UNITED STATES
 SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
(Mark One)

Annual Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

For the fiscal year ended December 31, 2015

or
Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

For the transition period from _____________to_____________

Commission File No.: 000-25805

Fauquier Bankshares, Inc.
(Exact name of registrant as specified in its charter)
 
Virginia
 
54-1288193
(State or other jurisdiction of  incorporation or organization)
 
(I.R.S. Employer Identification No.)

10 Courthouse Square, Warrenton, Virginia
 
20186
(Address of principal executive offices)
 
(Zip Code)

(540) 347-2700
(Registrant's telephone number, including area code)

Securities registered pursuant to Section 12(b) of the Act:

Title of each class
 
Name of each exchange on which registered
Common Stock, par value $3.13 per share
 
The NASDAQ Stock Market LLC
 
 
(NASDAQ Capital Market)

Securities registered pursuant to Section 12(g) of the Act: None

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes   No

 Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Exchange Act. Yes   No

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

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

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company.  See the definitions of "large accelerated filer," "accelerated filer," and "smaller reporting company" in Rule 12b-2 of the Exchange Act. (Check one):
 
Large accelerated filer
Accelerated filer
Non-accelerated filer
Smaller reporting company
   
(Do not check if smaller reporting company)
 

Indicate by check mark if the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act.) Yes No  

The aggregate market value of the registrant's common shares held by "non-affiliates" of the registrant, based upon the closing sale price of its common stock on the NASDAQ Capital Market on June 30, 2015, was $56.2 million.  Shares held by each executive officer, director and holder of 10% or more of the registrant's outstanding common stock have been excluded as shares held by affiliates.  Such determination of affiliate status is not a conclusive determination for other purposes.

The registrant had 3,757,972 shares of common stock outstanding as of March 9, 2016.

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the definitive proxy statement for the 2016 Annual Meeting of Shareholders to be held on May 17, 2016 are incorporated by reference into Part III of this Form 10-K.


TABLE OF CONTENTS

 
 
 
Page
PART I
 
 
 
 
 
 
 
Item 1.
Business
2
 
 
 
 
 
Item 1A.
Risk Factors
10
 
 
 
 
 
Item 1B.
Unresolved Staff Comments
10
       
 
Item 2.
Properties
11
 
 
 
 
 
Item 3.
Legal Proceedings
12
 
 
 
 
 
Item 4.
Mine Safety Disclosures
12
 
 
 
 
PART II
 
 
 
 
 
 
 
Item 5.
Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
12
 
 
 
 
 
Item 6.
Selected Financial Data
13
 
 
 
 
 
Item 7.
Management's Discussion and Analysis of Financial Condition and Results of Operation
14
 
 
 
 
 
Item 7A.
Quantitative and Qualitative Disclosures About Market Risk
36
 
 
 
 
 
Item 8.
Financial Statements and Supplementary Data
39
 
 
 
 
 
Item 9.
Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
89
 
 
 
 
 
Item 9A.
Controls and Procedures
89
 
 
 
 
 
Item 9B.
Other Information
89
 
 
 
 
PART III
 
 
 
 
 
 
 
Item 10
Directors, Executive Officers and Corporate Governance
89
 
 
 
 
 
Item 11.
Executive Compensation
90
 
 
 
 
 
Item 12.
Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
90
 
 
 
 
 
Item 13.
Certain Relationships and Related Transactions, and Director Independence
90
 
 
 
 
 
Item 14.
Principal Accounting Fees and Services
90
 
 
 
 
PART IV
 
 
 
 
 
 
 
Item 15.
Exhibits, Financial Statement Schedules
91

1

ITEM 1. BUSINESS

GENERAL

Fauquier Bankshares, Inc. ("the Company") was incorporated under the laws of the Commonwealth of Virginia on January 13, 1984. The Company is a registered bank holding company and owns all of the voting shares of The Fauquier Bank ("the Bank").  The Company engages in its business through the Bank, a Virginia state-chartered bank that commenced operations in 1902. The Company has no significant operations other than owning the stock of the Bank. The Company had issued and outstanding 3,744,562 shares of common stock, par value $3.13 per share, held by approximately 341 holders of record on December 31, 2015.  The Bank has 11 full service branch offices located in the Virginia communities of Old Town-Warrenton, Warrenton, Catlett, The Plains, Sudley Road-Manassas, New Baltimore, Bealeton, Bristow, Haymarket, Gainesville and Centreville Road-Manassas, Virginia. The executive offices of the Company and the main office of the Bank are located at 10 Courthouse Square, Warrenton, Virginia 20186.

THE FAUQUIER BANK

The Bank's general market area principally includes Fauquier County, western Prince William County, and neighboring communities and is located approximately 50 miles southwest of Washington, D.C. The Bank provides a range of consumer and commercial banking services to individuals, businesses and industries. The deposits of the Bank are insured up to applicable limits by the Deposit Insurance Fund of the Federal Deposit Insurance Corporation ("FDIC"). The basic services offered by the Bank include: interest and non-interest bearing demand deposit accounts, money market deposit accounts, NOW accounts, time deposits, safe deposit services, automated teller machines ("ATM"), debit and credit cards, cash management, direct deposits, notary services, night depository, prepaid debit cards, cashier's checks, domestic and international collections, savings bonds, automated teller services, drive-in tellers, mobile and internet banking, telephone banking, and banking by mail. In addition, the Bank makes secured and unsecured commercial and real estate loans, issues stand-by letters of credit and grants available credit for installment, unsecured and secured personal loans, residential mortgages and home equity loans, as well as automobile and other types of consumer financing. The Bank provides ATM cards, as a part of the Maestro, Accel - Exchange, and Plus ATM networks, thereby permitting customers to utilize the convenience of larger ATM networks. The Bank also is a member of the Certificate of Deposit Account Registry Service ("CDARS") and Insured Cash Sweep Service ("ICS"), to provide customers multi-million dollar FDIC insurance on certificate of deposit investments and deposit sweeps through the transfer and/or exchange with other FDIC insured institutions. CDARS and ICS are registered service marks of Promontory Interfinancial Network, LLC.

The Bank operates a Wealth Management Services ("WMS" or "Wealth Management") division that began with the granting of trust powers to the Bank in 1919. The WMS division provides personalized services that include investment management, trust, estate settlement, retirement, insurance, and brokerage services.

The Bank, through its subsidiary Fauquier Bank Services, Inc., has equity ownership interests in Bankers Insurance, LLC, a Virginia independent insurance company, Bankers Title Shenandoah, LLC, a title insurance company, and Infinex Investments, Inc., a full service broker/dealer. Bankers Insurance and Bankers Title Shenandoah are owned by a consortium of Virginia community banks, and Infinex is owned by banks and banking associations in various states.

The revenues of the Bank are primarily derived from interest on, and fees received in connection with, real estate and other loans, and from interest and dividends from investment and mortgage-backed securities, and short-term investments. The principal sources of funds for the Bank's lending activities are its deposits, repayment of loans, the sale and maturity of investment securities, and borrowings from the Federal Home Loan Bank ("FHLB") of Atlanta. Additional revenues are derived from fees for deposit-related and WMS-related services. The Bank's principal expenses are the interest paid on deposits and operating and general administrative expenses.

As is the case with banking institutions generally, the Bank's operations are materially and significantly influenced by general economic conditions and by related monetary and fiscal policies of financial institution regulatory agencies, including the Board of Governors of the Federal Reserve System ("Federal Reserve"). As a Virginia-chartered bank and a member of the Federal Reserve, the Bank is supervised and examined by the Federal Reserve and the Virginia State Corporation Commission. Interest rates on competing investments and general market rates of interest influence deposit flows and costs of funds. Lending activities are affected by the demand for financing of real estate and other types of loans, which in turn is affected by the interest rates at which such financing may be offered and other factors affecting local demand and availability of funds. The Bank faces strong competition in the attraction of deposits (its primary source of lendable funds) and in the origination of loans. See "Competition" below.

As of December 31, 2015, the Company had total consolidated assets of $601.4 million, total consolidated loans net of allowance for loan losses of $442.7 million, total consolidated deposits of $524.3 million, and total consolidated shareholders' equity of $52.6 million.
2

LENDING ACTIVITIES

The Bank offers a range of lending services, including real estate and commercial loans, to individuals as well as small-to-medium sized businesses and other organizations that are located in or conduct a substantial portion of their business in the Bank's market area. The Bank's total loans, net of allowance, at December 31, 2015 were $442.7 million, or 73.6% of total assets. The interest rates charged on loans vary with the degree of risk, maturity, and amount of the loan, and are further subject to competitive pressures, money market rates, availability of funds and government regulations. The Bank has no foreign loans, sub-prime loans or loans for highly leveraged transactions.

The Bank's general market area for lending consists of Fauquier and Prince William Counties, Virginia and the neighboring communities. There is no assurance that this area will experience economic growth. Continued adverse economic conditions in any one or more of the industries operating in Fauquier or Prince William Counties, the continued sluggishness in general economic conditions, and/or declines in the market value of local commercial and/or residential real estate may have an adverse effect on the Company and the Bank.

The Bank's loans are concentrated in the following areas: residential real estate loans, commercial real estate loans, construction and land loans, commercial and industrial loans, consumer loans, and U.S. Government guaranteed student loans. The majority of the Bank's loans are made on a secured basis. As of December 31, 2015, approximately 90.5% of the loan portfolio consisted of loans secured by mortgages on real estate. Income from loans decreased $139,000 to $20.11 million for 2015 compared with $20.25 million for 2014 due to the increase in average loans balances, partially offset by the decline in the average rate received.

LOANS SECURED BY REAL ESTATE

ONE TO FOUR ("1-4") FAMILY RESIDENTIAL REAL ESTATE LOANS. The Bank's 1-4 family residential real estate loan portfolio primarily consists of conventional loans, generally with fixed interest rates with 15 or 30 year terms, and balloon loans with fixed interest rates, and 3, 5, 7, or 10-year maturities but utilizing amortization schedules of 30 years or less. As of December 31, 2015, the Bank's 1-4 family residential loans amounted to $150.6 million, or 33.7% of the total loan portfolio. Substantially, the Bank's entire single-family residential mortgage loans are secured by properties located in the Bank's market area. The Bank requires private mortgage insurance if the principal amount of the loan exceeds 80% of the value of the property held as collateral.

HOME EQUITY LINES OF CREDIT LOANS. The Bank's home equity line of credit loan portfolio primarily consists of conventional loans, generally with variable interest rates that are tied to the Wall Street Journal prime rate and with 10 year terms. As of December 31, 2015, the Bank's home equity loans amounted to $44.0 million, or 9.8% of the total loan portfolio. Substantially, the Bank's entire home equity line of credit loan portfolio is secured by properties located in the Bank's market area. The Bank allows a maximum loan-to-value ratio of 85% of the value of the property held as collateral at the time of origination.

CONSTRUCTION AND LAND LOANS. The majority of the Bank's construction and land loans are made to individuals to construct a primary residence. Such loans have a maximum term of twelve months, a fixed rate of interest, and loan-to-value ratios of 80% or less of the appraised value upon completion. The Bank requires that permanent financing, with the Bank or some other lender, be in place prior to closing any construction loan. Construction loans are generally considered to involve a higher degree of credit risk than single-family residential mortgage loans. The risk of loss on a construction loan is dependent largely upon the accuracy of the initial estimate of the property's value at completion. The Bank also provides construction loans and lines of credit to developers. Such loans generally have maximum loan-to-value ratios of 80% of the appraised value upon completion. The loans are made with a fixed rate of interest. The majority of construction loans are made to selected local developers for the building of single-family dwellings on either a pre-sold or speculative basis. The Bank limits the number of unsold units under construction at one time. Loan proceeds are disbursed in stages after inspections of the project indicate that such disbursements are for costs already incurred and that have added to the value of the project. Construction loans include loans to developers to acquire the necessary land, develop the site and construct the residential units. As of December 31, 2015, the Bank's construction and land loans totaled $49.9 million, or 11.2% of the total loan portfolio. Included in the $49.9 million of construction and land loans are $7.7 million of commercial acquisition and development loans, $30.7 million of raw land loans and $1.9 million of agricultural land loans.

COMMERCIAL REAL ESTATE LOANS. Loans secured by commercial real estate comprised $160.0 million, or 35.8% of total loans at December 31, 2015, and consist principally of commercial loans for which real estate constitutes a source of collateral. Approximately $65.4 million or 40.9% of commercial real estate loans are owner-occupied. Approximately $5.6 million or 3.5% of commercial real estate loans are tax exempt loans to local governmental entities. Commercial real estate loans generally involve a greater degree of risk than single-family residential mortgage loans because repayment of commercial real estate loans may be more vulnerable to adverse conditions in the real estate market or the economy.
3


COMMERCIAL LOANS

The Bank's commercial loans include loans to individuals and small-to-medium sized businesses located primarily in Fauquier and Prince William Counties for working capital, equipment purchases, and various other business purposes. Equipment or similar assets secure approximately 81.2% of the Bank's commercial loans, on a dollar-value basis, and the remaining 18.8% of commercial loans are on an unsecured basis. Commercial loans have variable or fixed rates of interest. Commercial lines of credit are typically granted on a one-year basis. Other commercial loans with terms or amortization schedules longer than one year will normally carry interest rates that vary with the prime lending rate and other financial indices and will be payable in full in three to five years.

Loan originations are derived from a number of sources, including existing customers and borrowers, walk-in customers, advertising, and direct solicitation by the Bank's loan officers. Certain credit risks are inherent in originating and keeping loans on the Bank's balance sheet. These include interest rate and prepayment risks, risks resulting from uncertainties in the future value of collateral, risks resulting from changes in economic and industry conditions, and risks inherent in dealing with individual borrowers. In particular, longer maturities increase the risk that economic conditions will change and adversely affect our ability to collect. The Bank attempts to minimize loan losses through various means. In particular, on larger credits, the Bank generally relies on the cash flow of a debtor as the source of repayment and secondarily on the value of the underlying collateral. In addition, the Bank attempts to utilize shorter loan terms in order to reduce the risk of a decline in the value of such collateral. The commercial loan portfolio was $23.7 million or 5.3% of total loans at December 31, 2015.
 
CONSUMER AND STUDENT LOANS
 
The Bank's consumer loans include loans to individuals such as auto loans, credit card loans and overdraft loans. The consumer loan portfolio was $3.2 million or 0.7% of total loans at December 31, 2015.

The Bank has U.S. Government guaranteed student loans, which were purchased through and serviced by a third party and have a variable rate of interest. The U.S. Government guaranteed student loan portfolio was $15.5 million or 3.5% of total loans at December 31, 2015.

DEPOSIT ACTIVITIES

Deposits are the major source of the Bank's funds for lending and other investment activities. The Bank considers its regular savings, demand, negotiable order of withdrawal ("NOW"), premium NOW, money market deposit accounts, and non-brokered time deposits under $100,000 to be core deposits. These accounts comprised approximately 94.4% of the Bank's total deposits at December 31, 2015. Generally, the Bank attempts to maintain the rates paid on its deposits at a competitive level. Time deposits of $100,000 through $250,000, and time deposits greater than $250,000 made up approximately 3.9% and 1.6%, respectively, of the Bank's total deposits at December 31, 2015. During 2015, time deposits of $100,000 and over generally paid interest at rates the same or higher than certificates of less than $100,000. The majority of the Bank's deposits are generated from Fauquier and Prince William Counties, Virginia.  Included in interest-bearing deposits at December 31, 2015 were $20.5 million of brokered deposits, or 3.9% of total deposits. Of the brokered deposits, $12.9 million or 2.5% of total deposits represent a reciprocal arrangement for existing Bank customers who desire FDIC insurance for deposits above current limits.

INVESTMENTS

The Bank invests a portion of its assets in U.S. Government-sponsored corporation and agency obligations, state, county and municipal obligations, corporate obligations, mutual funds, FHLB stock and equity securities. The Bank's investments are managed in relation to loan demand and deposit growth, and are generally used to provide for the investment of excess funds at reduced yields and risks relative to yields and risks of the loan portfolio, while providing liquidity to fund increases in loan demand or to offset fluctuations in deposits. The Bank's total unrestricted and restricted investments, at fair value, were $55.2 million and $1.3 million, respectively, or 9.2% and 0.2% of total assets, respectively, at December 31, 2015. During 2015, income from investments totaled $1.5 million, consisting of $1.4 million of interest and dividend income and $4,000 in gains on the sale/calls of investments.

GOVERNMENT SUPERVISION AND REGULATION

GENERAL. Bank holding companies and banks are extensively regulated under both federal and state law. The following summary briefly addresses certain provisions of federal and state laws that apply to the Company or the Bank. This summary does not purport to be complete and is qualified in its entirety by reference to the particular statutory or regulatory provisions.

EFFECT OF GOVERNMENTAL MONETARY POLICIES. The earnings and business of the Company and the Bank are affected by the economic and monetary policies of various regulatory authorities of the United States, especially the Federal Reserve. The Federal Reserve, among other things, regulates the supply of credit and money and setting interest rates in order to influence general economic conditions within the United States. The instruments of monetary policy employed by the Federal Reserve for those purposes influence in various ways the overall level of investments, loans, other extensions of credits, and deposits, and the interest rates paid on liabilities and received on assets. Federal Reserve monetary policies have had a significant effect on the operating results of commercial banks in the past and are expected to continue to do so in the future.
4


SARBANES-OXLEY ACT OF 2002. The Company is subject to the periodic reporting requirements of the Securities Exchange Act of 1934, as amended (the "Exchange Act"), including the filing of annual, quarterly, and other reports with the Securities and Exchange Commission (the "SEC"). As an Exchange Act reporting company, the Company is directly affected by the Sarbanes-Oxley Act of 2002 (the "SOX"), which is aimed at improving corporate governance, internal controls and reporting procedures. The Company is complying with applicable SEC and other rules and regulations implemented pursuant to the SOX.
 
FINANCIAL SERVICES MODERNIZATION LEGISLATION. The Gramm-Leach-Bliley Financial Services Modernization Act of 1999 (the "GLB Act") was intended to modernize the financial services industry by establishing a comprehensive framework to permit affiliations among commercial banks, insurance companies, securities firms and other financial service providers under a "financial holding company" structure. Under the GLB Act, bank holding companies that are well-capitalized and well-managed and meet other conditions can elect to become "financial holding companies." As financial holding companies, they and their subsidiaries are permitted to acquire or engage in previously impermissible activities such as insurance underwriting, securities underwriting and distribution, travel agency activities, insurance agency activities, merchant banking and other activities that the Federal Reserve determines to be financial in nature or complementary to these activities. Financial holding companies continue to be subject to the overall oversight and supervision of the Federal Reserve, but the GLB Act applies the concept of functional regulation to the activities conducted by subsidiaries. For example, insurance activities would be subject to supervision and regulation by state insurance authorities. Although the Company could qualify to become a financial holding company under the GLB Act, it does not contemplate seeking to do so unless it identifies significant specific benefits from doing so. The GLB Act has not had a material effect on the Company operations.

BANK HOLDING COMPANY REGULATION. The Company is a one-bank holding company, registered with the Federal Reserve under the Bank Holding Company Act of 1956 (the "BHC Act"). As such, the Company is subject to the supervision, examination, and reporting requirements of the BHC Act and the regulations of the Federal Reserve. The Company is required to furnish to the Federal Reserve an annual report of its operations at the end of each fiscal year and such additional information as the Federal Reserve may require pursuant to the BHC Act. The BHC Act generally prohibits the Company from engaging in activities other than banking or managing or controlling banks or other permissible subsidiaries and from acquiring or retaining direct or indirect control of any company engaged in any activities other than those activities determined by the Federal Reserve to be sufficiently related to banking or managing or controlling banks. With some limited exceptions, the BHC Act requires every bank holding company to obtain the prior approval of the Federal Reserve before: acquiring substantially all the assets of any bank; acquiring direct or indirect ownership or control of any voting shares of any bank if after such acquisition it would own or control more than 5% of the voting shares of such bank (unless it already owns or controls the majority of such shares); or merging or consolidating with another bank holding company.  In addition, and subject to some exceptions, the BHC Act and the Change in Bank Control Act, together with the regulations promulgated thereunder, require Federal Reserve approval prior to any person or company acquiring "control" of a bank holding company.

BANK REGULATION. The Bank is chartered under the laws of the Commonwealth of Virginia. The FDIC insures the deposits of the Bank's customers to the maximum extent provided by law. The Bank is subject to comprehensive regulation, examination and supervision by the Federal Reserve and to other laws and regulations applicable to banks. These regulations include limitations on loans to a single borrower and to the Bank's directors, officers and employees; requirements on the opening and closing of branch offices; requirements regarding the maintenance of prescribed regulatory capital and liquidity ratios; requirements to grant credit under equal and fair conditions; and requirements to disclose the costs and terms of such credit. The Bank, as a Virginia chartered commercial bank, is subject to extensive regulatory examination and supervision by the Bureau of Financial Institutions of the Virginia State Corporation Commission (the "SCC"). The SCC also has broad enforcement powers over the Bank, including the power to impose fines and other civil or criminal penalties and to appoint a receiver in order to conserve the Bank's assets for the benefit of depositors and other creditors.

The Bank is also subject to the provisions of the Community Reinvestment Act of 1977 ("CRA"). Under the terms of the CRA, the appropriate federal bank regulatory agency is required, in connection with its examination of a bank, to assess the bank's record in meeting the credit needs of the community served by that bank, including low-and moderate-income neighborhoods. The regulatory agency's assessment of a bank's record is made available to the public. Such assessment is required of any bank that has applied to (i) charter a national bank, (ii) obtain deposit insurance coverage for a newly chartered institution, (iii) establish a new branch office that will accept deposits, (iv) relocate an office, or (v) merge or consolidate with, or acquire the assets or assume the liabilities of, a federally regulated financial institution. In the case of a bank holding company applying for approval to acquire a bank or other bank holding company, the Federal Reserve will assess the record of each subsidiary bank of the applicant bank holding company, and such records may be the basis for denying the application. The Bank received a rating of "satisfactory" at its last CRA performance evaluation as of February 6, 2012.
 
DIVIDENDS. Dividends from the Bank constitute the primary source of funds for dividends to be paid by the Company. There are various statutory and contractual limitations on the ability of the Bank to pay dividends, extend credit, or otherwise supply funds to the Company, including the requirement under Virginia banking laws that cash dividends only be paid out of net undivided profits and only if such dividends would not impair the capital of the Bank. The Federal Reserve also has the general authority to limit the dividends paid by bank holding companies and state member banks, if the payment of dividends is deemed to constitute an unsafe and unsound practice. The Federal Reserve has indicated that banking organizations should generally pay dividends only if (i) the organization's net income available to common shareholders over the past year has been sufficient to fund fully the dividends and (ii) the prospective rate of earnings retention appears consistent with the organization's capital needs, asset quality and overall financial condition. The Bank does not expect any of these laws, regulations or policies to materially impact its ability to pay dividends to the Company.
5

DEPOSIT INSURANCE. The deposits of the Bank are insured up to applicable limits by the Deposit Insurance Fund (the "DIF") of the FDIC and are subject to deposit insurance assessments to maintain the DIF. On April 1, 2011, the deposit insurance assessment base changed from total deposits to average total assets minus average tangible equity, pursuant to a rule issued by the FDIC as required by the Dodd-Frank Wall Street Reform and Consumer Protection Act (the "Dodd-Frank Act").

The Federal Deposit Insurance Act (the "FDIA"), as amended by the Federal Deposit Insurance Reform Act and the Dodd-Frank Act, requires the FDIC to set a ratio of deposit insurance reserves to estimated insured deposits of at least 1.35%. The FDIC utilizes a risk-based assessment system that imposes insurance premiums based upon a risk matrix that takes into account a bank's capital level and supervisory rating. On February 27, 2009, the FDIC introduced three possible adjustments to an institution's initial base assessment rate: (i) a decrease of up to five basis points for long-term unsecured debt, including senior unsecured debt (other than debt guaranteed under the Temporary Liquidity Guarantee Program) and subordinated debt and, for small institutions, a portion of Tier 1 capital; (ii) an increase not to exceed 50% of an institution's assessment rate before the increase for secured liabilities in excess of 25% of domestic deposits; and (iii) for non-Risk Category I institutions, an increase not to exceed 10 basis points for brokered deposits in excess of 10% of domestic deposits.  In 2015 and 2014, the Company paid only the base assessment rate for "well capitalized" institutions, which totaled $386,000 and $360,000, respectively, in regular deposit insurance assessments.

On May 22, 2009, the FDIC issued a final rule that levied a special assessment applicable to all insured depository institutions totaling 5 basis points of each institution's total assets less Tier 1 capital as of June 30, 2009, not to exceed 10 basis points of domestic deposits. The special assessment was part of the FDIC's efforts to rebuild the DIF. Deposit insurance expense during 2009 for the Company included an additional $1.2 million recognized in the second quarter related to the special assessment. On November 12, 2009, the FDIC issued a rule that required all insured depository institutions, with limited exceptions, to prepay their estimated quarterly risk-based assessments for the fourth quarter of 2009 and for all of 2010, 2011 and 2012. In the fourth quarter of 2009, the Company paid $2.43 million in prepaid risk-based assessments, most of which has been expensed in the appropriate periods through December 31, 2012. The balance of the prepayment was approximately $620,000 on December 31, 2012. In June 2013, the FDIC refunded the remaining balance of $492,000.
 
In addition, all FDIC insured institutions are required to pay assessments to the FDIC at an annual rate of approximately one basis point of insured deposits to fund interest payments on bonds issued by the Financing Corporation, an agency of the federal government established to recapitalize the predecessor to the Savings Association Insurance Fund. These assessments will continue until the Financing Corporation bonds mature in 2017 through 2019.

CAPITAL REQUIREMENTS. The Company meets the eligibility criteria of a small bank holding company in accordance with the Federal Reserve's Small Bank Holding Company Policy Statement issued in February 2015, and is no longer obligated to report consolidated regulatory capital. The Bank continues to be subject to various capital requirements administered by banking agencies. Failure to meet minimum capital requirements can trigger certain mandatory and discretionary actions by regulators that could have a direct material effect on the Company's financial statements. Under capital adequacy guidelines that involve quantitative measures of their assets, liabilities, and certain off-balance sheet items as calculated under regulatory accounting practices. The Bank's capital amounts and classifications are also subject to qualitative judgments by regulators about components, risk weightings and other factors.

In July 2013, the Federal Reserve issued final rules that make technical changes to its capital rules to align them with the Basel III regulatory capital framework and meet certain requirements of the Dodd-Frank Act. The final rules maintain the general structure of the prompt corrective action framework in effect at such time while incorporating certain increased minimum requirements. The final rules modified or left unchanged the components of regulatory capital, which are: (i) "total capital", defined as core capital and supplementary capital less certain specified deductions from total capital such as reciprocal holdings of depository institution capital instruments and equity investments; (ii) "Tier 1 capital," which consists principally of common and certain qualifying preferred shareholders' equity (including grandfathered trust preferred securities) as well as retained earnings, less certain intangibles and other adjustments; and (iii) "Tier 2 capital", which consists of cumulative preferred stock, long-term perpetual preferred stock, a limited amount of subordinated and other qualifying debt (including certain hybrid capital instruments), and a limited amount of the general loan loss allowance.  The Federal Reserve also has established a minimum leverage capital ratio of Tier 1 capital to average adjusted assets ("Tier 1 leverage ratio").

Effective January 1, 2015, the final rules require the Bank to comply with the following minimum capital ratios: (i) a new common equity Tier 1 capital ratio of 4.5% of risk-weighted assets; (ii) a Tier 1 capital ratio of 6.0% of risk-weighted assets (increased from the prior requirement of 4.0%); (iii) a total capital ratio of 8.0% of risk-weighted assets (unchanged from the prior requirement); and (iv) a leverage ratio of 4.0% of total assets (unchanged from the prior requirement). These are the initial capital requirements, which will be phased in over a four-year period. When fully phased in on January 1, 2019, the rules will require the  Bank to maintain (i) a minimum ratio of common equity Tier 1 to risk-weighted assets of at least 4.5%, plus a 2.5% "capital conservation buffer" (which is added to the 4.5% common equity Tier 1 ratio as that buffer is phased in, effectively resulting in a minimum ratio of common equity Tier 1 to risk-weighted assets of at least 7.0% upon full implementation), (ii) a minimum ratio of Tier 1 capital to risk-weighted assets of at least 6.0%, plus the 2.5% capital conservation buffer (which is added to the 6.0% Tier 1 capital ratio as that buffer is phased in, effectively resulting in a minimum Tier 1 capital ratio of 8.5% upon full implementation), (iii) a minimum ratio of total capital to risk-weighted assets of at least 8.0%, plus the 2.5% capital conservation buffer (which is added to the 8.0% total capital ratio as that buffer is phased in, effectively resulting in a minimum total capital ratio of 10.5% upon full implementation), and (iv) a minimum leverage ratio of 4.0%, calculated as the ratio of Tier 1 capital to average assets.
6

Beginning January 1, 2016, the capital conservation buffer requirement will be phased in at 0.625% of risk-weighted assets, increasing by the same amount each year until fully implemented at 2.5% on January 1, 2019. The capital conservation buffer is designed to absorb losses during periods of economic stress. Banking institutions with a ratio of common equity Tier 1 to risk-weighted assets above the minimum but below the conservation buffer will face constraints on dividends, equity repurchases, and compensation based on the amount of the shortfall.

As of December 31, 2015, the Tier 1 and total capital to risk-weighted assets ratios of the Bank were 11.6% and 12.5%, respectively, thus exceeding the minimum requirements. The common equity Tier 1 capital ratio and leverage ratio of the Bank were 11.6% and 9.1%, respectively, as of December 31, 2015, well above the minimum requirements. Based on management's understanding and interpretation of the new capital rules, it believes that, as of December 31, 2015, the Company and the Bank would meet all capital adequacy requirements under such rules on a fully phased-in basis as if such requirements were in effect as of such date.
 
PROMPT CORRECTIVE ACTION. Federal banking regulators are authorized and, under certain circumstances, required to take certain actions against banks that fail to meet their capital requirements. The federal bank regulatory agencies have additional enforcement authority with respect to undercapitalized depository institutions. "Well capitalized" institutions may generally operate without supervisory restriction. With respect to "adequately capitalized" institutions, such banks cannot normally pay dividends or make any capital contributions that would leave it undercapitalized, they cannot pay a management fee to a controlling person if, after paying the fee, it would be undercapitalized, and they cannot accept, renew or roll over any brokered deposit unless the bank has applied for and been granted a waiver by the FDIC.

Immediately upon becoming "undercapitalized," a depository institution becomes subject to the provisions of Section 38 of the Federal Deposit Insurance Act, which: (i) restrict payment of capital distributions and management fees; (ii) require that the appropriate federal banking agency monitor the condition of the institution and its efforts to restore its capital; (iii) require submission of a capital restoration plan; (iv) restrict the growth of the institution's assets; and (v) require prior approval of certain expansion proposals. The appropriate federal banking agency for an undercapitalized institution also may take any number of discretionary supervisory actions if the agency determines that any of these actions is necessary to resolve the problems of the institution at the least possible long-term cost to the DIF, subject in certain cases to specified procedures. These discretionary supervisory actions include: (i) requiring the institution to raise additional capital; (ii) restricting transactions with affiliates; (iii) requiring divestiture of the institution or the sale of the institution to a willing purchaser; and (iv) any other supervisory action that the agency deems appropriate. These and additional mandatory and permissive supervisory actions may be taken with respect to significantly undercapitalized and critically undercapitalized institutions.

The new capital requirement rules issued by the Federal Reserve incorporated new requirements into the prompt corrective action framework, pursuant to Section 38 of the FDIA, by (i) introducing a common equity Tier 1 capital ratio requirement at each level (other than critically undercapitalized), with the required ratio being 6.5% for well capitalized status; (ii) increasing the minimum Tier 1 capital ratio requirement for each category, with the minimum ratio for well-capitalized status being 8.0% (as compared to the prior ratio of 6.0%); and (iii) eliminating the current provision that provides that a bank with a composite supervisory rating of 1 may have a 3.0% Tier 1 leverage ratio and still be well-capitalized. These new thresholds were effective for the Bank as of January 1, 2015. The minimum total capital to risk-weighted assets ratio (10.0%) and minimum leverage ratio (5.0%) for well-capitalized status were unchanged by the final rules. The Bank meets the definition of being "well capitalized" as of December 31, 2015.

The new capital requirements also include changes in the risk weights of assets to better reflect credit risk and other risk exposures. These include a 150% risk weight (up from 100%) for certain high volatility commercial real estate acquisition, development and construction loans and nonresidential mortgage loans that are 90 days past due or otherwise on nonaccrual status, a 20% (up from 0%) credit conversion factor for the unused portion of a commitment with an original maturity of one year or less that is not unconditionally cancellable, a 250% risk weight (up from 100%) for mortgage servicing rights and deferred tax assets that are not deducted from capital, and increased risk-weights (from 0% to up to 600%) for equity exposures.

SOURCE OF STRENGTH. Federal Reserve policy has historically required bank holding companies to act as a source of financial and managerial strength to their subsidiary banks. The Dodd-Frank Act codified this policy as a statutory requirement. Under this requirement, the Company is expected to commit resources to support the Bank, including at times when the Company may not be in a financial position to provide such resources. Any capital loans by a bank holding company to any of its subsidiary banks are subordinate in right of payment to depositors and to certain other indebtedness of such subsidiary banks. In the event of a bank holding company's bankruptcy, any commitment by the bank holding company to a federal bank regulatory agency to maintain the capital of a subsidiary bank will be assumed by the bankruptcy trustee and entitled to priority of payment.
 
FEDERAL HOME LOAN BANK OF ATLANTA. The Bank is a member of the FHLB of Atlanta, which is one of eleven regional FHLBs that provide funding to their members for making housing loans as well as loans for affordable housing and community development lending. Each FHLB serves as a reserve or central bank for its members within its assigned region. It is funded primarily from proceeds derived from the sale of consolidated obligations of the FHLB system. It makes loans to its members (i.e., advances) in accordance with policies and procedures established by the Board of Directors of the FHLB. As a member, the Bank is required to purchase and maintain stock in the FHLB in an amount equal to at least 5% of the aggregate outstanding advances made by the FHLB to the Bank. In addition, the Bank is required to pledge collateral for outstanding advances. The borrowing agreement with the FHLB of Atlanta provides for the pledge by the Bank of various forms of securities and mortgage loans as collateral.

7

USA PATRIOT ACT. The USA PATRIOT Act became effective on October 26, 2001 and provides for the facilitation of information sharing among governmental entities and financial institutions for the purpose of combating terrorism and money laundering. Among other provisions, the USA PATRIOT Act permits financial institutions, upon providing notice to the United States Treasury, to share information with one another in order to better identify and report to the federal government concerning activities that may involve money laundering or terrorists' activities. The USA PATRIOT Act is considered a significant banking law in terms of information disclosure regarding certain customer transactions. Certain provisions of the USA PATRIOT Act impose the obligation to establish anti-money laundering programs, including the development of a customer identification program, and the screening of all customers against any government lists of known or suspected terrorists. Although it does create a reporting obligation and a cost of compliance, the USA PATRIOT Act has not materially affected the Bank's products, services, or other business activities.
 
