bayk-10q_20190331.htm

(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, every Interactive Data File required to be submitted 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 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.

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: 13,314,850 shares of common stock on May 2, 2019.

	March 31, 2019			December 31, 2018 (1)
(Dollars in thousands, except share data)	(unaudited)
ASSETS
Cash and due from banks	$	7,404		$	7,685
Interest-earning deposits		23,091			18,981
Certificates of deposit		3,746			3,746
Federal funds sold		182			625
Available-for-sale securities, at fair value		82,030			82,232
Restricted securities		7,804			7,600
Loans receivable, net of allowance for loan losses of $7,858 and $7,902, respectively		910,762			894,191
Loans held for sale		—			368
Premises and equipment, net		21,822			18,169
Accrued interest receivable		3,274			3,172
Other real estate owned, net		3,718			3,597
Bank owned life insurance		19,390			19,270
Goodwill		10,374			10,374
Mortgage servicing rights		923			977
Core deposit intangible		2,013			2,193
Deferred tax asset, net		1,295			1,510
Other assets		6,012			5,927
Total assets	$	1,103,840		$	1,080,617
LIABILITIES
Noninterest-bearing demand deposits	$	112,315		$	114,122
Savings and interest-bearing demand deposits		371,587			359,400
Time deposits		372,751			368,670
Total deposits		856,653			842,192
Securities sold under repurchase agreements		7,220			6,089
Federal Home Loan Bank advances		100,000			100,000
Subordinated notes, net of issuance costs		6,897			6,893
Other liabilities		13,133			7,967
Total liabilities		983,903			963,141
SHAREHOLDERS’ EQUITY
Common stock ($5 par value; authorized - 30,000,000 shares; outstanding - 13,313,537 and 13,201,682 shares, respectively) (2)		66,568			66,008
Additional paid-in capital		36,493			36,972
Unearned employee stock ownership plan shares		(1,697	)		(1,734	)
Retained earnings		19,094			17,557
Accumulated other comprehensive loss, net		(521	)		(1,327	)
Total shareholders’ equity		119,937			117,476
Total liabilities and shareholders’ equity	$	1,103,840		$	1,080,617

	For the Three Months Ended
(Dollars in thousands, except per share data)	March 31, 2019			March 31, 2018
INTEREST INCOME
Loans, including fees	$	11,461		$	9,984
Securities:
Taxable		595			397
Tax-exempt		118			120
Federal funds sold		56			74
Interest-bearing deposit accounts		86			98
Certificates of deposit		20			19
Total interest income		12,336			10,692
INTEREST EXPENSE
Deposits		2,809			1,604
Securities sold under repurchase agreements		3			3
Subordinated notes		137			128
Federal Home Loan Bank advances		704			313
Total interest expense		3,653			2,048
Net interest income		8,683			8,644
Provision for loan losses		314			320
Net interest income after provision for loan losses		8,369			8,324
NONINTEREST INCOME
Income from fiduciary activities		214			247
Service charges and fees on deposit accounts		238			135
Wealth management		206			132
Interchange fees, net		101			(8	)
Other service charges and fees		29			30
Secondary market sales and servicing		71			133
Increase in cash surrender value of bank owned life insurance		120			127
Net (loss) on disposition of other assets		(1	)		(69	)
Gain on rabbi trust assets		90			52
Gain on curtailment of post-retirement benefit plan		—			352
Other		22			39
Total noninterest income		1,090			1,170
NONINTEREST EXPENSE
Salaries and employee benefits		4,001			4,106
Occupancy		868			785
Data processing		588			472
Bank franchise tax		216			176
Telecommunications and other technology		207			195
FDIC assessments		216			183
Foreclosed property		43			12
Consulting		115			382
Advertising and marketing		67			68
Directors’ fees		164			168
Audit and accounting		204			363
Legal		83			133
Merger-related		—			363
Core deposit intangible amortization		180			211
Net other real estate owned (gains)		(6	)		(141	)
Other		684			644
Total noninterest expense		7,630			8,120
Income before income taxes		1,829			1,374
Income tax expense		337			250
Net income	$	1,492		$	1,124
Basic and diluted earnings per share	$	0.11		$	0.09

								Unearned
								Employee Stock					Accumulated
	Shares of				Additional			Ownership					Other			Total
	Common		Common		Paid-in			Plan			Retained		Comprehensive			Shareholders’
(Dollars in thousands)	Stock		Stock		Capital			Shares			Earnings		Loss, net			Equity
Three months ended March 31, 2019
Balance at beginning of period		13,201,682	$	66,008	$	36,972		$	(1,734	)	$	17,557	$	(1,327	)	$	117,476
Net income		—		—		—			—			1,492		—			1,492
Other comprehensive income		—		—		—			—			—		806			806
Stock options exercised, net		5,173		26		(17	)		—			—		—			9
Director stock grant		762		4		2			—			—		—			6
Restricted stock awards		105,920		530		(530	)		—			—		—			—
ESOP collateral release		—		—		—			37			—		—			37
Share-based compensation expense		—		—		66			—			—		—			66
Cumulative effect adjustment of adoption of accounting principle		—		—		—			—			45		—			45
Balance at end of period		13,313,537	$	66,568	$	36,493		$	(1,697	)	$	19,094	$	(521	)	$	119,937

							Unearned
							Employee Stock					Accumulated
	Shares of				Additional		Ownership					Other			Total
	Common		Common		Paid-in		Plan			Retained		Comprehensive			Shareholders’
(Dollars in thousands)	Stock		Stock		Capital		Shares			Earnings		Loss, net			Equity
Three months ended March 31, 2018
Balance at beginning of period		13,203,605	$	66,018	$	37,142	$	(1,129	)	$	13,679	$	(1,156	)	$	114,554
Net income		—		—		—		—			1,124		—			1,124
Other comprehensive loss		—		—		—		—			—		(944	)		(944	)
Stock options exercised, net		19,491		97		16		—			—		—			113
ESOP collateral release		—		—		—		41			—		—			41
Share-based compensation expense		—		—		31		—			—		—			31
Balance at end of period		13,223,096	$	66,115	$	37,189	$	(1,088	)	$	14,803	$	(2,100	)	$	114,919

	For the Three Months Ended
(Dollars in thousands)	March 31, 2019			March 31, 2018
Cash Flows From Operating Activities
Net income	$	1,492		$	1,124
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization		446			382
Net premium amortization on available-for-sale securities		118			111
Amortization of subordinated notes issuance costs		4			4
Amortization of core deposit intangible		180			211
Accretion of fair value adjustment on acquired time deposits		(34	)		(68	)
Accretion of fair value adjustments (discounts) on acquired loans		(439	)		(503	)
Provision for loan losses		314			320
Share-based compensation expense		66			31
Increase in other real estate owned valuation allowance		16			78
Gain on sale of other real estate owned		(22	)		(219	)
Net loss on the disposition of fixed and other assets		1			69
Decrease in value of mortgage servicing rights		54			69
Originations of loans held for sale (HFS)		(2,344	)		(7,189	)
Proceeds from HFS loan sales		2,773			8,544
Gain on HFS sold loans		(61	)		(118	)
Increase in cash surrender value of bank owned life insurance		(120	)		(127	)
Gain on curtailment of post-retirement benefit plan		—			(352	)
(Increase) decrease in other assets and accrued interest receivable		(4,099	)		787
Increase in other liabilities		5,110			1,986
Net cash provided by operating activities		3,455			5,140
Cash Flows From Investing Activities
Proceeds from maturities and principal paydowns of available-for-sale securities		1,098			816
Purchases of available-for-sale securities		—			(400	)
(Purchases) sales of restricted securities, net		(204	)		277
Decrease in federal funds sold		443			3,603
Net increase in loans		(16,583	)		(24,103	)
Proceeds from sale of other real estate owned		22			1,879
Net disposals (purchases) of premises and equipment		27			(580	)
Net cash used in investing activities		(15,197	)		(18,508	)
Cash Flows From Financing Activities
Increase in demand, savings, and other interest-bearing demand deposits		10,380			20,931
Net increase in time deposits		4,115			14,242
Stock options exercised, net		9			113
Net increase (decrease) in securities sold under repurchase agreements and other borrowings		1,061			(2,947	)
Director stock grant		6			—
(Decrease) in Federal Home Loan Bank advances		—			(10,000	)
Net cash provided by financing activities		15,571			22,339
Net increase in cash and due from banks		3,829			8,971
Cash and cash equivalents (including interest-earning deposits) at beginning of period		26,666			51,367
Cash and cash equivalents (including interest-earning deposits) at end of period	$	30,495		$	60,338
Supplemental Schedule of Cash Flow Information
Cash paid for:
Interest	$	3,587		$	2,166
Income taxes		—			—
Non-cash investing and financing activities:
Unrealized gain (loss) on available-for-sale securities		1,020			(1,192	)
Loans transferred to other real estate owned		137			47
Changes in deferred taxes resulting from other comprehensive income transactions		(214	)		248
Cumulative effect adjustment of adoption of accounting principle		(45	)		—
Employee stock ownership plan transactions		(37	)		(41	)

Bay Banks of Virginia, Inc. (the “Company”) is the holding company for Virginia Commonwealth Bank (the “Bank”), for VCB Financial Group, Inc. (the “Financial Group” or “VCBFG”), and for Steptoes Holdings, LLC (“Steptoes Holdings”). The consolidated financial statements of the Company include the accounts of Bay Banks of Virginia, Inc., the Bank, the Financial Group, and Steptoes Holdings.

