per average share for the three months ended September 30, 2017 and 2016 were $0.07 and $0.18, respectively. The primary factors contributing to the earnings profile during the quarter were as follows:

• Net interest income before loan provision expense increased by $ 4.1 million resulting from loans acquired in the merger as well as organic loan portfolio growth;

• Provision for loan losses increased by $816 thousand resulting from organic loan portfolio growth;

• Non-interest income decreased by $268 thousand primarily due to the effect of investment sale gains recorded last year; and

• Non-interest expense increased by $3.2 million due the combined operations resulting from the merger, growth in Richmond market staffing and infrastructure costs, $141 thousand of merger-related expenses and $108 thousand of severance costs.

Annualized return on average assets was 0.32% for the third quarter of 2017 compared to 0.72% for the third quarter of 2017. Annualized return on average equity was 3.10% and 8.16% for the three months ended September 30, 2017 and 2016, respectively.

For the nine months ended September 30, 2017 and 2016, net income was $1.1 thousand and $2.0 million, respectively, a decrease of $842 thousand or 42.9%. Diluted earnings per average share for the nine months ended September 30, 2017 and 2016 were $0.14 and $0.41, respectively. The primary factors contributing to the earnings profile during the first nine months of 2017 were as follows:

• Net interest income before loan provision expense increased by $ 8.5 million resulting from loans acquired in the merger as well as post-merger organic loan portfolio growth;

• Provision for loan losses increased by $1.4 million resulting from loan portfolio growth;

• Non-interest income decreased by $210 thousand primarily due to the effect of investment sale gains recorded last year; and

• Non-interest expense increased by $8.0 million due the combined operations resulting from the merger, growth in Richmond market staffing and infrastructure costs, $1.1 million of merger-related expenses and $264 thousand of severance costs.

Annualized return on average assets was 0.20% for the first nine months of 2017 compared to 0.57% for the same period of 2016. Annualized return on average equity was 2.03% and 6.44% for the nine months ended September 30, 2017 and 2016, 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 assets which earn interest. Changes in the volume and mix of assets which earn interest and liabilities that bear interest, the associated yields and rates, the level of non-interest bearing deposits, and the volume of non-performing assets have an effect on net interest income, the net interest margin, and net income.

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FOR THE THREE MONTHS ENDED SEPTEMBER 30, 2017 COMPARED TO THE THREE MONTHS ENDED SEPTEMBER 30, 2016

NET INTEREST INCOME

Net Interest Income Analysis	Average Balances, Income and Expense, Yields and Rates
(Fully taxable equivalent basis)
(Dollars in Thousands)	Three months ended 9/30/2017							Three months ended 9/30/2016
	Average Balance		Income/ Expense		Yield/ Cost			Average Balance		Income/ Expense		Yield/ Cost
INTEREST EARNING ASSETS:
Taxable investments	$	58,838	$	329		2.24	%	$	33,149	$	233		2.81	%
Tax-exempt investments (1)		19,285		176		3.64	%		20,987		186		3.55	%
Total investments		78,123		505		2.58	%		54,136		419		3.10	%
Gross loans (2)		737,742		8,874		4.81	%		358,087		4,153		4.63	%
Interest-bearing deposits and federal funds sold		48,764		159		1.30	%		20,896		26		0.50	%
Certificates of deposits		3,224		18		2.20	%		5,083		20		1.57	%
Total Interest Earning Assets	$	867,853	$	9,556		4.40	%	$	438,202	$	4,618		4.22	%
INTEREST-BEARING LIABILITIES:
Savings deposits	$	64,115	$	32		0.20	%	$	43,588	$	24		0.22	%
NOW deposits		93,809		40		0.17	%		43,122		21		0.20	%
Time deposits		330,496		999		1.21	%		127,855		443		1.37	%
Money market deposit accounts		134,148		221		0.66	%		89,727		160		0.71	%
Total Deposits		622,568		1,292		0.83	%		304,292		648		0.84	%
Federal funds purchased		—		—		0.00	%		154		1		0.87	%
Securities sold under repurchase agreements		13,939		5		0.13	%		9,545		4		0.17	%
Subordinated debt		6,871		118		6.86	%		6,854		118		6.84	%
FHLB advances		72,500		279		1.54	%		29,334		118		1.60	%
Total Interest-Bearing Liabilities	$	715,878	$	1,694		0.95	%	$	350,179	$	889		1.01	%
Net interest income and net interest margin			$	7,862		3.62	%			$	3,729		3.40	%
Non-interest-bearing deposits	$	96,644		—		0.00	%	$	76,810		—		0.00	%
Total Cost of funds						0.83	%						0.83	%
Net interest rate spread						3.57	%						3.38	%

Notes:

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

(2)    Includes loan fees and nonaccrual loans.