MORTGAGE BANKING REGULATION. The Bank's mortgage banking activities are subject to the rules and regulations of, and examination by the Department of Housing and Urban Development, the Federal Housing Administration, the Department of Veterans Affairs and state regulatory authorities with respect to originating, processing and selling mortgage loans. Those rules and regulations, among other things, establish standards for loan origination, prohibit discrimination, provide for inspections and appraisals of property, require credit reports on prospective borrowers and, in some cases, restrict certain loan features, and fix maximum interest rates and fees. In addition to other federal laws, mortgage origination activities are subject to the Equal Credit Opportunity Act, Truth-in-Lending Act, Home Mortgage Disclosure Act, Real Estate Settlement Procedures Act, and Home Ownership Equity Protection Act, and the regulations promulgated under these acts. These laws prohibit discrimination, require the disclosure of certain basic information to mortgagors concerning credit and settlement costs, limit payment for settlement services to the reasonable value of the services rendered and require the maintenance and disclosure of information regarding the disposition of mortgage applications based on race, gender, geographical distribution and income level.

CONSUMER LAWS AND REGULATIONS. The Bank is also subject to certain consumer laws and regulations that are designed to protect consumers in transactions with banks. While the list set forth herein is not exhaustive, these laws and regulations include the Truth-in-Lending Act, the Truth-in-Savings Act, the Electronic Funds Transfer Act, the Expedited Funds Availability Act, the Equal Credit Opportunity Act, the Fair Credit Reporting Act, and the Fair Housing Act, and regulations issued under such acts, among others. These laws and regulations mandate certain disclosure requirements and regulate the manner in which financial institutions must deal with customers when taking deposits, making loans to or engaging in other types of transactions with such customers.

The Dodd-Frank Act centralized responsibility for consumer financial protection by creating a new agency, the Consumer Financial Protection Bureau (the "CFPB"), and giving it responsibility for implementing, examining, and enforcing compliance with federal consumer protection laws. The CFPB focuses on (i) risks to consumers and compliance with the federal consumer financial laws, (ii) the markets in which firms operate and risks to consumers posed by activities in those markets, (iii) depository institutions that offer a wide variety of consumer financial products and services, and (iv) non-depository companies that offer one or more consumer financial products or services.

The CFPB has broad rulemaking authority for a wide range of consumer financial laws that apply to all banks, including, among other things, the authority to prohibit "unfair, deceptive or abusive" acts and practices. Abusive acts or practices are defined as those that materially interfere with a consumer's ability to understand a term or condition of a consumer financial product or service or take unreasonable advantage of a consumer's (i) lack of financial savvy, (ii) inability to protect himself in the selection or use of consumer financial products or services, or (iii) reasonable reliance on a covered entity to act in the consumer's interests. The CFPB can issue cease-and-desist orders against banks and other entities that violate consumer financial laws. The CFPB may also institute a civil action against an entity in violation of federal consumer financial law in order to impose a civil penalty or injunction.
 
LOANS TO INSIDERS. The Federal Reserve Act and related regulations impose specific restrictions on loans to directors, executive officers and principal shareholders of banks. Under Section 22(h) of the Federal Reserve Act, loans to a director, an executive officer and to a principal shareholder of a bank, and some affiliated entities of any of the foregoing, may not exceed, together with all other outstanding loans to such person and affiliated entities, the bank's loan-to-one borrower limit. Loans in the aggregate to insiders and their related interests as a class may not exceed the Bank's unimpaired capital and unimpaired surplus. Section 22(h) also prohibits loans, above amounts prescribed by the appropriate federal banking agency, to directors, executive officers and principal shareholders of a bank or bank holding company, and their respective affiliates, unless such loan is approved in advance by a majority of the board of directors of the bank with any "interested" director not participating in the voting. The FDIC has prescribed the loan amount, which includes all other outstanding loans to such person, as to which such prior board of director approval is required, as being the greater of $25,000 or 5% of capital and surplus (up to $500,000). Section 22(h) requires that loans to directors, executive officers and principal shareholders be made on terms and underwriting standards substantially the same as offered in comparable transactions to other persons.
8

VOLCKER RULE. The Dodd-Frank Act prohibits insured depository institutions and their holding companies from engaging in proprietary trading except in limited circumstances, and prohibits them from owning equity interests in excess of 3% of Tier 1 capital in private equity and hedge funds (known as the "Volcker Rule"). The Volcker Rule, which became effective in July 2015, does not significantly impact the operations of the Company or the Bank, as they do not have any significant engagement in the businesses prohibited by the Volcker Rule. The Company also has evaluated the implications of the Volcker Rule on its investments and does not expect any material financial implications.
 
Ability-to-Repay and Qualified Mortgage Rule. Pursuant to the Dodd-Frank Act, the CFPB issued a final rule effective January 10, 2014, amending Regulation Z as implemented by the Truth in Lending Act, requiring mortgage lenders to make a reasonable and good faith determination based on verified and documented information that a consumer applying for a mortgage loan has a reasonable ability to repay the loan according to its terms. Mortgage lenders are required to determine consumers' ability to repay in one of two ways. The first alternative requires the mortgage lender to consider the following eight underwriting factors when making the credit decision: (i) current or reasonably expected income or assets; (ii) current employment status; (iii) the monthly payment on the covered transaction; (iv) the monthly payment on any simultaneous loan; (v) the monthly payment for mortgage-related obligations; (vi) current debt obligations, alimony, and child support; (vii) the monthly debt-to-income ratio or residual income; and (viii) credit history. Alternatively, the mortgage lender can originate "qualified mortgages," which are entitled to a presumption that the creditor making the loan satisfied the ability-to-repay requirements. In general, a "qualified mortgage" is a mortgage loan without negative amortization, interest-only payments, balloon payments, or terms exceeding 30 years. In addition, to be a qualified mortgage the points and fees paid by a consumer cannot exceed 3% of the total loan amount. Qualified mortgages that are "higher-priced" (e.g. subprime loans) garner a rebuttable presumption of compliance with the ability-to-repay rules, while qualified mortgages that are not "higher-priced" (e.g. prime loans) are given a safe harbor of compliance. The Company is predominantly an originator of compliant qualified mortgages.
 
Cybersecurity.  In March 2015, federal regulators issued two related statements regarding cybersecurity.  One statement indicates that financial institutions should design multiple layers of security controls to establish lines of defense and to ensure that their risk management processes also address the risk posed by compromised customer credentials, including security measures to reliably authenticate customers accessing internet-based services of the financial institution. The other statement indicates that a financial institution's management is expected to maintain sufficient business continuity planning processes to ensure the rapid recovery, resumption and maintenance of the institution's operations after a cyber-attack involving destructive malware.  A financial institution is also expected to develop appropriate processes to enable recovery of data and business operations and address rebuilding network capabilities and restoring data if the institution or its critical service providers fall victim to this type of cyber-attack.  If the Company fails to observe the regulatory guidance, it could be subject to various regulatory sanctions, including financial penalties.  To date, the Company has not experienced a significant compromise, significant data loss or any material financial losses related to cybersecurity attacks, but its systems and those of its customers and third-party service providers are under constant threat and it is possible that the Company could experience a significant event in the future. Risks and exposures related to cybersecurity attacks are expected to remain high for the foreseeable future due to the rapidly evolving nature and sophistication of these threats, as well as due to the expanding use of Internet banking, mobile banking and other technology-based products and services by the Company and its customers.

INCENTIVE COMPENSATION. In June 2010, the federal bank regulatory agencies issued comprehensive final guidance on incentive compensation policies intended to ensure that the incentive compensation policies of financial institutions do not undermine the safety and soundness of such institutions by encouraging excessive risk-taking. The Interagency Guidance on Sound Incentive Compensation Policies, which covers all employees that have the ability to materially affect the risk profile of a financial institutions, either individually or as part of a group, is based upon the key principles that a financial institution's incentive compensation arrangements should (i) provide incentives that do not encourage risk-taking beyond the institution's ability to effectively identify and manage risks, (ii) be compatible with effective internal controls and risk management, and (iii) be supported by strong corporate governance, including active and effective oversight by the financial institution's board of directors.

The Federal Reserve will review, as part of the regular, risk-focused examination process, the incentive compensation arrangements of financial institutions, such as the Bank, that are not "large, complex banking organizations." These reviews will be tailored to each financial institution based on the scope and complexity of the institution's activities and the prevalence of incentive compensation arrangements. The findings of the supervisory initiatives will be included in reports of examination. Deficiencies will be incorporated into the institution's supervisory ratings, which can affect the institution's ability to make acquisitions and take other actions. Enforcement actions may be taken against a financial institution if its incentive compensation arrangements, or related risk-management control or governance processes, pose a risk to the institution's safety and soundness and the financial institution is not taking prompt and effective measures to correct the deficiencies. At December 31, 2015, the Company had not been made aware of any instances of non-compliance with the new guidance.

FUTURE REGULATORY UNCERTAINTY. Because federal regulation of financial institutions changes regularly and is the subject of constant legislative debate, the Company cannot forecast how federal regulation of financial institutions may change in the future and impact its operations. Although Congress in recent years has sought to reduce the regulatory burden on financial institutions with respect to the approval of specific transactions, the Company fully expects that the financial institution industry will remain heavily regulated in the near future and that additional laws or regulations may be adopted further regulating specific banking practices.
9


COMPETITION

The Company encounters strong competition both in making loans and in attracting deposits. In one or more aspects of its business, the Bank competes with other commercial banks, savings and loan associations, credit unions, finance companies, mutual funds, insurance companies, brokerage and investment banking companies, and other financial intermediaries. Most of these competitors, some of which are affiliated with bank holding companies, have substantially greater resources and lending limits, and may offer certain services that the Bank does not currently provide. In addition, many of the Bank's non-bank competitors are not subject to the same level of federal regulation that governs bank holding companies and federally insured banks. Recent federal and state legislation has heightened the competitive environment in which financial institutions must conduct their business, and the potential for competition among financial institutions of all types has increased significantly. To compete, the Bank relies upon specialized services, responsive handling of customer needs, and personal contacts by its officers, directors, and staff. Large multi-branch banking institutions tend to compete based primarily on price and the number and location of branches while smaller, independent financial institutions tend to compete primarily on price and personal service.
 
EMPLOYEES
 
As of December 31, 2015, the Company and the Bank employed 139 full-time employees and 9 part-time employees compared with 132 full-time and 13 part-time employees as of December 31, 2014. No employee is represented by a collective bargaining unit. The Company and the Bank consider relations with employees to be good.
 
AVAILABLE INFORMATION
 
The Company files annual, quarterly and current reports, proxy statements and other information with the SEC. The Company's SEC filings are filed electronically and are available to the public over the internet at the SEC's website at http://www.sec.gov. In addition, any document filed by the Company with the SEC can be read and copied at the SEC's public reference facilities at 100 F Street, N.E., Washington, D.C. 20549. Copies of documents can be obtained at prescribed rates by writing to the Public Reference Section of the SEC at 100 F Street, N.E., Washington, D.C. 20549. The public may obtain information on the operation of the public reference room by calling 1-800-SEC-0330. The Company's website is http://www.tfb.bank. The Company makes its SEC filings available through this website under "Investor Relations," "Documents" as soon as practicable after filing or furnishing the material to the SEC. Copies of documents can also be obtained free of charge by writing to Danielle Jenkins, Investor Relations, Fauquier Bankshares, Inc. at 10 Courthouse Square, Warrenton, Virginia 20186 or by calling 540-349-0209. The information on the Company's website is not incorporated into this report or any other filing the Company makes with the SEC.

The Company's transfer agent and registrar is American Stock Transfer & Trust Company, LLC and can be contacted by writing to 6201 15th Avenue, Brooklyn, New York 11209 or by phone 800-937-5449. Their website is www.amstock.com.

ITEM 1A. RISK FACTORS

Not applicable as the Company is a smaller reporting company under SEC rules.

ITEM 1B. UNRESOLVED STAFF COMMENTS

None.
10


ITEM 2. PROPERTIES

The Bank owns or leases property and operates branches at the following locations except as noted:
 
Location
 
Lease/Own
 
Rent (Annual)
   
Expiration
   
Renewal
 
Main Office *
P.O. Box 561
10 Courthouse Square
Warrenton, VA 20186
 
Own
   
N/
A
   
N/
A
   
N/
A
 
 
 
                       
Catlett Office
Rt. 28 and 806
Catlett, VA 20119
 
Own
   
N/
A
   
N/
A
   
N/
A
 
 
 
                       
Sudley Road Office
8091 Sudley Rd.
Manassas, VA 20109
 
Lease
 
$251,000 for 2016 to 2018;
$271,000 for 2019 to 2023;
$325,000 for 2024 to 2029
     
2029
   
None
 
 
 
 
                       
Old Town Office**
Center Street
Manassas, VA 20110
 
Lease
 
$20,000 for 2016
     
2016
   
One additional
option for 5 years
 
 
 
 
                       
New Baltimore Office
5119 Lee Highway
Warrenton, VA 20187
 
Own
   
N/
A
   
N/
A
   
N/
A
 
 
 
                       
The Plains Office
6464 Main Street
The Plains, VA 20198
 
Own
   
N/
A
   
N/
A
   
N/
A
 
 
 
                       
View Tree Property
87 Lee Highway
Warrenton, VA 20186
 
Own
   
N/
A
   
N/
A
   
N/
A
 
 
 
                       
Bealeton Office
US Rt. 17 & Station Dr.
Bealeton, VA 22712
 
Own
   
N/
A
   
N/
A
   
N/
A
 
 
 
                       
Haymarket Property
Market Square at Haymarket
Haymarket, VA 20169
 
Lease
 
$207,000 for 2016 and
increasing 3% annually
     
2029
   
Two additional options for 5 years each
 
 
 
 
                       
Bristow Property
Bristow Shopping Center
10250 Bristow Center Drive
Bristow, VA 20136
 
Lease
 
$207,000 for 2016 and
increasing 3% annually
     
2019
   
Two additional options for 5 years
 
                             
Gainesville Property
7485 Limestone Drive
Gainesville, VA 20155
 
Own
   
N/
A
   
N/
A
   
N/
A
                             
Centreville Road Property
8780 Centerville Road
Manassas, VA 20110
 
Own
   
N/
A
   
N/
A
   
N/
A
 
* The Bank and the Company occupy this location.
** No branch is operating at this location.

All of these properties are in good operating condition and are adequate for the Company's and the Bank's present and anticipated future needs. The Bank maintains comprehensive general liability and casualty loss insurance covering its properties and activities conducted in or about its properties. Management believes this insurance provides adequate protection for liabilities or losses that might arise out of the ownership and use of these properties.
11


ITEM 3. LEGAL PROCEEDINGS

In the ordinary course of operations, the Company and the Bank are parties to various legal proceedings.  There are no pending or threatened legal proceedings to which the Company or the Bank is a party or to which the property of either the Company or the Bank is subject that, in the opinion of management, may materially impact the financial condition of either entity.

ITEM 4. MINE SAFETY DISCLOSURES

Not applicable.

ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

The Company's common stock trades on the NASDAQ Capital Market of the NASDAQ Stock Market LLC ("NASDAQ") under the symbol "FBSS". As of March 9, 2016, there were 3,757,972 shares outstanding of the Company's common stock, which is the Company's only class of stock outstanding. These shares were held by approximately 341 holders of record. As of March 9, 2016, the closing market price of the Company's common stock was $15.86.

The following table sets forth the high and low sales prices as reported by NASDAQ for the Company's common stock and the amounts of the cash dividends paid for each full quarterly period within the two most recent fiscal years.

 
 
2015
   
2014
   
Dividends per share
 
 
 
High
   
Low
   
High
   
Low
   
2015
   
2014
 
1st Quarter
 
$
21.00
   
$
16.04
   
$
$15.98
   
$
13.54
   
$
0.12
   
$
0.12
 
 
                                               
2nd Quarter
 
$
17.99
   
$
15.68
   
$
$16.00
   
$
13.91
   
$
0.12
   
$
0.12
 
 
                                               
3rd Quarter
 
$
16.49
   
$
13.47
   
$
$17.00
   
$
$15.25
   
$
0.12
   
$
0.12
 
 
                                               
4th Quarter
 
$
15.90
   
$
14.05
   
$
$21.50
   
$
16.00
   
$
0.12
   
$
0.17
 

The Company's future dividend policy is subject to the discretion of the Board of Directors and will depend upon a number of factors, including future earnings, financial condition, cash and capital requirements, and general business conditions. The Company's ability to pay cash dividends will depend entirely upon the Bank's ability to pay dividends to the Company. Transfers of funds from the Bank to the Company in the form of loans, advances and cash dividends are restricted by federal and state regulatory authorities. As of December 31, 2015, the aggregate amount of unrestricted funds that could be transferred from the Bank to the Company without prior regulatory approval totaled $3.8 million.

On an annual basis, the Company's Board of Directors authorizes the number of shares of common stock that can be repurchased.  On January 21, 2016, the Board of Directors authorized the Company to repurchase up to 112,336 shares (3% of the shares of common stock outstanding on January 1, 2016) beginning January 1, 2016. No shares of common stock were repurchased during 2015.
12


ITEM 6. SELECTED FINANCIAL DATA

The selected consolidated financial data set forth below should be read in conjunction with "Management's Discussion and Analysis of Financial Condition and Results of Operation" and the consolidated financial statements and accompanying notes included elsewhere in this report. The historical results are not necessarily indicative of results to be expected for any future period.

Selected Financial Data
 
 
 
For the Year Ended December 31,
 
(Dollars in thousands)
 
2015
   
2014
   
2013
   
2012
   
2011
 
EARNINGS STATEMENT DATA:
 
   
   
   
   
 
Interest income
 
$
21,694
   
$
21,935
   
$
23,045
   
$
24,954
   
$
27,149
 
Interest expense
   
1,962
     
2,564
     
3,062
     
4,029
     
5,075
 
Net interest income
   
19,732
     
19,371
     
19,983
     
20,925
     
22,074
 
Provision for loan losses
   
8,000
     
-
     
1,800
     
5,807
     
1,933
 
Net interest income after provision for loan losses
   
11,732
     
19,371
     
18,183
     
15,118
     
20,141
 
Non-interest income
   
6,414
     
6,619
     
6,551
     
6,199
     
6,361
 
Securities gains (losses)
   
4
     
3
     
144
     
166
     
(87)
 
Non-interest expense
   
20,186
     
19,807
     
19,106
     
19,070
     
20,863
 
Income (loss) before income taxes
   
(2,036)
 
   
6,186
     
5,772
     
2,413
     
5,552
 
Income taxes
   
(1,424)
 
   
1,380
     
1,441
     
360
     
1,435
 
Net income (loss)
 
$
(612)
 
 
$
4,806
   
$
4,331
   
$
2,053
   
$
4,117
 
PER SHARE DATA:
                                       
Net income (loss) per share, basic
 
$
(0.16)
 
 
$
1.29
   
$
1.17
   
$
0.56
   
$
$1.12
 
Net income (loss) per share, diluted
 
$
(0.16)
 
 
$
1.28
   
$
13.16
   
$
0.55
   
$
$1.12
 
Cash dividends
 
$
0.48
   
$
0.53
   
$
0.48
   
$
0.48
   
$
0.48
 
Average basic shares outstanding
   
3,742,725
     
3,728,316
     
3,710,802
     
3,691,517
     
3,666,206
 
Average diluted shares outstanding
   
3,742,725
     
3,747,247
     
3,727,886
     
3,707,094
     
3,684,161
 
Book value at period end
 
$
14.06
   
$
14.78
   
$
13.80
   
$
12.92
   
$
12.92
 
 
                                       
BALANCE SHEET DATA:
                                       
Total assets
 
$
601,400
   
$
606,286
   
$
615,774
   
$
601,387
   
$
614,224
 
Loans, net
   
442,669
     
435,070
     
444,710
     
445,108
     
452,086
 
Investment securities, at fair value
   
56,510
     
58,700
     
55,033
     
50,429
     
50,193
 
Deposits
   
524,294
     
525,215
     
540,204
     
515,134
     
530,569
 
Shareholders' equity
   
52,633
     
55,157
     
51,227
     
47,748
     
47,571
 
 
                                       
PERFORMANCE RATIOS:
                                       
Net interest margin(1)
   
3.62
%
   
3.55
%
   
3.64
%
   
3.85
%
   
4.00
%
Return on average assets
   
(0.10
)%
   
0.80
%
   
0.72
%
   
0.35
%
   
0.69
%
Return on average equity
   
(1.09
)%
   
8.98
%
   
8.89
%
   
4.25
%
   
8.93
%
Dividend payout
   
(293.79
)%
   
41.16
%
   
41.15
%
   
86.41
%
   
42.78
%
Efficiency ratio(2)
   
75.50
%
   
74.96
%
   
70.72
%
   
68.98
%
   
72.05
%
 
                                       
ASSET QUALITY RATIOS:
                                       
Allowance for loan losses to period end loans
   
0.94
%
   
1.22
%
   
1.48
%
   
1.39
%
   
1.47
%
Allowance for loan losses to period end non-performing loans
   
226.77
%
   
439.36
%
   
305.27
%
   
58.76
%
   
145.61
%
Non-performing assets to period end total assets
   
0.53
%
   
0.43
%
   
1.23
%
   
2.06
%
   
1.10
%
Non-performing loans to period end loans
   
0.41
%
   
0.28
%
   
0.48
%
   
2.36
%
   
1.01
%
Net charge-offs to average loans
   
2.04
%
   
0.29
%
   
0.31
%
   
1.38
%
   
0.33
%
 
                                       
CAPITAL RATIOS:
                                       
Leverage
   
9.13
%
   
9.83
%
   
9.24
%
   
9.12
%
   
8.70
%
Common Equity Tier 1 Capital Ratio
   
11.64
%
 
NA
   
NA
   
NA
   
NA
 
Tier 1 Capital Ratio
   
11.64
%
   
14.05
%
   
13.28
%
   
12.52
%
   
12.05
%
Total Capital Ratio
   
12.53
%
   
15.30
%
   
14.54
%
   
13.78
%
   
13.31
%

(1)     Net interest margin is calculated as fully taxable equivalent net interest income divided by average earning assets and represents the Company's net yield on its earning assets.
(2)     Efficiency ratio is computed by dividing non-interest expense by the sum of fully taxable equivalent net interest income and fully taxable equivalent non-interest income. Gains and losses on the sale or impairment of securities are excluded from non-interest income in the calculation of this ratio.
13


ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATION

CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS

In addition to the historical information contained herein, this report contains forward-looking statements. Forward-looking statements are based on certain assumptions and describe future plans, strategies, and expectations of the Company and are generally identifiable by use of the words "believe," "expect," "intend," "anticipate," "estimate," "project" "may," "will" or similar expressions. Although we believe our plans, intentions and expectations reflected in these forward-looking statements are reasonable, we can give no assurance that these plans, intentions, or expectations will be achieved. Our ability to predict results or the actual effect of future plans or strategies is inherently uncertain, and actual results could differ materially from those contemplated. Factors that could have a material adverse effect on our operations and future prospects 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 Federal Reserve, the quality and composition of the Bank's loan or investment portfolios, the value of the collateral securing loans in the loan portfolio, demand for loan products, deposit flows, level of net charge-offs on loans and the adequacy of our allowance for loan losses, competition, demand for financial services in our market area, our plans to increase our market share, and accounting principles, policies and guidelines. These risks and uncertainties should be considered in evaluating forward-looking statements in this report and you should not place undue reliance on such statements, which reflect our position as of the date of this report.

CRITICAL ACCOUNTING POLICIES

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

ALLOWANCE FOR LOAN LOSSES. The allowance for loan losses is an estimate of the losses that may be sustained in our loan portfolio. The allowance is based on three basic principles of accounting: (i) Accounting Standards Codification ("ASC") 450 "Contingencies" which requires that losses be accrued when they are probable of occurring and estimable, (ii) ASC 310 "Receivables" which requires that losses be accrued based on the differences between the value of collateral, present value of future cash flows or values that are observable in the secondary market and the loan balance and (iii) SEC Staff Accounting Bulletin No. 102, "Selected Loan Loss Allowance Methodology and Documentation Issues," which requires adequate documentation to support the allowance for loan losses estimate.

The Company's allowance for loan losses has three basic components: the specific allowance, the general allowance and the unallocated component. Each of these components is determined based upon estimates that can and do change  as actual events occur. The specific allowance is used to individually allocate an allowance for larger balance and/or non-homogeneous loans identified as impaired. The specific allowance uses various techniques to arrive at an estimate of loss. Analysis of the borrower's overall financial condition, resources and payment record, the prospects for support and financial guarantors, and the fair market value of collateral are used to estimate the probability and severity of inherent losses. The general allowance is used for estimating the loss on pools of smaller-balance, homogeneous loans; including 1-4 family mortgage loans, installment loans and other consumer loans. Also, the general allowance is used for the remaining pool of larger balance and/or non-homogeneous loans which were not identified as impaired. The general allowance begins with estimates of probable losses inherent in the homogeneous portfolio based upon various statistical analyses. These include analysis of historical delinquency and credit loss experience, together with analyses that reflect current trends and conditions. The Company also considers trends and changes in the volume and term of loans, changes in the credit process and/or lending policies and procedures, and an evaluation of overall credit quality. The general allowance uses a historical loss view as an indicator of future losses. As a result, even though this history is regularly updated with the most recent loss information, it could differ from the loss incurred in the future. The general allowance also captures losses that are attributable to various economic events, industry or geographic sectors whose impact on the portfolio have occurred but have yet to be recognized.  The unallocated component of the allowance reflects the margin of imprecision inherent in the underlying assumptions used in the methodologies for estimating specific and general losses in the portfolio.
 
14


Specifically, the Company uses both external and internal qualitative factors when determining the non-loan-specific allowances. The external factors utilized include: unemployment in the Company's defined market area of Fauquier County, Prince William County, and the City of Manassas ("market area"), as well as state and national unemployment trends; new residential construction permits for the market area; bankruptcy statistics for the Virginia Eastern District and trends for the United States; and foreclosure statistics for the market area and the state. Quarterly, these external qualitative factors, as well as relevant anecdotal information, are evaluated from data compiled from local periodicals such as The Washington Post, The Fauquier Times, and The Bull Run Observer, which cover the Company's market area. Additionally, data is gathered from the Federal Reserve Beige Book for the Richmond Federal Reserve District, Global Insight's monthly economic review, the George Mason School of Public Policy Center for Regional Analysis, and daily economic updates from various other sources. Internal Bank data utilized includes: past due loan aging statistics, non-performing loan trends, trends in collateral values, loan concentrations, loan review status downgrade trends, and lender turnover and experience trends. Both external and internal data is analyzed on a rolling eight quarter basis to determine risk profiles for each qualitative factor. Ratings are assigned through a defined matrix to calculate the allowance consistent with authoritative accounting literature. A narrative summary of the reserve allowance is produced quarterly and reported directly to the Company's Board of Directors. The Company's application of these qualitative factors to the allowance for loan losses has been consistent over the reporting period.

The Company employs an independent outsourced loan review function, which annually substantiates and/or adjusts internally generated risk ratings. This independent review is reported directly to the Company's Board of Directors' audit committee, and the results of this review are factored into the calculation of the allowance for loan losses.
 
INTEREST RATE SWAP AGREEMENTS USED FOR INTEREST RATE RISK MANAGEMENT. Interest rate swaps are recorded at fair value on a recurring, no less than quarterly, basis.  The Company utilizes an interest rate swap agreement as part of the management of interest rate risk to modify the repricing characteristics of certain portions of the Company's interest-bearing assets and liabilities.  The Company has contracted with a third party vendor to provide valuations for interest rate swaps using standard swap valuation techniques.  The Company has considered counterparty credit risk in the valuation of its interest rate swap assets and has considered its own credit risk in the valuation of its interest rate swap liabilities.
 
INCOME TAXES AND DEFERRED INCOME TAX ASSETS AND LIABILITIES. Deferred income tax assets and liabilities are determined using the balance sheet method.  Under this method, the net deferred tax asset or liability is determined based on the tax effects of the temporary differences between the book and tax bases of the various balance sheet assets and liabilities and gives current recognition to changes in tax rates and laws. When tax returns are filed, it is highly certain that some positions taken would be sustained upon examination by the taxing authorities, while others are subject to uncertainty about the merits of the position taken or the amount of the position that would be ultimately sustained.  The benefit of a tax position is recognized in the financial statements in the period during which, based on all available evidence, management believes it is more likely than not that the position will be sustained upon examination, including the resolution of appeals or litigation processes, if any.  Tax positions taken are not offset or aggregated with other positions.  Tax positions that meet the more-likely-than-not recognition threshold are measured as the largest amount of tax benefit that is more than 50 percent likely of being realized upon settlement with the applicable taxing authority.  The portion of the benefits associated with tax positions taken that exceeds the amount measured as described above is reflected as a liability for unrecognized tax benefits in the accompanying balance sheet along with any associated interest and penalties that would be payable to the taxing authorities upon examination.  There were no unrecognized tax benefits recorded as a liability as of December 31, 2015 and 2014. Interest and penalties associated with unrecognized tax benefits are classified as additional income taxes in the statement of income. The Company has no uncertain tax positions.

EXECUTIVE OVERVIEW

This discussion is intended to focus on certain financial information regarding the Company and the Bank and may not contain all the information that is important to the reader. The purpose of this discussion is to provide the reader with a more thorough understanding of our financial statements. As such, this discussion should be read carefully in conjunction with the consolidated financial statements and accompanying notes contained elsewhere in this report.

The Bank is the primary independent community bank in its immediate market area as measured by deposit market share. It seeks to be the primary financial service provider for its market area by providing the right mix of consistently high quality customer service, efficient technological support, value-added products, and a strong commitment to the community.

The Company had a net loss of $612,000 in 2015 compared with net income of $4.81 million for 2014. The net loss for 2015 was primarily due to an $8.5 million charge-off on an $8.5 million commercial loan relationship. See Management's Discussion and Analysis of Financial Condition and Results of Operations "Provision for Loan Losses, Allowance for Loan Losses and Asset Quality" for further discussion. The year to year decrease in net income was primarily due to an $8.0 million increase in the provision for loan losses, partially offset by a $361,000 increase in net interest income. The $8.0 million increase in the provision for loan losses from 2014 to 2015 reflects an $8.5 million  charge-off on an $8.5 million commercial and industrial loan relationship, made up of five loans with one borrower. The Company and the Bank's primary operating businesses are in commercial and retail lending, core deposit account relationships, and assets under WMS management. Loans, net of reserve, were $442.7 million at year-end 2015 and $435.1 million year-end 2014, an increase of 1.7 %, compared with a decrease of 2.2% from year-end 2013 to year-end 2014. Deposits decreased 0.2% from year-end 2014 to year-end 2015 compared with a decrease of 2.8% from year-end 2013 to year-end 2014. The market value of assets under WMS management decreased 19.6% from year-end 2014 to year-end 2015, and increased 11.5% from year-end 2013 to year-end 2014. The changes in assets under WMS management reflect both the changes in the U.S. stock market, as well as the net decrease in WMS customer relationships. Assets under WMS management are not reflected in the Company's consolidated balance sheets.
15


 
Net interest income is the largest component of net income, and equals the difference between income generated on interest-earning assets and interest expense incurred on interest-bearing liabilities. Future trends regarding net interest income are dependent on the absolute level of market interest rates, the shape of the yield curve, the amount of lost income from non-performing assets, the amount of prepaying loans, the mix and amount of various deposit types, and many other factors, as well as the overall volume of interest-earning assets. Many of these factors are individually difficult to predict, and when taken together, the uncertainty of future trends compounds. Based on management's current projections, net interest income may increase in 2016 with the growth of average loans, but this may be offset in part or in whole by a possible contraction in the Bank's net interest margin resulting from the prolonged historically low levels in market interest rates. The Bank is also subject to a decline in net interest income due to competitive market conditions and/or a flat or inverted yield curve. A steeper yield curve is projected to result in an increase in net interest income, while a flatter or inverted yield curve is projected to result in a decrease in net interest income.

The Bank's non-performing assets totaled $3.2 million or 0.53% of total assets at December 31, 2015, as compared with $2.6 million or 0.43% of total assets at December 31, 2014. There was an $8.0 million provision for loan losses for 2015 compared with no provision for 2014. Loan chargeoffs, net of recoveries, totaled $9.2 million or 2.04% of total average loans for 2015, compared with $1.3 million or 0.29% of total average loans for 2014.

The following table presents a quarterly summary of earnings for the last two years.

Earnings

 
 
Three Months Ended 2015
   
Three Months Ended 2014
 
(Dollars in thousands, except per share data)
 
Dec. 31
   
Sep. 30
   
June 30
   
Mar. 31
   
Dec. 31
   
Sep. 30
   
June 30
   
Mar. 31
 
Interest income
 
$
5,436
   
$
5,460
   
$
5,425
   
$
5,373
   
$
5,422
   
$
5,526
   
$
5,479
   
$
5,508
 
Interest expense
   
438
     
448
     
516
     
560
     
621
     
635
     
657
     
651
 
Net interest income
   
4,998
     
5,012
     
4,909
     
4,813
     
4,801
     
4,891
     
4,822
     
4,857
 
Provision for loan losses
   
7,800
     
100
     
100
     
-
     
-
     
-
     
-
     
-
 
Net interest income after provision for loan losses
   
(2,802)
 
   
4,912
     
4,809
     
4,813
     
4,801
     
4,891
     
4,822
     
4,857
 
Other income
   
1,562
     
1,881
     
1,695
     
1,276
     
1,569
     
1,930
     
1,698
     
1,422
 
Securities gains
   
1
     
3
     
-
     
-
     
3
     
-
     
-
     
-
 
Other expense
   
4,609
     
5,212
     
5,150
     
5,215
     
4,952
     
5,021
     
4,851
     
4,983
 
Income before income taxes
   
(5,848)
 
   
1,584
     
1,354
     
874
     
1,421
     
1,800
     
1,669
     
1,296
 
Income tax (benefit) expense
   
(2,098)
 
   
238
     
305
     
131
     
269
     
378
     
430
     
303
 
Net income
 
$
(3,750)
 
 
$
1,346
   
$
1,049
   
$
743
   
$
1,152
   
$
1,422
   
$
1,239
   
$
993
 
 
                                                               
Net income per share, basic
 
$
(1.00)
 
 
$
0.36
   
$
$0.28
   
$
$0.20
   
$
0.31
   
$
0.38
   
$
0.33
   
$
0.27
 
 
                                                               
Net income per share, diluted
 
$
(1.00)
 
 
$
0.36
   
$
$0.28
   
$
$0.20
   
$
0.30
   
$
0.38
   
$
0.33
   
$
0.27
 

2015 COMPARED WITH 2014
The Company had a net loss of $612,000  in 2015 compared with net income of $4.81 million for 2014. Net loss per share on a fully diluted basis was $0.16 in 2015 compared with net earnings per share of $1.28 on a fully diluted basis in 2014. Profitability as measured by return on average equity decreased from 8.98% in 2014 to (1.09)% in 2015. Profitability as measured by return on average assets decreased from 0.80% in 2014 to (0.10)% in 2015. The year to year decrease in net income was primarily due to a $8.0 million increase in the provision for loan losses, partially offset by a $361,000 increase in net interest income. The $8.0 million increase in the provision for loan losses from 2014 to 2015 reflects an $8.5 million charge-off of an $8.5 million commercial and industrial loan relationship, made up of five loans with one borrower. See Management's Discussion and Analysis of Financial Condition and Results of Operations "Provision for Loan Losses, Allowance for Loan Losses and Asset Quality" for further discussion.