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, 2018.

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.

All dollar amounts included in the tables in these notes are in thousands, except per share data, unless otherwise stated.

In June 2016, the FASB issued Accounting Standards Update (“ASU”) 2016-13, Financial Instruments – Credit Losses (Accounting Standards Codification (“ASC”) 326), which is new guidance for the accounting for credit losses on instruments within its scope. This ASU 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, including 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, this ASC will replace 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. This ASU also addresses purchased financial assets with credit deterioration. Disclosure requirements are expanded regarding an entity’s assumptions, models, and methods for estimating the allowance for loan losses. This ASU is effective for interim and annual reporting periods beginning after December 15, 2019. The Company has a CECL cross-functional working group that is evaluating the effect this ASU will have on the Company’s consolidated financial statements. During 2019, this working group has begun implementation of the standard supported by its third-party vendor.

In February 2016, the FASB issued ASU 2016-02, Leases (ASC 842) (“ASU 2016-02”). 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. This ASU is effective for the fiscal years beginning after December 15, 2018, with early adoption permitted. The Company is a lessee in several lease agreements, such as for office space, which were considered operating leases and not recognized on its consolidated balance sheet for the year ended December 31, 2018. On January 1, 2019, the Company adopted the requirements of ASU 2016-02, and as part of the transition to the new standard, the Company measured and recognized leases that existed on January 1, 2019 using a modified retrospective approach.

The adoption of ASU 2016-02 resulted in the recognition of operating Right-of-Use (ROU) assets and operating lease liabilities of $3.5 million and $3.8 million, respectively, primarily related to real estate leases for branches and office space and information technology related equipment. The Company does not have any finance leases as stipulated in ASC 842. A cumulative effect adjustment of $45 thousand was recorded upon adoption of ASU 2016-02, which is reflected in the Company’s statement of shareholders’ equity. Refer to Note 7 for additional information and disclosures regarding ASU 2016-02.

The aggregate amortized costs and fair values of available-for-sale securities as of the dates stated were as follows.

Securities with fair values of $18.8 million and $17.5 million were pledged as collateral for securities sold under repurchase agreements as of March 31, 2019 and December 31, 2018, respectively. As of March 31, 2019 and December 31, 2018, all of the securities pledged for repurchase agreements were state and municipal obligations. All of the repurchase agreements had remaining contractual maturities that were overnight and continuous. Securities sold under repurchase agreements were $7.2 million and $6.1 million as of March 31, 2019 and December 31, 2018, respectively, and are 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 changes.

Securities in an unrealized loss position as of March 31, 2019 and December 31, 2018, by period of the unrealized loss, are shown below. The unrealized loss positions were primarily related to interest rate movements and not the credit quality of the issuers. All agency securities and state and municipal securities are investment grade or better, and their losses are considered temporary. Management does not intend to sell nor expect to be required to sell these securities, and all amortized cost bases are expected to be recovered.

The following tables provide information on securities in an unrealized loss position as of the dates stated.

The following table presents the amortized cost and fair value by contractual maturity of available-for-sale securities as of the dates stated. Expected maturities may differ from contractual maturities, as issuers may have the right to call or prepay obligations with or without call or prepayment penalties.

The Company’s investment in Federal Home Loan Bank of Atlanta (“FHLB”) stock totaled $5.2 million and $5.1 million as of March 31, 2019 and December 31, 2018, respectively. The Company also has an investment in the Federal Reserve Bank of Richmond (“FRB”) stock, which totaled $2.4 million as of March 31, 2019 and $2.3 million as of December 31, 2018 and a stock investment in the Bank’s primary correspondent bank totaling $220 thousand at March 31, 2019 and December 31, 2018. 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.

Loans are reported at their recorded investment, which is the outstanding principal balance net of any unearned income and costs, such as deferred fees and costs, charge-offs, and discounts or premiums on acquired or purchased loans. Interest on loans is recognized in earnings over the contractual term of the loan and is calculated using the interest method on principal amounts outstanding. Loan 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 or principal curtailments, as applicable.

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

As of March 31, 2019 and December 31, 2018, the Company had $234.3 million and $229.1 million, respectively, of loans pledged to the FHLB as collateral for borrowings.

The following tables present the recorded investment for past due, based upon contractual terms, and nonaccrual loans as of the dates stated. A loan past due 90 days or more is generally placed on nonaccrual unless it is both well secured and in the process of collection. Loans presented below as 90 days or more past due and still accruing include purchased credit-impaired (“PCI”) loans.

March 31, 2019	30-89 Days Past Due		90 Days or More Past Due and Still Accruing		Nonaccrual		Total Past Due and Nonaccrual		Current		Total Loans
Mortgage loans on real estate:
Construction, land and land development	$	137	$	—	$	914	$	1,051	$	116,451	$	117,502
Commercial mortgages (non-owner occupied)		—		—		435		435		179,572		180,007
Commercial mortgages (owner occupied)		1,573		23		1,060		2,656		85,988		88,644
Residential first mortgages		2,735		24		1,846		4,605		298,485		303,090
Residential revolving and junior mortgages		179		—		803		982		35,269		36,251
Commercial and industrial		—		—		—		—		173,360		173,360
Consumer		310		—		326		636		19,459		20,095
Total loans	$	4,934	$	47	$	5,384	$	10,365	$	908,584	$	918,949

December 31, 2018	30-89 Days Past Due		90 Days or More Past Due and Still Accruing		Nonaccrual		Total Past Due and Nonaccrual		Current		Total Loans
Mortgage loans on real estate:
Construction, land and land development	$	552	$	—	$	740	$	1,292	$	108,183	$	109,475
Commercial mortgages (non-owner occupied)		50		—		996		1,046		179,028		180,074
Commercial mortgages (owner occupied)		—		56		1,064		1,120		86,121		87,241
Residential first mortgages		1,341		55		1,361		2,757		296,137		298,894
Residential revolving and junior mortgages		115		—		782		897		37,416		38,313
Commercial and industrial		—		—		48		48		164,560		164,608
Consumer		329		—		215		544		23,196		23,740
Total loans	$	2,387	$	111	$	5,206	$	7,704	$	894,641	$	902,345

Approximately $2.2 million of the $4.9 million of loans 30-89 days past due as of March 31, 2019 was attributable to four loans (two relationships) that were brought current in the second quarter of 2019.

The following tables include an aging analysis, based upon contractual terms, of the recorded investment of PCI loans as of the dates stated, included in the tables above.

March 31, 2019	30-89 Days Past Due		90 Days or More Past Due and Still Accruing		Nonaccrual		Total Past Due and Nonaccrual		Current		Total PCI Loans
Mortgage loans on real estate:
Construction, land and land development	$	23	$	—	$	—	$	23	$	1,348	$	1,371
Commercial mortgages (non-owner occupied)		—		—		—		—		135		135
Commercial mortgages (owner occupied)		26		23		—		49		232		281
Residential first mortgages		257		24		—		281		3,154		3,435
Residential revolving and junior mortgages		—		—		—		—		—		—
Commercial and industrial		—		—		—		—		—		—
Consumer		—		—		—		—		48		48
Total purchased credit-impaired loans	$	306	$	47	$	—	$	353	$	4,917	$	5,270

December 31, 2018	30-89 Days Past Due		90 Days or More Past Due and Still Accruing		Nonaccrual		Total Past Due and Nonaccrual		Current		Total PCI Loans
Mortgage loans on real estate:
Construction, land and land development	$	23	$	—	$	—	$	23	$	1,355	$	1,378
Commercial mortgages (non-owner occupied)		—		—		—		—		142		142
Commercial mortgages (owner occupied)		—		56		—		56		237		293
Residential first mortgages		92		55		—		147		3,317		3,464
Residential revolving and junior mortgages		—		—		—		—		—		—
Commercial and industrial		—		—		—		—		—		—
Consumer		—		—		—		—		46		46
Total purchased credit-impaired loans	$	115	$	111	$	—	$	226	$	5,097	$	5,323

The following table presents the changes in accretable yield for PCI loans for the period stated.

Loans in the Company’s loan portfolio are risk rated on a periodic basis by experienced credit personnel.

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 an asset is not warranted.

The following tables present the Company’s risk rating of loans by loan type as of the dates stated.