Interest income for the three months ended September 30, 2017, on a tax-equivalent basis, was $9.5 million, an increase of $4.9 million from the third quarter of 2016 driven primarily by loan growth from both a merger and organic standpoint. Interest expense for the three months ended September 30, 2017 was $1.7 million, an increase of $806 thousand from the third quarter of 2016 due to an increase in retail deposits organically and arising from the merger, complemented by tactical use of FHLB advances, all of which supported loan growth. As a result, net interest income for the three months ended September 30, 2017, on a tax-equivalent basis, was $7.9 million, an increase of $4.1 million from the third quarter of 2016.

The annualized net interest margin was 3.62% and 3.40% for the three months ended September 30, 2017 and 2016, respectively. This increase is due primarily to a higher average earning asset yield of 4.40% in the third quarter of 2017 compared to 4.22% in the third quarter of 2016, complimented by an overall costs of funds comparable to the same period last year. The cost of funds was 0.83% for the third quarter of 2017 and 0.83% for the third quarter of 2016, a result of a stable core retail funding base supported by low marginal cost FHLB advances.

The net interest spread, which is the difference between the annualized yield on earning assets and the total cost of funds, increased to 3.57% for the three months ended September 30, 2017, compared to 3.38% for the three months ended September 30, 2016.

NON-INTEREST INCOME

Non-interest income was $1.1 million compared to $1.3 million for both the third quarter of 2017 and 2016. Primary changes in non-interest income were as follows:

• There were no investment sales during the 2017 quarter as compared to $180 thousand in net gains on the sale of investment securities for the same period last year; and

• During the September 30, 2016 quarter ended, the Company recognized a $150 thousand gain on the sale of the VISA credit card portfolio.

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NON-INTEREST EXPENSE

For the three months ended September 30, 2017 and 2016, non-interest expenses totaled $6.8 million and $3.6 million, respectively. Contributing to the increase in non-interest expense was:

• $1.8 million increase in salaries and wages related to severance costs and new hires associated with the merger and growth into the Richmond market

• Increased operating expense, including occupancy, software maintenance, telecommunications, advertising, audit and director fees are reflective of the combined bank resulting from the merger as compared to pre-merger costs for the same period last year. The Company expects to complete its realization of projected cost synergies during early 2018; and

• Merger expense of $141 thousand and intangible asset amortization of $227 thousand, which are reflective of post-merger expenses that were not incurred during the same period last year

FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2017 COMPARED TO THE NINE MONTHS ENDED SEPTEMBER 30, 2016

NET INTEREST INCOME

Net Interest Income Analysis	Average Balances, Income and Expense, Yields and Rates
(Fully taxable equivalent basis)
(Dollars in Thousands)	Nine months ended 9/30/2017							Nine months ended 9/30/2016
	Average Balance		Income/ Expense		Yield/ Cost			Average Balance		Income/ Expense		Yield/ Cost
INTEREST EARNING ASSETS:
Taxable investments	$	40,765	$	946		3.10	%	$	31,181	$	651		2.78	%
Tax-exempt investments (1)		19,233		521		3.61	%		23,024		597		3.46	%
Total investments		59,998		1,467		3.26	%		54,205		1,248		3.07	%
Gross loans (2)		601,278		21,588		4.79	%		351,805		12,140		4.60	%
Interest-bearing deposits and federal funds sold		27,566		253		1.23	%		15,742		54		0.46	%
Certificates of deposits		3,564		55		2.05	%		5,343		62		1.57	%
Total Interest Earning Assets	$	692,406	$	23,364		4.50	%	$	427,095	$	13,504		4.22	%
INTEREST-BEARING LIABILITIES:
Savings deposits	$	58,563	$	91		0.21	%	$	42,826	$	66		0.21	%
NOW deposits		76,558		103		0.18	%		40,781		52		0.17	%
Time deposits		247,839		2,248		1.21	%		128,829		1,334		1.38	%
Money market deposit accounts		116,419		557		0.64	%		86,059		482		0.75	%
Total Deposits		499,379		2,999		0.80	%		298,495		1,934		0.87	%
Federal funds purchased		1,999		10		0.69	%		254		2		1.06	%
Securities sold under repurchase agreements		9,827		12		0.16	%		7,361		10		0.18	%
Subordinated debt		6,867		354		6.87	%		6,850		354		6.90	%
FHLB advances		64,659		681		1.41	%		32,754		360		1.47	%
Total Interest-Bearing Liabilities	$	582,731	$	4,056		0.93	%	$	345,714	$	2,660		1.03	%
Net interest income and net interest margin			$	19,308		3.72	%			$	10,844		3.39	%
Non-interest-bearing deposits	$	87,776		—		0.00	%	$	70,096		—		0.00	%
Total Cost of funds						0.81	%						0.85	%
Net interest rate spread						3.69	%						3.36	%