2014 COMPARED WITH 2013
Net income of $4.81 million in 2014 was an 11.0 % increase from 2013 net income of $4.33 million. Earnings per share on a fully diluted basis were $1.28 in 2014 compared with $1.16 in 2013. Profitability as measured by return on average equity increased from 8.89% in 2013 to 8.98% in 2014. Profitability as measured by return on average assets increased from 0.72% in 2013 to 0.80% in 2014. The year to year increase in net income was primarily due to a $1.80 million decrease in the provision for loan losses.
16


 
NET INTEREST INCOME AND EXPENSE

2015 COMPARED WITH 2014
Net interest income increased $361,000 or 1.9% to $19.73 million for the year ended December 31, 2015 from $19.37 million for the year ended December 31, 2014.  The increase in net interest income was due to the impact of the average loan portfolio increasing from $442.8 million in 2014 to $451.8 million in 2015, partially offset by the decline on the rate earned on loans over the same period from 4.60% to 4.48%. This led to the Company's net interest margin increasing from 3.55% in 2014 to 3.62% in 2015.  Total average earning assets decreased from $552.5 million in 2014 to $550.9 million in 2015. The percentage of average earning assets to total assets decreased from 92.4% in 2014 to 92.1% in 2015.

Total interest income decreased $241,000 or 1.1% to $21.69 million in 2015 from $21.94 million in 2014. This decrease was due to the four basis point decrease in the average yield on assets, as well as the decrease in total average earning assets of $1.5 million or 0.3%, from 2014 to 2015. The yield on earning assets declined from 4.02% in 2014 to 3.98% in 2015 due to the decline in market interest rates in the economy at large over the last six years.

Average total loan balances increased $9.0 million or 2.0% from $442.8 million in 2014 to $451.8 million in 2015. The tax-equivalent average yield on loans decreased to 4.48% in 2015 compared with 4.60% in 2014. Together, this resulted in a $139,000 decrease in interest and fee income from loans for 2015 compared with 2014. On a tax-equivalent basis, the year-to-year decrease in interest and fee income on loans was $165,000.

Average investment security balances increased $913,000 from $56.8 million in 2014 to $57.7 million in 2015. The tax-equivalent average yield on investments decreased from 2.90% in 2014 to 2.71% in 2015. Together interest and dividend income on security investments decreased $83,000 from 2014 to 2015 on a tax-equivalent basis.

Interest income on deposits at other banks decreased from $171,000 in 2014 to $139,000 in 2015 due to the decrease in average balances from $52.9 million in 2014 to $41.5 million in 2015.

Total interest expense decreased $602,000 or 23.5% from $2.56 million in 2014 to $1.96 million in 2015, primarily due to the replacement of more costly time deposits with less expensive demand deposit accounts, NOW accounts, and savings deposits. Interest paid on deposits decreased $608,000 or 29.8% from $2.04 million in 2014 to $1.43 million in 2015. Average NOW deposit balances increased $4.9 million from 2014 to 2015 while the average rate on NOW accounts decreased from 0.22% during 2014 to 0.21% during 2015, resulting in $2,000 less interest expense in 2015.  Average money market account deposit balances increased $2.8 million from 2014 to 2015, and the average rate on money market account deposits remained at 0.21% for both respective years, resulting in $8,000 more interest expense in 2015.  Average savings account deposit balances increased $6.7 million from 2014 to 2015 while the average rate on savings account deposits decreased from 0.11% to 0.10%, resulting in $5,000 more interest expense in 2015.  Average time deposit balances decreased $25.7 million from 2014 to 2015 while the average rate on time deposits decreased from 1.44% to 1.10%, resulting in a decrease of $619,000 in interest expense from 2014 to 2015.

Interest expense on FHLB of Atlanta advances decreased $2,000 from 2014 to 2015 due to a $66,000  decrease in average balances over the same time periods.  The interest expense on trust preferred capital securities were $199,000 for both 2014 and 2015. The average rate on total interest-bearing liabilities decreased from 0.57% in 2014 to 0.45% in 2015.
17


 
2014 COMPARED WITH 2013
Net interest income decreased $612,000 or 3.1% to $19.37 million for the year ended December 31, 2014 from $19.98 million for the year ended December 31, 2013.  The decrease in net interest income was due to the impact of the higher yielding average loan portfolio decreasing from $450.9 million in 2013 to $442.8 million in 2014, as well as the decline on the rate earned on loans over the same period from 4.83% to 4.60%. This led to the Company's net interest margin decreasing from 3.64% in 2013 to 3.55% in 2014.  Total average earning assets decreased from $557.3 million in 2013 to $552.5 million in 2014. The percentage of average earning assets to total assets decreased from 93.2% in 2013 to 92.4% in 2014.

Total interest income decreased $1.11 million or 4.8% to $21.94 million in 2014 from $23.05 million in 2013. This decrease was due to the 17 basis point decrease in the average yield on assets, as well as the decrease in total average earning assets of $4.9 million or 0.9%, from 2013 to 2014. The yield on earning assets declined from 4.19% in 2013 to 4.02% in 2014 due to the decline in market interest rates in the economy at large over the last five years.

Average total loan balances decreased $8.1 million or 1.8% from $450.9 million in 2013 to $442.8 million in 2014. The tax-equivalent average yield on loans decreased to 4.60% in 2014 compared with 4.83% in 2013. Together, this resulted in a $1.39 million decrease in interest and fee income from loans for 2014 compared with 2013. On a tax-equivalent basis, the year-to-year decrease in interest and fee income on loans was $1.40 million.

Average investment security balances increased $6.2 million from $50.5 million in 2013 to $56.8 million in 2014. The tax-equivalent average yield on investments increased from 2.70% in 2013 to 2.90% in 2014. Together, interest and dividend income on security investments increased $276,000 from 2013 to 2014.

Interest income on deposits at other banks increased from $169,000 in 2013 to $171,000 in 2014 due to the increase in the average interest rates paid on these deposits from 0.30% in 2013 to 0.32% in 2014.

Total interest expense decreased $498,000 or 16.3% from $3.06 million in 2013 to $2.56 million in 2014, primarily due to the replacement of more costly time deposits and FHLB of Atlanta advances with less expensive demand deposit accounts, NOW accounts, and savings deposits. Interest paid on deposits decreased $219,000 or 9.7% from $2.26 million in 2013 to $ 2.04 million in 2014. Average NOW deposit balances increased $11.6 million from 2013 to 2014 while the average rate on NOW accounts remained at 0.22% for both years, resulting in $14,000 more interest expense in 2014.  Average money market account deposit balances increased $6.2 million from 2013 to 2014 while the average rate on money market account deposits increased from 0.18% to 0.21%, resulting in $25,000 more interest expense in 2014.  Average savings account deposit balances increased $3.1 million from 2013 to 2014 while the average rate on savings account deposits decreased from 0.12% to 0.11%, resulting in $10,000 less interest expense in 2014.  Average time deposit balances decreased $22.3 million from 2013 to 2014 while the average rate on time deposits increased from 1.38% to 1.44%, resulting in a decrease of $248,000 in interest expense from 2013 to 2014.

Interest expense on FHLB of Atlanta advances decreased $279,000 from 2013 to 2014 due to the decrease on the average rate paid from 3.12% in 2013 to 2.49% in 2014, as well as a $6.3 million decrease in average balances over the same time periods.  The interest expense on trust preferred capital securities remained at $199,000 for both 2013 to 2014. The average on total interest-bearing liabilities decreased from 0.67% in 2013 to 0.57% in 2014.
18


 
The following table sets forth information relating to the Company's average balance sheet and reflects the average yield on assets and average cost of liabilities for the periods indicated and the average yields and rates paid for the periods indicated. These yields and costs are derived by dividing income or expense by the average daily balances of assets and liabilities, respectively, for the periods presented.

Average Balances, Income and Expenses, and Average Yields and Rates

(Dollars in thousands)
 
12 Months Ended
December 31, 2015
     
12 Months Ended
December 31, 2014
     
12 Months Ended
December 31, 2013
 
Assets
 
Average
Balances
   
Income/
Expense
   
Average
Rate
     
Average
Balances
   
Income/
Expense
   
Average
Rate
     
Average
Balances
   
Income/
Expense
   
Average
Rate
 
Loans
 
   
   
     
   
   
     
   
   
 
Taxable
 
$
443,303
   
$
19,884
     
4.49
%
   
$
434,111
   
$
19,973
     
4.60
%
   
$
435,962
   
$
21,337
     
4.89
%
Tax-exempt (1)
   
6,007
     
338
     
5.63
%
     
6,527
     
414
     
6.34
%
     
7,147
     
454
     
6.35
%
Non-accrual (2)
   
2,457
     
-
               
2,125
     
-
               
7,785
     
-
         
Total Loans
   
451,767
     
20,222
     
4.48
%
     
442,763
     
20,387
     
4.60
%
     
450,894
     
21,791
     
4.83
%
 
                                                                           
Securities
                                                                           
Taxable
   
51,722
     
1,230
     
2.38
%
     
50,177
     
1,276
     
2.54
%
     
43,855
     
995
     
2.27
%
Tax-exempt (1)
   
5,946
     
331
     
5.57
%
     
6,578
     
368
     
5.60
%
     
6,687
     
373
     
5.57
%
Total securities
   
57,668
     
1,561
     
2.71
%
     
56,755
     
1,644
     
2.90
%
     
50,542
     
1,368
     
2.70
%
 
                                                                           
Deposits in banks
   
41,480
     
139
     
0.34
%
     
52,931
     
171
     
0.32
%
     
55,865
     
169
     
0.30
%
Federal funds sold
   
9
     
-
     
0.17
%
     
11
     
-
     
0.20
%
     
10
     
-
     
0.15
%
Total earning assets
 
$
550,924
   
$
21,922
     
3.98
%
   
$
552,460
   
$
22,202
     
4.02
%
   
$
557,311
   
$
23,328
     
4.19
%
 
                                                                           
Less: Reserve for loan losses
   
(5,730
)
                     
(6,862
)
                     
(6,618
)
               
Cash and due from banks
   
5,308
                       
5,123
                       
5,105
                 
Bank premises and equipment, net
   
20,807
                       
19,954
                       
14,928
                 
Other real estate owned
   
1,516
                       
1,961
                       
1,413
                 
Other assets
   
25,536
                       
25,214
                       
25,800
                 
Total Assets
 
$
598,361
                     
$
597,850
                     
$
597,939
                 
 
                                                                           
Liabilities & Shareholders' Equity
                                                                           
Deposits
                                                                           
Demand deposits
 
$
96,538
                     
$
89,240
                     
$
87,390
                 
 
                                                                           
Interest-bearing deposits
                                                                           
NOW accounts
   
211,273
   
$
443
     
0.21
%
     
206,343
   
$
445
     
0.22
%
     
194,746
   
$
431
     
0.22
%
Money market accounts
   
52,787
     
112
     
0.21
%
     
50,027
     
104
     
0.21
%
     
43,799
     
79
     
0.18
%
Savings accounts
   
82,626
     
85
     
0.10
%
     
75,908
     
80
     
0.11
%
     
72,818
     
90
     
0.12
%
Time deposits
   
72,056
     
790
     
1.10
%
     
97,786
     
1,409
     
1.44
%
     
120,065
     
1,657
     
1.38
%
Total interest-bearing deposits
   
418,742
     
1,430
     
0.34
%
     
430,064
     
2,038
     
0.47
%
     
431,428
     
2,257
     
0.52
%
 
                                                                           
 
                                                                           
Federal  funds purchased
   
1,415
     
8
     
0.53
%
     
2
     
-
     
0.79
%
     
2
     
-
     
0.82
%
Federal Home Loan Bank advances
   
13,041
     
325
     
2.49
%
     
13,107
     
327
     
2.49
%
     
19,444
     
606
     
3.12
%
Capital securities of subsidiary trust
   
4,124
     
199
     
4.83
%
     
4,124
     
199
     
4.83
%
     
4,124
     
199
     
4.83
%
Total interest-bearing liabilities
   
437,322
     
1,962
     
0.45
%
     
447,297
     
2,564
     
0.57
%
     
454,998
     
3,062
     
0.67
%
 
                                                                           
Other liabilities
   
8,543
                       
7,796
                       
6,826
                 
Shareholders'  equity
   
55,958
                       
53,517
                       
48,725
                 
 
                                                                           
Total Liabilities & Shareholders' Equity
 
$
598,361
                     
$
597,850
                     
$
597,939
                 
 
                                                                           
Net interest income (tax equivalent basis)
           
19,960
     
3.53
%
             
19,638
     
3.45
%
             
20,266
     
3.51
%
Less: tax equivalent adjustment
           
228
                       
267
                       
283
         
Net interest income
         
$
19,732
                     
$
19,371
                     
$
19,983
         
 
                                                                           
Interest expense as a percent of average earning assets
                   
0.36
%
                     
0.46
%
                     
0.55
%
Net interest margin
                   
3.62
%
                     
3.55
%
                     
3.64
%
 
                                                                                                                                                                                                      
(1)  Income and rates on non-taxable assets are computed on a tax equivalent basis using a federal tax rate of 34%.
(2)  Loans are included in the average balance of total loans and total earning assets.
19


 
RATE/VOLUME ANALYSIS
 
The following table sets forth certain information regarding changes in interest income and interest expense of the Company for the periods indicated. For each category of interest-earning asset and interest-bearing liability, information is provided on changes attributable to changes in volume (change in volume multiplied by old rate); and changes in rates (change in rate multiplied by old volume). Changes in rate-volume, which cannot be separately identified, are allocated proportionately between changes in rate and changes in volume.

Rate / Volume Variance
 
 
 
2015 Compared to 2014
   
2014 Compared to 2013
 
(In thousands)
 
Change
   
Due to
Volume
   
Due to
Rate
   
Change
   
Due to
Volume
   
Due to
Rate
 
Interest Income
 
   
   
   
   
   
 
Loans; taxable
 
$
(89
)
 
$
423
   
$
(512
)
 
$
(1,364
)
 
$
(90
)
 
$
(1,274
)
Loans; tax-exempt (1)
   
(76
)
   
(33
)
   
(43
)
   
(40
)
   
(39
)
   
(1
)
Securities; taxable
   
(46
)
   
39
     
(85
)
   
281
     
143
     
138
 
Securities; tax-exempt (1)
   
(37
)
   
(36
)
   
(1
)
   
(5
)
   
(7
)
   
2
 
Deposits in banks
   
(32
)
   
(37
)
   
5
     
2
     
(9
)
   
11
 
Federal funds sold
   
-
     
-
     
-
     
-
     
-
     
-
 
Total Interest Income
   
(280
)
   
356
     
(636
)
   
(1,126
)
   
(2
)
   
(1,124
)
 
                                               
Interest Expense
                                               
Checking accounts
   
(2
)
   
11
     
(13
)
   
14
     
25
     
(11
)
Money market accounts
   
8
     
6
     
2
     
25
     
12
     
13
 
Savings accounts
   
5
     
7
     
(2
)
   
(10
)
   
4
     
(14
)
Time deposits
   
(619
)
   
(370
)
   
(249
)
   
(248
)
   
(307
)
   
59
 
Federal funds purchased and securities sold under agreements to repurchase
   
8
     
-
     
8
     
-
     
-
     
-
 
Federal Home Loan Bank advances
   
(2
)
   
(2
)
   
-
     
(279
)
   
(197
)
   
(82
)
Capital securities of subsidiary trust
   
-
     
-
     
-
     
-
     
-
     
-
 
Total Interest Expense
   
(602
)
   
(348
)
   
(254
)
   
(498
)
   
(463
)
   
(35
)
Net Interest Income
 
$
322
   
$
704
   
$
(382
)
 
$
(628
)
 
$
461
   
$
(1,089
)
 
                                                                                                                                                                                      
(1)  Income and rates on non-taxable assets are computed on a tax equivalent basis using a federal tax rate of 34%.
20


 
PROVISION FOR LOAN LOSSES, ALLOWANCE FOR LOAN LOSSES, AND ASSET QUALITY

There was an $8.0 million provision for loan losses during 2015. There was no provision for loan losses for 2014, and $1.80 million was provided for 2013. The amount of the provision for loan loss for 2015, 2014, and 2013 was based upon management's continual evaluation of the adequacy of the allowance for loan losses, which encompasses the overall risk characteristics of the loan portfolio, trends in the Bank's delinquent and non-performing loans, estimated values of collateral, and the impact of economic conditions on borrowers. The loss history by loan category, prolonged changes in portfolio delinquency trends by loan category, and changes in economic trends are also utilized in the determining the allowance. There can be no assurances, however, that future losses will not exceed estimated amounts, or that increased amounts of provisions for loan losses will not be required in future periods.

The $8.0 million increase in the provision for loan losses from 2014 to 2015 reflects an $8.5 million charge-off on an $8.5 million commercial and industrial  loan relationship, made up of five loans with one borrower. Based on a third-party field audit retained by the Bank and received on November 18, 2015, the audit indicated potential evidence of a sophisticated loan scheme by the borrower, orchestrated to deceive and avoid attention of the Bank through the falsification of financial documents and other false statements. As stated in the November 20, 2015 Form 8-K filing with the SEC, the Company recognized an impairment charge of $5.5 million based on a best efforts estimation of value of collateral with respect to the loan relationship, including inventory, receivables and equipment at that time. The loss on the five loans was increased to a total of $8.5 million for the quarter ending December 31, 2015 based on all relevant information at that time. Negotiations are in process for the sale of the assets of the borrower. Any future receipt of sale proceeds will be recognized as a loan recovery in the quarter when received.
The ratio of allowance for loan losses as a percentage of total loans declined from 1.22% in 2014 to 0.94% in 2015, and the ratio of allowance for loan losses as a percentage of non-performing loans declined from 439% to 227% over the same time period. During 2015, one loan relationship, which totaled $1.5 million at December 31, 2015, of which $1.2 million has a 100% U.S. Government guarantee, was added to non-performing loans. Net of this government guaranteed portion, non-performing loans declined from $1.2 million at December 31, 2014 to $337,000 at December 31, 2015, and the ratio of allowance for loan losses as a percentage of non-performing loans, net of the government guarantee, would be 1244% at that date. In, addition, restructured loans still accruing declined from $7.4 million at December 31, 2014 to $5.5 million at December 31, 2015. Both the decline in non-performing loans, net of  the 100% U.S. Government guarantee portion, and the decline in restructured loans still accruing were the major factors in the year-end 2014 to year-end 2015 decline in the allowance for loan losses.
The $1.8 million decrease in the provision for loan losses from 2013 to 2014 was largely in response to the $115,000 decrease in net loan charge-offs in 2014 from 2013. Additional factors contributing to the decline in the provision for loan losses from 2013 through 2014 include the decline in non-accrual loans from $2.2 million to $1.2 million, the decline in impaired loans from $10.8 million to $8.8 million, and the decline in substandard loans from $31.4 million to $25.1 million over the same respective time period.
LOAN PORTFOLIO
 
At December 31, 2015, 2014, and 2013, net loans accounted for 73.6%, 71.8%, and 72.2% of total assets, respectively, and were the largest category of the Company's earning assets. Loans are shown on the balance sheets net of unearned discounts and the allowance for loan losses. Interest is computed by methods that result in level rates of return on principal. Loans are charged-off when deemed by management to be uncollectible, after taking into consideration such factors as the current financial condition of the customer and the underlying collateral and guarantees.

Authoritative accounting guidance requires that the impairment of loans that have been separately identified as impaired is to be measured based on the present value of expected future cash flows or, alternatively, the observable market price of the loans or the fair value of the collateral. However, for those loans that are collateral dependent (that is, if repayment of those loans is expected to be provided solely by the underlying collateral) and for which management has determined foreclosure is probable, the measure of impairment is to be based on the net realizable value of the collateral. The guidance also requires certain disclosures about investments in impaired loans and the allowance for loan losses and interest income recognized on loans.

A loan is considered impaired when there is an identified weakness that makes it probable that the Bank will not be able to collect all principal and interest amounts according to the contractual terms of the loan agreement. Factors involved in determining if a loan is impaired include, but are not limited to, expected future cash flows, financial condition of the borrower, and the current economic conditions. A performing loan may be considered impaired if the factors above indicate a need for impairment. A loan on non-accrual status may not necessarily be impaired if it is in the process of collection or if the shortfall in payment is insignificant. A delay of less than 30 days or a shortfall of less than 5% of the required principal and interest payments generally is considered "insignificant" and would not indicate an impairment situation, if in management's judgment the loan will be paid in full. Loans that meet the regulatory definitions of doubtful or loss generally qualify as impaired loans under authoritative accounting guidance. As is the case for all loans, charge-offs for impaired loans occur when the loan or portion of the loan is determined to be uncollectible.

The Bank considers all consumer installment loans and smaller residential mortgage loans to be homogenous loans. These loans are not subject to individual evaluation for impairment under authoritative accounting guidelines unless the loan is identified as a troubled debt restructuring ("TDR").
21


 
ASSET QUALITY

Non-performing assets, in most cases, consist of loans, other real estate owned, repossessed property such as automobiles that are 90 days or more past due and for which the accrual of interest has been discontinued. Management evaluates all loans and investments that are 90 days or more past due, as well as borrowers that have suffered financial distress, to determine if they should be placed on non-accrual status. Factors considered by management include the net realizable value of collateral, if any, and other resources of the borrower that may be available to satisfy the delinquency.

Loans are placed on non-accrual status when principal or interest is delinquent for 90 days or more, unless the loans are well secured and in the process of collection. Any unpaid interest previously accrued on such loans is reversed from income. Interest income generally is not recognized on nonaccrual loans unless the likelihood of further loss is remote. Interest payments received on such loans are applied as a reduction of the loan principal balance.

A TDR identification process has been established using a template of questions that determine whether a  borrower is experiencing financial difficulty and, if so, whether the Bank has granted a concession to the borrower by modifying the loan. Then, mitigating factors are evaluated to determine a final conclusion as to the whether the loan should be classified as a TDR.

There are 12 loans in the portfolio totaling $7.1 million that have been identified as TDRs at December 31, 2015. Four loans totaling $4.2 million were modified and identified as TDRs during 2015. Five loans totaling $5.6 million and eight loans totaling $5.2 million were modified and identified as TDRs during 2014 and 2013, respectively. At December 31, 2015, four of the loans that were identified as TDRs, totaling $1.6 million, remain in nonaccrual status due to irregular payments. Reserves on TDRs have been established as appropriate. Seven of the remaining eight loans were current and performing in accordance with the modified terms.

Non-performing assets totaled $3.2 million or 0.53% of total assets at December 31, 2015, as compared with $2.6 million or 0.43% of total assets at December 31, 2014 and $7.6 million or 1.23% of total assets at December 31, 2013.  Included in non-performing assets at December 31, 2015 were $1.4 million of other real estate owned, and $1.8 million of non-accrual loans.

At December 31, 2015, no concentration of loans to commercial borrowers engaged in similar activities exceeded 10% of total loans. The largest industry concentration at December 31, 2015 was approximately $17.9 million or 4.0% of loans to the childcare industry.

Based on regulatory guidelines, the Bank is required to monitor the commercial investment real estate loan portfolio for: (a) concentrations above 100% of Tier 1 capital and loan loss reserve for construction and land loans and (b) 300% for permanent investor real estate loans. As of December 31, 2015, construction and land loans are $38.2 million or 64.6% of the concentration limit, while permanent investor real estate loans (by NAICS code) are $133.0 million or 224.9% of the concentration level.

The allowance for loan losses as a percentage of non-performing loans was 226.8%, 439.4%, and 305.3% at December 31, 2015, 2014, and 2013, respectively. The primary reason for the increase in this coverage ratio from 2013 to 2014 was due to the decrease in nonaccrual loans from $2.2 million at December 31, 2013 to $1.2 million at December 31, 2014.

The number of non-performing loan relationships was four at December 31, 2015 compared with 11 at December 31, 2014, and 12 at December 31, 2013.

The Bank's other real estate owned at December 31, 2015 was one property with a total net value of $1.36 million consisting of 47 acres of undeveloped land in Opal, Virginia. Other real estate owned at December 31, 2014 was the same property valued at $1.41 million.

There were no loans, excluding student loans, that were 90 days past due and accruing interest at December 31, 2015 and 2014 and  $506,000 at December 31, 2013.

There were loans totaling $7.1 million at December 31, 2015 that were considered impaired and were allocated $407,000 of loan loss reserves.  This included eight loans totaling $5.5 million that were performing and accruing interest at December 31, 2015. Additionally, there were five loans totaling $1.6 million that were not in accrual status.  There are no loans, other than those disclosed above as either non-performing or impaired, where information known about the borrower has caused management to have serious doubts about the borrower's ability to repay.

At December 31, 2015, there are no other interest-bearing assets that would be subject to disclosure as either non-performing or impaired.

Total loans on the balance sheet are comprised of the following classifications as of December 31, 2015, 2014, 2013, 2012, and 2011.
22


Loan Portfolio

 
 
December 31,
 
(In thousands)
 
2015
   
2014
   
2013
   
2012
   
2011
 
Loans secured by real estate:
 
   
   
   
   
 
Construction and land
 
$
49,855
   
$
39,085
   
$
32,807
   
$
40,045
   
$
38,112
 
Residential real estate
   
150,575
     
143,477
     
142,256
     
136,590
     
139,046
 
Home equity lines of credit
   
44,013
     
42,732
     
43,476
     
45,025
     
45,724
 
Commercial real estate
   
160,036
     
165,528
     
176,320
     
193,005
     
201,420
 
Commercial and industrial loans (except those secured by real estate)
   
23,705
     
26,924
     
24,746
     
27,140
     
29,061
 
Consumer loans to individuals (except those secured by real estate)
   
3,160
     
3,015
     
3,810
     
4,567
     
5,451
 
Student
   
15,518
     
19,700
     
27,962
     
4,994
     
-
 
Total loans
 
$
446,862
   
$
440,461
   
$
451,377
   
$
451,366
   
$
458,814
 

The following table sets forth certain information with respect to the Bank's non-accrual, restructured and past due loans, as well as foreclosed assets, at the dates indicated:

Non-Performing Assets and Loans Contractually Past Due

 
 
At December 31,
 
(Dollars in thousands)
 
2015
   
2014
   
2013
   
2012
   
2011
 
 
 
   
   
   
   
 
Non-accrual loans
 
$
1,849
   
$
1,227
   
$
2,184
   
$
10,650
   
$
4,621
 
Other real estate owned
   
1,356
     
1,406
     
4,085
     
1,406
     
1,776
 
Other repossessed assets owned
   
-
     
-
     
-
     
-
     
15
 
Non-performing corporate bond investments, at fair value
   
-
     
-
     
1,300
     
325
     
335
 
Total non-performing assets
   
3,205
     
2,633
     
7,569
     
12,381
     
6,747
 
 
                                       
Restructured loans still accruing
   
5,495
     
7,431
     
8,613
     
5,556
     
-
 
 
Student loans (U.S. Gov. guaranteed) past due 90 or more days and still accruing
   
2,814
     
4,551
     
7,917
     
-
     
-
 
 
Loans past due 90 days and still accruing interest
   
-
     
-
     
506
     
132
     
101
 
Total non-performing and other risk assets
 
$
11,514
   
$
14,615
   
$
24,605
   
$
18,069
   
$
6,848
 
 
                                       
Allowance for loan losses as percentage of total loans, period end
   
0.94
%
   
1.22
%
   
1.48
%
   
1.39
%
   
1.47
%
 
                                       
Non-accrual loans to total loans, period end
   
0.41
%
   
0.28
%
   
0.48
%
   
2.36
%
   
1.01
%
 
                                       
Allowance for loan losses as percentage of non-performing loans, period end
   
226.77
%
   
439.36
%
   
305.27
%
   
58.76
%
   
145.60
%
 
                                       
Non-accrual loans and restructured loans still accruing to total loans, period end
   
1.64
%
   
1.97
%
   
2.39
%
   
3.59
%
   
1.01
%
 
                                       
Non-performing assets as percentage of total assets, period end
   
0.53
%
   
0.43
%
   
1.23
%
   
2.06
%
   
1.10
%

Potential Problem Loans: For additional information regarding non-performing assets and potential loan problems, see "Loans and Allowance for Loan Losses" Note 3 of the Notes to Consolidated Financial Statements contained herein.
23


 
ANALYSIS OF LOAN LOSS EXPERIENCE

The allowance for loan losses is maintained at a level which, in management's judgment, is adequate to absorb credit losses inherent in the loan portfolio. The amount of the allowance is based on management's evaluation of the collectability of the loan portfolio, credit concentration, trends in historical loan loss experience, specific impaired loans, and current economic conditions. Management periodically reviews the loan portfolio to determine probable credit losses related to specifically identified loans as well as credit losses inherent in the remainder of the loan portfolio. Allowances for impaired loans are generally determined based on net realizable values or the present value of estimated cash flows. The allowance is increased by a provision for loan losses, which is charged to expense and reduced by charge-offs, net of recoveries. Changes in the allowances relating to impaired loans are charged or credited to the provision for loan losses. Because of uncertainties inherent in the estimation process, management's estimate of credit losses inherent in the loan portfolio and the related allowance remains subject to change. Additions to the allowance for loan losses, recorded as the provision for loan losses on the Company's statements of income, are made as needed to maintain the allowance at an appropriate level based on management's analysis of the inherent risk in the loan portfolio. The amount of the provision is a function of the level of loans outstanding, the level and nature of impaired and non-performing loans, historical loan loss experience, the amount of loan losses actually charged off or recovered during a given period and current national and local economic conditions.

At December 31, 2015, 2014, 2013, 2012, and 2011, the allowance for loan losses was $4.2 million, $5.4 million, $6.7 million, $6.3 million, and $6.7 million, respectively.  As a percentage of total loans, the allowance for loan losses decreased from 1.48% at December 31, 2013 to 1.22% at December 31, 2014 and decreased to 0.94% at December 31, 2015. The allowance for loan losses equaled 226.8% of non-accrual loans at December 31, 2015 compared with 439.4% and 305.3% at December 31, 2014 and 2013, respectively.

The following table summarizes the Bank's loan loss experience for each of the years ended December 31, 2015, 2014, 2013, 2012, and 2011, respectively:

Analysis of Allowance for Loan Losses
 
 
 
Years ended December 31,
 
(Dollars in thousands)
 
2015
   
2014
   
2013
   
2012
   
2011
 
 
 
   
   
   
   
 
Allowance for loan losses, January 1,
 
$
5,391
   
$
6,667
   
$
6,258
   
$
6,728
   
$
6,307
 
 
                                       
Secured by real estate:
                                       
Construction and land
   
17
     
313
     
-
     
-
     
-
 
1-4 family residential
   
167
     
172
     
284
     
126
     
597
 
Home equity line of credit
   
50
     
91
     
174
     
536
     
472
 
Commercial real estate
   
568
     
560
     
686
     
5,004
     
0
 
Commercial and industrial
   
8,525
     
171
     
257
     
526
     
599
 
Student
   
50
     
139
     
-
     
-
     
-
 
Consumer
   
10
     
18
     
104
     
117
     
60
 
Total loans charged-off
   
9,387
     
1,464
     
1,505
     
6,309
     
1,728
 
 
                                       
Secured by real estate:
                                       
Construction and land
   
-
     
65
     
-
     
-
     
-
 
1-4 family residential
   
52
     
22
     
2
     
2
     
-
 
Home equity line of credit
   
21
     
5
     
11
     
-
     
3
 
Commercial real estate
   
-
     
-
     
-
     
9
     
161
 
Commercial and industrial
   
102
     
86
     
76
     
7
     
12
 
Student
   
-
     
-
     
-
     
-
     
-
 
Consumer
   
14
     
10
     
25
     
14
     
40
 
Total loans recoveries
   
189
     
188
     
114
     
32
     
216
 
 
                                       
Net Charge-Offs
   
9,198
     
1,276
     
1,391
     
6,277
     
1,512
 
 
                                       
Provision for loan losses
   
8,000
     
-
     
1,800
     
5,807
     
1,933
 
 
                                       
Allowance for loan losses, December 31,
 
$
4,193
   
$
5,391
   
$
6,667
   
$
6,258
   
$
6,728
 
 
                                       
Ratio of net charge-offs to average loans
   
2.04
%
   
0.29
%
   
0.31
%
   
1.38
%
   
0.33
%

24

 
The following table allocates the allowance for loan losses at December 31, 2015, 2014, 2013, 2012, and 2011 to each loan category. The allowance has been allocated according to the amount deemed to be reasonably necessary to provide for the possibility of losses being incurred within the following categories of loans at the dates indicated, although the entire allowance balance is available to absorb any actual charge-offs that may occur.

Allocation of Allowance for Loan Losses
 
 
 
2015
     
2014
     
2013
 
(Dollars in thousands)
 
Allowance
for Loan
Losses
   
Percentage
of Total
Loans
     
Allowance
for Loan
Losses
   
Percentage
of Total
Loans
     
Allowance
for Loan
Losses
   
Percentage
of Total
Loans
 
Secured by real estate:
                           
Construction and land
 
$
924
     
11.16
%
   
$
699
     
8.87
%
   
$
412
     
7.27
%
1-4 family residential
   
886
     
33.70
%
     
1,424
     
32.58
%
     
1,261
     
31.52
%
Home equity line of credit
   
356
     
9.85
%
     
296
     
9.70
%
     
1,314
     
9.63
%
Commercial real estate
   
1,162
     
35.81
%
     
1,943
     
37.58
%
     
2,320
     
39.06
%
Commercial and industrial
   
526
     
5.30
%
     
516
     
6.11
%
     
964
     
5.48
%
Student
   
117
     
3.47
%
     
72
     
4.47
%
     
196
     
6.20
%
Consumer
   
13
     
0.71
%
     
37
     
0.69
%
     
18
     
0.84
%
Unallocated
   
209
     
-
       
404
     
-
       
182
     
-
 
 
 
$
4,193
     
100.00
%
   
$
5,391
     
100.00
%
   
$
6,667
     
100.00
%

 
 
2012
     
2011
 
 
 
Allowance
for Loan
Losses
   
Percentage
of Total
Loans
     
Allowance
for Loan
Losses
   
Percentage
of Total
Loans
 
Secured by real estate:
 
   
     
   
 
Construction
 
$
402
     
8.87
%
   
$
195
     
8.31
%
1-4 family residential
   
1,691
     
30.26
%
     
1,584
     
30.31
%
Home equity line of credit
   
1336
     
9.98
%
     
698
     
9.97
%
Commercial real estate
   
1,685
     
42.76
%
     
2,899
     
43.90
%
Commercial and industrial
   
932
     
6.01
%
     
795
     
6.33
%
Student
   
-
     
1.11
%
     
-
     
-
 
Consumer
   
40
     
1.01
%
     
31
     
1.18
%
Unallocated
   
172
     
-
       
526
     
-
 
 
 
$
6,258
     
100.00
%
   
$
6,728
     
100.00
%

25

 
NON-INTEREST INCOME

2015 COMPARED WITH 2014
Total non-interest income decreased by $204,000 from $6.62 million in 2014 to $6.42 million in 2015, primarily due to a $205,000 decrease in service charges on deposit accounts, a $61,000 decrease in brokerage income, and a $67,000 decrease in other service charges partially offset by a $128,000 increase in trust and estate income during 2015 compared with 2014.