March 31, 2019	Construction, Land and Land Development		Commercial Mortgages (Non-Owner Occupied)		Commercial Mortgages (Owner Occupied)		Residential First Mortgages		Residential Revolving and Junior Mortgages		Commercial and Industrial		Consumer		Total Loans
Grade:
Pass	$	108,907	$	176,780	$	78,620	$	285,717	$	34,218	$	167,408	$	6,306	$	857,956
Watch		6,236		2,657		8,644		14,049		905		4,587		13,447		50,525
Special mention		67		—		158		454		—		—		—		679
Substandard		2,292		570		1,222		2,870		1,128		1,365		342		9,789
Doubtful		—		—		—		—		—		—		—		—
Total loans	$	117,502	$	180,007	$	88,644	$	303,090	$	36,251	$	173,360	$	20,095	$	918,949

December 31, 2018	Construction, Land and Land Development		Commercial Mortgages (Non-Owner Occupied)		Commercial Mortgages (Owner Occupied)		Residential First Mortgages		Residential Revolving and Junior Mortgages		Commercial and Industrial		Consumer		Total Loans
Grade:
Pass	$	101,007	$	174,661	$	79,375	$	280,663	$	35,900	$	158,590	$	8,144	$	838,340
Watch		6,299		4,275		6,522		14,709		1,306		3,802		15,245		52,158
Special mention		68		—		107		1,071		—		893		121		2,260
Substandard		2,101		1,138		1,237		2,451		1,107		1,323		230		9,587
Doubtful		—		—		—		—		—		—		—		—
Total loans	$	109,475	$	180,074	$	87,241	$	298,894	$	38,313	$	164,608	$	23,740	$	902,345

The allowance for loan losses (“ALL”) reflects management’s judgment of probable loan losses inherent in the loan portfolio as of the balance sheet date. Management uses a disciplined process and methodology to establish the ALL each quarter-end. To determine the total ALL, the Company estimates the reserves needed for each homogenous type of the loan portfolio, in addition to loans analyzed individually for impairment. Depending on the nature of each type, 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.

The ALL consists of specific, general, and unallocated components. The specific component is determined by identifying impaired loans (as described below) then evaluating each one to calculate the amount of impairment. Impaired loans measured individually for impairment generally include (1) any loan risk rated Special Mention or worse where the borrower has filed for bankruptcy; (2) all loans risk rated Substandard or worse with balances of $400 thousand or more; and (3) all loans classified as a troubled debt restructuring (“TDR”). For the general component of the ALL, the Company collectively evaluates any loans not evaluated individually for a specific reserve, including impaired loans risk rated Substandard or worse with balances less than $400 thousand. All loans evaluated collectively are grouped into types, and historical loss experience is calculated and applied to each loan type and the resultant reserve is 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 types. An unallocated component is maintained, if needed, to cover uncertainties that could affect management’s estimate of probable losses.

The following table presents the ALL by loans evaluated for impairment individually and collectively by loan type as of the dates stated.

March 31, 2019	Mortgage Loans on Real Estate		Commercial and Industrial		Consumer		Total
Allowance for loan losses applicable to:
Loans individually evaluated for impairment	$	1,151	$	—	$	120	$	1,271
Loans collectively evaluated for impairment		4,108		1,406		1,073		6,587
Purchased credit-impaired loans		—		—		—		—
Total allowance for loan losses	$	5,259	$	1,406	$	1,193	$	7,858
Loan balances applicable to:
Loans individually evaluated for impairment	$	7,444	$	—	$	120	$	7,564
Loans collectively evaluated for impairment		712,828		173,360		19,927		906,115
Purchased credit-impaired loans		5,222		—		48		5,270
Total loans	$	725,494	$	173,360	$	20,095	$	918,949
December 31, 2018
Allowance for loan losses applicable to:
Loans individually evaluated for impairment	$	1,036	$	—	$	121	$	1,157
Loans collectively evaluated for impairment		3,931		1,374		1,440		6,745
Purchased credit-impaired loans		—		—		—		—
Total allowance for loan losses	$	4,967	$	1,374	$	1,561	$	7,902
Loan balances applicable to:
Loans individually evaluated for impairment	$	7,485	$	—	$	121	$	7,606
Loans collectively evaluated for impairment		701,235		164,608		23,573		889,416
Purchased credit-impaired loans		5,277		—		46		5,323
Total loans	$	713,997	$	164,608	$	23,740	$	902,345

The following tables present an analysis of the change in the ALL by loan type for the periods presented.

	Mortgage Loans on Real Estate			Commercial and Industrial			Consumer			Total
For the Three Months Ended March 31, 2019
Beginning Balance	$	4,967		$	1,374		$	1,561		$	7,902
Charge-offs		(54	)		—			(407	)		(461	)
Recoveries		24			1			78			103
Provision (recovery of)		322			31			(39	)		314
Ending Balance	$	5,259		$	1,406		$	1,193		$	7,858

	Mortgage Loans on Real Estate			Commercial and Industrial			Consumer			Total
For the Three Months Ended March 31, 2018
Beginning Balance	$	3,864		$	878		$	3,028		$	7,770
Charge-offs		(31	)		(14	)		(343	)		(388	)
Recoveries		27			—			194			221
Provision (recovery of)		330			179			(189	)		320
Ending Balance	$	4,190		$	1,043		$	2,690		$	7,923

Net charge-offs of consumer loans relate primarily to a select portfolio of purchased loans. The recovery of provision in the quarter ended March 31, 2019 was primarily attributable to loan loss factor adjustments in the consumer loan portfolio.

The following tables present the Company’s recorded investment and the borrowers’ unpaid principal balances for impaired loans, excluding PCI loans, with the associated ALL amount, if applicable, as of the dates stated.

	As of March 31, 2019						As of December 31, 2018
	Recorded Investment		Borrowers’ Unpaid Principal Balance		Related Allowance		Recorded Investment		Borrowers’ Unpaid Principal Balance		Related Allowance
With no related allowance:
Construction, land and land development	$	332	$	403	$	—	$	335	$	406	$	—
Commercial mortgages (non-owner occupied)		—		—		—		386		386		—
Commercial mortgages (owner occupied)		382		382		—		—		—		—
Residential first mortgages		1,428		1,428		—		—		—		—
Residential revolving and junior mortgages		—		—		—		1,028		1,028		—
Commercial and industrial		—		—		—		—		—		—
Consumer		—		—		—		—		—		—
Total impaired loans with no related allowance		2,142		2,213		—		1,749		1,820		—
With an allowance recorded:
Construction, land and land development		274		274		135		275		275		132
Commercial mortgages (non-owner occupied)		435		435		35		443		443		18
Commercial mortgages (owner occupied)		1,063		1,063		56		1,069		1,069		57
Residential first mortgages		3,029		3,029		641		3,447		3,447		565
Residential revolving and junior mortgages		501		501		284		502		502		264
Commercial and industrial		—		—		—		—		—		—
Consumer		120		120		120		121		121		121
Total impaired loans with allowance recorded		5,422		5,422		1,271		5,857		5,857		1,157
Total impaired loans:
Construction, land and land development		606		677		135		610		681		132
Commercial mortgages (non-owner occupied)		435		435		35		829		829		18
Commercial mortgages (owner occupied)		1,445		1,445		56		1,069		1,069		57
Residential first mortgages		4,457		4,457		641		3,447		3,447		565
Residential revolving and junior mortgages		501		501		284		1,530		1,530		264
Commercial and industrial		—		—		—		—		—		—
Consumer		120		120		120		121		121		121
Total impaired loans	$	7,564	$	7,635	$	1,271	$	7,606	$	7,677	$	1,157

The following table presents the average recorded investment and interest income recognized for impaired loans, excluding PCI loans, for the periods presented.

	For the Three Months Ended
	March 31, 2019				March 31, 2018
	Average Recorded Investment		Interest Income Recognized		Average Recorded Investment		Interest Income Recognized
With no related allowance:
Construction, land and land development	$	334	$	2	$	851	$	1
Commercial mortgages (non-owner occupied)		—		—		—		—
Commercial mortgages (owner occupied)		384		6		1,777		7
Residential first mortgages		1,431		19		1,510		17
Residential revolving and junior mortgages		—		—		414		1
Commercial and industrial		—		—		—		—
Consumer		—		—		—		1
Total impaired loans with no allowance		2,149		27		4,552		27
With an allowance recorded:
Construction, land and land development		274		4		500		5
Commercial mortgages (non-owner occupied)		439		23		—		—
Commercial mortgages (owner occupied)		1,066		14		544		6
Residential first mortgages		3,034		33		2,159		10
Residential revolving and junior mortgages		502		3		1,357		3
Commercial and industrial		—		—		97		—
Consumer		121		2		—		—
Total impaired loans with allowance recorded		5,436		79		4,657		24
Total impaired loans:
Construction, land and land development		608		6		1,351		6
Commercial mortgages (non-owner occupied)		439		23		—		—
Commercial mortgages (owner occupied)		1,450		20		2,321		13
Residential first mortgages		4,465		52		3,669		27
Residential revolving and junior mortgages		502		3		1,771		4
Commercial and industrial		—		—		97		—
Consumer		121		2		—		1
Total impaired loans	$	7,585	$	106	$	9,209	$	51

The following table presents a reconciliation of nonaccrual loans to impaired loans as of the dates stated.