Notes:

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

(2)    Includes loan fees and nonaccrual loans.

Interest income for the nine months ended September 30, 2017, on a tax-equivalent basis, was $23.4 million, an increase of $9.9 million from the first nine months of 2016 driven primarily by loan growth from both a merger and post-merger standpoint. Interest expense for the nine months ended September 30, 2017 was $4.1 million, an increase of $1.4 million from the first nine months of 2016 due to an increase in deposits organically and arising from the merger, complemented by tactical use of FHLB advances all of which supported loan growth. As a result, net interest income for the nine months ended September 30, 2017, on a tax-equivalent basis, was $19.3 million, an increase of $8.5 million from the first nine months of 2016.

The annualized net interest margin was 3.72% and 3.39% for the nine months ended September 30, 2017 and 2016, respectively. This increase is due primarily to higher average earning asset yields of 4.50% for the first nine months of 2017 compared to 4.22% for the first nine months of 2016, complimented by decreased overall cost of funds. The cost of funds were 0.81% for the first nine months of 2017 and 0.85% for the first nine months of 2016, a result of a stable core retail funding base supported by low marginal cost FHLB advances.

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The net interest spread, which is the difference between the annualized yield on earning assets and the total cost of funds, increased to 3.69% for the nine months ended September 30, 2017, compared to 3.36% for the nine months ended September 30, 2016.

NON-INTEREST INCOME

Non-interest income for the nine months ended September 30, 2017 was $3.1 million compared to $3.3 million for the first nine months of 2016. Primary changes in non-interest income were as follows:

• $144 thousand increase in the cash surrender value of bank owned life insurance resulting primarily from the merger;

• $288 thousand decrease in gain on the sale of investment securities;

• $94 thousand decrease in VISA-related fees from 2016 sale of portfolio;

• $107 thousand decrease in secondary market lending income due to a decrease in mortgage originations; and

• $136 thousand increase in service charges and fees primarily related to merger

NON-INTEREST EXPENSE

For the nine months ended September 30, 2017 and 2016, non-interest expenses totaled $18.8 million and $10.9 million, respectively. Contributing to the increase in non-interest expense was:

• $4.1 million increase in salaries and wages related to severance costs and new hires associated with the merger and growth into the Richmond market;

• Increased operating expense, including occupancy, software maintenance, telecommunications, advertising, audit and director fees are reflective of the combined bank resulting from the merger as compared to pre-merger costs for the same period last year. The Company expects to complete its realization of projected cost synergies during early 2018; and

• Merger expense of $1.1 million and intangible asset amortization of $461 thousand are reflective of post-merger expenditures that were not incurred during the same period last year.

AVERAGE INTEREST-EARNING ASSETS AND AVERAGE INTEREST-BEARING LIABILITIES

Average interest-earning assets increased 62.1% to $692.4 million for the nine months ended September 30, 2017, as compared to $427.1 million for the nine months ended September 30, 2016, due mainly the assets acquired in the merger and loan growth. Average interest-earning assets as a percent of total average assets were 93.8% for the nine months ended September 30, 2017 as compared to 92.9% for the same period in 2016. The loan portfolio, with $601.3 million in average balances as of September 30, 2017, is the largest category of interest-earning assets.

