Note 3: 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 “Merger”). 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, a wholly owned subsidiary of the Company, and immediately thereafter Bank of Lancaster changed its name to Virginia Commonwealth Bank.

The Merger was accounted for using the acquisition method of accounting in accordance with ASC 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 for the loan portfolio, is a complex process involving significant judgment regarding methods and assumptions used to calculate the estimated fair values. As a result, the Company recognized goodwill of $7.6 million in connection with the Merger, none of which is deductible for income tax purposes.

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

			Fair Value
	As Recorded		Adjustments			As Recorded
	by Virginia BanCorp		and Reclassifications			by the 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		(62,068	)		210,411
Loans held for sale		—		55,648			55,648
Deferred income taxes		1,325		255			1,580
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		365		—			365
Total identified assets acquired		328,951		184			329,135
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	$	35,230	$	(549	)	$	34,681
Goodwill resulting from acquisition						$	7,566

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, 2017. The unaudited combined pro forma revenue and net income combines the historical results of Virginia BanCorp with the Company’s consolidated statements of operations for the period noted, 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, 2017. Merger-related expenses of $1.1 million were included in the Company’s actual consolidated statements of operations for the nine months ended September 30, 2017, but were excluded from the unaudited pro forma information below. Operational cost savings and other efficiencies expected to be achieved by the Company due to the Merger are also not reflected in the unaudited pro forma amounts.

	For the Nine Months Ended September 30, 2017
Net interest income	$	22,014
Net income		2,752

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 effect on the consolidated statements of operations for the periods presented.

	Three Months Ended September 30, 2018			Nine Months Ended September 30, 2018
Loans (1)	$	357		$	1,408
Core deposit intangible (2)		(196	)		(610	)
Time deposits (3)		40			150
Depreciation (4)		(10	)		(30	)
Net impact to income before income taxes	$	191		$	918

(1)	Loan discount accretion is included in loan interest income, including fees, in the consolidated statements of operations.

(2)	Core deposit intangible amortization is included in noninterest expense in the consolidated statements of operations.

(3)	Time deposit premium amortization is included in deposits in interest expense in the consolidated statements of operations.

(4)	Depreciation on the fair value adjustment of fixed assets is included in occupancy expense in noninterest expense in the consolidated statements of operations.