For economic or legal reasons related to a borrower’s financial condition, management may grant a concession to a borrower that it would not otherwise consider. In cases where borrowers are granted new terms that provide for a reduction of either interest or principal or an extension of the maturity date at a stated interest rate lower than the current market rate for new debt with similar risks, the related loan is classified as a troubled debt restructuring. Management strives to identify borrowers in financial difficulty early and may work with them to modify their loan(s) to more affordable terms before their loan reaches nonaccrual status. These modified terms may include rate reductions, principal forgiveness, payment forbearance, and other actions intended to minimize the economic loss to the Company.

Loans modified as TDRs are considered impaired and are individually evaluated for impairment for the ALL. The following table presents by loan type information related to loans modified as TDRs for the periods presented.

No loans designated as TDRs subsequently defaulted in the first three months of 2019 or 2018.

The following table presents a roll-forward of accruing and nonaccrual TDRs for the period presented.

The following table presents the number and carrying values of properties included in other real estate owned (“OREO”) as of the dates stated.

There was one $13 thousand residential mortgage loan in the process of foreclosure as of March 31, 2019.

On January 1, 2019, the Company adopted the requirements of ASU 2016-02. As part of the adoption of this accounting standard, the Company evaluated its population of existing real estate and equipment leases as of January 1, 2019. The purpose of this exercise was to determine whether the Company’s existing contractual arrangements constitute a lease, or contains an embedded lease, which would be in scope under ASU 2016-02, and whether such leases would meet the requirements of an operating or financing lease under the new accounting standard. Based on this evaluation, the Company identified 16 operating leases for land, buildings, and equipment with remaining lease terms ranging from one to 10 years. Most of the Company’s leases include renewal options, with renewal terms extending the lease obligation up to as much as five years. Lease terms may include renewal or extension options to the extent they are reasonably certain to be exercised as assessed at lease commencement. As of and for the three months ended March 31, 2019, the Company does not have any leases that meet the standard definition of a finance lease nor does it engage in any sale-leaseback transactions, have any short-term leases, or have any sublease income.

For operating leases, ROU assets and lease liabilities are recognized at the commencement date of the respective lease. ROU assets represent the Company’s right to use leased assets over the term of the lease. Lease liabilities represent the Company’s contractual obligation to make lease payments over the lease term and are measured as the present value of the lease payments over the lease term. ROU assets are measured as the amount of the lease liability adjusted for certain items such as prepaid lease payments, unamortized lease incentives, and unamortized direct costs. ROU assets are amortized on a straight-line basis less the periodic interest expense adjustment of the lease liability and the amortization is included in occupancy expense in the Company’s consolidated statements of operations. For the three months ended March 31, 2019, operating lease expense totaled $227 thousand. The discount rate used for the present value calculations for lease liabilities was the rate implicit in the lease if determinable, and when the rate was not

determinable, the Company used its incremental, collateralized borrowing rate with the FHLB for the period that most closely coincided with the respective lease as of the commencement date of the lease.

The Company recorded ROU assets and lease liabilities of $3.5 million and $3.8 million, respectively, and recorded a cumulative effect adjustment of $45 thousand to retained earnings, upon adoption of ASU 2016-02 effective January 1, 2019. During the first quarter of 2019, the Company commenced a new operating lease for the Richmond, Virginia office of the Financial Group, which resulted in the recognition of an operating ROU asset and lease liability of $826 thousand.

The following table presents the ROU assets and lease liabilities as of the date stated. ROU assets and lease liabilities are included in other assets and other liabilities, respectively, in the Company’s consolidated balance sheets.

The following table presents the weighted average remaining lease term and discount rate associated with the Company’s operating leases as of the date stated.

The following table presents a maturity analysis of the Company’s operating lease liabilities for the subsequent periods after March 31, 2019 and in total thereafter.

The following table presents supplemental cash flow information related to the Company’s operating leases for the period stated.

As of March 31, 2019, the Company had entered into an additional operating lease for branch office space that had not yet commenced with an estimated ROU asset and lease liability at lease commencement of $478 thousand and $473 thousand, respectively. The Company anticipates this operating lease will commence in 2019 with an expected lease term of 10 years, including the likely exercise of one 5-year renewal option.

As part of the implementation of ASU 2016-02, the Company elected the following practical expedients. The Company elected to retain the operating lease classification for all of its existing leases as of January 1, 2019 under the former lease accounting standard. The Company elected not to reassess whether existing leases contained embedded lease arrangements or whether there were initial directs costs that should have been considered as part of the transition to ASU 2016-02. The Company also elected not to recognize an ROU asset and lease obligation for contracts with an initial term of twelve months or less. The expense associated with these short-term leases is included in occupancy expense in the consolidated statements of operations. To the extent that a lease arrangement includes both lease and non-lease components, the Company has elected not to account for these separately. Lastly, the Company has

elected to utilize a fair value threshold, such that a contract with an ROU asset or lease obligation below a minimum threshold of $7.5 thousand is excluded from the provisions of ASU 2016-02.

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 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 earnings per common share. For both computations, the weighted average number of employee stock ownership plan (“ESOP”) shares not committed to be released to participant accounts purchased by the ESOP are not assumed to be outstanding. The weighted average ESOP shares excluded from the computation were 210,005 and 161,369 for the three months ended March 31, 2019 and 2018, respectively. For the three months ended March 31, 2019 and 2018, options on 88,784 and 87,548 shares, respectively, were not included in computing diluted earnings per share because their effects would have been anti-dilutive.

As of March 31, 2019 and December 31, 2018, the Bank had $100.0 million of outstanding FHLB borrowings, consisting of two and four advances, respectively. Advances on the FHLB lines are secured by a blanket lien on qualified one-to-four family real estate, commercial real estate, and multifamily residential loans. Immediate available credit, as of March 31, 2019, was $151.0 million against a total line of credit of $269.0 million. As of March 31, 2019, the Bank had $18.0 million of letters of credit issued by FHLB for the benefit of the Virginia Department of the Treasury as collateral for public deposits held by the Bank to comply with the Security of Public Deposits Act. The $18.0 million is not an outstanding borrowing, as of March 31, 2019, but does reduce the available credit under the FHLB credit line.

The following table presents information regarding the two advances outstanding as of March 31, 2019.

On May 28, 2015, the Company entered into a purchase agreement with 29 accredited investors under which the Company issued an aggregate of $7.0 million of subordinated notes (the “notes”) to the accredited investors. The notes have a maturity date of May 28, 2025 and bear interest, payable on the first of March and September of each year, 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, 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 notes to be due and immediately payable. The notes are unsecured, subordinated obligations of the Company and 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. The aggregate carrying value of the notes, including capitalized debt issuance costs, was $6.9 million as of March 31, 2019 and December 31, 2018. For the three months ended March 31, 2019 and 2018, the effective interest rate on the notes was 6.84% and 6.86%, respectively.

The aggregate carrying value of debt secured by shares of Company stock, issued and outstanding, in the Company’s ESOP was $1.7 million as of March 31, 2019 and December 31, 2018 and is included in other liabilities on the consolidated balance sheets. The debt is comprised of five fixed rate-amortizing notes, four of which carry an interest rate of 3.25% and one that carries an interest rate of 4.50% with maturity dates ranging from March 1, 2019 to December 31, 2027, and one variable rate amortizing note with a maturity date of June 14, 2024. Shares that collateralize these loans are not allocated to ESOP participants’ accounts.

The Company uses fair value to record certain assets and liabilities and to determine fair value disclosures. Authoritative accounting guidance (ASC 820, Fair Value Measurements (“ASC 820”)) 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 at the measurement date. Fair value also assumes that the reporting entity would sell the asset or transfer the liability in the principal or most advantageous market.

ASC 820 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:

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:

Available-for-sale securities: Available-for-sale securities 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. The Company engages a third-party to determine the fair value of its available-for-sale securities.

Rabbi trust: The Company has a rabbi trust for the benefit of participants in the company’s deferred compensation benefit plan. The assets held by the rabbi trust are invested at the direction of the individual participants and are generally invested in marketable investment securities such as common stocks and mutual funds or short-term investments (e.g., cash) (Level 1). Rabbi trust assets are included in other assets on the consolidated balance sheets.

Mortgage servicing rights (“MSRs”): The Company currently owns MSRs from two residential loan portfolios, one serviced for Fannie Mae (“FNMA”) and one serviced for Freddie Mac (“FHLMC”). The MSRs are recorded at fair value on a recurring basis, with changes in fair value recorded in results of operations.

A third-party 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 12 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 $6.50 per loan as of March 31, 2019 and as of December 31, 2018. 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 154% and 133% as of March 31, 2019 and December 31, 2018, respectively. A discount rate of 12.5% was then applied to each pool as of March 31, 2019 and as of December 31, 2018. The discount rate is intended to represent the estimated market yield for the highest quality grade of comparable servicing. MSRs are classified as Level 3.

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

The following table presents the change in financial assets valued using Level 3 inputs for the periods stated.

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 will not be collected according to the contractual terms of the loan agreement. The measurement of loss associated with impaired loans can be based on either the discounted cash flows of the loan or the fair value of the collateral, if any, less estimated costs to sell, if the loan is collateral-dependent. 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; however, the majority of the Company’s loan collateral is real estate. The value of real estate collateral is generally 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 lack of marketability, then the fair value is considered Level 3. The value of business equipment is based upon an outside appraisal if deemed significant, or the net book value on the applicable business’ financial statements if not considered significant. Likewise, values for inventory and accounts receivables collateral are based on financial statement balances or aging reports (Level 3). Fair value adjustments are recorded in the period incurred as provision for loan losses on the consolidated statements of operations.