Average interest-bearing liabilities increased 68.6% to $582.7 million for the nine months ended September 30, 2017, as compared to $345.7 million for the nine months ended September 30, 2017. In the merger, the Company acquired $122.2 million in time deposits, $124.6 million in savings and interest-bearing demand deposits and $21.9 million in noninterest-bearing deposits.

ASSET QUALITY

Asset quality remains stable. Loans charged off during the first nine months of 2017, net of recoveries, totaled $777 thousand compared to $862 thousand for the first nine months of 2016. This represents a decrease in the annualized net charge-off ratio to 0.18% for the first nine months of 2017 compared to 0.25% for the first nine months of 2016. Management believes it is maintaining an adequate level of the ALL at 0.66% of total loans at September 30, 2017 (inclusive of loans acquired in the merger which have been marked to fair value) and 1.00% at December 31, 2016.

Non-performing assets (“NPAs”) were $10.0 million, or 1.04% of total assets as of September 30, 2017 compared to $7.8 million, or 1.60% of total assets, as of December 31, 2016. NPAs as of September 30, 2017 include $5.2 million of other real estate owned (including $3.1 million acquired in the merger), up from $2.5 million as of December 31, 2016. Nonaccrual loans were $4.8 million, or 0.65% of total loans as of September 30, 2017 (excludes purchased credit-impaired loans), compared to $5.3 million, or 1.39% of total loans as of December 31, 2016.

	September 30, 2017			December 31, 2016
(Dollars in Thousands)
Loans past due 90 days or more and still accruing	$	3		$	—
Non-accruing loans		4,799			5,300
Total non-performing loans		4,802			5,300
Other real estate owned		5,159			2,494
Total non-performing assets	$	9,961		$	7,794
Allowance for loan losses	$	4,920		$	3,863
Allowance to non-performing loans		102.5	%		72.9	%
Non-performing assets to total assets		1.0	%		1.6	%

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Classified assets, which include loans with risk rating grades of substandard, doubtful and loss, plus OREO, increased by $5.8 million (inclusive of $3.9 million in acquired substandard loans and $2.8 million in acquired OREO) during the first nine months of 2017 to $15.4 million, or 18.5% of Tier 1 capital plus the allowance for loan losses. Risk rating grades are assigned conservatively, causing some homogenous loans, such as residential mortgages, to fall into the pool of adversely risk rated loans and thereby evaluated for impairment, even though they may be performing as agreed and therefore not impaired. All loan portfolios acquired in the merger are risk graded using loan risk grading software that employs a variety of algorithms based on detailed account characteristics to include borrower’s payment history on a total relationship basis as well as loan to value exposure. For non-homogenous loans, management reviews these resulting grade assignments and makes adjustments to the final grade where appropriate based on an assessment of additional external information that may affect a particular loan. The Bank is in the process of adopting the new risk grading system over its entire loan portfolio, including the Bank’s legacy loans and expects to fully utilize it after core system conversion later in 2017.

As of September 30, 2017, loans valued at $9.7 million were considered impaired (excluding purchased credit impaired loans), whereas $10.4 million were considered impaired as of December 31, 2016. Including purchased credit impaired loans, impaired loans increased to $15.6 million as of September 30, 2017. Between December 31, 2016 and September 30, 2017, one new loans was identified as impaired, one loan was fully charged off and one was dispensed through foreclosure. Management has reviewed the impaired credits and the underlying collateral and the current losses have been specifically reserved.

FINANCIAL CONDITION

Total assets increased to $959.9 million as of September 30, 2017 compared to $486.7 million as of December 31, 2016, primarily as a result of assets acquired in the merger with Virginia BanCorp and organic loan growth. Cash and due from banks was $5.8 million and $4.9 million as of September 30, 2017 and December 31, 2016, respectively. Interest-bearing deposits at other banks, which is mainly the Bank’s cash on deposit at the Federal Reserve Bank of Richmond, has increased by $58.6 million to $72.6 million since year end 2016 partly due to cash secured from the private placement of common stock $32.9 million. Assets acquired in the merger with Virginia BanCorp included $14.7 million of cash and interest-bearing deposits, $268.2 million of loans acquired at their fair value and $3.1 million of OREO.