Recurring non-interest income is derived primarily from non-interest fee income, which consists primarily of fiduciary trust and estate fees, brokerage income, service charges on deposit accounts, and other fee income.

Trust and estate income increased $128,000 or 7.1% from 2014 to 2015, primarily due to the growth in new relationships through the first half of 2015. Future trust and estate income, particularly in 2016, may be negatively impacted by the resignation of two investment management personnel during September 2015. Management believes that there may be an approximate $500,000 annual reduction in fees on managed investment accounts and related assets as result of their resignation.

Brokerage income decreased $61,000 or 19.7% from 2014 to 2015. Management believes that there may be an approximate 15% annual increase in brokerage income in 2016 due to increased productivity from brokerage sales staff.

Service charges on deposit accounts decreased $205,000 or 8.1% to $2.34 million for 2015, compared with $2.54 million for 2014. The reason for the change may be due to changes in consumer behavior in their personal funds management because of greater access to account information via mobile technology, as well as improved personal cash flow due to the decline in gasoline and other fuel prices.

Other service charges, commissions and fees decreased $67,000 or 3.4 % from $1.96 million during 2014 to $1.89 million during 2015, primarily due to the recognition of increased passive losses within community development tax credit investments.  These losses were $482,000 in 2015 compared with $180,000 in 2014. These passive losses will be more than offset in future periods by federal tax credits related to low/moderate income housing and/or buildings of historical significance. Included in other service charges, commissions, and income is debit card interchange income, net, which totaled $1.22 million and $1.09 million for 2015 and 2014, respectively.  Also included in other service charges, commissions, and income is the increase in bank owned life insurance ("BOLI") income, which was $796,000 in 2015 compared with $677,000 in 2014.  Approximately $433,000 of BOLI income was in tax-free death benefits in excess of surrender value in 2015, compared with approximately $300,000 in 2014. Total cash value of BOLI was $12.5 million at December 31, 2015 compared with $12.5 million at December 31, 2014.

The gains on the sale of securities increased from $3,000 in 2014 to $4,000 in 2015. See Note 2 "Securities" of the Notes to Consolidated Financial Statements for further discussion regarding the methodology for determining impairment on the Bank's investment securities, as well as the gains on the sale of securities.

2014 COMPARED WITH 2013
Total non-interest income decreased by $73,000 from $6.70 million in 2013 to $6.62 million in 2014, primarily due to a $276,000 decrease in service charges on deposit accounts, a $141,000 decrease on gains on the sale of securities, and a $101,000 decrease in brokerage income, partially offset by a $314,000 increase in trust and estate income and a $131,000 increase in other service charges during 2014 compared with 2013.

Trust and estate income increased $314,000 or 21.0% from 2013 to 2014,  primarily due to the increase in new customer relationships and the higher stock market valuation in 2014 compared with 2013.

Brokerage income decreased $101,000 or 24.6% from  2013 to 2014.

Service charges on deposit accounts decreased $276,000 or 9.8% to $2.54 million for 2014, compared with $2.82 million for 2013. The reason for the change is difficult to determine, but may be due to changes in consumer behavior in their personal funds management because of greater access to account information via mobile technology.

Other service charges, commissions and fees increased $131,000 or 7.2 % from $1.83 million during 2013 to $1.96 million during 2014, primarily due to the receipt of approximately $300,000 in tax-free death benefit in excess of surrender value related to  BOLI. Included in other service charges, commissions, and income is debit card interchange income, net, which totaled $1.09 million and $1.15 million for 2014 and 2013, respectively.  Also included in other service charges, commissions, and income is the increase in BOLI income, which was $677,000 in 2014 compared with $395,000 in 2013.  Total cash value of BOLI was $12.5 million at December 31, 2014 compared with $12.4 million at December 31, 2013.

The gains on the sale of securities decreased from $144,000 in 2013 to $3,000 in 2014.
 
26

NON-INTEREST EXPENSE

2015 COMPARED WITH 2014
Total non-interest expense increased $379,000 or 1.9% in 2015 compared with 2014. The increase was primarily due to legal, audit and consulting expenses, and furniture and equipment expenses.

Salary and benefit expenses decreased $223,000, or 2.2% in 2015 compared with 2014, primarily reflecting the decrease in incentive pay and commissions, partially offset by the increase in salary expense. The Bank increased its full-time equivalent employees by approximately six people from year-end 2014 to year-end 2015.

The Bank expects personnel costs, consisting primarily of salary and benefits, to continue to be its largest non-interest expense. As such, the most important factor with regard to potential changes in other expenses is the expansion of staff. The cost of any additional staff expansion, however, would be expected to be offset by the increased revenue generated by the new and additional customer relationships that the new staff would enable the Bank to obtain.

Net occupancy expense increased $55,000 or 2.4%, and furniture and equipment expense increased $94,000 or 8.2%, from 2014 to 2015 reflecting the full year impact of building and equipment depreciation and real estate taxes for the Gainesville and Centreville Road branches.

Marketing expense increased $4,000 or 0.6% from 2014 to 2015.

Consulting expense, which includes legal and accounting professional fees, increased $309,000 or 35.7% in 2015 compared with 2014. This increase is primarily due to legal expenses associated with the workout of problem loans in 2015 compared with 2014, as well as consulting fees associated with the Company's chief executive officer succession plans.

Data processing expense decreased $103,000 or 7.2% in 2015 compared with 2014 due to the renegotiation and extension of The Bank's data processing contract. The Bank outsources most of its data processing to a third-party vendor.

The FDIC deposit insurance expense increased $26,000 or 7.2% from $360,000 for 2014 to $386,000 for 2015, primarily due to changes in the quarterly risk-based assessment  multiplier used by the FDIC. Management projects FDIC deposit insurance will be in the range of $450,000 to $500,000 for 2016 based on current assessment multiplier.

There was no loss or gain on sale or expense on Other Real Estate Owned ("OREO") properties in 2015 compared to a $91,000 net gain in 2014. At December 31, 2015, the Bank has one OREO property with a total valuation of $1.4 million.  Other real estate owned at December 31, 2014 was the same property valued at $1.4 million.

2014 COMPARED WITH 2013
Total non-interest expense increased $701,000 or 3.7% in 2014 compared with 2013. The increase was primarily due to increases in salary and benefit expenses, occupancy expenses, and furniture and equipment expenses, partially offset by decreases in legal, audit and consulting expenses, FDIC insurance premiums and a net recovery of  $91,000 on the sale of the OREO properties.

Salary and benefit expenses increased $712,000, or 7.5% in 2014 compared with 2013, primarily reflecting the increase in incentive pay, merit salary increases, and increases to the supplemental executive retirement plan. In addition, the Bank increased its full-time equivalent employees by approximately four people from year-end 2013 to year-end 2014, primarily reflecting the addition of the Gainesville branch in 2014.

Net occupancy expense increased $337,000 or 17.5%, and furniture and equipment expense increased $104,000 or 10.0%, from 2013 to 2014 reflecting the opening of the Gainesville and Centreville Road, Manassas branches.

Marketing expense increased $21,000 or 3.5% from 2013 to 2014 primarily due to an increase in advertising in 2014.

Consulting expense, which includes legal and accounting professional fees, decreased $373,000 or 30.1% in 2014 compared with 2013. This decrease is primarily due to a decline in legal expenses associated with the workout of problem loans in 2014 compared with 2013.

Data processing expense increased $60,000 or 4.4% in 2014 compared with 2013 primarily due to the increase in the volume of transactions processed. The Bank outsources much of its data processing to a third-party vendor.

The FDIC deposit insurance expense decreased $149,000 or 29.3% from $509,000 for 2013 to $360,000 for 2014, primarily due to improvements in the qualitative factors used to calculate the FDIC deposit insurance premium expense.

There was a $91,000 net gain on the sale of OREO properties in 2014 compared to a $20,000 net loss in 2013. At December 31, 2014, the Bank has one OREO property with a total valuation of $1.4 million compared with two properties with a valuation of $4.1 million at December 31, 2013.
27


 
INCOME TAXES
 
The income tax benefit was $1.42 million for the year ended December 31, 2015 compared with income tax expense of  $1.38 million for the year ended December 31, 2014 and $1.44 million for the year ended December 31, 2013. The effective tax rates were a benefit of 70.0% for 2015, as compared to tax rates of 22.3% for 2014, and 25.0% for 2013. The effective tax rate differs from the statutory federal income tax rate of 34% due to the Bank's investment in tax-exempt loans and securities, income from the BOLI, and community development tax credits. Community development tax credits increased from approximately $218,000 in 2013 and $334,000 in 2014 to $338,000 in 2015, and are projected to be approximately $410,000 in 2016.

COMPARISON OF FINANCIAL CONDITION AT DECEMBER 31, 2015 AND DECEMBER 31, 2014

Total assets were $601.4 million at December 31, 2015, a decrease of 0.8% or $4.9 million from $606.3 million at December 31, 2014. Balance sheet categories reflecting significant changes included interest-bearing deposits in other banks, total investments, net loans, net bank premises and equipment, total deposits and other liabilities. Each of these categories, as well as investment securities and company-obligated mandatorily redeemable capital securities of subsidiary trust, is discussed below.

INTEREST-BEARING DEPOSITS IN OTHER BANKS. Interest-bearing deposits in other banks decreased from $57.5 million at December 31, 2014 to $48.0 million at December 31, 2015. The decrease in interest-bearing deposits in other banks was primarily the result of less excess liquidity being temporarily deposited at the Federal Reserve Bank of Richmond due to the increase in net loans and the decrease in total deposits.

INVESTMENT SECURITIES. Total investment securities were $55.2 million at December 31, 2015, reflecting a decrease of $2.2 million from $57.4 million at December 31, 2014.  At December 31, 2015 and 2014, all investment securities were available for sale. The unrealized loss, net of tax benefit, of the available for sale securities portfolio totaled $229,000 at December 31, 2015 compared with an unrealized gain, net of taxes, of $160,000 at December 31, 2014. See Note 2 "Securities" of the Notes to Consolidated Financial Statements for further discussion on the Bank's investment securities.

At December 31, 2015, 2014, and 2013, the carrying values of the major classifications of securities were as follows:

Investment Portfolio

 
 
Available for Sale (1)
 
(In thousands)
 
2015
   
2014
   
2013
 
Obligations of U.S. Government corporations and agencies
 
$
45,792
   
$
46,965
   
$
43,937
 
Obligations of states and political subdivisions, taxable
   
524
     
526
     
509
 
Obligations of states and political subdivisions, tax-exempt
   
5,676
     
6,388
     
6,526
 
Corporate bonds
   
2,860
     
3,161
     
2,250
 
Mutual funds
   
372
     
366
     
349
 
Total
 
$
55,224
   
$
57,406
   
$
53,571
 


(1) Amounts for available for sale securities are based on fair value.

28

 
The following is a schedule of estimated maturities, or call date if more probable, or next rate repricing adjustment date and related weighted average yields of securities at December 31, 2015:

Estimated Repricing or Maturity Distribution and Yields of Securities
 
 
Due in one year
or less
     
Due after 1
through 5 years
     
Due after 5
through 10 years
 
(Dollars in thousands)
Amount
   
Yield
     
Amount
   
Yield
     
Amount
   
Yield
 
Securities available for sale:
   
     
   
     
   
 
Obligations of U.S. Government corporations and agencies
$
 
6,484
     
1.36
%
   
$
 
4,328
       
1.14
%
   
$
 
3,309
       
1.71
%
Obligations of states and political subdivisions, taxable
   
-
                 
524
       
1.95
%
       
-
           
Total taxable
   
6,484
     
1.36
%
       
4,852
       
1.23
%
       
3,309
       
1.71
%
Obligations of states and political subdivisions, tax-exempt
   
-
                 
5,155
       
1.50
%
       
521
       
1.89
%
Total securities:
$
 
6,484
     
1.36
%
   
$
 
10,007
       
1.37
%
   
$
 
3,830
       
1.73
%

 
   
Due after 10 years
and Equity Securities
     
Total
 
 
   
Amount
   
Yield
     
Amount
   
Yield
 
Securities available for sale:
   
   
     
   
 
Obligations of U.S. Government corporations and agencies
   
$
31,671
     
2.16
%
   
$
45,792
     
1.92
%
Obligations of states and political subdivisions, taxable
     
-
               
524
     
1.95
%
Corporate bonds
     
2,860
     
5.80
%
     
2,860
     
5.80
%
Other taxable securities
     
372
     
2.13
%
     
372
     
2.13
%
Total taxable
     
34,903
     
2.46
%
     
49,548
     
2.14
%
Obligations of states and political subdivisions, tax-exempt
     
-
               
5,676
     
1.54
%
Total securities:
   
$
34,903
     
2.46
%
   
$
55,224
     
2.08
%

Excluding obligations of U.S. Government corporations and agencies, no Bank security investment from a single issuer exceeded 10% of shareholders' equity.
 
LOANS. Total net loan balance after allowance for loan losses was $442.7 million at December 31, 2015, which represents an increase of $7.6 million or 1.7% from $435.1 million at December 31, 2014. Construction and land loans increased $10.8 million,  residential real estate loans increased $7.1 million, and home equity lines of credit increased $1.3 million from year-end 2014 to year-end 2015, while commercial real estate loans decreased $5.5 million, U.S. Government guaranteed student loans decreased $4.2 million and commercial and industrial loans decreased $3.2 million over the same time period. The Bank's loans are made primarily to customers located within the Bank's primary market area. The Bank continually modifies its loan pricing strategies and expands its loan product offerings in an effort to increase lending activity without sacrificing the existing credit quality standards.

29

 
MATURITIES AND SENSITIVITIES OF LOANS TO CHANGES IN INTEREST RATES.

The following is a schedule of maturities and sensitivities of loans subject to changes in interest rates as of December 31, 2015:

Maturity Schedule of Selected Loans
 
(In thousands)
 
Within
1 Year
   
1 Year
Within
5 Years
   
After
5 Years
   
Total
 
 
 
   
   
   
 
Commercial real estate loans
 
$
23,590
   
$
84,670
   
$
51,776
   
$
160,036
 
Commercial and industrial loans
   
14,878
     
6,998
     
1,829
     
23,705
 
Construction and land loans
   
16,577
     
30,260
     
3,018
     
49,855
 
 
 
$
55,045
   
$
121,928
   
$
56,623
   
$
233,596
 
For maturities over one year:
                               
Floating and adjustable rate loans
         
$
14,104
   
$
46,207
   
$
60,311
 
Fixed rate loans
           
107,824
     
10,416
     
118,240
 
 
         
$
121,928
   
$
56,623
   
$
178,551
 

BANK PREMISES AND EQUIPMENT, NET. For the year ended December 31, 2015, bank premises and equipment, net of depreciation, totaled $20.5 million, a decrease of $607,000, primarily due to normal depreciation of assets.

DEPOSITS. For the year ended December 31, 2015, total deposits decreased by $921,000 or 0.2% when compared with total deposits one year earlier. Non-interest-bearing deposits increased by $9.0 million and interest-bearing deposits decreased by $10.0 million.

Included in interest-bearing deposits at December 31, 2015 were $20.5 million of brokered deposits, or 3.9 % of total deposits. This compares with $18.1 million of brokered deposits at December 31, 2014, or 3.4% of total deposits. Of the $20.5 million in brokered deposits at December 31, 2015, $1.4 million were deposits of Bank customers, exchanged through the CDARS network and $11.5 million were money market deposits through the ICS network.  Of the $18.1 million in brokered deposits at December 31, 2014, $1.8 million were deposits of Bank customers, exchanged through the CDARS and $11.9 million through the ICS networks.  With these programs, funds are placed into certificate of deposits and money market deposits issued by other banks in the network, in increments usually less than $250,000, to ensure both principal and interest are eligible for complete FDIC coverage.  These deposits are exchanged with other member banks on a dollar-for-dollar basis, bringing the full amount of our customers deposits back to the Bank and making these funds fully available for lending in our community.

The Bank projects to increase its transaction account and other deposits in 2016 and beyond by offering value-added NOW and demand deposit products, and selective rate premiums on its interest-bearing deposits.
30


 
The average daily amounts of deposits and rates paid on deposits is summarized for the periods indicated in the following table:

Deposits and Rates Paid
 
 
 
December 31,
 
 
 
2015
     
2014
     
2013
 
(Dollars in thousands)
 
Amount
   
Rate
     
Amount
   
Rate
     
Amount
   
Rate
 
 
 
   
     
   
     
   
 
Non-interest-bearing
 
$
96,538
   
     
$
89,240
   
     
$
87,390
   
 
 
         
             
             
 
Interest-bearing:
         
             
             
 
NOW accounts
   
211,273
     
0.21
%
     
206,343
     
0.22
%
     
194,746
     
0.22
%
Money market accounts
   
52,787
     
0.21
%
     
50,027
     
0.21
%
     
43,799
     
0.18
%
Regular savings accounts
   
82,626
     
0.10
%
     
75,908
     
0.11
%
     
72,818
     
0.12
%
Time deposits:
   
72,056
     
1.10
%
     
97,786
     
1.44
%
     
120,065
     
1.38
%
Total interest-bearing
   
418,742
     
0.34
%
     
430,064
     
0.47
%
     
431,428
     
0.52
%
Total deposits
 
$
515,280
             
$
519,304
             
$
518,818
         

MATURITY OF TIME DEPOSITS OF $100,000 OR MORE.

The following is a schedule of maturities of time deposits in amounts of $100,000 or more at December 31, 2015:

Maturities of Certificates of Deposits and Other Time Deposits of $100,000 or More
 
 
December 31, 2015
 
(In thousands)
   Within
Three
Months
 
Three to
Six
Months
 
Six to
Twelve
Months
 
One to
Four
Years
 
Over
Four
Years
 
Total
 
$
100,000 to $250,000
  $
 
1,415
  $
 
1,470
 
 
8,852
 
$
 
4,861
 
 
3,905
 
 
20,503
 
Over $250,000
     
462
     
251
     
1,627
     
5,725
     
491
     
8,556
 
Total
  $
 
1,877
 
$
 
1,721
 
 
10,479
 
 
10,586
 
 
4,396
 
 
29,059
 

 
BORROWINGS. Amounts and weighted average rates for long and short-term borrowings as of December 31, 2015, 2014 and 2013 are as follows:

Borrowed Funds
 
 
December 31, 2015
   
December 31, 2014
   
December 31, 2013
 
(Dollars in thousands)
Amount
 
Rate
   
Amount
 
Rate
   
Amount
 
Rate
 
 
 
   
 
   
 
 
FHLB advances
$
 
13,007
     
2.46
%
 
$
 
13,075
     
2.46
%
 
$
 
13,139
     
2.46
%

At December 31, 2015, the weighted average life of the borrowed funds portfolio was approximately 5.6 years.

OTHER LIABILITIES. For the year ended December 31, 2015, other liabilities totaled $7.3 million, a decrease of $1.4 million, primarily due to a reduction in commitment liabilities associated with the Company's investment in community development tax credits.
31


 
CAPITAL RESOURCES AND LIQUIDITY

Shareholders' equity totaled $52.6 million at December 31, 2015 compared with $55.2 million at December 31, 2014. The amount of equity reflects management's desire to increase shareholders' return on equity while maintaining a strong capital base. No shares were repurchased in 2013, 2014 and 2015.

Accumulated other comprehensive income (loss) increased to an unrealized loss, net of taxes benefit, of $460,000 at December 31, 2015, compared with an unrealized loss net of tax benefit of $101,000  at December 31, 2014 and an unrealized loss net of tax benefit of $941,000 at December 31, 2013.

During 2006, the Company established a subsidiary trust that issued $4.0 million of capital securities as part of a separate pooled trust preferred security offering with other financial institutions. Under current applicable regulatory guidelines, the capital securities are treated as Tier 1 capital for purposes of the Federal Reserve's capital guidelines for bank holding companies, as long as the capital securities and all other cumulative preferred securities of the Company together do not exceed 25% of Tier 1 capital. As discussed above under "Government Supervision and Regulation" in Part I, Item 1 of this Form 10-K, banking regulations have established minimum capital requirements for financial institutions, including risk-based capital ratios and leverage ratios. As of December 31, 2015, the Bank falls into the "well capitalized" category as defined by the appropriate regulatory authorities.

The primary sources of funds are deposits, repayment of loans, maturities of investments, funds provided from operations and advances from the FHLB of Atlanta. While scheduled repayments of loans and maturities of investment securities are predictable sources of funds, deposit flows and loan repayments are greatly influenced by the general level of interest rates, economic conditions and competition. The Bank uses its sources of funds to fund existing and future loan commitments, to fund maturing certificates of deposit and demand deposit withdrawals, to invest in other interest-earning assets, to maintain liquidity, and to meet operating expenses. Management monitors projected liquidity needs and determines the desirable funding level based in part on the Bank's commitments to make loans and management's assessment of the Bank's ability to generate funds. Management is not aware of any market or institutional trends, events or uncertainties that are expected to have a material effect on the liquidity, capital resources or operations of the Company or the Bank. Nor is management aware of any current recommendations by regulatory authorities that would have a material effect on liquidity, capital resources or operations. The Bank's internal sources of such liquidity are deposits, loan and investment repayments, and securities available for sale. The Bank's primary external source of liquidity is advances from the FHLB of Atlanta.

Cash and amounts due from depository institutions, interest-bearing deposits in other banks, and federal funds sold totaled $53.2 million at December 31, 2015 compared with $64.4 million at December 31, 2014. These assets provide a primary source of liquidity for the Bank. In addition, management has designated the entire investment portfolio as available for sale, of which approximately $7.5 million was unpledged and readily salable at December 31, 2015. In addition, the Bank has an available line of credit with the FHLB of Atlanta with a borrowing limit of approximately $102.2 million at December 31, 2015 to provide additional sources of liquidity, as well as available federal funds purchased lines of credit with various commercial banks, including the Federal Reserve, totaling approximately $59.8 million. At December 31, 2015, $13.0 million of the FHLB of Atlanta line of credit and none of federal funds purchased lines of credit were in use.
32


 
The following table sets forth information relating to the Company's sources of liquidity and the outstanding commitments for use of liquidity at December 31, 2015 and 2014. The liquidity coverage ratio is derived by dividing the total sources of liquidity by the outstanding commitments for use of liquidity.

Liquidity Sources and Use

 
 
December 31, 2015
   
December 31, 2014
 
(Dollars in thousands)
 
Total
   
In Use
   
Available
   
Total
   
In Use
   
Available
 
Sources:
 
   
   
   
   
   
 
Federal funds borrowing lines of credit
 
$
59,842
   
$
-
   
$
59,842
   
$
60,302
   
$
-
   
$
60,302
 
Federal Home Loan Bank lines of credit
   
102,172
     
13,007
     
89,165
     
143,712
     
13,075
     
130,637
 
Federal funds sold and interest-bearing deposits in other banks, excluding reserve requirements
                   
28,112
                     
30,394
 
Securities, available for sale and unpledged at fair value
                   
7,540
                     
6,290
 
Total short-term funding sources
                 
$
184,659
                   
$
227,623
 
 
                                               
Uses:
                                               
Unfunded loan commitments and lending lines of credit
                 
$
66,698
                   
$
82,308
 
Letters of credit
                   
2,516
                     
3,349
 
Total potential short-term funding uses
                 
$
69,214
                   
$
85,657
 
 
                                               
Ratio of short-term funding sources to potential short-term funding uses
                   
266.8
%
                   
265.7
%

33

 
CAPITAL

The Company and the Bank are subject to various regulatory capital requirements administered by banking agencies. Failure to meet minimum capital requirements can trigger certain mandatory and discretionary actions by regulators that could have a direct material effect on the Company's financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Bank must meet specific capital guidelines that involve quantitative measures of their assets, liabilities, and certain off-balance sheet items as calculated under regulatory accounting practices. The Bank's capital amounts and classifications are also subject to qualitative judgments by the regulators about components, risk weightings and other factors. Quantitative measures in effect during 2015 established by regulation to ensure capital adequacy required the Bank to maintain minimum amounts and ratios (set forth in the table below) of Total and Tier 1 capital (as defined in the regulations) to risk-weighted assets (as defined in the regulations), and of Tier 1 capital to average assets (as defined in the regulations). In addition, effective January 1, 2015, a new common equity Tier 1 capital ratio of 4.5% of risk-weighted assets was established. Management believes, as of December 31, 2015, that the Bank more than satisfy all capital adequacy requirements to which they were subject.

The following table provides information on the regulatory capital ratios for the Bank at December 31, 2015 and December 31, 2014. Management believes that the Bank exceeds all capital adequacy requirements of Basel III, including the full conservation buffer, as of December 31, 2015.

Regulatory Capital Ratios

 
 
December 31,
 
(Dollars in thousands)
 
2015
   
2014
 
 
 
   
 
Tier 1 Capital:
 
   
 
Shareholders' Equity
 
$
54,699
   
$
57,093
 
Plus: Unrealized loss (gain) on securities available for sale, net
   
(229
)
   
(161
)
Less: Unrealized loss on equity securities, net
   
-
     
-
 
Plus: Accumulated net losses (gains) on hedges and supplemental retirement plans
   
(41
)
   
62
 
Less: Disallowed deferred tax assets
   
-
     
-
 
Total Tier 1 Capital
   
54,969
     
56,994
 
 
               
Tier 2 Capital:
               
Allowable Allowance for Loan Losses
   
4,193
     
5,391
 
 
               
Total Capital:
 
$
59,162
   
$
62,385
 
 
               
Risk Weighted Assets:
 
$
472,268
   
$
443,908
 
 
               
Leverage Ratio
   
9.13
%
   
9.48
%
Risk Based Capital Ratios:
               
Common Equity Tier 1 to Risk Weighted Assets
   
11.64
%
 
NA
 
Tier 1 to Risk Weighted Assets
   
11.64
%
   
12.84
%
Total Capital to Risk Weighted Assets
   
12.53
%
   
14.05
%

34

 
CONTRACTUAL OBLIGATIONS

The following table sets forth information relating to the Company's contractual obligations and scheduled payment amounts due at various intervals over the next five years and beyond as of December 31, 2015.

(In thousands)
Payments due by period
 
Contractual Obligations:
Total
 
Less than
One Year
 
2-3 Years
 
4-5 Years
 
More
than 5
Years(1)
 
Debt obligations
 
17,131
 
 
71
 
 
5,156
 
 
174
 
 
11,730
 
Operating lease obligations
   
21,789
     
2,679
   
5,522
     
5,579
     
8,009
 
Total
 
38,920
 
2,750
 
 
10,678
 
$
 
5,753
 
 
19,739
 
 
                                                                                                                                                                                                      
(1) Includes $4.1 million of capital securities with varying put provisions beginning September 21, 2011 with a mandatory redemption September 21, 2036.

OFF-BALANCE SHEET ARRANGEMENTS

The Bank's off-balance sheet arrangements consist of interest rate swap agreements, commitments to extend credit and letters of credit.

The Company entered into an interest rate swap agreement with a notional amount of $4.0 million on July 1, 2010.  The Bank uses this interest rate swap to reduce interest rate risks and to manage interest income, specifically with regard to the interest rate expense on its Floating Rate Junior Subordinated Deferrable Interest Debentures due 2036.  By entering into this agreement, the Company converts a floating rate liability priced at three month London Interbank Offered Rate ("LIBOR") plus 1.70% into a fixed rate liability priced at 4.91% through 2020.

The Company has entered into three swap agreements with a total notional amount of $7.0 million at December 31, 2015 to manage the interest rate risk related to three amortizing commercial loans.  The agreement allows the Company to convert fixed rate assets to floating rate assets for ten year periods ranging from February 2022 through April 2025. The Company receives interest monthly at the rate equivalent to one month LIBOR, plus a spread repricing each month on the same date, and pays interest at fixed rates.

Interest differentials paid or received under the swap agreements are reflected as adjustments to interest income and expense.  These interest rate swap agreements are considered derivative instruments that qualify for hedge accounting.  The notional amounts of the interest rate swaps are not exchanged, and do not represent exposure to credit loss.  In the event of default by a counterparty, the risk in these transactions is the cost of replacing the swap agreements at current market rates. The net interest expense on the four interest rate swaps was $279,000 for the year ended December 31, 2015. In addition, the net gain or loss on the hedged items and the hedges resulted in recognition of $112,000 in net interest expense in 2015.  This net gain or loss will net to zero as the loans and underlying hedge reach maturity.  In the year ended December 31, 2014, the net interest expense on the interest rate swaps was $228,000 and the net gain or loss on the hedged items and hedges resulted in recognition of $58,000 in net interest expense in 2014.

Cash collateral held at other banks for these swaps was $900,000 at December 31, 2015.  Collateral posted and received is dependent on the market valuation of the underlying hedges.

Commitments to extend credit and letters of credit were $66.7 million and $2.5 million, respectively, at December 31, 2015, and $82.3 million and $3.3 million, respectively, at December 31, 2014.

See Note 15 "Financial Instruments with Off-Balance Sheet Risk" and  Note 16 "Derivative Instruments and Hedging Activities" of the Notes to Consolidated Financial Statements for further discussion on the specific arrangements and elements of credit and interest rate risk inherent to the arrangements. The impact on liquidity of these arrangements is illustrated in the Liquidity Sources and Uses table above.

Revenues for standby letters of credit were $28,000 and $49,000 for 2015 and 2014, respectively. There were 27 and 40 separate standby letters of credit at December 31, 2015 and 2014, respectively. During 2015 and 2014, no liabilities arose from standby letters of credit arrangements. Past history gives little indication as to future trends regarding revenues and liabilities from standby letters of credit.
35


 
IMPACT OF INFLATION AND CHANGING PRICES

The consolidated financial statements and the accompanying notes presented elsewhere in this document have been prepared in accordance with accounting principles generally accepted in the United States of America, which require the measurement of financial position and operating results in terms of historical dollars without considering the change in the relative purchasing power of money over time and due to inflation. Unlike most industrial companies, virtually all the assets and liabilities of the Company and the Bank are monetary in nature. The impact of inflation is reflected in the increased cost of operations. As a result, interest rates have a greater impact on our performance than inflation does. Interest rates do not necessarily move in the same direction or to the same extent as the prices of goods and services.

RECENT ACCOUNTING PRONOUNCEMENTS

For information regarding recent accounting pronouncements and their effect on the Company, see "Recent Accounting Pronouncements" in Note 1 of the Notes to Consolidated Financial Statements contained herein.

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

An important component of both earnings performance and liquidity is management of interest rate sensitivity. Interest rate sensitivity reflects the potential effect on net interest income and economic value of equity from a change in market interest rates. The Bank is subject to interest rate sensitivity to the degree that its interest-earning assets mature or reprice at different time intervals than its interest-bearing liabilities. However, the Bank is not subject to the other major categories of market risk such as foreign currency exchange rate risk or commodity price risk. The Bank uses a number of tools to manage its interest rate risk, including simulating net interest income under various scenarios, monitoring the present value change in equity under the same scenarios, and monitoring the difference or gap between rate sensitive assets and rate sensitive liabilities over various time periods. Management believes that interest rate risk is best measured by simulation modeling.

The earnings simulation model forecasts annual net income under a variety of scenarios that incorporate changes in the absolute level of interest rates, changes in the shape of the yield curve, and changes in interest rate relationships. Management evaluates the effect on net interest income and present value of equity under varying market rate assumptions. The Bank monitors exposure to instantaneous changes both up and down in rates of 100 basis points, 200 basis points, 300 basis points and 400 basis points over a rolling 12-month and 24-month period. The Bank has a two tier policy limit for the maximum negative impact on net interest income and change in equity from all instantaneous changes in interest rates up to 400 basis points. The first limit, or a level I variance, indicates a risk which is approaching unacceptable levels and could be reflective of an unfavorable balance sheet trend. When a level I variance is reached, an explanation of the variance is reported to the Bank's Board of Directors until the variance is within policy. This report to the Bank's Board of Directors analyzes whether the variance represents a long-term problem, or if the variance will be self-correcting. If the variance is determined to be a long-term problem, the level II actions will be taken. A level II measurement represents a risk to earnings which is unacceptable to senior management. If a level II measurement is reached, an action plan is presented to the Board of Directors to decrease variance level. This action plan may include, but is not limited to, changing loan pricing to alter fixed vs. adjustable-rate balances, changing time deposit pricing to alter term length of deposits, use of FHLB borrowings to lengthen duration, restructure the duration/maturity structure of the investment portfolio, use of off-balance sheet hedging instruments such as swaps, and adjust pricing of non-maturity deposits. Management has maintained a risk position within all policy guideline levels during 2014 and 2015.
36


 
The following tables present the Bank's anticipated market value changes in equity under various rate scenarios as of December 31, 2015 and 2014:
 
Market Risk
 
 
2015
 
(Dollars in thousands)
Percentage
Change
Market
Value
Change
Minus
200 pts
 
Current
Fair
Value
   
Plus
200 pts
   
Market
Value
Change
   
Percentage
Change
 
 
 
 
 
 
   
   
   
 
Interest earning deposits in banks
 
 
   
 
$
47,787
   
$
47,692
   
$
(95
)
   
(0.20
)%
Fed funds sold
 
 
 
   
9
     
9
     
-
     
-
 
Securities
 
 
 
   
56,058
     
51,937
     
(4,121
)
   
(7.35
)%
Restricted securities
 
 
 
   
1,286
     
1,286
     
-
     
-
 
Loans receivable
         
443,768
     
419,438
     
(24,330
)
   
(5.48
)%
Total rate sensitive assets
         
548,908
     
520,362
     
(28,546
)
   
(5.20
)%
Other assets
         
54,241
     
54,241
     
-
     
-
 
Total assets
         
$
603,149
   
$
574,603
   
$
(28,546
)
   
(4.73
)%
 
 
                                   
                                       
Demand deposits
 
       
$
86,514
   
$
77,850
   
$
(8,664
)
   
(10.01
)%
Rate-bearing deposits
 
 
     
404,560
     
397,160
     
(7,400
)
   
(1.83
)%
Borrowed funds
 
 
     
17,265
     
15,926
     
(1,339
)
   
(7.76
)%
Other liabilities
 
 
 
   
7,341
     
7,341
     
-
     
-
 
Total liabilities
 
 
 
   
515,680
     
498,277
     
(17,403
)
   
(3.37
)%
 
 
 
 
                               
Present value equity
 
 
 
   
86,614
     
76,508
     
(10,106
)
   
(11.67
)%
Total liabilities and equity
 
 
   
 
$
603,149
   
$
574,603
   
$
(28,546
)
   
(4.73
)%
Total off-balance sheet
         
$
(855
)
 
$
182
   
$
1,037
     
(121.29
)%

Note: Due to the absolute level of market interest rates at December 31, 2015, the calculation of a change in value due to an instantaneous decrease of 200 basis points would not be meaningful.