Other Real Estate Owned, net: OREO is measured at fair value less estimated costs to sell, generally based on an appraisal conducted by an independent, licensed appraiser, or using other methods such as a brokered price opinion of a third-party real estate agent. If the collateral value is significantly adjusted due to differences in the comparable properties, or is discounted by the Company because of lack of marketability, then the fair value is considered Level 3. Fair value adjustments, if any, are recorded in the period incurred and included in other noninterest expense on the consolidated statements of operations.

The following tables present the Company’s assets that were measured at fair value on a nonrecurring basis as of the dates stated.

The following tables present quantitative information about Level 3 fair value measurements as of the dates stated.

The carrying values of cash and due from banks, interest-earning deposits, federal funds sold or purchased, noninterest-bearing deposits, savings and interest-bearing deposits, and securities sold under repurchase agreements are payable on demand, or are of such short duration, that carrying value approximates market value (Level 1).

The carrying values of certificates of deposit, loans held for sale, and accrued interest receivable are payable on demand, or are of such short duration, that carrying value approximates market value (Level 2).

The carrying value of restricted securities approximates fair value based on the redemption provisions of the issuer (Level 3).

The fair value of performing loans is estimated by discounting the future cash flows using two sets of data sources. First, recent originations, occurring over the prior twelve months, were evaluated, and second, market data showing originations over the prior three months was evaluated. The selected rate was the greater of the two sources. For all loans other than a selective consumer loan portfolio, credit loss severity rates were calculated using the probability of default and the loss given default percentages derived from market data. For the consumer loan portfolio, historical delinquency data was obtained by the servicer of the portfolio. The fair value of impaired loans is measured as described within the Impaired Loans section of this note. The fair value of loans does consider the lack of liquidity and uncertainty in the market that might affect the valuation (Level 3).

Time deposits are presented at estimated fair value by discounting the future cash flows using recent issuance rates over the prior three months and a market rate analysis of recent offering rates (Level 3).

The fair value of the Company’s subordinated notes is estimated by utilizing recent issuance rates for subordinated debt offerings of similar issuer size (Level 3).

The fair value of the FHLB advances is estimated by discounting the future cash flows using current interest rates offered for similar advances (Level 2).

Commitments to extend and standby letters of credit are generally not sold or traded. The estimated fair values of off-balance sheet credit commitments, including standby letters of credit and guarantees written, are not readily available due to the lack of cost-effective and reliable measurement methods for these instruments.

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.

The following tables summarize the Company’s financial assets and liabilities at carrying values and estimated fair values on a nonrecurring basis as of the dates stated.

	Carrying Value as of		Fair Value as of		Fair Value Measurements as of March 31, 2019 Using
	March 31, 2019		March 31, 2019		Level 1		Level 2		Level 3
Financial Assets:
Cash and due from banks	$	7,404	$	7,404	$	7,404	$	—	$	—
Interest-earning deposits		23,091		23,091		23,091		—		—
Certificates of deposit		3,746		3,746		—		3,746		—
Federal funds sold		182		182		182		—		—
Restricted securities		7,804		7,804		—		—		7,804
Loans receivable, net		910,762		896,740		—		—		896,740
Loans held for sale		—		—		—		—		—
Accrued interest receivable		3,274		3,274		—		3,274		—
Financial Liabilities:
Noninterest-bearing demand deposits		112,315		112,315		112,315		—		—
Savings and interest-bearing demand deposits		371,587		330,690		330,690		—		—
Time deposits		372,751		372,921		—		—		372,921
Securities sold under repurchase agreements		7,220		7,220		7,220		—		—
FHLB advances		100,000		99,773		—		99,773		—
Subordinated notes, net		6,897		7,045		—		—		7,045

	Carrying Value as of		Fair Value as of		Fair Value Measurements as of December 31, 2018 Using
	December 31, 2018		December 31, 2018		Level 1		Level 2		Level 3
Financial Assets:
Cash and due from banks	$	7,685	$	7,685	$	7,685	$	—	$	—
Interest-earning deposits		18,981		18,981		18,981		—		—
Certificates of deposit		3,746		3,746		—		3,746		—
Federal funds sold		625		625		625		—		—
Restricted securities		7,600		7,600		—		—		7,600
Loans receivable, net		894,191		877,114		—		—		877,114
Loans held for sale		368		368		—		368		—
Accrued interest receivable		3,172		3,172		—		3,172		—
Financial Liabilities:
Noninterest-bearing demand deposits		114,122		114,122		114,122		—		—
Savings and interest-bearing demand deposits		359,400		359,400		359,400		—		—
Time deposits		368,670		369,347		—		—		369,347
Securities sold under repurchase agreements		6,089		6,089		6,089		—		—
FHLB advances		100,000		99,727		—		99,727		—
Subordinated notes, net		6,893		7,046		—		—		7,046

The components of accumulated other comprehensive income (loss), net of deferred taxes, are presented in the following table for the period presented.

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

The following discussion is intended to assist in understanding the results of operations and the financial condition of Bay Banks of Virginia, Inc. (the “Company”), the holding company for Virginia Commonwealth Bank (the “Bank”) and VCB Financial Group, Inc. (the “Financial Group”). This discussion should be read in conjunction with the consolidated financial statements and the notes thereto included in Item 1 of this Quarterly Report on Form 10-Q and in the Company’s Annual Report on Form 10-K for the year ended December 31, 2018 (the “2018 Form 10-K”).

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 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: 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 “Federal Reserve”); the quality or composition of the loan and 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; changes in banking, tax, and other laws and regulations and interpretations or guidance thereunder; and other factors detailed in the Company’s publicly filed documents, including the factors described in Item 1A., “Risk Factors,” in the 2018 Form 10-K. 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.

All dollar amounts included in the tables of this discussion are in thousands, except per share data, unless otherwise stated. There were no changes to the Critical Accounting Policies disclosed in Item 7 of the 2018 Form 10-K.

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. Net interest margin is net interest income expressed as a percentage of average interest-earning assets. Changes in the volume and/or mix of interest-earning assets and interest-bearing liabilities, the associated yields and rates, the level of noninterest-bearing deposits, and the volume of nonperforming assets have an effect on net interest income, net interest margin, and net income.

The following table presents average interest-earning assets and interest-bearing liabilities, taxable-equivalent yields on such assets, and rates (costs) paid on such liabilities, net interest margin (“NIM”), and net interest spread, as of and for the periods stated. Yields and costs are annualized.

	Average Balances, Income and Expense, Yields and Rates
	As of and for the For the Three Months Ended March 31,
	2019							2018							2019 Compared to 2018
	'Average		Income/		Yield/			Average		Income/		'Yield/			Income/ Expense			Variance Attributable to (8)
	Balance		Expense		Cost			Balance		Expense		Cost			Variance			Rate			Volume
INTEREST-EARNING ASSETS:
Taxable securities	$	70,263	$	595		3.43	%	$	61,303	$	397		2.59	%	$	198		$	141		$	57
Tax-exempt securities (1)		19,257		149		3.15	%		20,741		152		2.94	%		(3	)		8			(11	)
Total securities		89,520		744		3.37	%		82,044		549		2.68	%		195			149			46
Gross loans (2) (3)		907,606		11,461		5.12	%		772,009		9,984		5.17	%		1,477			(253	)		1,730
Interest-earning deposits and federal funds sold		23,186		142		2.48	%		47,714		172		1.44	%		(30	)		57			(87	)
Certificates of deposits		3,746		20		2.17	%		3,224		19		2.36	%		1			(2	)		3
Total interest-earning assets		1,024,058		12,367		4.90	%		904,991		10,724		4.74	%	$	1,643		$	(49	)	$	1,692
Noninterest-earning assets		64,122							77,625
Total average assets	$	1,088,180						$	982,616
INTEREST-BEARING LIABILITIES:
Savings deposits	$	57,502	$	42		0.30	%	$	64,258	$	44		0.27	%	$	(2	)	$	3		$	(5	)
Demand deposits		75,266		35		0.19	%		85,450		41		0.19	%		(6	)		(1	)		(5	)
Time deposits (4)		369,629		1,826		2.00	%		366,392		1,215		1.33	%		611			600			11
Money market deposits		236,399		906		1.55	%		149,056		304		0.82	%		602			426			176
Total deposits		738,796		2,809		1.54	%		665,156		1,604		0.98	%		1,205			1,028			177
Securities sold under repurchase agreements		6,217		3		0.20	%		7,651		3		0.00	%		—			—			—
Subordinated notes and ESOP debt		8,598		137		6.46	%		8,006		128		6.40	%		9			—			9
FHLB advances		100,000		704		2.86	%		67,000		313		1.87	%		391			239			152
Total interest-bearing liabilities		853,611		3,653		1.74	%		747,813		2,048		1.10	%	$	1,605		$	1,267		$	338
Noninterest-bearing deposits		108,916							112,978
Other noninterest-bearing liabilities		7,554							7,089
Total average liabilities		970,081							867,880
Average shareholders' equity		118,099							114,736
Total average liabilities and shareholders' equity	$	1,088,180						$	982,616
Net interest income and NIM (5)			$	8,714		3.45	%			$	8,676		3.83	%	$	38		$	(1,316	)	$	1,354
Total cost of funds (6)						1.54	%						0.95	%
Net interest spread (7)						3.16	%						3.64	%

Interest income for the three months ended March 31, 2019, on a taxable-equivalent basis, was $12.4 million, an increase of $1.6 million from the first quarter of 2018, primarily driven by higher average interest-earning assets of $1.02 billion in the 2019 period compared to $905.0 million in the 2018 period, an increase of $119.1 million. This increase in average interest-earning assets was primarily attributable to higher average loan balances in the 2019 period of $135.6 million. Interest income in the first quarter of 2018 also included approximately $300 thousand of additional fee income and other adjustments, a portion of which was reversed in the second quarter of 2018.