During the nine months ended September 30, 2017, gross loans, excluding acquired loans, increased by $174.3 million. The largest components of this increase were $15.0 million related to construction and land, $34.2 million related to residential mortgages, $77.2 million related to non-residential mortgages,$25.9 million related to commercial and industrial loans and $18.8 million related to consumer loans.

The Bank had $5.2 million and $2.5 million of OREO at September 30, 2017 and December 31, 2016, respectively. As of September 30, 2017, OREO consists of four residences, 17 lots, one former convenience store, a former restaurant and five commercial business properties. During the first nine months of 2017, two properties with a book value of $259 thousand from 2 borrowers were added through foreclosure, 17 properties with a fair market value of $3.1 million were acquired in the merger, and nine properties with a total book value of $501 thousand were sold. There was $146 thousand in write-downs of OREO properties during the first nine months of 2017, compared to $53 thousand in the same period in 2016. All properties maintained as OREO are valued at the lesser of cost or fair value less estimated costs to sell and are actively marketed.

As of September 30, 2017, securities available-for-sale at fair value totaled $71.9 million as compared to $51.2 million on December 31, 2016. This represents an increase of $20.7 million or 40.5% for the nine months ended September 30, 2017. As of September 30, 2017, available-for-sale securities represented 7.5% of total assets and 8.0% 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. Unrealized gains or losses, net of tax, are booked as an adjustment to shareholders’ equity, and are not realized as an adjustment to earnings until the securities are actually sold or other than temporary impairment occurs.

The bank owned life insurance’s cash surrender value as of September 30, 2017 was $18.6 million. The insurance’s purpose is to offset the cost of employee benefits.

As of September 30, 2017, total deposits were $735.4 million compared to $381.7 million at year-end 2016. Excluding deposits acquired in the merger, this represents an increase in balances of $85.7 million or 22.4% during the first nine months of 2017. The increase was driven by increases of $88.7 million in time deposits, $3.7 million in noninterest-bearing deposits partially offset by a $6.7 million decrease in savings and interest-bearing deposits.

FHLB advances have increased by $40.0 million since December 31, 2016, to $75.0 million as of September 30, 2017, with $25 million being added in the acquisition and the remaining $15 million as a tactical funding source in order to support loan growth.

In 2015, the Company issued an aggregate of $7,000,000 of subordinated notes to the accredited investors. The Notes have a maturity date of May 28, 2025. The Notes bear interest, payable on the 1st of March and September of each year, commencing September 1, 2015, at a fixed interest rate of 6.50% per year. The Notes are not convertible into common stock or preferred stock, and are not callable by the holders. The Company has the right to redeem the Notes, in whole or in part, without premium or penalty, on any interest payment date on or after May 28, 2020 and prior to the maturity date, but in all cases in a principal amount with integral multiples of $1,000, plus interest accrued and unpaid through the date of redemption. If an event of default occurs, such as the bankruptcy of the Company, the holder of a Note may declare the principal amount of the Note to be due and immediately payable. The Notes are unsecured, subordinated obligations of the Company and will rank junior in right of payment to the Company’s existing and future senior indebtedness. The Notes qualify as Tier 2 capital for regulatory reporting.

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At the end of August 2017, the Company announced the completion of a $35 million capital raise offered to certain existing shareholders, institutional investors and other accredited investors, raising $32.9 million in common equity net of offering expenses. In the capital raise the Company sold 3,783,784 shares of its common stock at an offering price of $9.25 per share.

As of September 30, 2017, securities sold under repurchase agreements decreased by $1.2 million to $17.1 million from $18.3 million at December 31, 2016.

LIQUIDITY

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

At September 30, 2017, cash totaled $5.8 million, federal funds sold totaled $23.4 million, interest-bearing deposits totaled $46.1 million, investment securities maturing in one year or less totaled $8.4 million and loans maturing in one year or less totaled $78.6 million. This results in a liquidity ratio as of September 30, 2017 of 16.9% as compared to 8.3% as of December 31, 2016. The Company determines this ratio by dividing the sum of cash and cash equivalents, investment securities maturing in one year or less, loans maturing in one year or less and federal funds sold, by total assets. The Bank has a formal liquidity management policy and contingency plan, which includes periodic evaluation of cash flow projections.

In addition, the Company has a line of credit with the FHLB of $215.8 million, with $134.8 million available, plus federal funds lines of credit with correspondent banks totaling $15 million.