37

 
2014
 
(Dollars in thousands)
Percentage
Change
Market
Value
Change
Minus
200 pts
 
Current
Fair
Value
   
Plus
200 pts
   
Market
Value
Change
   
Percentage
Change
 
 
 
 
 
 
   
   
   
 
Interest earning deposits in banks
 
 
   
 
$
57,599
   
$
57,264
   
$
(335
)
   
(0.58
)%
Fed funds sold
 
 
 
   
11
     
11
     
-
     
-
 
Securities
 
 
 
   
57,406
     
53,573
     
(3,833
)
   
(6.68
)%
Restricted securities
 
 
 
   
1,294
     
1,294
     
-
     
-
 
Loans receivable
 
       
434,405
     
417,252
     
(17,153
)
   
(3.95
)%
Total rate sensitive assets
 
       
550,715
     
529,394
     
(21,321
)
   
(3.87
)%
Other assets
 
       
54,971
     
54,971
     
-
     
-
 
Total assets
 
       
$
605,686
   
$
584,365
   
$
(21,321
)
   
(3.52
)%
 
 
                                   
                                       
Demand deposits
 
       
$
74,212
   
$
70,220
   
$
(3,992
)
   
(5.38
)%
Rate-bearing deposits
 
 
     
407,983
     
399,853
     
(8,130
)
   
(1.99
)%
Borrowed funds
 
 
     
17,299
     
15,449
     
(1,850
)
   
(10.69
)%
Other liabilities
 
 
 
   
8,715
     
8,715
     
-
     
-
 
Total liabilities
 
 
 
   
508,209
     
494,237
     
(13,972
)
   
(2.75
)%
 
 
 
 
                               
Present value equity
 
 
 
   
97,477
     
90,128
     
(7,349
)
   
7.54
%
Total liabilities and equity
 
 
   
 
$
605,686
   
$
584,365
   
$
(21,321
)
   
(3.52
)%

Note: Due to the absolute level of market interest rates at December 31, 2014, the calculation of a change in value due to an instantaneous decrease of 200 basis points would not be meaningful.
38


 
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

FAUQUIER BANKSHARES, INC. AND SUBSIDIARIES
CONSOLIDATED FINANCIAL REPORT
DECEMBER 31, 2015

CONTENTS

CONSOLIDATED FINANCIAL STATEMENTS
Consolidated balance sheets
Consolidated statements of operations
Consolidated statements of comprehensive income (loss)
Consolidated statements of changes in shareholders' equity
Consolidated statements of cash flows
Notes to consolidated financial statements
39



REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
 
To the Board of Directors and Shareholders of
Fauquier Bankshares, Inc.
Warrenton, Virginia
 
We have audited the accompanying consolidated balance sheets of Fauquier Bankshares, Inc. and its subsidiaries as of December 31, 2015 and 2014, and the related consolidated statements of operations, comprehensive income (loss), changes in shareholders' equity, and cash flows for each of the years in the three-year period ended December 31, 2015. The management of Fauquier Bankshares, Inc. and its subsidiaries (the "Company") is responsible for these consolidated financial statements. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.
 
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audit included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company's internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provided a reasonable basis for our opinion.
 
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Fauquier Bankshares, Inc. and its subsidiaries as of December 31, 2015 and 2014, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2015 in conformity with accounting principles generally accepted in the United States of America.
 
/s/ Smith Elliott Kearns & Company, LLC
SMITH ELLIOTT KEARNS & COMPANY, LLC

Chambersburg, Pennsylvania
March 16, 2016
 
40


 
Fauquier Bankshares, Inc. and Subsidiaries
Consolidated Balance Sheets

(In thousands, except share information)
 
December 31, 2015
   
December 31, 2014
 
Assets
 
   
 
Cash and due from banks
 
$
5,235
   
$
6,831
 
Interest-bearing deposits in other banks
   
47,971
     
57,534
 
Federal funds sold
   
9
     
11
 
Securities available for sale
   
55,224
     
57,406
 
Restricted investments
   
1,286
     
1,294
 
Loans
   
446,862
     
440,461
 
  Allowance for loan losses
   
(4,193
)
   
(5,391
)
Net loans
   
442,669
     
435,070
 
Bank premises and equipment, net
   
20,461
     
21,068
 
Accrued interest receivable
   
1,462
     
1,473
 
Other real estate owned, net of allowance
   
1,356
     
1,406
 
Bank-owned life insurance
   
12,511
     
12,458
 
Other assets
   
13,216
     
11,735
 
Total assets
 
$
601,400
   
$
606,286
 
 
               
Liabilities
               
Deposits:
               
Noninterest-bearing
 
$
97,015
   
$
87,971
 
Interest-bearing:
               
  Checking
   
223,154
     
222,371
 
  Savings and money market accounts
   
140,173
     
126,714
 
  Time deposits
   
63,952
     
88,159
 
Total interest-bearing
   
427,279
     
437,244
 
Total deposits
   
524,294
     
525,215
 
 
               
Federal Home Loan Bank advances
   
13,007
     
13,075
 
Company-obligated mandatorily redeemable capital securities
   
4,124
     
4,124
 
Other liabilities
   
7,342
     
8,715
 
Commitments and contingencies
   
-
     
-
 
Total liabilities
   
548,767
     
551,129
 
 
               
Shareholders' Equity
               
Common stock, par value, $3.13; authorized 8,000,000 shares; issued and outstanding 2015: 3,744,562 shares including 33,267 non-vested shares; 2014: 3,730,877 shares including 34,965 non-vested shares
   
11,616
     
11,568
 
Retained earnings
   
41,477
     
43,690
 
Accumulated other comprehensive income (loss), net
   
(460
)
   
(101
)
Total shareholders' equity
   
52,633
     
55,157
 
Total liabilities and shareholders' equity
 
$
601,400
   
$
606,286
 
 
See accompanying Notes to Consolidated Financial Statements.

41

Fauquier Bankshares, Inc. and Subsidiaries
Consolidated Statements of Operations
For Each of the Three Years Ended December 31

(Dollars in thousands)
 
2015
   
2014
   
2013
 
Interest Income
 
   
   
 
Interest and fees on loans
 
$
20,106
   
$
20,245
   
$
21,636
 
Interest and dividends on securities available for sale:
                       
Taxable interest income
   
1,119
     
1,175
     
883
 
Interest income exempt from federal income taxes
   
219
     
243
     
246
 
Dividends
   
111
     
101
     
111
 
Interest on deposits in other banks
   
139
     
171
     
169
 
Total interest income
   
21,694
     
21,935
     
23,045
 
 
                       
Interest Expense
                       
Interest on deposits
   
1,430
     
2,038
     
2,257
 
Interest on federal funds purchased
   
8
     
-
     
-
 
Interest on Federal Home Loan Bank advances
   
325
     
327
     
606
 
Distribution on capital securities of subsidiary trusts
   
199
     
199
     
199
 
Total interest expense
   
1,962
     
2,564
     
3,062
 
 
                       
Net interest income
   
19,732
     
19,371
     
19,983
 
 
                       
Provision for loan losses
   
8,000
     
-
     
1,800
 
 
                       
Net interest income after provision for loan losses
   
11,732
     
19,371
     
18,183
 
 
                       
Other Income
                       
Trust and estate income
   
1,939
     
1,811
     
1,497
 
Brokerage income
   
249
     
310
     
411
 
Service charges on deposit accounts
   
2,336
     
2,541
     
2,817
 
Other service charges, commissions and income
   
1,890
     
1,957
     
1,826
 
Total other-than-temporary impairment gains on securities
   
-
     
-
     
-
 
Less: Portion of gain recognized in other comprehensive income before taxes
   
-
     
-
     
-
 
Net other-than-temporary impairment losses on securities
   
-
     
-
     
-
 
Gain on sale of securities
   
4
     
3
     
144
 
Total other income
   
6,418
     
6,622
     
6,695
 
 
                       
Other Expenses
                       
Salaries and benefits
   
9,964
     
10,187
     
9,475
 
Occupancy expense of premises
   
2,314
     
2,259
     
1,922
 
Furniture and equipment
   
1,237
     
1,143
     
1,039
 
Marketing expense
   
624
     
620
     
599
 
Legal, audit and consulting expense
   
1,174
     
865
     
1,238
 
Data processing expense
   
1,319
     
1,422
     
1,362
 
Federal Deposit Insurance Corporation expense
   
386
     
360
     
509
 
(Gain) loss on sale or impairment and expense of other real estate owned
   
-
     
(91
)
   
20
 
Other operating expenses
   
3,168
     
3,042
     
2,942
 
Total other expenses
   
20,186
     
19,807
     
19,106
 
 
                       
Income (loss) before income taxes
   
(2,036
)
   
6,186
     
5,772
 
 
                       
Income tax expense (benefit)
   
(1,424
)
   
1,380
     
1,441
 
 
                       
Net Income (Loss)
 
$
(612
)
 
$
4,806
   
$
4,331
 
 
                       
Earnings (Loss) per Share, basic
 
$
(0.16
)
 
$
1.29
   
$
1.17
 
 
                       
Earnings (Loss) per Share, assuming dilution
 
$
(0.16
)
 
$
1.28
   
$
1.16
 
 
                       
Dividends per Share
 
$
0.48
   
$
0.53
   
$
0.48
 

See accompanying Notes to Consolidated Financial Statements.

42

Fauquier Bankshares, Inc. and Subsidiaries
Consolidated Statements of Comprehensive Income (Loss)
For Each of the Years Ended December 31

(In thousands)
 
2015
   
2014
   
2013
 
Net Income (Loss)
 
   
   
 
Other comprehensive income (loss), net of tax:
 
$
(612
)
 
$
4,806
   
$
4,331
 
Interest rate swap, net of tax effect of $(5) in 2015, $27 in 2014 and $(110) in 2013
   
10
     
(53
)
   
214
 
Change in fair value of securities available for sale, net of tax effect of $199 in 2015, $(520) in 2014 and $(333) in 2013
   
(386
)
   
1,009
     
646
 
Reclassification adjustment for gain on sale of securities available for sale, net of tax effect of $1 in 2015, $1 in 2014 and $49 in 2013
   
(3
)
   
(2
)
   
(95
)
Change in unrecognized benefit obligation for SERP plan, net of tax effect of $(10) in 2015, $59 in 2014 and $(3) in 2013
   
20
     
(114
)
   
6
 
Total other comprehensive income (loss), net of tax of $185 in 2015, $(433) in 2014 and $(397) in 2013
   
(359
)
   
840
     
771
 
Comprehensive Income (Loss)
 
$
(971
)
 
$
5,646
   
$
5,102
 

See accompanying Notes to Consolidated Financial Statements.

43

Fauquier Bankshares, Inc. and Subsidiaries
Consolidated Statements of Changes in Shareholders' Equity
For Each of the Three Years in the Period Ended December 31, 2015
 
(Dollars in thousands)
 
Common
Stock
   
Retained
Earnings
   
Accumulated
Other
Comprehensive
Income (Loss)
   
Total
 
Balance, December 31, 2012
 
$
11,467
   
$
37,993
   
$
(1,712
)
 
$
47,748
 
Net income
   
-
     
4,331
     
-
     
4,331
 
Other comprehensive income (loss) net of tax effect of $(397)
   
-
     
-
     
771
     
771
 
Cash dividends ($0.48 per share)
   
-
     
(1,782
)
   
-
     
(1,782
)
Amortization of unearned compensation, restricted stock awards
   
-
     
147
     
-
     
147
 
Issuance of common stock - non-vested shares (9,784 shares)
   
31
     
(31
)
   
-
     
-
 
Issuance of common stock - vested shares (5,712 shares)
   
18
     
50
     
-
     
68
 
Tax effect of restricted stock awards
   
-
     
(56
)
   
-
     
(56
)
Balance, December 31, 2013
 
$
11,516
   
$
40,652
   
$
(941
)
 
$
51,227
 
 
                               
Balance, December 31, 2013
 
$
11,516
   
$
40,652
   
$
(941
)
 
$
51,227
 
Net income
   
-
     
4,806
     
-
     
4,806
 
Other comprehensive income net of tax effect of $(433)
   
-
     
-
     
840
     
840
 
Cash dividends ($0.53 per share)
   
-
     
(1,978
)
   
-
     
(1,978
)
Amortization of unearned compensation, restricted stock awards
   
-
     
151
     
-
     
151
 
Issuance of common stock - non-vested shares (10,570 shares)
   
30
     
(30
)
   
-
     
-
 
Issuance of common stock - vested shares (6,965 shares)
   
22
     
82
     
-
     
104
 
Tax effect of restricted stock awards
   
-
     
7
     
-
     
7
 
Balance, December 31, 2014
 
$
11,568
   
$
43,690
   
$
(101
)
 
$
55,157
 
 
                               
Balance, December 31, 2014
 
$
11,568
   
$
43,690
   
$
(101
)
 
$
55,157
 
Net income (loss)
   
-
     
(612
)
   
-
     
(612
)
Other comprehensive income (loss) net of tax effect of $185
   
-
     
-
     
(359
)
   
(359
)
Cash dividends ($0.48 per share)
   
-
     
(1,798
)
   
-
     
(1,798
)
Amortization of unearned compensation, restricted stock awards
   
-
     
163
     
-
     
163
 
Issuance of common stock - non-vested shares (11,925 shares)
   
37
     
(37
)
   
-
     
-
 
Issuance of common stock - vested shares (3,458 shares)
   
11
     
49
     
-
     
60
 
Tax effect of restricted stock awards
   
-
     
22
     
-
     
22
 
Balance, December 31, 2015
 
$
11,616
   
$
41,477
   
$
(460
)
 
$
52,633
 

See accompanying Notes to Consolidated Financial Statements.

44

Fauquier Bankshares, Inc. and Subsidiaries
Consolidated Statements of Cash Flows
For Each of the Three Years in the Period Ended December 31, 2015
 
(In thousands)
 
2015
   
2014
   
2013
 
Cash Flows from Operating Activities
 
   
   
 
Net income (loss)
 
$
(612
)
 
$
4,806
   
$
4,331
 
Adjustments to reconcile net income (loss) to net cash provided by operating activities:
                       
Depreciation and amortization
   
1,421
     
1,288
     
1,104
 
Disposal of obsolete assets fixed assets
   
32
     
-
     
11
 
Provision for loan losses
   
8,000
     
-
     
1,800
 
(Gain) on sale or impairment of other real estate
   
(31
)
   
(130
)
   
-
 
(Gain) loss on interest rate swaps
   
(44
)
   
58
     
(51
)
Deferred tax expense
   
(1,192
)
   
(219
)
   
(292
)
(Gain) on sale and call of securities
   
(4
)
   
(3
)
   
(144
)
Issuance of vested restricted stock
   
60
     
104
     
68
 
Tax effect of restricted stock awards
   
22
     
7
     
(56
)
Amortization of security premiums, net
   
46
     
56
     
412
 
Amortization of unearned compensation, net of forfeiture
   
28
     
190
     
147
 
Changes in assets and liabilities:
                       
(Increase) in other assets
   
(160
)
   
(511
)
   
(196
)
Increase (decrease) in other liabilities
   
(925
)
   
1,028
     
1,512
 
Net cash provided by operating activities
   
6,641
     
6,674
     
8,646
 
 
                       
Cash Flows from Investing Activities
                       
Proceeds from sale of securities available for sale
   
-
     
-
     
504
 
Proceeds from maturities, calls and principal payments of securities available for sale
   
13,349
     
10,796
     
15,998
 
Purchase of securities available for sale
   
(11,798
)
   
(13,160
)
   
(21,413
)
Purchase of premises and equipment
   
(845
)
   
(6,983
)
   
(1,725
)
Proceeds from redemption of other bank stock, net
   
8
     
168
     
875
 
Net (increase) decrease in loans
   
(16,157
)
   
9,790
     
(4,421
)
Proceeds from sale of other real estate owned
   
614
     
2,809
     
-
 
Net cash provided by (used in) investing activities
   
(14,829
)
   
3,420
     
(10,182
)
 
                       
Cash Flows from Financing Activities
                       
Net increase in demand deposits, NOW accounts and savings accounts
   
23,286
     
5,669
     
42,290
 
Net (decrease) in certificates of deposit
   
(24,207
)
   
(20,658
)
   
(17,220
)
Federal Home Loan Bank advances
   
-
     
-
     
-
 
Federal Home Loan Bank principal repayments
   
(68
)
   
(64
)
   
(15,061
)
Cash dividends paid on common stock
   
(1,984
)
   
(1,791
)
   
(1,782
)
Net cash provided by (used in) financing activities
   
(2,973
)
   
(16,844
)
   
8,227
 
 
                       
Increase (decrease) in cash and cash equivalents
   
(11,161
)
   
(6,750
)
   
6,691
 
 
                       
Cash and Cash Equivalents
                       
Beginning
   
64,376
     
71,126
     
64,435
 
Ending
 
$
53,215
   
$
64,376
   
$
71,126
 
Supplemental Disclosures of Cash Flow Information
                       
 
                       
Cash payments for:
                       
Interest
 
$
2,040
   
$
2,597
   
$
3,155
 
Income taxes
 
$
266
   
$
1,344
   
$
11
 
 
                       
Supplemental Disclosures of Noncash Investing Activities
                       
 
                       
Foreclosed assets acquired in settlement of loans
 
$
533
   
$
-
   
$
2,679
 
 
                       
Unrealized gain (loss) on securities available for sale, net of tax effect
 
$
(389
)
 
$
1,007
   
$
551
 
 
                       
Unrealized gain (loss) on interest rate swap, net of tax effect
 
$
10
   
$
(53
)
 
$
214
 
 
                       
Changes in benefit obligations and plan assets for defined benefit and post-retirement benefit plans, net of tax effect
 
$
20
   
$
(114
)
 
$
6
 

See accompanying Notes to Consolidated Financial Statements.
45

FAUQUIER BANKSHARES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements

For Each of the Three Years in the Period Ended December 31, 2015

Note 1. Nature of Banking Activities and Significant Accounting Policies

Fauquier Bankshares, Inc. ("the Company") is the holding company of The Fauquier Bank ("the Bank") and Fauquier Statutory Trust II ("Trust II").  The Bank provides commercial, financial, agricultural, and residential and consumer loans to customers primarily in Virginia.  The loan portfolio is well diversified and generally is collateralized by assets of the customers.  The loans are expected to be repaid from cash flows or proceeds from the sale of selected assets of the borrowers.  The purpose of the September 2006 Trust II issuance was to use the proceeds to redeem the existing capital security Trust I issued on March 26, 2002.

The accounting and reporting policies of the Company conform to U.S. generally accepted accounting principles ("GAAP") and to the reporting guidelines prescribed by regulatory authorities.  The following is a description of the more significant of those policies and practices.

Principles of Consolidation

The consolidated financial statements include the accounts of the Company, and its wholly-owned subsidiaries, the Bank and Trust II; and the Bank's wholly-owned subsidiary, Fauquier Bank Services, Inc.  In consolidation, significant intercompany accounts and transactions between the Bank and the Company have been eliminated.

Authoritative accounting guidance clarifies the rules for consolidation of certain entities in which voting rights are not effective in identifying the investor with the controlling financial interest.  An entity is subject to deconsolidation under the guidance if the investors do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support, are unable to direct the entity's activities, or are not exposed to the entity's losses or entitled to its residual returns ("variable interest entities").  Variable interest entities within the scope of the authoritative accounting guidance will be required to be consolidated with their primary beneficiary.  The primary beneficiary of a variable interest entity is determined to be the party that absorbs a majority of the entity's losses, receives a majority of its expected returns, or both.

Management has determined that the Trust II qualifies as variable interest entity.  Trust II issued mandatorily redeemable capital securities to investors and loaned the proceeds to the Company.  Trust II held, as its sole asset, subordinated debentures issued by the Company in 2006.  The deconsolidation resulted in the Company's investment in the common securities of Trust II being included in other assets as of December 31, 2007 and a corresponding increase in outstanding debt of $124,000.  

The Board of Governors of the Federal Reserve System ("Federal Reserve") has issued guidance on the regulatory capital treatment for the trust-preferred securities issued by the Company as a result of the adoption of the authoritative accounting guidance.  The rule retains the current maximum percentage of total capital permitted for trust preferred securities at 25%, but enacts other changes to the rules governing trust preferred securities that affect their use as part of the collection of entities known as "restricted core capital elements."  

Securities

Debt securities that management has the positive intent and ability to hold to maturity are classified as "held to maturity" and recorded at amortized cost.  The Company has no securities in this category.  Securities not classified as held to maturity, including equity securities with readily determinable fair values, are classified as "available for sale" and recorded at fair value, with unrealized gains and losses excluded from earnings and reported in other comprehensive income.

Purchase premiums and discounts are recognized in interest income using the interest method over the terms of the securities.  Declines in the fair value of held to maturity and available for sale securities below their cost that are deemed to be other than temporary are reflected in earnings as realized losses.  In estimating other-than-temporary impairment ("OTTI") losses, management considers (1) the length of time and the extent to which the fair value has been less than cost, (2) the financial condition and near-term prospects of the issuer, and (3) whether the Company intends to sell the security, whether it is more likely than not that the Company will be required to sell the security before recovery of its amortized cost basis, and whether the Company expects to recover the security's entire amortized cost basis. Gains and losses on the sale of securities are recorded on the trade date and are determined using the specific identification method.

The Bank is required to maintain an investment in the capital stock of certain correspondent banks.  No readily available market exists for this stock and it has no quoted market value.  The investment in these securities is recorded at cost and they are reported on the Company's consolidated balance sheet as restricted securities.
 
46


 
Loans

Loans are presented on the consolidated balance sheet at their recorded investment, which represents the unpaid principal balances, less the allowance for loan losses, partial charge-offs and the net of unamortized deferred loans fees and costs.

The Company grants mortgage, commercial and consumer loans to customers.  A substantial portion of the loan portfolio is represented by commercial and residential mortgage loans.  The ability of the Company's debtors to honor their contracts is dependent upon the real estate and general economic conditions in the Company's market area. The Company does not have significant concentrations in any one industry or customer.

Loans that management has the intent and ability to hold for the foreseeable future or until maturity or pay-off generally are reported at their outstanding unpaid principal balances adjusted for the allowance for loan losses, and any deferred fees or costs on originated loans.  Interest income is accrued on the unpaid principal balance.  Loan origination fees, net of certain direct origination costs, are deferred and recognized as an adjustment of the related loan yield using the interest method.

The accrual of interest on mortgage, commercial and installment loans is discontinued at the time the loan is 90 days delinquent unless the credit is well-secured and in process of collection. Loans are typically charged off no later than 180 days past due.  In all cases, loans are placed on nonaccrual and charged-off sooner if principal or interest is considered uncollectable.

All interest accrued but not collected for loans that are placed on nonaccrual or charged-off is reversed against interest income.  The interest on these loans is accounted for on the cost-recovery method, until qualifying for return to accrual.  Loans are returned to accrual status when all the principal and interest amounts contractually due are brought current and future payments are reasonably assured.

Allowance for Loan Losses

The allowance for loan losses is increased through a provision for loan losses charged to earnings.  Loan losses are charged against the allowance when management believes the uncollectability of loan principal is confirmed.  Subsequent recoveries, if any, are credited to the allowance.

The allowance for loan losses is evaluated on a regular basis by management and is based upon management's periodic review of the collectability of the loans in light of historical experience, the nature and volume of the loan portfolio, adverse situations that may affect the borrower's ability to repay, estimated value of any underlying collateral and prevailing economic conditions.  This evaluation is inherently subjective as it requires estimates that are susceptible to significant revision as more information becomes available.

All loans are risk rated by a universal bank grading system, (1-9), endorsed by federal agencies. Level 1-a loan with minimal risk, Level 2-modest risk, Level 3-average risk, Level 4- acceptable risk, Level 5-marginally acceptable risk, Level 6-Other Assets Especially Mentioned, (potential weaknesses identified), Level 7-Substandard, (well defined weaknesses that may result in possible losses), Level 8-Doubtful, (unlikely to be repaid in full and will probably result in losses) and Level 9-Loss, (will not be repaid in full and losses will occur).

The allowance consists of specific (Accounting Standards Codification ("ASC") 310.10.35) and general (ASC 450.10) components.  The specific component relates to loans that are classified as impaired.  For such loans, an allowance is established when the discounted cash flows (or collateral value or observable market price) of the impaired loan is lower than the carrying value of that loan.  The general component covers nonimpaired loans and is based on historical loss experience adjusted for qualitative factors and is also maintained to cover uncertainties that could affect management's estimate of probable losses.  This includes an unallocated portion of the allowance which reflects the margin of imprecision inherent in the underlying assumptions used in the methodologies for estimating general losses in the portfolio. Individual portfolio segments are evaluated on a rolling quarterly basis for the most recent eight quarters through a rating matrix that values internal and external qualitative factors and within a range of performing allocations by the following categories: delinquency, short term and long term loss history, and non-performing loans.
47


 
The Company has identified the following as loan segments and classes: commercial and industrial, commercial real estate, construction and land, residential real estate, home equity lines of credit, student and consumer.  Risk characteristics are evaluated for each portfolio segment by reviewing external factors such as: unemployment, new building permits, bankruptcies, foreclosures, regional economic conditions, competition and regulatory factors. Internal risk characteristics evaluated include: lender turnover, lender experience, lending policy changes, loan portfolio characteristics, collateral, risk rating downgrades, loan concentrations, and loan review analysis.

Commercial real estate loans are subject to being in a cyclical industry that has economic and collateral value fluctuations. Commercial real estate lending is primarily limited to our specific geographic market area of Fauquier and western Prince William counties. Generally, the Bank does not provide stand-alone construction financing for the commercial or residential market. Construction lending normally results in permanent financing provided by the Bank. Commercial and industrial loans are made to small businesses in our geographic market area that are subject to management, industry and economic fluctuations that can impact cash flow, which is the primary source of repayment for both commercial and industrial loans and commercial real estate loans. Collateral for these loans is real estate and/or business assets, such as equipment and inventories. This collateral can fluctuate in value based on market conditions and timing of sale. Retail loans, which include residential mortgages, home equity lines of credit, and consumer loans, are made within strict loan policies, procedures, and regulatory compliance guidelines. These loans are regularly reviewed by independent third party consultants for compliance. Retail loans, when compared to commercial and industrial loans and commercial real estate loans, are of relatively smaller amounts made to many diverse customers within the Bank's specific market area. There is not a dominant industry within the Bank's defined market area, but due to the Bank's proximity to Washington, D.C., a significant amount of local employment is directly or indirectly related to the federal government.

Large groups of smaller balance homogeneous loans, such as residential real estate loans, home equity lines of credit, and consumer loans, are collectively evaluated for impairment.

Commercial and industrial loans, commercial real estate loans, construction loans and large residential real estate loans  are considered impaired when, based on current information and events, it is probable that the Company will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement.  Factors considered by management in determining impairment include payment status, collateral value, and the probability of collecting scheduled principal and interest payments when due.  Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired.  Management determines the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrower's prior payment record, and the amount of the shortfall in relation to the principal and interest owed.  Impairment is measured on a loan-by-loan basis for these loans by either the present value of expected future cash flows discounted at the loan's effective interest rate, the loan's obtainable market price or the fair value of the collateral if the loan is collateral dependent.

A troubled debt restructuring ("TDR") identification process has been established using a template of questions that determine whether a debtor is experiencing financial difficulty and, if so, whether the Bank has granted a concession to a borrower by modifying the loan. Then, mitigating factors are evaluated to determine a final conclusion as to whether the loan is a TDR.  All TDRs are individually evaluated for impairment.

Bank Premises and Equipment

Land is carried at cost. Premises and equipment are stated at cost less accumulated depreciation and amortization. Premises and equipment are depreciated over their estimated useful lives ranging from 3 to 39 years; leasehold improvements are amortized over the lives of the respective leases or the estimated useful life of the leasehold improvement, whichever is less.  Software is amortized over its estimated useful life ranging from 3 to 5 years.  Depreciation and amortization are recorded on the straight-line method.

Costs of maintenance and repairs are charged to expense as incurred.  Costs of replacing structural parts of major units are considered individually and are expensed or capitalized as the facts dictate.

Income Taxes

Deferred income tax assets and liabilities are determined using the balance sheet method.  Under this method, the net deferred tax asset or liability is determined based on the tax effects of the temporary differences between the book and tax bases of the various balance sheet assets and liabilities and gives current recognition to changes in tax rates and laws.

The Company follows GAAP, which provides guidance on accounting for uncertainty in income taxes recognized in a Company's financial statements.  The Company's federal and state income tax returns are subject to examinaton by the Internal Revenue Service and state tax authorities, generally for a period of three years after the returns are filed.

Interest and penalties associated with unrecognized tax benefits are classified as additional income taxes in the statement of income. The Company has no uncertain tax positions.
48


 
Earnings Per Share

Basic earnings per share represent income available to common shareholders divided by the weighted-average number of common shares outstanding during the period.  Diluted earnings per share reflect additional common shares that would have been outstanding if dilutive potential common shares had been issued, as well as any adjustment to income that would result from the assumed issuance.  Potential common shares that may be issued by the Company relate solely to outstanding stock options, and are determined using the treasury method.

Stock Compensation Plans

Stock compensation accounting guidance requires that the compensation cost relating to share-based payment transactions be recognized in the financial statements.  That cost will be measured based on the grant date fair value of the equity or liability instruments issued.  The stock compensation accounting guidance covers a wide range of share-based compensation arrangements, including stock options, restricted share plans, performance-based awards, and share appreciation rights. The stock compensation accounting guidance requires that compensation cost for all stock awards be calculated and recognized over the employees service period, generally defined as the vesting period. For awards with graded-vesting, compensation cost is recognized on a straight-line basis over the requisite service period for the entire award. A Black-Scholes model is used to estimate the fair value of stock options, while the price of the Company's common stock at the date of the grant is used for restricted awards. There were no options granted in 2015, 2014 or 2013.

Wealth Management Services Division

Securities and other property held by the Wealth Management Services division in a fiduciary or agency capacity are not assets of the Company and are not included in the accompanying consolidated financial statements.

Cash and Cash Equivalents

Cash and cash equivalents include cash on hand, amounts due from banks, interest bearing deposits in banks and federal funds sold.  Generally, federal funds are purchased and sold for one day periods.

Other Real Estate

Assets acquired through, or in lieu of, loan foreclosure are held for sale and are initially recorded at fair value, less cost to sell, at the date of foreclosure, establishing a new cost basis.  Capitalized costs include accrued interest and any costs that significantly improve the value of the properties. Subsequent to foreclosure, valuations are periodically performed by management and the assets are carried at the lower of carrying amount established at foreclosure or fair value less cost to sell. Gains and losses resulting from the sale or write-down of foreclosed real estate are recorded in other expense. Revenue and expenses from operations and changes in the valuation allowance are also included in other operating expenses.

Use of Estimates

In preparing consolidated financial statements in conformity with GAAP, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities as of the date of the balance sheet and reported amounts of revenues and expenses during the reporting period.  Actual results could differ from those estimates.  Material estimates that are particularly susceptible to significant change in the near term relate to the determination of the allowance for loan losses, and the valuation of foreclosed real estate, deferred tax assets and fair value measurements.

Marketing

The Company follows the policy of charging the costs of marketing, including advertising, to expense as incurred. Marketing expenses of $624,000, $620,000 and $599,000 were incurred in 2015, 2014 and 2013, respectively.

Fair Value Measurements

Fair values of financial instruments are estimated using relevant information and assumptions, as more fully disclosed in Note 18. Fair value estimates involve uncertainties and matters of significant judgment. Changes in assumptions or in market conditions could significantly affect the estimates.
49


 
Comprehensive Income

Under GAAP, comprehensive income is defined as the change in equity from transactions and other events from non-owner sources. It includes all changes in equity except those resulting from investments by shareholders and distributions to shareholders.  Comprehensive income includes net income and certain elements of "other comprehensive income" such as employers' accounting for pensions, certain investments in debt and equity securities, and interest rate swaps.

Transfers of Financial Assets

Transfers of financial assets are accounted for as sales, when control over the asset has been surrendered. Control over transferred assets is deemed to be surrendered when (1) the assets have been isolated from the Company, and put presumptively beyond the reach of the transferor and its creditors, even in bankruptcy or other receivership, (2) the transferee obtains the right (free of conditions that constrain it from taking advantage of that right) to pledge or exchange the transferred assets, and (3) the Company does not maintain effective control over the transferred assets through an agreement to repurchase them before their maturity or the ability to unilaterally cause the holder to return specific assets.

Reclassifications

Certain reclassifications have been made to prior period balances to conform to the current year presentation.

Recent Accounting Pronouncements

In June 2014, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Updated ("ASU") No. 2014-12, "Compensation – Stock Compensation (Topic 718): Accounting for Share-Based Payments When the Terms of an Award Provide That a Performance Target Could Be Achieved after the Requisite Service Period." The new guidance applies to reporting entities that grant employees share-based payments in which the terms of the award allow a performance target to be achieved after the requisite service period. The amendments in the ASU require that a performance target that affects vesting and that could be achieved after the requisite service period be treated as a performance condition.  Existing guidance in Compensation-Stock Compensation (Topic 718)", should be applied to account for these types of awards. The amendments in this ASU are effective for annual periods and interim periods within those annual periods beginning after December 15, 2015. Early adoption is permitted and reporting entities may choose to apply the amendments in the ASU either on a prospective or retrospective basis.  The Company is currently assessing the impact that ASU 2014-12 will have on its consolidated financial statements.

In August 2014, the FASB issued ASU No. 2014-15, "Presentation of Financial Statements – Going Concern (Subtopic  205-40): Disclosure of Uncertainties about an Entity's Ability to Continue as a Going Concern." This update is intended to provide guidance about management's responsibility to evaluate whether there is substantial doubt about an entity's ability to continue as a going concern and to provide related footnote disclosures. Management is required under the new guidance to evaluate whether there are conditions or events, considered in the aggregate, that raise substantial doubt about  the entity's ability to continue as a going concern within one year after the date the financial statements are issued when preparing financial statements for each interim and annual reporting period. If conditions or events are identified, the ASU specifies the process that must be followed by management and also clarifies the timing and content of going concern footnote disclosures in order to reduce diversity in practice. The amendments in this ASU are effective for annual periods and interim periods within those annual periods beginning after December 15, 2016. Early adoption is permitted. The Company does not expect the adoption of ASU 2014-15 to have a material impact on its consolidated financial statements.