Loans acquired in the Merger were discounted to estimated fair value (for credit losses and interest rates) as of the effective date of the Merger. A portion of the acquisition accounting adjustments (discounts) to record the acquired loans at estimated fair value is being recognized (accreted) into interest income over the estimated remaining life of the loans for those loans that were deemed to be, as of the Merger date, purchased performing and over the period of expected cash flows from the loans that were deemed to be purchased credit-impaired (“PCI”). The amount of accretion income recognized within a period is based on many factors, including among other factors, loan prepayments and curtailments; therefore, amounts recognized are subject to volatility.

Average interest-earning assets comprised 94.1% and 92.1% of the Company’s average assets for the three months ended March 31, 2019 and 2018, respectively.

Interest expense for the three months ended March 31, 2019 was $3.7 million, an increase of $1.6 million from the first quarter of 2018, primarily driven by higher costs of interest-bearing liabilities. Average interest-bearing liabilities grew by $105.8 million to $853.6 million in the 2019 period compared to $747.8 million in the 2018 period. This increase in average interest-bearing liabilities was primarily attributable to deposit growth, particularly money market deposits, which grew $87.3 million. Higher costs of deposits (1.54% and 0.98% for the first quarters of 2019 and 2018, respectively) were primarily due to competition for deposits in the Company’s markets, higher interest rates in general, and the repricing of maturing time deposits. In addition, higher rates were paid on higher balances of Federal Home Loan Bank of Atlanta (“FHLB”) advances (2.86% and 1.87% for the first quarters of 2019 and 2018, respectively).

A time deposit (certificate of deposit) fair value adjustment was also recorded as of the Merger date, which represents a premium over the value of the contractual repayments of fixed-maturity deposits using prevailing market interest rates for similar term deposits. The resulting fair value adjustment is being amortized into interest expense on a level-yield basis over the weighted average remaining life of the acquired time deposit portfolio.

Due to the changes in interest income and interest expense discussed above, net interest income, on a taxable-equivalent basis, for the three months ended March 31, 2019 was $8.7 million, an increase of $38 thousand from the three months ended March 31, 2018.

Net interest margin was 3.45% and 3.83% for the three months ended March 31, 2019 and 2018, respectively. This decrease was primarily attributable to the increase in costs of interest-bearing liabilities, as noted above, the effect of interest income adjustments in the 2018 period, also noted above, and lower accretion of fair value adjustments (discounts) on acquired loans ($439 thousand and $503 thousand for 2019 and 2018, respectively). Excluding the acquisition accounting adjustments on loans and time deposits, net interest margin was 3.26% in the 2019 period compared to 3.58% in the 2018 period.

The following table presents the effect of acquisition accounting adjustments (accretion of loan discounts and amortization of acquired time deposits) on net interest margin for the periods stated.

Provision for loan losses was $314 thousand for the three months ended March 31, 2019, while the provision for loan losses was $320 thousand in the same period of 2018. Provision for loan losses in the first quarter of 2019 was primarily attributable to an increase of approximately $16.5 million of gross loans in the quarter.

The following table presents a summary of noninterest income and the dollar and percentage change for the periods presented.

	Three Months Ended
	March 31, 2019			March 31, 2018			$ Change			% Change
Income from fiduciary activities	$	214		$	247		$	(33	)		(13.4	%)
Service charges and fees on deposit accounts		238			135			103			76.3	%
Wealth management		206			132			74			56.1	%
Interchange fees, net		101			(8	)		109		(N/M
Other service charges and fees		29			30			(1	)		(3.3	%)
Secondary market sales and servicing		71			133			(62	)		(46.6	%)
Increase in cash surrender value of bank owned life insurance		120			127			(7	)		(5.5	%)
Net (loss) on disposition of other assets		(1	)		(69	)		68			98.6	%
Gain on rabbi trust assets		90			52			38			(73.1	%)
Gain on curtailment of post-retirement benefit plan		—			352			(352	)		(100.0	%)
Other		22			39			(17	)		(43.6	%)
Total noninterest income	$	1,090		$	1,170		$	(80	)		(6.8	%)

Contributing to lower noninterest income in the 2019 period was a gain on the curtailment of the Company’s post-retirement benefit plan of $352 thousand in the 2018 period. Partially offsetting this decline was higher service charges and fees on deposit accounts and interchange fee income, net, in the first quarter of 2019 of $103 thousand and $109 thousand, respectively. The increase in service charges and fees on deposit accounts was primarily attributable to lower fee income collected in the first quarter of 2018 due to fee waivers after the core operating system conversion (as a result of the Merger) occurring in the fourth quarter of 2017. Interchange fee income, net, in the first quarter of 2018 was understated by approximately $90 thousand due to core operating system conversion issues, resulting in amounts being incorrectly reported in the consolidated balance sheet as March 31, 2018, which was corrected in the Company’s 2018 second quarter Form 10-Q. Lower secondary market sales and servicing income in the first quarter of 2019 was primarily due to a lower volume of secondary market sales in the period.

The following table presents a summary of noninterest expense and the dollar and percentage change for the periods presented.

	Three Months Ended
	March 31, 2019			March 31, 2018			$ Change			% Change
Salaries and employee benefits	$	4,001		$	4,106		$	(105	)		(2.6	%)
Occupancy		868			785			83			10.6	%
Data processing		588			472			116			24.6	%
Bank franchise tax		216			176			40			22.7	%
Telecommunications and other technology		207			195			12			6.2	%
FDIC assessments		216			183			33			18.0	%
Foreclosed property		43			12			31			258.3	%
Consulting		115			382			(267	)		(69.9	%)
Advertising and marketing		67			68			(1	)		(1.5	%)
Directors’ fees		164			168			(4	)		(2.4	%)
Audit and accounting		204			363			(159	)		(43.8	%)
Legal		83			133			(50	)		(37.6	%)
Merger-related		—			363			(363	)		(100.0	%)
Core deposit intangible amortization		180			211			(31	)		(14.7	%)
Net other real estate owned (gains)		(6	)		(141	)		135			95.7	%
Other		684			644			40			6.2	%
Total noninterest expense	$	7,630		$	8,120		$	(490	)		(6.0	%)

Noninterest expenses in the first quarter of 2018 included $363 thousand of merger-related expenses, while there were no merger-related expenses in the first quarter of 2019. Costs associated with the succession of the Company’s Chief Financial Officer and costs related to fees incurred in the first quarter of 2018 in the completion of the company’s 2017 year-end financial reporting totaled approximately $1.0 million, which were primarily reported in salaries and employee benefits, consulting, and audit and accounting. Higher noninterest expenses in the first quarter of 2019 compared to the same period of 2018, when excluding these items, were primarily due to the Company’s expansion into the Hampton Roads market, expansion of the Financial Group in the Richmond, Virginia market, and costs for general infrastructure to support the Company’s growing operations. Additionally, the first quarter of 2018 included a net gain on the sale of other real estate owned of $141 thousand compared to a $6 thousand gain in the first quarter of 2019.

The following table presents income tax expense and effective income tax rate for the periods presented.

Loans charged-off during the first quarter of 2019, net of recoveries, totaled $358 thousand compared to $167 thousand for the first quarter of 2018. This resulted in an increase in the annualized net charge-off ratio to 0.16% for the first quarter of 2019 compared to 0.09% for the first quarter of 2018.

The ratio of allowance for loan losses (“ALL”) to gross loans was 0.86% as of March 31, 2019 compared to 0.88% as of December 31, 2018.

The following table presents certain asset quality measures as of the dates stated.

Total assets increased by $23.2 million to $1.10 billion as of March 31, 2019 from $1.08 billion as of December 31, 2018, primarily due to net loan growth in the first three months of 2019 of $16.6 million. Cash, including federal funds sold and interest-earning deposits, was $30.7 million and $27.2 million as of March 31, 2019 and December 31, 2018, respectively.