As of September 30, 2017, the Company was not aware of any other known trends, events or uncertainties that have or are reasonably likely to have a material impact on liquidity.

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.

Several factors impact shareholders’ equity, including net income and regulatory capital requirements. The Company’s capital resources are also impacted by net unrealized gains or losses on securities. The available-for-sale securities portfolio is marked to market monthly and unrealized gains or losses, net of taxes, are recognized as accumulated other comprehensive income (loss) on the balance sheets and statement of changes in shareholders’ equity. Another factor affecting accumulated other comprehensive income (loss) is changes in the market value of the Company’s pension and post-retirement benefit plans and changes in the plan obligations. The Company’s shareholders’ equity before accumulated other comprehensive loss was $118.6 million as of September 30, 2017 compared to $42.9 million as of December 31, 2016. Accumulated other comprehensive loss decreased by $359 thousand between December 31, 2016 and September 30, 2017, primarily as a result of decreases in unrealized net losses in the investment portfolio.

At the end of August 2017, the Company announced the completion of a $35 million capital raise offered to certain existing shareholders, institutional investors and other accredited investors, raising $32.9 million in common equity, net of offering expenses. In the capital raise the Company sold 3,783,784 shares of its common stock at an offering price of $9.25 per share.

Book value per share, excluding accumulated other comprehensive loss, as of September 30, 2017, compared to December 31, 2016, remained flat at $8.99. Book value per share, including accumulated other comprehensive loss, increased to $8.93 as of September 30, 2017 from $8.73 as of December 31, 2016. On June 30, 2017, the Board of Directors declared a quarterly cash dividend to shareholders of $0.04 per common share, payable July 24, 2017, to shareholders of record July 11, 2017. In addition, on September 26, 2017, the Board of Directors declared a quarterly cash dividend to shareholders of $0.04 per common share, payable October 24, 2017, to shareholders of record October 11, 2017

The parent company has no substantial operations of its own, so its primary sources of liquidity are fees received from the Bank, interest on investments and borrowings. The parent company’s liquid assets consisted of cash totaling $35.4 million as of September 30, 2017. The parent company has sufficient liquidity to meet its obligations and provide a source of capital for the Bank.

The Bank is subject to minimum regulatory capital ratios as defined by the Board of Governors of the Federal Reserve System (the “Federal Reserve”). As of September 30, 2017, the Bank’s capital ratios continue to be well in excess of regulatory minimums.

In July 2013, the Federal Reserve issued final rules that made changes to its capital rules to align them with the Basel III regulatory capital framework and meet certain requirements of the Dodd-Frank Act. Effective January 1, 2015, the final rules require the Bank to comply with the following minimum capital ratios: (i) a new Common Equity Tier 1 capital ratio of 4.5% of risk-weighted assets; (ii) a Tier 1 capital ratio

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of 6.0% of risk-weighted assets (increased from the prior requirement of 4.0%); (iii) a total capital ratio of 8.0% of risk-weighted assets (unchanged from the prior requirement); and (iv) a leverage ratio of 4.0% of total assets (unchanged from the prior requirement). The following additional capital requirements related to the capital conservation buffer are being phased in over a four year period, which began on January 1, 2016. When fully phased in on January 1, 2019, the rules will require the Bank to maintain (i) a minimum ratio of Common Equity Tier 1 to risk-weighted assets of at least 4.5%, plus a 2.5% “capital conservation buffer” (which is added to the 4.5% Common Equity Tier 1 ratio as that buffer is phased in, effectively resulting in a minimum ratio of Common Equity Tier 1 to risk-weighted assets of at least 7.0% upon full implementation), (ii) a minimum ratio of Tier 1 capital to risk-weighted assets of at least 6.0%, plus the 2.5% capital conservation buffer (which is added to the 6.0% Tier 1 capital ratio as that buffer is phased in, effectively resulting in a minimum Tier 1 capital ratio of 8.5% upon full implementation), (iii) a minimum ratio of total capital to risk-weighted assets of at least 8.0%, plus the 2.5% capital conservation buffer (which is added to the 8.0% total capital ratio as that buffer is phased in, effectively resulting in a minimum total capital ratio of 10.5% upon full implementation), and (iv) a minimum leverage ratio of 4.0%, calculated as the ratio of Tier 1 capital to average assets. The capital conservation buffer requirement is being phased in as of January 1, 2016, at 0.625% of risk-weighted assets, increasing by the same amount each year until fully implemented at 2.5% on January 1, 2019. The capital conservation buffer is designed to absorb losses during periods of economic stress. Banking institutions with a ratio of Common Equity Tier 1 to risk-weighted assets above the minimum but below the conservation buffer will face constraints on dividends, equity repurchases and compensation based on the amount of the shortfall. As of September 30, 2017, the Bank maintained Common Equity Tier 1 capital of $78.3 million, Tier 1 capital of $78.3 million, risk weighted assets of $709.5 million, and total regulatory capital of $83.3 million. As of September 30, 2017, all ratios were in excess of the fully phased-in requirements, with the Common Equity Tier 1 ratio at 11.04% of risk-weighted assets, the Tier 1 capital ratio at 11.04% of risk-weighted assets, the total capital ratio at 11.74% of risk-weighted assets, and the Tier 1 leverage ratio at 8.75% of total assets.