In November 2014, the FASB issued ASU No. 2014-16, "Derivatives and Hedging (Topic 815):  Determining Whether the Host Contract in a Hybrid Financial Instrument Issued in the Form of a Share Is More Akin to Debt or to Equity."  The amendments in ASU do not change the current criteria in GAAP for determining when separation of certain embedded derivative features in a hybrid financial instrument is required. The amendments clarify how current GAAP should be interpreted in evaluating the economic characteristics and risks of a host contract in a hybrid financial instrument that is issued in the form of a share. Specifically, the amendments clarify that an entity should consider all relevant terms and features, including the embedded derivative feature being evaluated for bifurcation, in evaluating the nature of the host contract. Furthermore, the amendments clarify that no single term or feature would necessarily determine the economic characteristics and risks of the host contract. Rather, the nature of the host contract depends upon the economic characteristics and risks of the entire hybrid financial instrument.  The amendments in this ASU also clarify that, in evaluating the nature of a host contract, an entity should assess the substance of the relevant terms and features (i.e., the relative strength of the debt-like or equity-like terms and features given the facts and circumstances) when considering how to weight those terms and features.  The amendments in this ASU are effective for public business entities for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2015. Early adoption, including adoption in an interim period, is permitted. The Company does not expect the adoption of ASU 2014-16 to have a material impact on its consolidated financial statements.
50

 
In January 2015, the FASB issued ASU No. 2015-01, "Income Statement—Extraordinary and Unusual Items (Subtopic 225-20): Simplifying Income Statement Presentation by Eliminating the Concept of Extraordinary Items."  The amendments in this ASU eliminate from GAAP the concept of extraordinary items. Subtopic 225-20, Income Statement - Extraordinary and Unusual Items, required that an entity separately classify, present, and disclose extraordinary events and transactions.  Presently, an event or transaction is presumed to be an ordinary and usual activity of the reporting entity unless evidence clearly supports its classification as an extraordinary item.  If an event or transaction meets the criteria for extraordinary classification, an entity is required to segregate the extraordinary item from the results of ordinary operations and show the item separately in the income statement, net of tax, after income from continuing operations. The entity also is required to disclose applicable income taxes and either present or disclose earnings-per-share data applicable to the extraordinary item.  The amendments in this ASU are effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2015.  Early adoption is permitted provided that the guidance is applied from the beginning of the fiscal year of adoption.  The Company does not expect the adoption of ASU 2015-01 to have a material impact on its consolidated financial statements.
 
In February 2015, the FASB issued ASU No. 2015-02, "Consolidation (Topic 810): Amendments to the Consolidation Analysis."  The amendments in this ASU are intended to improve targeted areas of consolidation guidance for legal entities such as limited partnerships, limited liability corporations, and securitization structures (collateralized debt obligations, collateralized loan obligations, and mortgage-backed security transactions).  In addition to reducing the number of consolidation models from four to two, the new standard simplifies the ASC and improves current GAAP by placing more emphasis on risk of loss when determining a controlling financial interest, reducing the frequency of the application of related-party guidance when determining a controlling financial interest in a variable interest entity, and changing consolidation conclusions for public and private companies in several industries that typically make use of limited partnerships or variable interest entities.  The amendments in this ASU are effective for public business entities for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2015.  Early adoption is permitted, including adoption in an interim period. ASU 2015-02 may be applied retrospectively in previously issued financial statements for one or more years with a cumulative-effect adjustment to retained earnings as of the beginning of the first year restated.  The Company does not expect the adoption of ASU 2015-02 to have a material impact on its consolidated financial statements.
 
In April 2015, the FASB issued ASU No. 2015-03, "Interest – Imputation of Interest (Subtopic 835-30): Simplifying the Presentation of Debt Issuance Costs."  The amendments in this ASU are intended to simplify the presentation of debt issuance costs.  These amendments require that debt issuance costs related to a recognized debt liability be presented in the balance sheet as a direct deduction from the carrying amount of that debt liability, consistent with debt discounts. The recognition and measurement guidance for debt issuance costs are not affected by the amendments in this ASU.  The amendments in this ASU are effective for public business entities for financial statements issued for fiscal years beginning after December 15, 2015, and interim periods within those fiscal years. Early adoption is permitted for financial statements that have not been previously issued.  The Company does not expect the adoption of ASU 2015-03 to have a material impact on its consolidated financial statements.

In April 2015, the FASB issued ASU No. 2015-05, "Intangibles - Goodwill and Other - Internal-Use Software (Subtopic 350-40): Customer's Accounting for Fees Paid in a Cloud Computing Arrangement."  The amendments in this ASU provide guidance to customers about whether a cloud computing arrangement includes a software license. If a cloud computing arrangement includes a software license, then the customer should account for the software license element of the arrangement consistent with the acquisition of other software licenses. If a cloud computing arrangement does not include a software license, the customer should account for the arrangement as a service contract. The amendments do not change the accounting for a customer's accounting for service contracts. As a result of the amendments, all software licenses within the scope of Subtopic 350-40 will be accounted for consistent with other licenses of intangible assets.  The amendments in this ASU are effective for public business entities for annual periods, including interim periods within those annual periods, beginning after December 15, 2015.  Early adoption is permitted. An entity can elect to adopt the amendments either: (1) prospectively to all arrangements entered into or materially modified after the effective date; or (2) retrospectively.  The Company does not expect the adoption of ASU 2015-05 to have a material impact on its consolidated financial statements.
 
In May 2015, the FASB issued ASU No. 2015-08, "Business Combinations (Topic 805): Pushdown Accounting – Amendments to SEC Paragraphs Pursuant to Staff Accounting Bulletin No. 115."  The amendments in this ASU amend various Securities and Exchange Commission ("SEC") paragraphs pursuant to the issuance of Staff Accounting Bulletin No. 115, Topic 5: Miscellaneous Accounting, regarding various pushdown accounting issues, and did not have a material impact on the Company's consolidated financial statements.

In July 2015, the FASB issued ASU No. 2015-12, "Plan Accounting: Defined Benefit Pension Plans (Topic 960), Defined Contribution Pension Plans (Topic 962), and Health and Welfare Benefit Plans (Topic 965) – 1. Fully Benefit-Responsive Investment Contracts, 2. Plan Investment Disclosures, and 3. Measurement Date Practical Expedient." The amendments within this ASU are in three parts. Among other things, Part 1 amendments designate contract value as the only required measure for fully benefit-responsive investment contracts; Part 2 amendments eliminate the requirement that plans disclose: (a) individual investments that represent 5 percent or more of net assets available for benefits; and (b) the net appreciation or depreciation for investments by general type requirements for both participant-directed investments and nonparticipant-directed investments. Part 3 amendments provide a practical expedient to permit plans to measure investments and investment-related accounts (e.g., a liability for a pending trade with a broker) as of a month-end date that is closest to the plan's fiscal year-end, when the fiscal period does not coincide with month-end. The amendments in Parts 1 and 2 of this ASU are effective on a retrospective basis and Part 3 is effective on a prospective basis, for fiscal years beginning after December 15, 2015. Early adoption is permitted. The Company does not expect the adoption of ASU 2015-12 to have a material impact on its consolidated financial statements.

51

In August 2015, the FASB issued ASU No. 2015-14, "Revenue from Contracts with Customers (Topic 606): Deferral of Effective Date." The amendments in ASU 2015-14 defer the effective date of ASU 2014-09 for all entities by one year. Public business entities, certain not-for-profit entities, and certain employee benefit plans should apply the guidance in ASU 2014-09 to annual reporting periods beginning after December 15, 2017, including interim reporting periods within that reporting period. Earlier application is permitted only as of annual reporting periods beginning after December 15, 2016, including interim reporting periods within that reporting period. All other entities should apply the guidance in ASU 2014-09 to annual reporting periods beginning after December 15, 2018, and interim reporting periods within annual reporting periods beginning after December 15, 2019. All other entities may apply the guidance in ASU 2014-09 earlier as of an annual reporting period beginning after December 15, 2016, including interim reporting periods within that reporting period. All other entities also may apply the guidance in ASU 2014-09 earlier as of an annual reporting period beginning after December 15, 2016, and interim reporting periods within annual reporting periods beginning one year after the annual reporting period in which the entity first applies the guidance in ASU 2014-09. The Company does not expect the adoption of ASU 2015-14 (or ASU 2014-09) to have a material impact on its consolidated financial statements.

In August 2015, the FASB issued ASU 2015-15, "Interest – Imputation of Interest (Subtopic 835-30) – Presentation and Subsequent Measurement of Debt Issuance Costs Associated with Line-of-Credit Arrangements (Amendments to SEC Paragraphs Pursuant to Staff Announcement at June 18, 2015 EITF Meeting)." On April 7, 2015, the FASB issued ASU 2015-03, Interest—Imputation of Interest (Subtopic 835-30): Simplifying the Presentation of Debt Issuance Costs, which requires entities to present debt issuance costs related to a recognized debt liability as a direct deduction from the carrying amount of that debt liability. The guidance in ASU 2015-03 (see paragraph 835-30-45-1A) does not address presentation or subsequent measurement of debt issuance costs related to line-of-credit arrangements.  Given the absence of authoritative guidance within ASU 2015-03 for debt issuance costs related to line-of-credit arrangements, the SEC staff stated that they would not object to an entity deferring and presenting debt issuance costs as an asset and subsequently amortizing the deferred debt issuance costs ratably over the term of the line-of-credit arrangement, regardless of whether there are any outstanding borrowings on the line-of-credit arrangement. ASU 2015-15 adds these SEC comments to the "S" section of the Codification. The adoption of ASU 2015-15 did not have a material impact on our consolidated financial statements.

In September 2015, the FASB issued ASU 2015-16, "Business Combinations (Topic 805): Simplifying the Accounting for Measurement-Period Adjustments." The amendments in ASU 2015-16 require that an acquirer recognize adjustments to estimated amounts that are identified during the measurement period in the reporting period in which the adjustment amounts are determined. The amendments require that the acquirer record, in the same period's financial statements, the effect on earnings of changes in depreciation, amortization, or other income effects, if any, as a result of the change to the estimated amounts, calculated as if the accounting had been completed at the acquisition date. The amendments also require an entity to present separately on the face of the income statement or disclose in the notes the portion of the amount recorded in current-period earnings by line item that would have been recorded in previous reporting periods if the adjustment to the estimated amounts had been recognized as of the acquisition date. The amendments in this ASU are effective for public business entities for fiscal years beginning after December 15, 2015, including interim periods within those fiscal years. For all other entities, the amendments are effective for fiscal years beginning after December 15, 2016, and interim periods within fiscal years beginning after December 15, 2017.  The amendments should be applied prospectively to adjustments to provisional amounts that occur after the effective date with earlier application permitted for financial statements that have not been issued. The Company does not expect the adoption of ASU 2015-16 to have a material impact on its consolidated financial statements.

In January 2016, the FASB issued ASU 2016-01, "Financial Instruments - Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities." The amendments in ASU 2016-01, among other things: (1) Requires equity investments (expect those accounted for under the equity method of accounting, or those that result in consolidation of the investee) to be measured at fair value with changes in fair value recognized in net income; (2) Requires public business entities to use the exit price notion when measuring the fair value of financial instruments for disclosure purposes; (3) Requires separate presentation of financial assets and liabilities by measurement category and form of financial asset (i.e., securities or loans and receivables); and (4) Eliminates the requirement for public business entities to disclose the method(s) and significant assumptions used to estimate the fair value that is required to be disclosed for financial instruments measured at amortized cost. The amendments in this ASU are effective for public companies for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years. The Company is currently assessing the impact that ASU 2016-01 will have on its consolidated financial statements.

In February 2016, the FASB issued ASU No. 2016-02, "Leases (Topic 842)." Among other things, in the amendments in ASU 2016-02, lessees will be required to recognize the following for all leases (with the exception of short-term leases) at the commencement date: (1) A lease liability, which is a lessee's obligation to make lease payments arising from a lease, measured on a discounted basis; and (2) A right-of-use asset, which is an asset that represents the lessee's right to use, or control the use of, a specified asset for the lease term. Under the new guidance, lessor accounting is largely unchanged. Certain targeted improvements were made to align, where necessary, lessor accounting with the lessee accounting model and Topic 606, Revenue from Contracts with Customers. The amendments in this ASU are effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. Early application is permitted upon issuance. Lessees (for capital and operating leases) and lessors (for sales-type, direct financing, and operating leases) must apply a modified retrospective transition approach for leases existing at, or entered into after, the beginning of the earliest comparative period presented in the financial statements. The modified retrospective approach would not require any transition accounting for leases that expired before the earliest comparative period presented. Lessees and lessors may not apply a full retrospective transition approach. The Company is currently assessing the impact that ASU 2016-02 will have on its consolidated financial statements.
52


 
Note 2. Securities

The amortized cost and fair value of securities available for sale, with unrealized gains and losses follows:

 
 
December 31, 2015
 
(In thousands)
 
Amortized
Cost
   
Gross
Unrealized
Gains
   
Gross
Unrealized
(Losses)
   
Fair
Value
 
Obligations of U.S. Government corporations and agencies
 
$
45,605
   
$
352
   
$
(165
)
 
$
45,792
 
Obligations of states and political subdivisions
   
5,924
     
276
     
-
     
6,200
 
Corporate bonds
   
3,671
     
-
     
(811
)
   
2,860
 
Mutual funds
   
370
     
2
     
-
     
372
 
 
 
$
55,570
   
$
630
   
$
(976
)
 
$
55,224
 

 
 
December 31, 2014
 
(In thousands)
 
Amortized
Cost
   
Gross
Unrealized
Gains
   
Gross
Unrealized
(Losses)
   
Fair
Value
 
Obligations of U.S. Government corporations and agencies
 
$
46,666
   
$
464
   
$
(165
)
 
$
46,965
 
Obligations of states and political subdivisions
   
6,537
     
377
     
-
     
6,914
 
Corporate bonds
   
3,597
     
34
     
(470
)
   
3,161
 
Mutual funds
   
362
     
4
     
-
     
366
 
 
 
$
57,162
   
$
879
   
$
(635
)
 
$
57,406
 

The amortized cost and fair value of securities available for sale, by contractual maturity, are shown below.  Expected maturities may differ from contractual maturities because issuers may have the right to call or prepay obligations without penalties.

(In thousands)
 
December 31, 2015
 
 
 
Amortized
Cost
   
Fair
Value
 
Due in one year or less
 
$
2,000
   
$
2,000
 
Due after one year through five years
   
11,306
     
11,411
 
Due after five years through ten years
   
6,701
     
6,908
 
Due after ten years
   
35,193
     
34,533
 
Equity securities
   
370
     
372
 
 
 
$
55,570
   
$
55,224
 

During 2015, seven bonds with an aggregate amortized cost of $6.3 million were called and $4,000 in gains were recognized.  U.S. Government corporation and agency bonds totaling $11.8 million were purchased in 2015. There were no OTTI losses on the investment in pooled trust preferred securities in 2015.

During 2014, five bonds with an aggregate amortized cost of $5.2 million were called and $3,000 in gains were recognized. U.S. Government corporation and agency bonds totaling $13.2 million were purchased in 2014. There were no OTTI losses on the investment in pooled trust preferred securities in 2014.

During 2013, one non-performing pooled trust preferred security with a fair value of $504,000 was sold, resulting in a gain of $144,000. Six bonds with an aggregate amortized cost of $7.0 million were called and no gains were recognized.  U.S. Government corporation and agency bonds totaling $21.4 million were purchased in 2013.
53


 
The following table shows the Company securities with gross unrealized losses and fair value, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position, at December 31, 2015 and 2014, respectively.
 
(In thousands)
Less than 12 Months
 
12 Months or More
 
Total
 
December 31, 2015
Fair
Value
 
Unrealized
(Losses)
 
Fair
Value
 
Unrealized
(Losses)
 
Fair
Value
 
Unrealized
(Losses)
 
 
 
 
 
 
 
 
Obligations of U.S. Government, corporations and agencies
 
$
14,357
   
$
(76
)
 
$
3,645
   
$
(89
)
 
$
18,002
   
$
(165
)
Corporate bonds
   
560
     
(58
)
   
2,531
     
(753
)
   
3,091
     
(811
)
Total temporary impaired securities
 
$
14,917
   
$
(134
)
 
$
6,176
   
$
(842
)
 
$
21,093
   
$
(976
)

(In thousands)
Less than 12 Months
 
12 Months or More
 
Total
 
December 31, 2014
Fair
Value
 
Unrealized
(Losses)
 
Fair
Value
 
Unrealized
(Losses)
 
Fair
Value
 
Unrealized
(Losses)
 
 
 
 
 
 
 
 
Obligations of U.S. Government, corporations and agencies
 
$
10,405
   
$
(35
)
 
$
8,412
   
$
(130
)
 
$
18,817
   
$
(165
)
Corporate bonds
   
-
     
-
     
2,531
     
(470
)
   
2,531
     
(470
)
Total temporary impaired securities
 
$
10,405
   
$
(35
)
 
$
10,943
   
$
(600
)
 
$
21,348
   
$
(635
)

The nature of securities which were impaired at December 31, 2015 consisted of three corporate bonds with a cost basis net of OTTI losses totaling $3.7 million and a temporary loss of approximately $811,000. Beginning December 31, 2013, the value of these bonds is based on quoted market prices for similar assets.  These corporate bonds are the "Class B" or subordinated "mezzanine" tranche of pooled trust preferred securities. The trust preferred securities are collateralized by the interest and principal payments made on trust preferred capital offerings by a geographically diversified pool of approximately 60 different financial institutions per bond. They have an estimated average maturity of 18 years. These bonds could have been called at par on the five year anniversary date of issuance, which has already passed for all three bonds.  The bonds reprice every three months at a fixed rate index above the three-month London Interbank Offered Rate ("LIBOR").  These bonds have sufficient collateralization and cash flow projections to satisfy their valuation based on the cash flow portion of the OTTI test under authoritative accounting guidance as of December 31, 2015. All three bonds, totaling $2.9 million at fair value, are projected to repay the full outstanding interest and principal, and are classified as performing corporate bond investments.  During 2015, $189,000 of interest income was received and recorded, of which $92,000 represented deferred interest from prior periods.
54


 
Additional information regarding each of the pooled trust preferred securities as of December 31, 2015 follows:

(Dollars in thousands)
Cost, net of
OTTI loss
   
Fair
Value(1)
   
Percent of
Underlying
Collateral
Performing
   
Percent of
Underlying
Collateral in
Deferral
   
Percent of
Underlying
Collateral in
Default
   
Cumulative
Amount of
OTTI Loss
   
Cumulative
Other
Comprehensive
(Gain) Loss, net of
tax
benefit
 
$
1,653
   
$
1,140
     
78.5
%
   
4.4
%
   
17.1
%
 
$
304
   
$
339
 
 
1,400
     
1,160
     
80.3
%
   
9.1
%
   
10.6
%
   
600
     
158
 
 
618
     
560
     
82.8
%
   
7.5
%
   
9.7
%
   
382
     
38
 
$
3,671
   
$
2,860
                           
$
1,286
   
$
535
 

(1) Current Moody's Ratings range from B1 to Caa3.

The Company monitors these pooled trust preferred securities in its portfolio as to collateral, issuer defaults and deferrals, which as a general rule indicate that additional impairment may have occurred. Due to the continued stress on banks in general, and the issuer banks in particular, as a result of overall economic conditions, the Company acknowledges that it may have to recognize additional impairment in future periods; however the extent, timing, and probability of any additional impairment cannot be reasonably estimated at this time.

The following roll forward reflects the amount related to credit losses recognized in earnings (in accordance with ASC 320-10-35-34D):

(In thousands)
Beginning balance as of December 31, 2014
 
$
1,360
 
Add: Amount related to the credit loss for which an other-than-temporary impairment was not previously recognized
   
-
 
Add: Increases to the amount related to the credit loss for which an other-than temporary  impairment was previously recognized
   
-
 
Less: Realized losses for securities sold
   
-
 
Less: Securities for which the amount previously recognized in other comprehensive income was recognized in earnings because the Company intends to sell the security or more likely than not will be required to sell the security before recovery of its amortized cost basis.
   
-
 
Less: Increases in cash flows expected to be collected that are recognized over the remaining life of the  security (FASB ASC 320-10-35-35)
   
(74
)
Ending balance as of December 31, 2015
 
$
1,286
 

The carrying value of securities pledged to secure deposits and for other purposes amounted to $44.5 million and $47.6 million at December 31, 2015 and 2014, respectively.
55


 
Note 3. Loans and Allowance for Loan Losses

The Company's allowance for loan losses has three basic components: the specific allowance, the general allowance, and the unallocated component. The specific allowance is used to individually allocate an allowance for larger balance, non-homogeneous loans identified as impaired. The general allowance is used for estimating the loss on pools of smaller balance, homogeneous loans; including 1-4 family mortgage loans, installment loans and other consumer loans. Also, the general allowance is used for the remaining pool of larger balance, non-homogeneous loans which were not identified as impaired. The unallocated component of the allowance reflects the margin of imprecision inherent in the underlying assumptions used in the methodologies for estimating specific and general losses in the portfolio.

The following table presents the activity in the allowance for loan losses by portfolio segment for each of the years ending December 31, 2015, 2014 and 2013.

Allowance for Loan Losses and Recorded Investment in Loans Receivable
 
 
 
As of and for the Year Ended December 31, 2015
 
(In thousands)
 
Commercial
and
Industrial
   
Commercial
Real
Estate
   
Construction
and Land
   
Consumer
   
Student
   
Residential
Real
Estate
   
Home
Equity
Line of
Credit
   
Unallocated
   
Total
 
Allowance for Loan Losses
 
   
   
   
           
   
   
 
Beginning balance at December 31, 2014
 
$
516
   
$
1,943
   
$
699
   
$
37
   
$
72
   
$
1,424
   
$
296
   
$
404
   
$
5,391
 
Charge-offs
   
(8,525
)
   
(568
)
   
(17
)
   
(10
)
   
(50
)
   
(167
)
   
(50
)
   
-
     
(9,387
)
Recoveries
   
102
     
-
     
-
     
14
     
-
     
52
     
21
     
-
     
189
 
Provision
   
8,433
     
(213
)
   
242
     
(28
)
   
95
     
(423
)
   
89
     
(195
)
   
8,000
 
Ending balance at December 31, 2015
 
$
526
   
$
1,162
   
$
924
   
$
13
   
$
117
   
$
886
   
$
356
   
$
209
   
$
4,193
 
 
                                                                       
Ending balances individually evaluated for impairment
 
$
111
   
$
-
   
$
296
   
$
-
   
$
-
   
$
-
   
$
-
   
$
-
   
$
407
 
 
                                                                       
Ending balances collectively evaluated for impairment
 
$
415
   
$
1,162
   
$
628
   
$
13
   
$
117
   
$
886
   
$
356
   
$
209
   
$
3,786
 
 
                                                                       
Loans Receivable
                                                                       
Individually evaluated
for impairment
 
$
217
   
$
2,896
   
$
3,515
   
$
-
   
$
-
   
$
419
   
$
70
           
$
7,117
 
Collectively evaluated
for impairment
   
23,488
     
157,140
     
46,340
     
3,160
     
15,518
     
150,156
     
43,943
             
439,745
 
Ending balance at December 31, 2015
 
$
23,705
   
$
160,036
   
$
49,855
   
$
3,160
   
$
15,518
   
$
150,575
   
$
44,013
           
$
446,862
 

56

 
 
 
 
As of and for the Year Ended December 31, 2014
 
(In thousands)
 
Commercial
and
Industrial
   
Commercial
Real
Estate
   
Construction
and Land
   
Consumer
   
Student
   
Residential
Real
Estate
   
Home
Equity
Line of
Credit
   
Unallocated
   
Total
 
Allowance for Loan Losses
 
   
   
   
       
   
   
   
 
Beginning balance at December 31, 2013
 
$
964
   
$
2,320
   
$
412
   
$
18
   
$
196
   
$
1,261
   
$
1,314
   
$
182
   
$
6,667
 
Charge-offs
   
(171
)
   
(560
)
   
(313
)
   
(18
)
   
(139
)
   
(172
)
   
(91
)
   
-
     
(1,464
)
Recoveries
   
86
     
-
     
65
     
10
     
-
     
22
     
5
     
-
     
188
 
Provision
   
(363
)
   
183
     
535
     
27
     
15
     
313
     
(932
)
   
222
     
-
 
Ending balance at December 31, 2014
 
$
516
   
$
1,943
   
$
699
   
$
37
   
$
72
   
$
1,424
   
$
296
   
$
404
   
$
5,391
 
 
                                                                       
Ending balances individually evaluated for impairment
 
$
246
   
$
456
   
$
470
   
$
-
   
$
-
   
$
173
   
$
-
   
$
-
   
$
1,345
 
 
                                                                       
Ending balances collectively evaluated for impairment
 
$
270
   
$
1,487
   
$
229
   
$
37
   
$
72
   
$
1,251
   
$
296
   
$
404
   
$
4,046
 
 
                                                                       
Loans Receivable
                                                                       
Individually evaluated
for impairment
 
$
316
   
$
3,272
   
$
3,620
   
$
-
   
$
-
   
$
1,550
   
$
70
           
$
8,828
 
Collectively evaluated
for impairment
   
26,608
     
162,256
     
35,465
     
3,015
     
19,700
     
141,927
     
42,662
             
431,633
 
Ending balance at December 31, 2014
 
$
26,924
   
$
165,528
   
$
39,085
   
$
3,015
   
$
19,700
   
$
143,477
   
$
42,732
           
$
440,461
 
 
57

 
 
 
As of and for the Year Ended December 31, 2013
 
(In thousands)
 
Commercial
and
Industrial
   
Commercial
Real
Estate
   
Construction
and Land
   
Consumer
   
Student
   
Residential
Real
Estate
   
Home
Equity
Line of
Credit
   
Unallocated
   
Total
 
Allowance for Loan Losses
 
   
   
   
       
   
   
   
 
Beginning balance at December 31, 2012
 
$
932
   
$
1,685
   
$
402
   
$
40
   
$
-
   
$
1,691
   
$
1,336
   
$
172
   
$
6,258
 
Charge-offs
   
(257
)
   
(686
)
   
-
     
(104
)
   
-
     
(284
)
   
(174
)
   
-
     
(1,505
)
Recoveries
   
76
     
-
     
-
     
25
     
-
     
2
     
11
     
-
     
114
 
Provision
   
213
     
1,321
     
10
     
57
     
196
     
(148
)
   
141
     
10
     
1,800
 
Ending balance at December 31, 2013
 
$
964
   
$
2,320
   
$
412
   
$
18
   
$
196
   
$
1,261
   
$
1,314
   
$
182
   
$
6,667
 
 
                                                                       
Ending balances individually evaluated for impairment
 
$
211
   
$
505
   
$
321
   
$
-
   
$
-
   
$
276
   
$
-
   
$
-
   
$
1,313
 
 
                                                                       
Ending balances collectively evaluated for impairment
 
$
753
   
$
1,815
   
$
91
   
$
18
   
$
196
   
$
985
   
$
1,314
   
$
182
   
$
5,354
 
 
                                                                       
Loans Receivable
                                                                       
Individually evaluated
for impairment
 
$
477
   
$
4,177
   
$
3,980
   
$
-
     
-
   
$
2,100
   
$
70
           
$
10,804
 
Collectively evaluated
for impairment
   
24,269
     
172,143
     
28,827
     
3,810
     
27,962
     
140,156
     
43,406
             
440,573
 
Ending balance at December 31, 2013
 
 
$
24,746
   
$
176,320
   
$
32,807
   
$
3,810
   
$
27,962
   
$
142,256
   
$
43,476
           
$
451,377
 

58

 
Based on a recent analysis, the risk category of loans by class is as follows:

Credit Quality Indicators

 
 
As of December 31, 2015
 
(In thousands)
 
Commercial
and
Industrial
   
Commercial
Real Estate
   
Construction
and Land
   
Consumer
   
Student Loan
   
Residential
Real Estate
   
Home Equity
Line of
Credit
   
Total
 
Grade:
 
   
   
   
       
   
   
 
Pass
 
$
20,657
   
$
148,409
   
$
38,105
   
$
3,157
   
$
15,518
   
$
141,428
   
$
40,351
   
$
407,625
 
Special mention
   
1,120
     
6,678
     
7,542
     
3
     
-
     
2,318
     
854
     
18,515
 
Substandard
   
1,928
     
4,949
     
4,208
     
-
     
-
     
6,773
     
2,808
     
20,666
 
Doubtful
   
-
     
-
     
-
     
-
     
-
     
56
     
-
     
56
 
Loss
   
-
     
-
     
-
     
-
     
-
     
-
     
-
     
-
 
Total
 
$
23,705
   
$
160,036
   
$
49,855
   
$
3,160
   
$
15,518
   
$
150,575
   
$
44,013
   
$
446,862
 

 

 
 
 
As of December 31, 2014
 
(In thousands)
 
Commercial
and
Industrial
   
Commercial
Real Estate
   
Construction
and Land
   
Consumer
   
Student Loan
   
Residential
Real Estate
   
Home Equity
Line of
Credit
   
Total
 
Grade:
 
   
   
   
       
   
   
 
Pass
 
$
23,255
   
$
154,106
   
$
31,127
   
$
2,990
   
$
19,700
   
$
132,168
   
$
37,423
   
$
400,769
 
Special mention
   
1,917
     
3,992
     
3,687
     
21
     
-
     
2,299
     
2,663
     
14,579
 
Substandard
   
1,752
     
7,430
     
4,271
     
4
     
-
     
9,010
     
2,587
     
25,054
 
Doubtful
   
-
     
-
     
-
     
-
     
-
     
-
     
59
     
59
 
Loss
   
-
     
-
     
-
     
-
     
-
     
-
     
-
     
-
 
Total
 
$
26,924
   
$
165,528
   
$
39,085
   
$
3,015
   
$
19,700
   
$
143,477
   
$
42,732
   
$
440,461
 

59

 
The following table presents the aging of the recorded investment in past due loans and nonaccrual loans as of December 31, 2015 and 2014 by loan class.

Age Analysis of Past Due Loans Receivable

 
 
As of December 31, 2015
 
(In thousands)
 
30-59
Days
Past Due
   
60-89
Days
Past Due
   
Greater
than 90
Days
   
Total
Past
Due
   
Current
   
Total
Financing
Receivables
   
Carrying
Amount >
90
Days and
Accruing
   
Nonaccruals
 
Commercial and industrial
 
$
235
   
$
-
   
$
-
   
$
235
   
$
23,470
   
$
23,705
   
$
-
   
$
110
 
Commercial real estate
   
-
     
296
     
-
     
296
     
159,740
     
160,036
     
-
     
-
 
Construction and land
   
599
     
-
     
1,462
     
2,061
     
47,794
     
49,855
     
-
     
1,512
 
Consumer
   
-
     
26
     
-
     
26
     
3,134
     
3,160
     
-
     
-
 
Student (U.S. Government guaranteed)
   
1,331
     
987
     
2,814
     
5,132
     
10,386
     
15,518
     
2,814
     
-
 
Residential real estate
   
887
     
90
     
228
     
1,205
     
149,370
     
150,575
     
-
     
227
 
Home equity line of credit
   
291
     
-
     
-
     
291
     
43,722
     
44,013
     
-
     
-
 
Total
 
$
3,343
   
$
1,399
   
$
4,504
   
$
9,246
   
$
437,616
   
$
446,862
   
$
2,814
   
$
1,849
 
 
 

 
 
 
As of December 31, 2014
 
(In thousands)
 
30-59
Days
Past Due
   
60-89
Days Past
Due
   
Greater
than
90 Days
   
Total
Past
Due
   
Current
   
Total
Financing
Receivables
   
Carrying
Amount >
90
Days and
Accruing
   
Nonaccruals
 
Commercial and industrial
 
$
140
   
$
106
   
$
-
   
$
246
   
$
26,678
   
$
26,924
   
$
-
   
$
166
 
Commercial real estate
   
444
     
-
     
-
     
444
     
165,084
     
165,528
     
-
     
98
 
Construction and land
   
551
     
145
     
-
     
696
     
38,389
     
39,085
     
-
     
1
 
Consumer
   
8
     
18
     
-
     
26
     
2,989
     
3,015
     
-
     
-
 
Student (U.S. Government guaranteed)
   
1,445
     
830
     
4,551
     
6,826
     
12,874
     
19,700
     
4,551
     
-
 
Residential real estate
   
798
     
1,242
     
459
     
2,499
     
140,978
     
143,477
     
-
     
962
 
Home equity line of credit
   
50
     
108
     
-
     
158
     
42,574
     
42,732
     
-
     
-
 
Total
 
$
3,436
   
$
2,449
   
$
5,010
   
$
10,895
   
$
429,566
   
$
440,461
   
$
4,551
   
$
1,227
 

The Company began purchasing rehabilitated student loans under the Federal Rehabilitated Student Loan Program during the quarter ended December 31, 2012. The repayment of both principal and accrued interest are 98% guaranteed by the U.S. Department of Education. At December 31, 2015, $2.8 million of the student loans were 90 days or more past due and still accruing.
60


 
The following table presents information related to impaired loans by class as of and for the years ended December 31, 2015 and 2014.