The following tables present information about the Company’s securities portfolio on a taxable-equivalent basis as of the dates stated. The decrease in fair value of $202 thousand from December 31, 2018 in the available-for-sale securities portfolio was primarily attributable to principal amortization, partially offset by a decrease in unrealized losses of $1.0 million primarily due to a decrease in long-term interest rates. As of March 31, 2019 and December 31, 2018, available-for-sale securities represented 7.4% and 7.6% of total assets, respectively.

The following table presents the Company’s composition of loans in dollar amounts and as a percentage of total loans as of the dates stated.

	March 31, 2019						December 31, 2018
	Amount			Percent of Total			Amount			Percent of Total
Mortgage loans on real estate:
Construction, land and land development	$	117,502			12.9	%	$	109,475			12.2	%
Commercial mortgages (non-owner occupied)		180,007			19.6	%		180,074			20.0	%
Commercial mortgages (owner occupied)		88,644			9.6	%		87,241			9.7	%
Residential first mortgages		303,090			32.9	%		298,894			33.1	%
Residential revolving and junior mortgages		36,251			3.9	%		38,313			4.2	%
Commercial and industrial		173,360			18.9	%		164,608			18.2	%
Consumer		20,095			2.2	%		23,740			2.6	%
Total loans		918,949			100.0	%		902,345			100.0	%
Net unamortized deferred loan (fees)		(329	)					(252	)
Allowance for loan losses		(7,858	)					(7,902	)
Loans receivable, net	$	910,762					$	894,191

During the three months ended March 31, 2019, gross loans increased by $16.6 million, an annualized growth rate over 7%, from December 31, 2018. Excluding the pay-down of approximately $16.4 million in the first three months of 2019 of purchased portfolio loans, including those acquired in the Merger, gross loan growth for the quarter ended March 31, 2019 on an annualized basis was approximately 14.5%. The largest components of this increase were an $8.8 million increase in commercial and industrial loans, an $8.0 million increase in construction, land, and land development loans, a $4.2 million increase in residential first mortgages, and a $1.3 million increase in owner-occupied commercial mortgages, partially offset by a $3.6 million decline in consumer loans. In the first quarter of 2019, the Company began intentionally slowing loan growth to preserve liquidity for higher yielding assets.

The following table presents the Company’s ALL by loan type and the percent of loans in each category to total loans as of the dates stated.

Allowance for loan losses decreased by $44 thousand since December 31, 2018 to $7.9 million as of March 31, 2019, primarily due to charge-offs (net of recoveries) of $358 thousand, almost exclusively for a select portfolio of purchased consumer loans, partially offset by loan loss provision of $314 thousand.

Other real estate owned, net, as of March 31, 2019 was $3.7 million, consisting of 26 properties (16 of which were land lots), compared to $3.6 million in OREO (26 properties) as of December 31, 2018, or a $121 thousand increase. This increase was primarily attributable to the addition of one residential property ($138 thousand carrying amount) in the first quarter of 2019, partially offset by the disposal of one land lot.

As of March 31, 2019, total deposits were $856.7 million compared to $842.2 million at December 31, 2018, a $14.5 million (or 6% annualized) increase. The increase was primarily due to an increase of $12.2 million in savings and interest-bearing demand deposits and a $4.1 million increase in time deposits.

Maturities of large denomination time deposits (equal to or greater than $100 thousand) as of March 31, 2019 are presented in the following table.

As of March 31, 2019, the Company had one fixed rate FHLB advance totaling $90.0 million and one variable rate FHLB advance of $10.0 million outstanding. As of December 31, 2018, the Company had three fixed rate FHLB advances totaling $90.0 million and one variable rate FHLB advance of $10.0 million outstanding. The following table presents various information regarding FHLB advances as of and for the periods presented.

Liquidity represents an institution’s ability to meet present and future financial obligations (such as commitments to fund loans or meet depositors’ requirements) through either the sale or maturity of existing assets or the acquisition of additional funds through liability management. Liquid assets include cash, interest-earning 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 its customers’ credit needs.

At March 31, 2019, cash and cash equivalents totaled $30.7 million; investment securities maturing in one year or less totaled $2.5 million, and loans maturing in one year or less totaled $208.0 million. This resulted in a liquidity ratio as of March 31, 2019 of 21.8% compared to 21.5% as of December 31, 2018. The Company determines this ratio by dividing the sum of cash and cash equivalents, and investment securities and loans maturing in one year or less, by total assets.

The Company has a line of credit with the FHLB of $269.0 million, with $151.0 million available as of March 31, 2019, and federal funds lines of credit with correspondent banks totaling $21.0 million. Federal funds lines of credit are uncommitted and can be cancelled at any time by the lending bank.

As of March 31, 2019, the Company was not aware of any other known trends, events, or uncertainties that have or are reasonably likely to have a material effect on liquidity.

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 primarily of outstanding common stock, additional paid-in capital, and retained earnings.

Shareholders’ equity is primarily affected by net income and net unrealized gains or losses on available-for-sale securities (net of tax). The available-for-sale securities portfolio is reported at fair value with unrealized gains or losses, net of taxes, recognized as accumulated other comprehensive income (loss) on the Company’s consolidated balance sheets. Another factor affecting accumulated other comprehensive income (loss) is changes in the fair value of the Company’s pension and post-retirement benefit plans and changes in said plan obligations. Shareholders’ equity before accumulated other comprehensive loss was $120.5 million as of March 31, 2019 compared to $118.8 million as of December 31, 2018. The increase of $1.7 million was primarily attributable to net income of $1.5 million for the three months ended March 31, 2019. Accumulated other comprehensive loss, net, increased by $806 thousand from December 31, 2018 to March 31, 2019, primarily due to a decrease in unrealized net losses (net of tax) in the Company’s available-for-sale securities portfolio, primarily due to increasing long-term interest rates.

Book value per share of the Company’s common stock, including accumulated other comprehensive loss, increased to $9.01 as of March 31, 2019 from $8.90 as of December 31, 2018.

The Bank is subject to minimum regulatory capital ratios as defined by the Federal Reserve. As of March 31, 2019, the Bank’s capital ratios continue to be in excess of regulatory minimums and the Bank was well-capitalized by these guidelines.

The Bank is required to comply with the following minimum capital ratios: (i) a Common Equity Tier 1 Capital ratio of 4.5% of risk-weighted assets; (ii) a Tier 1 Capital ratio of 6.0% of risk-weighted assets; (iii) a Total Risked-based Capital ratio of 8.0% of risk-weighted assets; and (iv) a Leverage ratio of 4.0% of total assets. The following additional capital requirements related to the “capital conservation buffer” have been phased in over a four-year period, beginning on January 1, 2016. As fully phased in on January 1, 2019, the rules require the Bank to maintain (i) a minimum ratio of Common Equity Tier 1 to risk-weighted assets of 4.5%, plus a 2.5% capital conservation buffer resulting in a minimum ratio of Common Equity Tier 1 to risk-weighted assets of 7.0% upon full

implementation, (ii) a minimum ratio of Tier 1 Capital to risk-weighted assets of 6.0%, plus the 2.5% capital conservation buffer, resulting in a minimum Tier 1 Capital ratio of 8.5% upon full implementation, (iii) a minimum ratio of Total Risk-based Capital to risk-weighted assets of 8.0%, plus the 2.5% capital conservation buffer, resulting in a minimum Total Risk-based 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 was phased in beginning January 1, 2016, increasing by 0.625% 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.

The following table presents capital ratios for the Bank, minimum capital ratios required, and ratios defined as “well-capitalized” by the Bank’s regulators as of the dates stated.

In the normal course of business, the Company offers various financial products to its customers to meet their credit and liquidity needs. These instruments involve elements of 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 stand-by letters of credit written is represented by the contractual amount of these instruments. The Company uses the same credit policies in making commitments and conditional commitments as it does for on-balance sheet commitments. 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 the 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. Additionally, but to a much lesser extent, the Company issues financial stand-by letters of credit, which guarantee payment to the underlying beneficiary (i.e., third party) if the customer fails to meet its designated financial obligation.

The following table presents the Company’s off balance sheet commitments as of the dates stated.

There have been no material changes outside the ordinary course of business to the contractual obligations disclosed in the Company’s 2018 Form 10-K.

Refer to Note 2, 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 amendments to the Accounting Standards Codification.

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 control and procedure 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 the 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 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 Securities and Exchange Commission’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 March 31, 2019.

There was no change to the Company’s internal control over financial reporting during the three months ended March 31, 2019 that materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.

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.

There have been no material changes to the risk factors disclosed in the 2018 Form 10-K.

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.