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

	September 30, 2017		December 31, 2016
(In thousands)
Total Loan Commitments Outstanding	$	79,159	$	38,152
Standby-by Letters of Credit		434		452

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 Operations” in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2016.

CONTRACTUAL OBLIGATIONS

On April 28, 2017, the Company entered into a seven year agreement with a computer software service provider. The total data processing services payments related to this contract are expected to be approximately $8.4 million with $0.2 million to be paid in 2017. On February 28, 2017, the Company entered into a 63-month lease related to office space in Richmond, Virginia. The total lease payments are expected to be $1.3 million over the term of the lease. There have been no other 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, 2016.

RECENT ACCOUNTING PRONOUNCEMENTS

Refer to Note 4, Amendments to the Accounting Standards Codification, in the Notes to the Consolidated Financial Statements contained in Item 1 of this report, 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.

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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 (the “Exchange Act”). 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 ensuring that information (including its consolidated subsidiaries) required to be disclosed by the Company in the reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified by the SEC’s reports and forms, and that such information is accumulated and communicated to management, including its Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding disclosure, as of September 30, 2017.

CHANGES IN INTERNAL CONTROLS OVER FINANCIAL REPORTING

There was no change to the Company’s internal control over financial reporting during the nine months ended September 30, 2017 that materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.

PART II - OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

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

ITEM 1A. RISK FACTORS

Not required.

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

None to report.

ITEM 3. DEFAULT UPON SENIOR SECURITIES

None to report.

ITEM 4. MINE SAFETY DISCLOSURES

Not applicable.

ITEM 5. OTHER INFORMATION

None to report.

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ITEM 6. EXHIBITS

10.1	Form of Securities Purchase Agreement, dated August 29, 2017, by and among the Company and the purchaser-thereto (incorporated by reference to Exhibit 10.1 to the Company’s current report on Form 8-K filed September 1, 2017)
31.1	Certification of Chief Executive Officer Pursuant to Rule 13a-14(a) as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
31.2	Certification of Chief Financial Officer Pursuant to Rule 13a-14(a) as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
32.1	Certification Pursuant to 18 U.S.C. Section 1350 as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
101	The following materials from the Company’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2017, formatted in Extensible Business Reporting Language (XBRL): (i) Consolidated Balance Sheets as of September 30, 2017 and December 31, 2016, (ii) Consolidated Statements of Income for the three months and nine months ended September 30, 2017 and 2016, (iii) Consolidated Statements of Comprehensive Income for the three months and nine months ended September 30, 2017 and 2016, (iv) Consolidated Statements of Changes in Shareholders’ Equity for the nine months ended September 30, 2017, (v) Consolidated Statements of Cash Flows for the nine months ended September 30, 2017 and 2016, and (vi) Notes to Consolidated Financial Statements.

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SIGNATURES

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

	Bay Banks of Virginia, Inc.
	(Registrant)
November 09, 2017		By:	/s/ Randal R. Greene
			Randal R. Greene
			President and Chief Executive Officer
			(Principal Executive Officer)
		By:	/s/ James A. Wilson, Jr.
			James A. Wilson, Jr.
			Executive Vice President and Chief Financial Officer
			(Principal Financial and Accounting Officer)

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