Impaired Loans Receivable

 
 
December 31, 2015
 
(In thousands)
 
Recorded
Investment
   
Unpaid
Principal
Balance
   
Related
Allowance
   
Average
Recorded
Investment
   
Interest
Income
Recognized
 
With no specific allowance recorded:
 
   
   
   
   
 
Commercial and industrial
 
$
-
   
$
-
   
$
-
   
$
-
   
$
-
 
Commercial real estate
   
2,896
     
2,896
     
-
     
3,205
     
49
 
Construction and land
   
2,988
     
2,988
     
-
     
3,027
     
88
 
Residential real estate
   
419
     
419
     
-
     
428
     
18
 
Home equity line of credit
   
70
     
70
     
-
     
70
     
3
 
Consumer
   
-
     
-
     
-
     
-
     
-
 
Student (U.S. Government guaranteed)
   
-
     
-
     
-
     
-
     
-
 
 
                                       
With an allowance recorded:
                                       
Commercial and industrial
 
$
217
   
$
230
   
$
111
   
$
234
   
$
5
 
Commercial real estate
   
-
     
-
     
-
     
-
     
-
 
Construction and land
   
527
     
527
     
296
     
531
     
13
 
Residential real estate
   
-
     
-
     
-
     
-
     
-
 
Home equity line of credit
   
-
     
-
     
-
     
-
     
-
 
Consumer
   
-
     
-
     
-
     
-
     
-
 
Student (U.S. Government guaranteed)
   
-
     
-
     
-
     
-
     
-
 
 
                                       
Total:
                                       
Commercial and industrial
 
$
217
   
$
230
   
$
111
   
$
234
   
$
5
 
Commercial real estate
   
2,896
     
2,896
     
-
     
3,205
     
49
 
Construction and land
   
3,515
     
3,515
     
296
     
3,558
     
101
 
Residential real estate
   
419
     
419
     
-
     
428
     
18
 
Home equity line of credit
   
70
     
70
     
-
     
70
     
3
 
Consumer
   
-
     
-
     
-
     
-
     
-
 
Student (U.S. Government guaranteed)
   
-
     
-
     
-
     
-
     
-
 
Total
 
$
7,117
   
$
7,130
   
$
407
   
$
7,495
   
$
176
 

61

 
 
 
 
December 31, 2014
 
(In thousands)
 
Recorded
Investment
   
Unpaid
Principal
Balance
   
Related
Allowance
   
Average
Recorded
Investment
   
Interest
Income
Recognized
 
With no specific allowance recorded:
 
   
   
   
   
 
Commercial and industrial
 
$
20
   
$
50
   
$
-
   
$
33
   
$
-
 
Commercial real estate
   
1,438
     
2,006
     
-
     
1,722
     
108
 
Construction and land
   
1,577
     
1,893
     
-
     
1,737
     
79
 
Residential real estate
   
1,220
     
1,477
     
-
     
1,351
     
19
 
Home equity line of credit
   
70
     
70
     
-
     
70
     
3
 
Consumer
   
-
     
-
     
-
     
-
     
-
 
Student (U.S. Government guaranteed)
   
-
     
-
     
-
     
-
     
-
 
                                         
With an allowance recorded:
                                       
Commercial and industrial
 
$
296
   
$
304
   
$
246
   
$
312
   
$
11
 
Commercial real estate
   
1,834
     
1,834
     
456
     
1,835
     
102
 
Construction and land
   
2,043
     
2,043
     
470
     
2,064
     
110
 
Residential real estate
   
330
     
338
     
173
     
445
     
21
 
Home equity line of credit
   
-
     
-
     
-
     
-
     
-
 
Consumer
   
-
     
-
     
-
     
-
     
-
 
Student (U.S. Government guaranteed)
   
-
     
-
     
-
     
-
     
-
 
 
                                       
Total:
                                       
Commercial and industrial
 
$
316
   
$
354
   
$
246
   
$
345
   
$
11
 
Commercial real estate
   
3,272
     
3,840
     
456
     
3,557
     
210
 
Construction and land
   
3,620
     
3,936
     
470
     
3,801
     
189
 
Residential real estate
   
1,550
     
1,815
     
173
     
1,796
     
40
 
Home equity line of credit
   
70
     
70
     
-
     
70
     
3
 
Consumer
   
-
     
-
     
-
     
-
     
-
 
Student (U.S. Government guaranteed)
   
-
     
-
     
-
     
-
     
-
 
Total
 
$
8,828
   
$
10,015
   
$
1,345
   
$
9,569
   
$
453
 

Authoritative accounting guidance requires that the impairment of loans that have been separately identified for evaluation is to be measured based on the present value of expected  future cash flows or, alternatively, the observable market price of the loans or the fair value of the collateral. However, for those loans that are collateral dependent (that is, if repayment of those loans is expected to be provided solely by the underlying collateral) and for which management has determined foreclosure is probable, the measure of impairment is to be based on the net realizable value of the collateral. Authoritative accounting guidance also requires certain disclosures about investments in impaired loans and the allowance for loan losses and interest income recognized on loans.

A loan is considered  impaired  when it is probable  that the Bank will be unable to collect all principal  and interest amounts according  to the contractual terms of the loan agreement. Factors involved in determining impairment include, but are not limited to, expected future cash flows, financial condition  of the borrower,  and the current economic  conditions.  A performing  loan may be considered  impaired if the factors above indicate a need for impairment. A loan on non-accrual status may not be impaired if it is in the process of collection or if the shortfall in payment is insignificant.  A delay of less than 30 days or a shortfall of less than 5% of the required principal and interest payments generally is considered "insignificant" and would not indicate an impairment  situation, if in management's  judgment  the loan will be paid in full. Loans  that  meet the regulatory definitions of doubtful or loss generally qualify as impaired loans under authoritative accounting guidance. As is the case for all loans, charge-offs for impaired loans occur when the loan or portion of the loan is determined to be uncollectible.

At December 31, 2015, there were $4.1 million of commercial loans classified as substandard which were deemed not to be impaired because borrowers continue to abide by the terms of their original loan agreements and are substandard based on their industry or changes in their cash flow that have not yet resulted in past dues.  Impaired loans totaled $7.1 million at December 31, 2015, representing a decrease of $1.7 million from the year earlier.  Approximately $6.9 million of loans classified as impaired at December 31, 2015 were collateralized by commercial buildings, residential real estate, or land.

No additional funds are committed to be advanced in connection with impaired loans.
62


 
The following table presents loans by class that were modified as a TDR during the years ended December 31, 2015 and 2014.

Troubled Debt Restructurings

   
Twelve Months Ended December 31, 2015
   
Twelve Months Ended December 31, 2014
 
(Dollars in thousands)
 
Number
of
Contracts
   
Pre-Modification
Outstanding
Recorded
Investment
   
Post-Modification
Outstanding
Recorded
Investment
   
Number
of
Contracts
   
Pre-Modification
Outstanding
Recorded
Investment
   
Post-Modification
Outstanding
Recorded
Investment
 
Troubled Debt Restructurings
                       
Commercial and industrial
   
-
   
$
-
   
$
-
     
2
   
$
198
   
$
198
 
Commercial real estate
   
3
     
2,898
     
2,898
     
2
     
3,735
     
3,735
 
Construction and Land
   
1
     
1,328
     
1,328
     
1
     
1,673
     
1,673
 
Consumer
   
-
     
-
     
-
     
-
     
-
     
-
 
Student (U.S. Government guaranteed)
   
-
     
-
     
-
     
-
     
-
     
-
 
Residential real estate
   
-
     
-
     
-
     
-
     
-
     
-
 
Home equity line of credit
   
-
     
-
     
-
     
-
     
-
     
-
 
 
                                               
Troubled Debt Restructurings That Subsequently Defaulted
                                               
Commercial and industrial
   
-
   
$
-
   
$
-
     
-
   
$
-
   
$
-
 
Commercial real estate
   
-
     
-
     
-
     
-
     
-
     
-
 
Construction and Land
   
-
     
-
     
-
     
-
     
-
     
-
 
Consumer
   
-
     
-
     
-
     
-
     
-
     
-
 
Student (U.S. Government guaranteed)
   
-
     
-
     
-
     
-
     
-
     
-
 
Residential real estate
   
-
     
-
     
-
     
-
     
-
     
-
 
Home equity line of credit
   
-
     
-
     
-
     
-
     
-
     
-
 

During the  year ended December 31, 2015, four loans totaling $4.2 million, were modified and deemed TDRs.  Three of these were annual renewals of previously identified TDRs.  At December 31, 2015, there were 12 TDRs in the portfolio, totaling $7.1 million.  Seven of the eight remaining loans were current and performing in accordance with the modified terms. The remaining four loans totaling $1.6 million remain in nonaccrual status due to irregular payments.  An appropriate specific reserve has been established.  Restructured loans are included in the specific reserve calculation in the allowance for loan losses and are included in the impaired loan disclosure.

At December 31, 2015, the Company had one foreclosed residential real estate property in its possession. There were two residential real estate properties with a total carrying value of $242,000 that were in the process of foreclosure.
 
Non-performing Assets, Restructured Loans Still Accruing, and Loans Contractually Past Due
 
(Dollars in thousands)
 
December 31,
2015
   
December 31,
2014
   
December 31,
2013
 
Non-accrual loans
 
$
1,849
   
$
1,227
   
$
2,184
 
Other real estate owned
   
1,356
     
1,406
     
4,085
 
Non-performing corporate bond investments, at fair value
   
-
     
-
     
1,300
 
Total non-performing assets
   
3,205
     
2,633
     
7,569
 
Restructured loans still accruing
   
5,495
     
7,431
     
8,613
 
Student loans (U.S. Gov guaranteed) past due 90 or more days and still accruing
   
2,814
     
4,551
     
7,917
 
All other loans past due 90 or more days and still accruing
   
-
     
-
     
506
 
Total non-performing and other risk assets
 
$
11,514
   
$
14,615
   
$
24,605
 
 
                       
Allowance for loan losses to total loans
   
0.94
%
   
1.22
%
   
1.48
%
Non-accrual loans to total loans
   
0.41
%
   
0.28
%
   
0.48
%
Allowance for loan losses to non-accrual loans
   
226.77
%
   
439.36
%
   
305.27
%
Total non-accrual loans and restructured loans still accruing to total loans
   
1.64
%
   
1.97
%
   
2.39
%
Allowance for loan losses to non-accrual loans and  restructured loans still accruing
   
57.09
%
   
62.27
%
   
61.75
%
Total non-performing assets to total assets
   
0.53
%
   
0.43
%
   
1.23
%

Restructured loans on non-accrual status are included with non-accrual loans and not with restructured loans in the above table. 
63


Note 4. Related Party Transactions

In the ordinary course of business, the Bank has granted loans to executive officers, directors, their immediate families and affiliated companies in which they are principal shareholders, which totaled $2.2 million at December 31, 2015 and $2.8 million at December 31, 2014.  During 2015, total principal additions were $635,000 and total principal payments were $1.3 million.  During 2014, total principal additions were $1.8 million and total principal payments were $2.5 million.  These loans were made on terms and underwriting standards substantially the same as offered in comparable transactions to other persons.

The Bank accepts deposits of executive officers, directors, their immediate families and affiliated companies in which they are principal shareholders on the same terms, including interest rates, as those prevailing at the time of comparable transactions with unrelated persons.  The aggregate dollar amount of deposits of executive officers and directors totaled $4.5 million and $3.9 million at December 31, 2015 and 2014, respectively.

Note 5. Bank Premises and Equipment, Net

A summary of the cost and accumulated depreciation of premises and equipment at December 31, 2015 and 2014 are as follows:
 
(In thousands)
 
2015
   
2014
 
Land
 
$
4,185
   
$
4,199
 
Buildings and improvements
   
21,807
     
21,748
 
Furniture and equipment
   
5,818
     
6,413
 
Leasehold improvements
   
307
     
307
 
 
   
32,117
     
32,667
 
Accumulated depreciation and amortization
   
(11,656
)
   
(11,599
)
 
 
$
20,461
   
$
21,068
 

Depreciation and amortization expensed for years ended December 31, 2015, 2014, and 2013 totaled $1.42 million, $1.29 million, and $1.10 million, respectively.
 
Note 6. Deposits

The aggregate amount of time deposits in denominations of $250,000 or more at December 31, 2015 and 2014 were $8.6 million and $15.1 million, respectively. Brokered deposits include balances of Bank customers who qualify to participate in the Certificate of Deposit Account Registry Service and Insured Cash Sweep Service.  As of December 31, 2015 and 2014, brokered balances totaled $20.5 million and $18.1 million, respectively.

Overdraft deposits totaling $187,000 and $192,000 were reclassified to loans at December 31, 2015 and 2014, respectively.

At December 31, 2015, the scheduled maturities of time deposits are as follows:

(In thousands)
 
 
 
 
 
2016
 
$
31,557
 
2017
   
11,716
 
2018
   
3,144
 
2019
   
7,953
 
2020
   
9,446
 
and thereafter
   
136
 
 
 
$
63,952
 

64

Note 7. Employee Benefit Plans

Supplemental Executive Retirement Plan

The following tables provide a reconciliation of the changes in the supplemental executive retirement plan's obligations over the three-year period ending December 31, 2015, computed as of December 31, 2015, 2014 and 2013.
 
Change in Benefit Obligations
(In thousands)
 
2015
   
2014
   
2013
 
   
   
   
 
Projected benefit obligation, beginning
 
$
2,181
   
$
1,808
   
$
1,637
 
Service cost
   
141
     
119
     
114
 
Interest cost
   
81
     
81
     
65
 
Actuarial (gain) loss
   
(31
)
   
173
     
(8
)
Benefit obligation, ending
 
$
2,372
   
$
2,181
   
$
1,808
 
 
                       
Fair value of plan assets, ending
 
$
-
   
$
-
   
$
-
 
 
                       
Funded status at December 31,
 
$
(2,372
)
 
$
(2,181
)
 
$
(1,808
)
 
Amount recognized on the Balance Sheet
(In thousands)
 
2015
   
2014
   
2013
 
             
Other assets, deferred income tax benefit
 
$
806
   
$
741
   
$
615
 
Other liabilities
   
2,372
     
2,181
     
1,808
 
Accumulated other comprehensive income (loss)
   
(41
)
   
(61
)
   
53
 
 
                       
Amounts recognized in accumulated other comprehensive gain (loss)
                       
Net gain (loss)
 
$
(81
)
 
$
(112
)
 
$
61
 
Prior service cost
   
19
     
19
     
19
 
Net obligation at transition
   
-
     
-
     
-
 
Deferred tax benefit (expense)
   
21
     
32
     
(27
)
Amount recognized
 
$
(41
)
 
$
(61
)
 
$
53
 
 
                       
Funded Status
                       
Benefit obligation
 
$
(2,372
)
 
$
(2,181
)
 
$
(1,808
)
Fair value of assets
   
-
     
-
     
-
 
Unrecognized net actuarial (gain)/loss
   
-
     
-
     
-
 
Unrecognized net obligation at transition
   
-
     
-
     
-
 
Unrecognized prior service cost
   
-
     
-
     
-
 
(Accrued)/prepaid benefit cost included in other liabilities
 
$
(2,372
)
 
$
(2,181
)
 
$
(1,808
)

65

Components of Net Periodic Benefit Cost
(In thousands)
 
2015
   
2014
   
2013
 
   
   
   
 
Service cost
 
$
141
   
$
119
   
$
114
 
Interest cost
   
81
     
81
     
65
 
Expected return on plan assets
   
-
     
-
     
-
 
Amortization of prior service cost
   
1
     
1
     
1
 
Amortization of net obligation at transition
   
-
     
-
     
-
 
Recognized net actuarial loss (gain)
   
-
     
-
     
-
 
Net periodic benefit cost
 
$
223
   
$
201
   
$
180
 

Other Changes in Plan Assets and Benefit Obligations Recognized in Other Comprehensive Income (Loss)
 
(In thousands)
 
2015
   
2014
   
2013
 
             
Net gain/(loss)
 
$
30
   
$
(174
)
 
$
8
 
Prior service cost
   
-
     
-
     
-
 
Amortization of prior service cost
   
1
     
1
     
1
 
Net obligation at transition
   
-
     
-
     
-
 
Amortization of net obligation a transition
   
-
     
-
     
-
 
Total recognized
   
31
     
(173
)
   
9
 
 
                       
Less: Income tax effect
   
10
     
(59
)
   
3
 
Net amount recognized in other comprehensive income (loss)
 
$
21
   
$
(114
)
 
$
6
 

 
Total Recognized in Net Periodic Benefit Costs and Other Comprehensive (Income) Loss before Income Tax
(In thousands)
2015
 
2014
 
2013
 
$
191
  
$
373
   $
171
 

The assumptions used in the measurement of the Company's benefit obligations are shown in the following table.

 Weighted-Average Assumptions used in computing ending obligations as of December 31
2015
 
2014
 
2013
 
 
 
 
 
 
Discount rate used for net periodic benefit cost
 
3.75%
 
 
4.50%
 
 
4.00%
Discount rate used for disclosures
 
4.00%
 
 
3.75%
 
 
4.50%
Expected return on plan assets
 
NA
 
 
NA
 
 
NA
Rate of compensation increase
 
3.25%
 
 
3.25%
 
 
3.25%

Estimated future benefit payments which reflect expected future service, as appropriate, are as follows.

Payment Dates
 
Amount
 
For the 12 months ending:
 
(In thousands)
 
December 31, 2016
 
$
100
 
December 31, 2017
   
99
 
December 31, 2018
   
141
 
December 31, 2019
   
145
 
December 31, 2020
   
178
 
Thereafter
   
836
 

During 2014, the Company also established a supplemental retirement plan for an additional executive. There was no expense for the plan during 2015.

66

401(k) Plan

The Company has a defined contribution retirement plan under Internal Revenue Code of 1986 ("Code") Section 401(k) covering employees who have completed three months of service and who are at least 18 years of age.  Under the plan, a participant may contribute an amount up to 100% of their covered compensation for the year, not to exceed the dollar limit set by law (Code Section 402(g)).  The Company will make an annual matching contribution, equal to 100% on the first 1% of compensation deferred and 50% on the next 5% of compensation deferred for a maximum match of 3.5% of compensation. Beginning in 2010, the Company began making an additional safe harbor contribution equal to 6% of compensation to all eligible participants.   The Company's 401(k) expenses for the years ended December 31, 2015, 2014 and 2013 were $715,000, $640,000 and $662,000, respectively.

Deferred Compensation Plan
 
The Company also maintains a Director Deferred Compensation Plan ("Deferred Compensation Plan"). This plan provides that any non-employee director of the Company or the Bank may elect to defer receipt of all or any portion of his or her compensation as a director. A participating director may elect to have amounts deferred under the Deferred Compensation Plan held in a deferred cash account, which is credited on a quarterly basis with interest equal to the highest rate offered by the Bank at the end of the preceding quarter. Alternatively, a participant may elect to have a deferred stock account in which deferred amounts are treated as if invested in the Company's common stock at the fair market value on the date of deferral. The value of a stock account will increase and decrease based upon the fair market value of an equivalent number of shares of common stock. In addition, the deferred amounts deemed invested in common stock will be credited with dividends on an equivalent number of shares. Amounts considered invested in the Company's common stock are paid, at the election of the director, either in cash or in whole shares of the common stock and cash in lieu of fractional shares. Directors may elect to receive amounts contributed to their respective accounts in one or up to five installments.  There were no directors participating in the Deferred Compensation plan in 2015, 2014 and 2013.

The Company has a nonqualified deferred compensation program for a former key employee's retirement, in which the contribution expense is solely funded by the Company.  The retirement benefit to be provided is variable based upon the performance of underlying life insurance policy assets.  Deferred compensation expense amounted to $45,000, $36,000 and $34,000 for the years ended December 31, 2015, 2014 and 2013, respectively. Concurrent with the establishment of the deferred compensation program, the Company purchased life insurance policies on this employee with the Company named as owner and beneficiary.  These life insurance policies are intended to be utilized as a source of funding the deferred compensation program.  The Company has recorded in other assets $1.3 million,  $1.2 million and $1.2 million  representing cash surrender value of these policies, and recorded income of $32,000, $32,000 and $30,000  for the years ended December 31, 2015, 2014 and 2013, respectively.

Note 8. Dividend Reinvestment and Stock Purchase Plan

In 2004, the Company implemented a dividend reinvestment and stock purchase plan (the "DRSPP") that allows participating shareholders to purchase additional shares of the Company's common stock through automatic reinvestment of dividends or optional cash investments at 100% of the market price of the common stock, which is either the actual purchase price of the shares if obtained on the open market, or the average of the closing bid and asked quotations for a share of common stock on the day before the purchase date for shares if acquired directly from the Company as newly issued shares under the DRSPP.  No new shares were issued during 2015, 2014 and 2013. The Company had 236,529 shares available for issuance under the DRSPP at December 31, 2015.

67

Note 9. Commitments and Contingent Liabilities

The Bank has entered into three banking facility leases of greater than one year.

The first lease was entered into on January 31, 1999. The lease provides for an original five-year term with a renewal option for additional periods of five years on the Bank's Sudley Road, Manassas branch. There have been three subsequent renewals. Rent for 2016 is expected to be $251,000.

The second lease is for the property in Haymarket, Virginia where the Bank opened its ninth full-service branch office in December 2009. The term of the lease is 20 years after the branch opening with two additional options for five years each. The projected rent for 2016 is $207,000, and will increase 3% annually.
 
The third lease is for the property in Bristow, Virginia where the Bank opened its tenth full-service branch office in July 2009. The lease will expire ten years after the branch opening with two additional options for five years each. The projected rent for 2016 is $207,000 and will increase 3% annually.

Total rent expense was $690,000, $712,000, and $634,000 for 2015, 2014, and 2013, respectively, and was included in occupancy expense.

The Bank has two data processing contractual obligations of greater than one year. The expense for the Bank's largest primary contractual obligation is for core data processing, and totaled $1.1 million, $1.2 million and $1.2 million for 2015, 2014 and 2013, respectively. In addition to core data processing, this contract provides for interchange processing where the expense is based on interchange volume. The interchange expense for 2015, 2014 and 2013 was $716,000, $828,000 and $740,000, respectively, but was offset by interchange income on the same transactions. The term of the current data processing obligation began in June 2014 and will end in December 2021, and is included in data processing expense in the Company's Consolidated Statement of Income.

The following is a schedule by year of future minimum lease requirements and contractual obligations required under the long-term non-cancellable agreements:

(In thousands)
 
Amount
 
2016
 
$
2,679
 
2017
   
2,727
 
2018
   
2,795
 
2019
   
2,746
 
2020
   
2,833
 
Thereafter
   
8,009
 
Total
 
$
21,789
 

As a member of the Federal Reserve System, the Bank is required to maintain certain average reserve balances.  For the final weekly reporting period in the years ended December 31, 2015 and 2014, the aggregate amounts of daily average required balances were approximately $19.9 million and $21.8 million, respectively.

In the normal course of business, there are various outstanding commitments and contingent liabilities, such as guarantees, commitments to extend credit, etc., which are not reflected in the accompanying consolidated financial statements. The Company does not anticipate a material impact on its financial statements.

See Note 15 with respect to financial instruments with off-balance sheet risk.
68


Note 10. Income Taxes

The Company files income tax returns in the U.S. federal jurisdiction and the state of Virginia.  With few exceptions, the Company is no longer subject to U.S. federal, state and local income tax examinations by tax authorities for years prior to 2012.

The components of the net deferred tax assets included in other assets at December 31, 2015 and 2014 are as follows:

(In thousands)
 
2015
   
2014
 
Deferred tax assets:
 
   
 
Allowance for loan losses
 
$
1,978
   
$
1,833
 
Securities available for sale
   
117
     
-
 
Impairment on securities
   
513
     
513
 
Interest on nonaccrual loans
   
813
     
267
 
Accrued vacation
   
125
     
117
 
SERP obligation
   
858
     
772
 
OREO
   
355
     
338
 
Accumulated depreciation
   
-
     
194
 
Interest rate swap
   
98
     
103
 
Net operating loss carryforward
   
168
     
-
 
Restricted stock
   
103
     
143
 
Other
   
352
     
151
 
 
   
5,480
     
4,431
 
Deferred tax liabilities:
               
Securities available for sale
   
-
     
83
 
Accumulated depreciation
   
25
     
-
 
Other
   
6
     
4
 
 
   
31
     
87
 
Net deferred tax assets
 
$
5,449
   
$
4,344
 

The Company has not recorded a valuation allowance for deferred tax assets as management feels it is more likely than not, that they will be ultimately realized.  Under the provisions of the Internal Revenue Code, the Company has $168,000 of net operating loss carryforwards which can be offset against future taxable income.  The carryforwards expire through December 31, 2035.


Allocation of federal income taxes between current and deferred portions is as follows:
 
 
 
 Year Ended December 31,          
(In thousands)
 
  2015    
2014
 
 
 2013  
 
   
 
 
Current tax expense
 
$
(232
)
   $
1,599
   
$
1,733
 
Deferred tax expense
   
(1,192
)
     
(219
)
   
(292
)
 
 
$
(1,424
)
   $
1,380
   
$
1,441
 

The reasons for the difference between the statutory federal income tax rate and the effective tax rates for the three years ended December 31, 2015 are summarized as follows:
 
(In thousands)
 
2015
   
2014
   
2013
 
 
 
   
   
 
Computed "expected" tax expense
 
$
(692
)
 
$
2,103
   
$
1,962
 
Decrease in income taxes resulting from:
                       
Tax-exempt interest income
   
(407
)
   
(388
)
   
(304
)
Other
   
(325
)
   
(335
)
   
(217
)
 
 
$
(1,424
)
 
$
1,380
   
$
1,441
 

69

Note 11. Earnings Per Share

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

 
2015
 
2014
 
2013
 
 
Shares
 
Per
Share
Amount
 
Shares
 
Per
Share
Amount
 
Shares
 
Per
Share
Amount
 
 
 
 
 
 
 
 
Basic earnings per share
   
3,742,725
   
$
(0.16
)
   
3,728,316
   
$
1.29
     
3,710,802
   
$
1.17
 
 
                                               
Effect of dilutive securities, stock-based awards
   
-
             
18,931
             
17,084
         
 
                                               
Diluted earnings per share
   
3,742,725
   
$
(0.16
)
   
3,747,247
   
$
1.28
     
3,727,886
   
$
1.16
 
 
Due to the Company's net loss in 2015, all potential common stock outstanding are considered to be anti-dilutive.
70


Note 12. Stock Based Compensation

Stock Incentive Plan

On May 19, 2009, the shareholders of the Company approved the Company's Stock Incentive Plan (the "Plan"), which superseded and replaced the Omnibus Stock Ownership and Long-Term Incentive Plan.

Under the Plan, stock options, stock appreciation rights, non-vested and/or restricted shares, and long-term performance unit awards may be granted to directors and certain employees for purchase of the Company's common stock.  The effective date of the Plan is March 19, 2009, the date the Company's Board approved the Plan, and it has a termination date of December 31, 2019.  The Company's Board may terminate, suspend or modify the Plan within certain restrictions. The Plan authorizes for issuance 350,000 shares of the Company's common stock.  The Plan requires that options be granted at an exercise price equal to at least 100% of the fair market value of the common stock on the date of the grant. Such options are generally not exercisable until three years from the date of issuance and generally require continuous employment during the period prior to exercise.  The options will expire in no more than ten years after the date of grant. The stock options, stock appreciation rights, restricted shares, and long-term performance unit awards for certain employees are generally subject to vesting requirements and are subject to forfeiture if vesting and other contractual provision requirements are not met.  The Company did not grant stock options during 2015, 2014 or 2013 and at December 31, 2015, there were none outstanding.

Restricted Shares

The restricted shares are accounted for using the fair market value of the Company's common stock on the date the restricted shares were awarded.  The restricted shares issued to certain officers are subject to a vesting period, whereby, the restrictions on the shares lapse on the third year anniversary of the date the restricted shares were awarded.  Compensation expense for these shares is accrued over the three year period.  The restricted shares issued to non-employee directors are not subject to a vesting period, and compensation expense is recognized at the date the shares are granted.

During 2015, 2014 and 2013, the Company granted awards of non-vested shares to certain officers and vested shares to non-employee directors under the Plan: 10,227 shares, 10,570 shares and 12,470 shares of non-vested restricted stock to executive officers; and 3,458 shares, 4,050 shares and 5,712 shares of vested restricted stock to non-employee directors on February 19, 2015, February 20, 2014 and February 21, 2013, respectively.  Compensation expense for these non-vested shares amounted to $163,000, $151,000 and $147,000, net of forfeiture, for the years ended December 31, 2015, 2014 and 2013, respectively. As of December 31, 2015, there was $187,000 of total unrecognized compensation cost related to non-vested share-based compensation arrangements granted under the Company's equity compensation plans.  This type of deferred compensation cost is recognized over a period of three years.  Compensation expense for non-employee director shares was $59,000 in 2015, and $64,000 in 2014 and  $68,000 in 2013 and was recognized at the date the shares were granted.

A summary of the status of the Company's non-vested restricted shares granted under the above-described plans is presented below:

 
 
2015
   
2014
   
2013
 
 
 
Shares
   
Weighted
Average
Grant Date
Fair Value
   
Shares
   
Weighted
Average
Grant Date
Fair Value
   
Shares
   
Weighted
Average
Grant Date
Fair Value
 
Non-vested at January 1,
   
34,965
   
     
34,109
   
     
31,423
   
 
 
         
           
           
 
Granted
   
13,685
   
$
17.20
     
14,620
   
$
15.70
     
18,182
   
$
11.91
 
Vested
   
(15,383
)
           
(13,764
)
           
(15,496
)
       
Forfeited
   
-
             
-
             
-
         
Non-vested at December 31,
   
33,267
             
34,965
             
34,109
         

The Company granted performance-based stock rights relating to 10,227 shares, 10,570 shares and 12,470 shares to certain officers on February 19, 2015, February 20, 2014 and February 21, 2013, respectively, under the Plan.  The performance-based stock rights are accounted for using the fair market value of the Company's common stock on the date awarded, and adjusted as the market value of the stock changes.  The performance-based stock rights shares issued to executive officers are subject to a vesting period, whereby the restrictions on the shares lapse on the third year anniversary of the date the restricted shares were awarded.  Until vesting, the shares are not issued and not included in shares outstanding.  The awards are subject to the Company reaching a predetermined three year performance average on the return on average equity ratio, also as compared to a predetermined peer group of banks.   The compensation expense for performance-based stock rights totaled $(148,000), $41,000 and $180,000 for the years ended December 31, 2015, 2014 and 2013, respectively. In the years ended December 31, 2015 and 2014, previously accrued compensation expense of $206,000 and $100,000, respectively, for performance-based stock rights was recovered because the predetermined metrics were not attained. As of December 31, 2015, there was no unrecognized compensation cost related to these stock rights.  This type of deferred compensation cost is recognized over a period of three years dependent upon management reaching the predetermined goals.   

71

A summary of the status of the Company's non-vested performance-based stock rights is presented below:

 
 
2015
 
2014
 
2013
 
 
Performance
Based
Stock
Rights (Shares)
 
Weighted
Average Fair
Value at
December 31
 
Performance
Based
Stock
Rights (Shares)
 
Weighted
Average Fair
Value at
December 31
 
Performance
Based
Stock
Rights (Shares)
 
Weighted
Average Fair
Value at
December 31
Non-vested at January 1,
   
35,141
 
 
   
34,109
 
 
   
31,423
 
  
 
       
 
       
 
       
          
Granted
   
10,227
 
 
   
10,746
 
 
   
12,470
 
  
Vested
   
-
 
 
   
(9,714
)
 
   
-
 
  
Forfeited
   
(11,925
)
 
   
-
 
 
   
(9,784
)
  
Non-vested at December 31,
   
33,443
 
$14.74
   
35,141
 
$13.12
   
34,109
 
$12.65
 

 
Note 13. Federal Home Loan Bank Advances and Other Borrowings

The Company's borrowings from the FHLB were $13.0 million at December 31, 2015 and $13.1 million at December 31, 2014.  At December 31, 2015, the interest rates on FHLB advances ranged from 2.82% to 2.06% and the weighted average interest rate was 2.46%. At December 31, 2014, the interest rates on FHLB advances ranged from 2.82% to 2.06% and the weighted average interest rate was 2.46%.

At December 31, 2015, the Bank had an available line of credit with the FHLB with a borrowing limit of approximately $177.7 million with advances of $13.0 million outstanding. The amount outstanding includes $3.0 million of amortizing balances that will mature with a balloon of $2.4 million in 2022.  FHLB advances and the available line of credit were secured by certain first and second lien loans on one-to-four unit single-family dwellings and eligible commercial real estate loans of the Bank.  As of December 31, 2015, the book value of eligible loans totaled approximately $146.4 million.  At December 31, 2014, the advances were secured by similar loans totaling $212.9 million.  The amount of available credit is limited to 100% of the market value of qualifying collateral for one-to-four unit single-family residential loans, 79% to 94% for home equity loans and 70% for commercial real estate loans.  Any borrowing in excess of the qualifying collateral requires pledging of additional assets.

The contractual maturities of FHLB advances at December 31, 2015 are as follows:

(In thousands)
   
Due in 2016
 
$
71
 
Due in 2017
   
5,076
 
Due in 2018
   
80
 
Due in 2019
   
85
 
Due in 2020
   
89
 
Thereafter
   
7,606
 
 
 
$
13,007
 

As additional sources of liquidity, the Bank has available federal funds purchased lines of credit with seven different commercial banks totaling $56.0 million, and the Federal Reserve Bank of Richmond for $3.8 million.  At December 31, 2015, none of the available federal funds purchased lines of credit with various commercial banks were in use.

72

Note 14. Dividend Limitations on Affiliate Bank

Transfers of funds from the banking subsidiary to the parent corporation in the form of loans, advances and cash dividends are restricted by federal and state regulatory authorities.  As of December 31, 2015, the aggregate amount of unrestricted funds, which could be transferred from the banking subsidiary to the parent corporation, without prior regulatory approval, totaled $3.8 million.

Note 15. Financial Instruments With Off-Balance Sheet Risk

The Company is party to credit-related financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of its customers.  These financial instruments include commitments to extend credit and standby letters of credit.  Such commitments involve, to varying degrees, 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 is represented by the contractual amount of these commitments.  The Company follows the same credit policies in making commitments as it does for on-balance-sheet instruments.

At December 31, 2015 and 2014, the following financial instruments were outstanding whose contract amounts represent credit risk:

(In thousands)
2015
   
2014
 
Financial instruments whose contract amounts represent credit risk:
   
 
Commitments to extend credit
$
 
66,698
   
$
 
82,308
 
Standby letters of credit
   
2,516
       
3,349
 
 
$
 
69,214
   
$
 
85,657
 

Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract.  Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee.  Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements.  The Company evaluates each customer's credit worthiness on a case-by-case basis.  The amount of collateral obtained, if deemed necessary by the Company, is based on management's credit evaluation of the customer.

Unfunded commitments under commercial lines of credit, revolving credit lines and overdraft protection agreements are commitments for possible future extensions of credit to existing customers. These lines of credit usually do not contain a specified maturity date and may not be drawn upon to the total extent to which the Company is committed.

Standby letters of credit are conditional commitments issued by the Company to guarantee the performance of a customer to a third party.  Those letters of credit are primarily issued to support public and private borrowing arrangements.  The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers.  The Company generally holds collateral supporting those commitments if deemed necessary.

73

Note 16. Derivative Instruments and Hedging Activities

GAAP requires that all derivatives be recognized in the Consolidated Financial Statements at their fair values.  On the date that the derivative contract is entered into, the Company designates the derivative as a hedge of variable cash flows to be paid or received in conjunction with recognized assets or liabilities as a cash-flow or fair value hedge. For a derivative treated as a cash flow hedge, the ineffective portion of changes in fair value is reported in current period earnings.  The effective portion of the cash flow hedge is recorded as an adjustment to the hedged item through other comprehensive income.  For a derivative treated as a fair value hedge, the gain or loss on the derivative as well as the offsetting loss or gain on the hedged item attributable to the hedged risk are recognized in current earnings in interest income.  The Company uses interest rate swaps to reduce interest rate risk and to manage net interest income.

The Company formally assesses, both at the hedges' inception, and on an on-going basis, whether derivatives used in hedging transactions have been highly effective in offsetting changes in cash flows of hedged items and whether those derivatives are expected to remain highly effective in subsequent periods.  The Company discontinues hedge accounting when (a) it determines that a derivative is no longer effective in offsetting changes in cash flows of a hedged item; (b) the derivative expires or is sold, terminated or exercised; (c) probability exists that the forecasted transaction will no longer occur; or (d) management determines that designating the derivative as a hedging instrument is no longer appropriate.  In all cases in which hedge accounting is discontinued and a derivative remains outstanding, the Company will carry the derivative at fair value in the Consolidated Financial Statements, recognizing changes in fair value in current period income in the consolidated statement of operations.

The Company follows GAAP, FASB ASU 815-10-50 "Disclosures about Derivative Instruments and Hedging Activities", which includes the disclosure requirements for derivative instruments and hedging activities to provide enhanced disclosures about (a) how and why an entity uses derivative instruments, (b) how derivative instruments and related hedged items are accounted for and (c) how derivative instruments and related hedged items affect an entity's financial position, financial performance and cash flows.