Title of each class	Trading Symbol(s)	Name of each exchange on which registered
None

PART I - FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS		4

CONSOLIDATED BALANCE SHEETS AS OF MARCH 31, 2019 (UNAUDITED) AND DECEMBER 31, 2018		4

CONSOLIDATED STATEMENTS OF OPERATIONS FOR THE THREE MONTHS ENDED MARCH 31, 2019 AND 2018 (UNAUDITED)		5

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME FOR THE THREE MONTHS ENDED MARCH 31, 2019 AND 2018 (UNAUDITED)		6

CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY FOR THE THREE MONTHS ENDED MARCH 31, 2019 AND 2018 (UNAUDITED)		7

CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE THREE MONTHS ENDED MARCH 31, 2019 AND 2018 (UNAUDITED)		8

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)		9

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS		26

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK		34

ITEM 4. CONTROLS AND PROCEDURES		35

PART II - OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS		35

ITEM 1A. RISK FACTORS		35

ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS		35

ITEM 3. DEFAULTS UPON SENIOR SECURITIES		35

ITEM 4. MINE SAFETY DISCLOSURES		35

ITEM 5. OTHER INFORMATION		35

ITEM 6. EXHIBITS		36

			Gross		Gross
	Amortized		Unrealized		Unrealized			Fair
March 31, 2019	Cost		Gains		(Losses)			Value
U.S. Government agencies and mortgage backed securities	$	49,965	$	74	$	(735	)	$	49,304
State and municipal obligations		20,437		192		(98	)		20,531
Corporate bonds		12,187		46		(38	)		12,195
Total available-for-sale securities	$	82,589	$	312	$	(871	)	$	82,030

			Gross		Gross
	Amortized		Unrealized		Unrealized			Fair
December 31, 2018	Cost		Gains		(Losses)			Value
U.S. Government agencies and mortgage backed securities	$	51,126	$	35	$	(1,279	)	$	49,882
State and municipal obligations		20,484		60		(327	)		20,217
Corporate bonds		12,194		23		(84	)		12,133
Total available-for-sale securities	$	83,804	$	118	$	(1,690	)	$	82,232

			Less than 12 months					12 months or more					Total
March 31, 2019	Number of Securities		Fair Value		Unrealized Loss			Fair Value		Unrealized Loss			Fair Value		Unrealized Loss
U.S. Government agencies and mortgage backed securities		50	$	161	$	(2	)	$	40,648	$	(733	)	$	40,809	$	(735	)
State and municipal obligations		26		660		(3	)		6,772		(95	)		7,432		(98	)
Corporate bonds		4		4,536		(36	)		498		(2	)		5,034		(38	)
Total temporarily impaired securities		80	$	5,357	$	(41	)	$	47,918	$	(830	)	$	53,275	$	(871	)

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

	March 31, 2019				December 31, 2018
	Amortized Cost		Fair Value		Amortized Cost		Fair Value
Due in one year or less	$	2,351	$	2,355	$	1,080	$	1,079
Due after one year but less than five years		47,354		47,006		47,065		46,358
Due after five years but less than ten years		25,015		24,956		26,615		26,149
Due after ten years		7,869		7,713		9,044		8,646
Total available-for-sale securities	$	82,589	$	82,030	$	83,804	$	82,232

	For the Three Months Ended
	March 31, 2019
Balance as of December 31, 2018	$	1,083
Accretion of acquisition accounting adjustment		(86	)
Reclassifications from nonaccretable balance, net		45
Other changes, net		65
Balance as of March 31, 2019	$	1,107

	March 31, 2019			December 31, 2018
Nonaccrual loans	$	5,384		$	5,206
Nonaccrual loans collectively evaluated for impairment		(1,622	)		(2,040	)
Nonaccrual impaired loans		3,762			3,166
TDRs on accrual		3,478			4,115
Other impaired loans on accrual		324			325
Total impaired loans	$	7,564		$	7,606

	Accruing			Nonaccrual			Total
Balance as of December 31, 2018	$	4,115		$	1,477		$	5,592
Charge-offs		—			—			—
Payments and other adjustments		(21	)		(6	)		(27	)
New TDR designation		—			—			—
Release TDR designation		—			—			—
Transfer		(616	)		616			—
Balance as of March 31, 2019	$	3,478		$	2,087		$	5,565

	March 31, 2019				December 31, 2018
	Number of		Carrying		Number of		Carrying
	Properties		Value		Properties		Value
Residential		7	$	1,477		6	$	1,339
Land		16		1,724		17		1,741
Commercial properties		3		517		3		517
Total other real estate owned, net		26		3,718		26		3,597

	March 31, 2019
Operating lease right-of-use assets	$	4,127

Current operating lease liabilities		766
Noncurrent lease liabilities		3,700
Total operating lease liabilities	$	4,466

	March 31, 2019
Weighted average remaining lease term - operating leases	8 years
Weighted average discount rate - operating leases		3.14	%

2019	$	663
2020		894
2021		925
2022		547
2023		296
Thereafter		1,746
Total		5,071
Less interest		(605	)
Lease liability	$	4,466

	For the Three Months Ended
	March 31, 2019
Cash paid for amount included in the measurement of lease liabilities:
Operating cash flows from operating leases	$	246
Right-of-use assets obtained in exchange for new operating lease liabilities	$	826

	For the Three Months Ended March 31,
	2019		2018
Net income	$	1,492	$	1,124
Weighted average shares outstanding, basic		12,972,850		13,038,593
Dilutive shares:
Stock options		33,944		67,596
Restricted stock		2,023		25
Weighted average shares outstanding, dilutive		13,008,817		13,106,214
Basic and diluted earnings per share	$	0.11	$	0.09

				Stated			Maturity
	Balance		Originated	Interest Rate			Date
Adjustable rate hybrid	$	10,000	4/12/2013		5.18	%	4/13/2020
Fixed rate credit		90,000	3/4/2019		2.55	%	4/5/2019
Total FHLB borrowings	$	100,000


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.

	MSRs			Corporate Bonds
Balance as of January 1, 2019	$	977		$	3,671
Purchases		—
Impairments		—			—
Fair value adjustments		(54	)		(2	)
Sales		—			—
Balance as of March 31, 2019	$	923		$	3,669

	Balance as of March 31, 2019		Valuation Technique	Unobservable Input	Range (Weighted Average)
Impaired loans, net	$	4,151	Discounted appraised value	Selling Cost Lack of Marketability	20%-25% (20%) 100%
			Discounted cash flows	Discount rate	5%-7% (6%)
Other real estate owned, net		3,718	Discounted appraised value	Selling Cost Lack of Marketability	6%-32% (13%) 9%-100% (27%)

	For the Three Months Ended March 31, 2019
	Net Unrealized Losses on Securities			Pension and Post-retirement Benefit Plans			Accumulated Other Comprehensive Loss, net
Balance as of January 1, 2019	$	(1,252	)	$	(75	)	$	(1,327	)
Change in net unrealized holding gain (loss) on available-for-sale securities, net of deferred tax expense of $214		806			—			806
Balance as of March 31, 2019	$	(446	)	$	(75	)	$	(521	)

	March 31, 2019			December 31, 2018
Loans 90 days or more past due and still accruing (1)	$	—		$	—
Nonaccrual loans (1)		5,384			5,206
Total nonperforming loans		5,384			5,206
Other real estate owned, net		3,718			3,597
Total nonperforming assets	$	9,102		$	8,803
Allowance for loan losses	$	7,858		$	7,902
ALL to gross loans		0.86	%		0.88	%
Nonperforming assets to total assets		0.82	%		0.81	%
Nonperforming loans to gross loans		0.59	%		0.58	%

		Within 3 Months				3-6 Months				6-12 Months				Over 12 Months				Total				Percent of Total Deposits
Time deposits		$	18,041			$	25,416			$	62,435			$	103,694			$	209,586				24.5	%

	Three Months Ended March 31, 2019										Twelve Months Ended December 31, 2018
	Period-End Balance		Highest Month-End Balance		Average Balance		Weighted Average Rate			Period-End Balance			Highest Month-End Balance			Average Balance			Weighted Average Rate
FHLB advances	$	100,000	$	100,000	$	100,000		2.86	%		$	100,000		$	100,000		$	71,753		2.38	%

As of March 31, 2019	Actual Ratio			Minimum Capital Requirement Ratio			Well- Capitalized Ratio
Total risk-based capital		12.60	%		10.50	%		10.00	%
Tier 1 capital		11.74	%		8.50	%		8.00	%
Common equity tier 1		11.74	%		7.00	%		6.50	%
Tier 1 leverage ratio		10.09	%		4.00	%		5.00	%

	March 31, 2019		December 31, 2018
Total loan commitments outstanding	$	156,786	$	160,479
Stand-by letters of credit		2,879		2,848


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 March 31, 2019, formatted in Extensible Business Reporting Language (XBRL): (i) Consolidated Balance Sheets as of March 31, 2019 and December 31, 2018, (ii) Consolidated Statements of Operations for the three months ended March 31, 2019 and 2018, (iii) Consolidated Statements of Comprehensive Income for the three months ended March 31, 2019 and 2018, (iv) Consolidated Statements of Changes in Shareholders’ Equity for the three months ended March 31, 2019 and 2018, (v) Consolidated Statements of Cash Flows for the three months ended March 31, 2019 and 2018, and (vi) Notes to Consolidated Financial Statements.

	Bay Banks of Virginia, Inc.
	(Registrant)

May 8, 2019	By:	/s/ Randal R. Greene
		Randal R. Greene
		President and Chief Executive Officer
		(Principal Executive Officer)

	By:	/s/ Judy C. Gavant
		Judy C. Gavant
		Executive Vice President and Chief Financial Officer
		(Principal Financial Officer)