Interest differentials paid or received under the swap agreements are reflected as adjustments to interest income.  These interest rate swap agreements include both cash flow and fair value hedge derivative instruments that qualify for hedge accounting.  The notional amounts of the interest rate swaps are not exchanged and do not represent exposure to credit loss.  In the event of default by a counter party, the risk in these transactions is the cost of replacing the agreements at current market rates.

The Company entered into an interest rate swap agreement on July 1, 2010 to manage the interest rate exposure on its Floating Rate Junior Subordinated Deferrable Interest Debentures due 2036.  By entering into this agreement, the Company converts a floating rate liability into a fixed rate liability through 2020.  Under the terms of the agreement, the Company receives interest quarterly at the rate equivalent to three-month LIBOR plus 1.70% repricing every three months on the same date as the Company's Floating Rate Junior Subordinated Deferrable Interest Debentures due 2036 and pays interest expense monthly at the fixed rate of 4.91%.  The interest expense on the interest rate swap was $118,000, $121,000 and $119,000 for the years ended December 31, 2015, 2014 and  2013, respectively.  The swap is designated as a cash flow hedge and changes in the fair value are recorded as an adjustment through other comprehensive income.

The Company entered into three swap agreements to manage the interest rate risk related to three commercial loans.  The agreements allow the Company to convert fixed rate assets to floating rate assets through 2022 and 2025.  The Company receives interest monthly at the rate equivalent to one-month LIBOR plus a spread repricing on the same date as the loans and pays interest at fixed rates.   The interest expense on the interest rate swaps was $161,000, $107,000 and $108,000 in 2015, 2014 and 2013, respectively, and is recorded in loan interest income.  These swaps are designated as fair value hedges and changes in fair value are recorded in current earnings.
 
Cash collateral posted for these hedges was $900,000 at December 31, 2015.  Collateral posted and received is dependent on the market valuation of the underlying hedges.
74


The effects of derivative instruments on the Consolidated Financial Statements for December 31, 2015 and 2014 are as follows:
 
(In thousands)
December 31, 2015
 
Derivatives designated as
hedging instruments
Notional/
Contract
Amount
 
Estimated Net
Fair Value
 
Fair Value
Balance Sheet
Location
Expiration
Date From
Expiration Date To
Interest rate swap
 
$
4,000
   
$
(289
)
Other Liabilities
 
 9/15/2020
Interest rate swap
   
973
     
2
 
Other Assets
 
 9/26/2022
Interest rate swap
   
5,996
     
(46
)
Other Liabilities
2/14/2022
4/9/2025
 
(In thousands)
December 31, 2015
 
 
Derivatives in cash flow
hedging relationships
 
Amount of Gain (Loss)
Recognized in OCI on
Derivatives, net of tax
(Effective Portion)
 
Location of Gain or (Loss) Recognized in
Income on Derivative
(Ineffective Portion)
Amount of Gain (Loss)
Recognized in Income
on Derivative
(Ineffective Portion)
 
Interest rate swap
 
$
10
 
Not applicable
 
$
-
 
 
(In thousands)
December 31, 2015
 
Derivatives in fair value
hedging relationships
Income
Statement
Classification
Gain or
(Loss) on
Swaps
 
Interest rate swaps
Interest income
 
$
(112
)

(In thousands)
December 31, 2014
Derivatives designated as
hedging instruments
Notional/
Contract
Amount
 
Estimated Net
Fair Value
 
Fair Value
Balance Sheet
Location
Expiration
Date
Interest rate swap
 
$
4,000
   
$
(304
)
Other Liabilities
9/15/2020
Interest rate swap
   
1,000
     
16
 
Other Assets
9/16/2022
Interest rate swap
   
4,107
     
(129
)
Other Liabilities
8/15/2021

(In thousands)
December 31, 2014
 
 
Derivatives in cash flow
hedging relationships
Amount of Gain (Loss)
Recognized in OCI on
Derivatives, net of tax
(Effective Portion)
 
Location of Gain or
(Loss) Recognized in
Income on Derivative
(Ineffective Portion)
Amount of Gain (Loss)
Recognized in Income
on Derivative
(Ineffective Portion)
 
Interest rate swap
 
$
(53
)
Not applicable
 
$
-
 

(In thousands)
December 31, 2014
 
Derivatives in fair value
hedging relationships
Income Statement
Classification
Gain or
(Loss) on Swaps
 
Interest rate swaps
Interest income
 
$
(58
)

75

Note 17. Accumulated Other Comprehensive Income

Changes in Accumulated Other Comprehensive Income (Loss) by Component (1)

 (In thousands)
 
Gains and Losses on Cash Flow Hedges
   
Unrealized Gains and Losses on Available-for-Sale Securities
   
Supplemental Executive Retirement Plans
   
Total
 
                 
Balance December 31, 2012
 
$
(361
)
 
$
(1,398
)
 
$
47
   
$
(1,712
)
Other comprehensive income before reclassifications
   
214
     
646
     
6
     
866
 
Amounts reclassified from accumulated other comprehensive (loss)
   
-
     
(95
)
   
-
     
(95
)
Net current-period other comprehensive income
   
214
     
551
     
6
     
771
 
Balance December 31, 2013
 
$
(147
)
 
$
(847
)
 
$
53
   
$
(941
)
                                 
Other comprehensive income (loss) before reclassifications
   
(53
)
   
1,009
     
(114
)
   
842
 
Amounts reclassified from accumulated other comprehensive (loss)
   
-
     
(2
)
   
-
     
(2
)
Net current-period other comprehensive income (loss)
   
(53
)
   
1,007
     
(114
)
   
840
 
Balance December 31, 2014
 
$
(200
)
 
$
160
   
$
(61
)
 
$
(101
)
                                 
Other comprehensive income (loss) before reclassifications
   
10
     
(386
)
   
20
     
(356
)
Amounts reclassified from accumulated other comprehensive (loss)
   
-
     
(3
)
   
-
     
(3
)
Net current-period other comprehensive income (loss)
   
10
     
(389
)
   
20
     
(359
)
Balance December 31, 2015
 
$
(190
)
 
$
(229
)
 
$
(41
)
 
$
(460
)

(1) All amounts are net of tax. Amounts in parentheses indicate debits.

Reclassifications Out of Accumulated Other Comprehensive Income

 
For the Twelve Months Ended December 31,
   
(In thousands)
2015
   
2014
   
2013
   
Details about accumulated other comprehensive income components
Amount reclassified from accumulated other comprehensive income
   
Amount reclassified from accumulated other comprehensive income
   
Amount reclassified from accumulated other comprehensive income
 
Affected line item in the statement where net income is presented.
Unrealized gains and losses on available-for-sale securities
$
 
4
   
$
 
3
   
$
 
144
 
Gain on sale of securities
     
4
       
3
       
144
 
Total income before income tax
     
1
       
1
       
49
 
Income tax expense
 
$
 
 3
   
$
 
 2
     $
 
 95
 
Net of tax

76

Note 18. Fair Value Measurement

The Company follows ASC 820 "Fair Value Measurement and Disclosures" to record fair value adjustments to certain assets and liabilities and to determine fair value disclosures. 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.

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 under ASC 820 based on these two types of inputs are as follows:

Level 1 – Valuation is based on quoted prices in active markets for identical assets and liabilities.

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

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

Securities available for sale: Securities available for sale are recorded at fair value on a recurring basis. Fair value measurement is based upon quoted market prices, when available (Level 1). If quoted market prices are not available, fair values are measured utilizing independent valuation techniques of identical or similar securities for which significant assumptions are derived primarily from or corroborated by observable market data (Level 2).  If the inputs used to provide the evaluation for certain securities are unobservable and/or there is little, if any, market activity then the security would fall to the lowest level of the hierarchy (Level 3).  The Company's investment portfolio is primarily valued using fair value measurements that are considered to be Level 2.  The Company has contracted with a third party portfolio accounting service vendor for valuation of its securities portfolio.  The vendor's primary source for security valuation is Interactive Data Corporation ("IDC"), which evaluates securities based on market data.  IDC utilizes evaluated pricing models that vary by asset class and include available trade, bid, and other market information. Generally, the methodology includes broker quotes, proprietary modes, vast descriptive terms and conditions databases, as well as extensive quality control programs.  See Note 2 "Securities" of the Notes to Consolidated Financial Statements for a description of the valuation of the pooled trust preferred securities.  The carrying value of restricted Federal Reserve Bank, Community Bankers Bank and FHLB stock approximates fair value based on the redemption provisions of each entity and are therefore excluded from the following table.

Interest rate swaps: The Company uses interest rate swaps to reduce interest rate risks and to manage net interest income. Interest rate swaps are recorded at fair value on a recurring basis.  The Company utilizes interest rate swap agreements as part of the management of interest rate risk to modify the repricing characteristics of certain portions of the Company's interest-bearing assets and liabilities.  The Company has contracted with a third party vendor to provide valuations for interest rate swaps using standard swap valuation techniques and therefore classifies such valuations as Level 2.  The Company has considered counterparty credit risk in the valuation of its interest rate swap assets and has considered its own credit risk in the valuation of its interest rate swap liabilities.

77

The following table presents the balances of financial assets and liabilities measured at fair value on a recurring basis as of December 31, 2015 and December 31, 2014 by levels within the valuation hierarchy:

 
 
Fair Value Measurements Using
 
(In thousands)
 
Balance
   
Quoted Prices
in Active Markets for
Identical
Assets
(Level 1)
   
Significant
Other
Observable
Inputs
(Level 2)
   
Significant
Unobservable
Inputs
(Level 3)
 
Assets at December 31, 2015
 
   
   
   
 
Available for sale securities:
 
   
   
   
 
Obligations of U.S. Government corporations and agencies
 
$
45,792
   
$
-
   
$
45,792
   
$
-
 
Obligations of states and political subdivisions
   
6,200
     
-
     
6,200
     
-
 
Corporate bonds
   
2,860
     
-
     
2,860
     
-
 
Mutual funds
   
372
     
372
     
-
     
-
 
Total available for sale securities
   
55,224
     
372
     
54,852
     
-
 
 
                               
Interest rate swaps
   
2
     
-
     
2
     
-
 
Total assets at fair value
 
$
55,226
   
$
372
   
$
54,854
   
$
-
 
 
                               
Liabilities at December 31, 2015
                               
Interest rate swaps
 
$
335
   
$
-
   
$
335
   
$
-
 
Total liabilities at fair value
 
$
335
   
$
-
   
$
335
   
$
-
 
 
                               
Assets at December 31, 2014
                               
Available for sale securities:
                               
Obligations of U.S. Government corporations and agencies
 
$
46,965
   
$
-
   
$
46,965
   
$
-
 
Obligations of states and political subdivisions
   
6,914
     
-
     
6,914
     
-
 
Corporate bonds
   
3,161
     
-
     
3,161
     
-
 
Mutual funds
   
366
     
366
     
-
     
-
 
Total available for sale securities
   
57,406
     
366
     
57,040
     
-
 
 
                               
Interest rate swaps
   
16
     
-
     
16
     
-
 
Total assets at fair value
 
$
57,422
   
$
366
   
$
57,056
   
$
-
 
 
                               
Liabilities at December 31, 2014
                               
Interest rate swaps
 
$
433
   
$
-
   
$
433
   
$
-
 
Total liabilities at fair value
 
$
433
   
$
-
   
$
433
   
$
-
 

78

Change in Level 3 Fair Value

There were no assets measured in level 3 at December 31, 2015 and 2014.

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 financial assets recorded at fair value on a nonrecurring basis in the financial statements:

Impaired Loans: Loans are designated as impaired when, in the judgment of management based on current information and events, it is probable that all amounts due according to the contractual terms of the loan agreement will not be collected. The measurement of loss associated with impaired loans can be based on either the observable market price of the loan or the fair value of the collateral securing the loans. Collateral may be in the form of real estate or business assets including equipment, inventory, and accounts receivable. The vast majority of the Company's collateral is real estate.  The value of real estate collateral is determined utilizing an income or market valuation approach based on an appraisal, of one year or less, conducted by an independent, licensed appraiser outside of the Company using observable market data (Level 2). However, if the collateral is a house or building in the process of construction or if an appraisal of the real estate property is more than one year old and not solely based on observable market comparables or management determines the fair value of the collateral is further impaired below the appraised value, then the fair value is considered Level 3. The value of business equipment is based upon an outside appraisal, of one year or less, if deemed significant, or the net book value on the applicable business' financial statements if not considered significant using observable market data. Likewise, values for inventory and accounts receivable collateral are based on financial statement balances or aging reports (Level 3). Impaired loans allocated to the Allowance for Loan Losses are measured at fair value on a nonrecurring basis. Any fair value adjustments are recorded in the period incurred as provision for loan losses on the Consolidated Statements of Income. At December 31, 2015, the Company's Level 3 loans for which a reserve has been taken, consisted of one loan totaling $314,000 secured by real estate with reserves of $275,000 and one loan totaling $110,000 secured with business assets and inventory with reserves of $105,000.  
 
Other Real Estate Owned ("OREO"):  Foreclosed assets are adjusted to fair value upon transfer of the loans to OREO.  Subsequently, OREO is carried at the lower of carrying value or fair market value less selling costs.  Fair value is based upon independent market prices, appraised values of the collateral, or management's estimation of the value of the collateral.  When the fair value of the collateral is based on an observable market price or a current appraised value, the Company considers the OREO as nonrecurring Level 2.  When a current appraised value is not available or management determines the fair value of the collateral is further impaired below the appraised value and there is no observable market price, the Company considers records the OREO as nonrecurring Level 3.  Total valuation of OREO property was $1.4 million at December 31, 2015 and $1.4 million at December 31, 2014.

79

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

 
Carrying Value at December 31, 2015
 
(In thousands)
Balance as of
December 31, 2015
 
Quoted Prices in Active Markets for Identical Assets
(Level 1)
 
Significant
Other
Observable
Inputs
(Level 2)
 
Significant
Other
Unobservable
Inputs
(Level 3)
 
Assets:
 
 
 
 
Impaired loans, net
 
$
337
   
$
-
   
$
293
   
$
44
 
Other real estate owned, net
   
1,356
     
-
     
1,356
     
-
 

 
Carrying Value at December 31, 2014
 
(In thousands)
Balance as of
December 31,
2014
 
Quoted Prices in
Active
Markets for
Identical
Assets
(Level 1)
 
Significant
Other
Unobservable
Inputs
(Level 2)
 
Significant
Other
Observable
Inputs
(Level 3)
 
Assets:
 
 
 
 
Impaired loans, net
 
$
3,158
   
$
-
   
$
3,109
   
$
49
 
Other real estate owned, net
   
1,406
     
-
     
1,406
     
-
 

The following table displays quantitative information about Level 3 Fair Value Measurements for December 31, 2015 and 2014:

 
Quantitative Information about Level 3 Fair Value Measurements at December 31, 2015
 
(In thousands)
Fair
Value
 
Valuation
Technique(s)
Unobservable Input
Weighted
Average
 
Impaired Loans
 
$
 
44
 
 Appraised values
 Age of appraisal, current market conditions, experience within local market, and U.S. Government guarantees.
   
90
%
Total
$
 
44
 
 
 
       

 
Quantitative Information about Level 3 Fair Value Measurements at December 31, 2014
 
(In thousands)
Fair
Value
 
Valuation
Technique(s)
Unobservable Input
Weighted
Average
 
Impaired Loans
 
$
 
49
 
Appraised values
   Age of appraisal, current market conditions, experience within local market, and U.S. Government guarantees.
   
92
%
Total
$
 
49
 
 
 
       
 

 
The fair value of a financial instrument is the current amount that would be exchanged between willing parties, other than in a forced liquidation.  Fair value is best determined based upon quoted market prices.  However, in many instances, there are no quoted market prices for the Company's various financial instruments.  In cases where quoted market prices are not available, fair values are based on estimates using present value or other valuation techniques.  Those techniques are significantly affected by the assumptions used, including the discount rate and estimates of future cash flows.  Accordingly, the fair value estimates may not be realized in an immediate settlement of the instruments.  ASC 820 excludes certain financial instruments and all non-financial instruments from its disclosure requirements.  Accordingly, the aggregate fair value amounts presented may not necessarily represent the underlying fair value of the Company.

80

The following methods and assumptions were used to estimate the fair value of each class of financial instruments for which it is practicable to estimate that value:

Cash and cash equivalents: The carrying amounts of cash and short-term instruments with a maturity of three months or less approximate fair value.  Instruments with maturities of greater than three months are estimated using a discounted cash flow calculation that applies interest rates currently being offered on similar instruments.

Securities: For securities and marketable equity securities held for investment purposes, fair values are based on quoted market prices or dealer quotes.  For other securities held as investments, fair value equals quoted market price, if available.  If a quoted market price is not available, fair values are based on quoted market prices for similar securities. See Note 2 "Securities" of the Notes to Consolidated Financial Statements for further discussion on determining fair value for pooled trust preferred securities.

Loans Receivable: For variable-rate loans that reprice frequently and with no significant change in credit risk, fair values are based on carrying values.  Fair values for certain mortgage loans (e.g., one-to-four family residential), credit card loans, and other consumer loans are based on quoted market prices of similar loans sold in conjunction with securitization transactions, adjusted for differences in loan characteristics.  Fair values for other loans (i.e., commercial real estate and investment property mortgage loans, commercial and industrial loans) are estimated using discounted cash flow analyses, using interest rates currently being offered for loans with similar terms to borrowers of similar credit quality.  Fair values for non-performing loans are estimated using discounted cash flow analyses or underlying collateral values, where applicable.

Accrued Interest: The carrying amounts of accrued interest approximate fair value.

Life Insurance: The carrying amount of life insurance contracts is assumed to be a reasonable fair value.  Life insurance contracts are carried on the balance sheet at their redemption value.  This redemption value is based on existing market conditions and therefore represents the fair value of the contract.

Interest Rate Swaps: The fair values are based on quoted market prices or mathematical models using current and historical data.

Deposit Liabilities: The fair values disclosed for demand deposits (i.e., interest and non-interest bearing checking, statement savings and money market accounts) are, by definition, equal to the amount payable at the reporting date (that is, their carrying  amounts).  Fair values of fixed rate certificates of deposit are estimated using a discounted cash flow calculation that applies interest rates currently being offered to a schedule of aggregated expected monthly maturities on time deposits.


Borrowed Funds: The fair values of the Company's FHLB advances and other borrowings are estimated using discounted cash flow analyses based on the Company's current incremental borrowing rates for similar types of borrowing arrangements.

Off-Balance Sheet Financial Instruments: The fair value of commitments to extend credit is estimated using the fees currently charged to enter similar agreements, taking into account the remaining terms of the agreements and the present creditworthiness of the counterparties.  For fixed-rate loan commitments, fair value also considers the difference between current levels of interest rates and the committed rates.

The fair value of standby letters of credit is based on fees currently charged for similar agreements or on the estimated cost to terminate them or otherwise settle the obligations with the counterparties at the reporting date.

At December 31, 2015 and December 31, 2014, the fair value of loan commitments and standby letters of credit were deemed immaterial.

81

The estimated fair values of the Company's financial instruments are as follows:
 
 
 
Fair Value Measurements at December 31, 2015
 
(In thousands)
 
Carrying
Value as of
December 31, 2015
   
Quoted Prices
in Active
Markets for
Identical Assets
(Level 1)
   
Significant
Other
Observable
Inputs
(Level 2)
   
Significant
Other
Unobservable
Inputs
(Level 3)
   
Fair Value as of
December 31, 2015
 
Assets
 
   
   
   
   
 
Cash and short-term investments
 
$
53,215
   
$
53,031
   
$
-
   
$
-
   
$
53,031
 
Securities available for sale
   
55,224
     
372
     
54,852
     
-
     
55,224
 
Restricted investments
   
1,286
     
-
     
1,286
     
-
     
1,286
 
Net loans
   
442,669
     
-
     
443,724
     
44
     
443,768
 
Accrued interest receivable
   
1,462
     
-
     
1,462
     
-
     
1,462
 
Interest rate swaps
   
2
     
-
     
2
     
-
     
2
 
BOLI
   
12,511
     
-
     
12,511
     
-
     
12,511
 
Total Financial Assets
 
$
566,369
   
$
53,403
   
$
513,837
   
$
44
   
$
567,284
 
 
                                       
Liabilities
                                       
Deposits
 
$
524,294
   
$
-
   
$
524,094
   
$
-
   
$
524,094
 
Borrowings
   
13,007
     
-
     
13,081
     
-
     
13,081
 
Company obligated mandatorily
                                       
redeemable capital securities
   
4,124
     
-
     
4,185
     
-
     
4,185
 
Accrued interest payable
   
108
     
-
     
108
     
-
     
108
 
Interest rate swaps
   
335
     
-
     
335
     
-
     
335
 
Total Financial Liabilities
 
$
541,868
   
$
-
   
$
541,803
   
$
-
   
$
541,803
 

 
 
 
Fair Value Measurements at December 31, 2014
 
(In thousands)
 
Carrying
Value as of
December 31, 2014
   
Quoted Prices
in Active
Markets for
Identical Assets
(Level 1)
   
Significant
Other
Observable
Inputs (Level 2)
   
Significant
Other
Unobservable
Inputs
(Level 3)
   
Fair Value as of
December 31, 2014
 
Assets
 
   
   
   
   
 
Cash and short-term investments
 
$
64,376
   
$
64,441
   
$
-
   
$
-
   
$
64,441
 
Securities available for sale
   
57,406
     
366
     
57,040
     
-
     
57,406
 
Restricted investments
   
1,294
     
-
     
1,294
     
-
     
1,294
 
Net loans
   
435,070
     
-
     
434,356
     
49
     
434,405
 
Accrued interest receivable
   
1,473
     
-
     
1,473
     
-
     
1,473
 
Interest rate swaps
   
16
     
-
     
16
     
-
     
16
 
BOLI
   
12,458
     
-
     
12,458
     
-
     
12,458
 
Total Financial Assets
 
$
572,093
   
$
64,807
   
$
506,637
   
$
49
   
$
571,493
 
 
                                       
Liabilities
                                       
Deposits
 
$
525,215
   
$
-
   
$
525,636
   
$
-
   
$
525,636
 
Borrowings
   
13,075
     
-
     
13,182
     
-
     
13,182
 
Company obligated mandatorily redeemable capital securities
   
4,124
     
-
     
4,117
     
-
     
4,117
 
Accrued interest payable
   
185
     
-
     
185
     
-
     
185
 
Interest rate swaps
   
433
     
-
     
433
     
-
     
433
 
Total Financial Liabilities
 
$
543,032
   
$
-
   
$
543,553
   
$
-
   
$
543,553
 
 
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 values 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.
82

Note 19. Other Operating Expenses

The principal components of "Other operating expenses" in the Consolidated Statements of Income are:

(In thousands)
 
2015
   
2014
   
2013
 
Postage and courier expenses
 
$
171
   
$
176
   
$
170
 
Paper and supplies
   
156
     
169
     
161
 
Taxes, other than income taxes
   
363
     
336
     
311
 
Charge-offs, other than loan charge-offs
   
400
     
318
     
353
 
Telephone
   
331
     
322
     
306
 
Directors' compensation
   
218
     
237
     
180
 
Managed service agreements
   
437
     
436
     
388
 
Other (no items exceed 1% of total revenue)
   
1,092
     
1,048
     
1,073
 
 
 
$
3,168
   
$
3,042
   
$
2,942
 

Directors' compensation is allocated and expensed separately at both the Bank and at the parent company. The above year to year comparisons of directors' compensation are on a consolidated basis.

Note 20. Concentration Risk

The Company maintains its cash accounts in several correspondent banks.  The total amount of cash on deposit in those banks exceeded the federally insured limits by $0 and $22,000 at December 31, 2015 and 2014, respectively.

Note 21. Capital Requirements

The Company meets the eligibility criteria of a small bank holding company in accordance with the Federal Reserve's Small Bank Holding Company Policy Statement issued in February 2015, and is no longer obligated to report consolidated regulatory capital.  The Bank continues to be subject to various capital requirements administered by banking agencies. Failure to meet minimum capital requirements can trigger certain mandatory and discretionary actions by regulators that could have a direct material effect on the Company's financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Bank must meet specific capital guidelines that involve quantitative measures of their assets, liabilities, and certain off-balance sheet items as calculated under regulatory accounting practices. The Bank's capital amounts and classifications are also subject to qualitative judgments by the regulators about components, risk weightings and other factors. In July 2013, the Federal Reserve issued final rules that make technical changes to its capital rules to align them with the Basel III regulatory capital framework and meet certain requirements of the Dodd-Frank Act. The final rules maintain the general structure of the prompt corrective action framework in effect at such time while incorporating certain increased minimum requirements.

On January 1, 2015, the Bank applied changes to the regulatory capital framework that were approved on July 9, 2013 by the federal banking regulators (the Basel III Final Rule).  The regulatory risk-based capital amounts presented above for December 31, 2015 include:  (1) common equity tier 1 capital ("CET1") which consists principally of common stock (including surplus) and retained earnings with adjustments for goodwill, intangible assets and deferred taxes; (2) Tier 1 capital which consists principally of CET1 plus the Bank's "grandfathered" trust preferred securities; and (3) Tier 2 capital which consists principally of Tier 1 capital plus a limited amount of the allowance for loan losses.  In addition, the Bank has made the one-time irrevocable election to continue treating accumulated other comprehensive income ("AOCI") under regulatory standards that were in place prior to the Basel III Final Rule in order to eliminate volatility of regulatory capital that can result from fluctuations in AOCI and the inclusion of AOCI in regulatory capital, as would otherwise be required under the Basel III Capital Rule.  The table above also reflects the minimum regulatory and certain prompt corrective action capitals that began on January 1, 2015.

Effective January 1, 2015, the final rules require the Bank to comply with the following minimum capital ratios: (i) a new common equity Tier 1 capital ratio of 4.5% of risk-weighted assets; (ii) a Tier 1 capital ratio of 6.0% of risk-weighted assets (increased from the prior requirement of 4.0%); (iii) a total capital ratio of 8.0% of risk-weighted assets (unchanged from the prior requirement); and (iv) a leverage ratio of 4.0% of total assets (unchanged from the prior requirement). These are the initial capital requirements, which will be phased in over a four-year period. When fully phased in on January 1, 2019, the rules will require the Bank to maintain such minimum ratios plus a 2.5% "capital conservation buffer" (other than for the leverage ratio). The capital conservation buffer requirement will be phased in beginning January 1, 2016, at 0.625% of risk-weighted assets, increasing by the same amount each year until fully implemented at 2.5% on January 1, 2019. Management believes the Bank will be compliant with the fully phased-in requirements when they become effective January 1, 2019.

Quantitative measures in effect during 2014 established by regulation to ensure capital adequacy required the Bank to maintain minimum amounts and ratios (set forth in the table below) of total and Tier 1 capital (as defined in the regulations) to risk-weighted assets (as defined), and of Tier 1 capital (as defined) to average assets (as defined).  Management believes that the Bank met all capital adequacy requirements to which they are subject to as of December 31, 2015.
 
83

As of December 31, 2015, the Bank as well capitalized under the regulatory framework for prompt corrective action.  To be categorized as "well capitalized," an institution must maintain minimum total risk-based, Tier 1 risk-based, and Tier 1 leverage ratios as set forth in the table.  There are no conditions or events since that notification that management believes have changed the institution's category.
 
The Bank's actual capital amounts and ratios are also presented in the following table. No amount was deducted from capital for interest-rate risk.
 
 
 
Actual
   
Minimum Capital
Requirement
   
Well Capitalized Under
Prompt Corrective
Action Provisions
 
(Dollars in thousands)
 
Amount
   
Ratio
   
Amount
   
Ratio
   
Amount
   
Ratio
 
As of December 31, 2015:
 
   
   
   
   
   
 
   
   
   
   
   
   
 
Total capital (to risk weighted assets):
 
$
59,162
     
12.5
%
 
$
37,781
     
8.0
%
 
$
47,227
     
10.0
%
                                                 
    Common equity tier 1 capital (to risk weighted assets
 
$
54,969
     
11.6
%
 
$
18,891
     
4.5
%
 
$
37,781
     
6.5
%
                                                 
    Tier 1 capital (to risk weighted assets):
 
$
54,969
     
11.6
%
 
$
18,891
     
6.0
%
 
$
37,781
     
8.0
%
                                                 
    Tier 1 capital (to average assets):
 
$
54,969
     
9.1
%
 
$
24,093
     
4.0
%
 
$
30,116
     
5.0
%
 
                                               
As of December 31, 2014:
                                               
                                                 
Total capital (to risk weighted assets):
 
$
62,242
     
14.8
%
 
$
33,578
     
8.0
%
 
$
41,972
     
10.0
%
                                                 
    Tier 1 capital (to risk weighted assets):
 
$
56,994
     
13.6
%
 
$
16,789
     
4.0
%
 
$
25,183
     
6.0
%
                                                 
     Tier 1 capital (to average assets):
 
$
56,994
     
9.5
%
 
$
24,037
     
4.0
%
 
$
30,047
     
5.0
%
 

 
Note 22. Company-Obligated Mandatorily Redeemable Capital Securities
 
On September 21, 2006, the Company's wholly-owned Connecticut statutory business trust privately issued $4.0 million face amount of the trust's Floating Rate Capital Securities in a pooled capital securities offering (Trust II). Simultaneously, the trust used the proceeds of that sale to purchase $4.0 million principal amount of the Company's Floating Rate Junior Subordinated Deferrable Interest Debentures due 2036. The interest rate on the capital security resets every three months at 1.70% above the then current three-month LIBOR. Interest is paid quarterly.  Total capital securities at December 31, 2015 and December 31, 2014 amounted to $4,124,000 on each date. The Trust II issuance of capital securities and the respective subordinated debentures are callable at any time after five years from the issue date. The subordinated debentures are an unsecured obligation of the Company and are junior in right of payment to all present and future senior indebtedness of the Company. The capital securities are guaranteed by the Company on a subordinated basis.

84

Note 23. Parent Corporation Only Financial Statements

FAUQUIER BANKSHARES, INC.
(Parent Corporation Only)
Balance Sheets

(In thousands)
 
December 31,
 
Assets
 
2015
   
2014
 
Cash on deposit with subsidiary bank
 
$
718
   
$
667
 
Interest-bearing deposits at other banks
   
1,450
     
1,650
 
Investment in subsidiaries, at cost, plus equity in undistributed net income
   
54,699
     
57,093
 
Other assets
   
252
     
432
 
Total assets
 
$
57,119
   
$
59,842
 
 
               
Liabilities and Shareholders' Equity
               
Company-obligated mandatorily redeemable capital securities
 
$
4,124
   
$
4,124
 
Other liabilities
   
362
     
561
 
Total liabilities
   
4,486
     
4,685
 
Shareholders' Equity
               
Common stock
   
11,616
     
11,568
 
Retained earnings, which are substantially distributed earnings of subsidiaries
   
41,477
     
43,690
 
Accumulated other comprehensive income (loss)
   
(460
)
   
(101
)
Total shareholders' equity
   
52,633
     
55,157
 
 
               
Total liabilities and shareholders' equity
 
$
57,119
   
$
59,842
 

85

FAUQUIER BANKSHARES, INC.
(Parent Corporation Only)
Statements of Operations
For Each of the Three Years Ended December 31, 2015

(In thousands)
 
2015
   
2014
   
2013
 
Income
 
   
   
 
Interest income
 
$
9
   
$
14
   
$
18
 
Dividends from subsidiaries
   
1,797
     
1,791
     
2,282
 
Total interest and dividend income
   
1,806
     
1,805
     
2,300
 
 
                       
Expenses
                       
Interest expense
   
199
     
199
     
199
 
Legal and professional fees
   
107
     
42
     
139
 
Directors' fees
   
141
     
157
     
133
 
Miscellaneous
   
143
     
140
     
122
 
Total expense
   
590
     
538
     
593
 
 
                       
Income before income tax benefits and equity in undistributed net income of subsidiaries
   
1,216
     
1,267
     
1,707
 
 
                       
Income tax benefit
   
(198
)
   
(178
)
   
(157
)
 
                       
Income before equity in undistributed net income of subsidiaries
   
1,414
     
1,445
     
1,864
 
 
                       
Equity in undistributed (distributed) net income of subsidiaries
   
(2,026
)
   
3,361
     
2,467
 
Net income (loss)
 
$
(612
)
 
$
4,806
   
$
4,331
 

86

FAUQUIER BANKSHARES, INC.
(Parent Corporation Only)
Statements of Cash Flows
For Each of the Three Years in the Period Ended December 31, 2015

(In thousands)
 
2015
   
2014
   
2013
 
Cash Flows from Operating Activities
 
   
   
 
Net income (loss)
 
$
(612
)
 
$
4,806
   
$
4,331
 
Adjustments to reconcile net income (loss) to net cash provided by operating activities:
                       
Undistributed (distributed) earnings of subsidiaries
   
2,026
     
(3,361
)
   
(2,467
)
Tax effect of restricted stock awards
   
22
     
7
     
(56
)
Issuance of common stock
   
60
     
104
     
68
 
Amortization of unearned compensation
   
28
     
190
     
147
 
(Increase) decrease in other assets
   
175
     
(1
)
   
30
 
(Decrease)  in other liabilities
   
136
     
(90
)
   
(4
)
Net cash provided by operating activities
   
1,835
     
1,655
     
2,049
 
 
                       
Cash Flows from Financing Activities
                       
Cash dividends paid
   
(1,984
)
   
(1,791
)
   
(1,782
)
Net cash (used in) financing activities
   
(1,984
)
   
(1,791
)
   
(1,782
)
 
                       
Increase (decrease) in cash and cash equivalents
   
(149
)
   
(136
)
   
267
 
 
                       
Cash and Cash Equivalents
                       
Beginning
   
2,317
     
2,453
     
2,186
 
 
                       
Ending
 
$
2,168
   
$
2,317
   
$
2,453
 

87

Note 24.          Investment in Affordable Housing Projects

The Company has investments in certain affordable housing projects located in the Commonwealth of Virginia through six limited liability partnerships of the Bank. These partnerships exist to develop and preserve affordable housing for low income families through residential rental property projects.  The Company exerts no control over the operating or financial policies of the partnerships.  Return on these investments is through receipt of tax credits and other tax benefits which are subject to recapture by taxing authorities based on compliance features at the project level. The investments are due to expire by 2032.  The Company accounts for the affordable housing investments using the equity method and has recorded $4.3 million in other assets at December 31, 2015. The Company has also recorded $2.7 million in other liabilities related to capital calls through 2019. The related federal tax credits and other tax benefits for the years ended December 31, 2015 and 2014 were $502,000 and $404,000,  respectively, and were included in income tax expense in the Consolidated Statements of Income.  There were $482,000 in flow-through losses recognized during the year ended December 31, 2015 and $180,000 in the year ended December 31, 2014.

88

ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE

None.

ITEM 9A. CONTROLS AND PROCEDURES

Disclosure Controls and Procedures
The Company maintains disclosure controls and procedures that are designed to provide assurance that the information required to be disclosed in the reports filed or submitted under the Exchange Act is recorded, processed, summarized, and reported within the time periods required by the SEC. An evaluation of the effectiveness of the design and operations of the Company's disclosure controls and procedures at the end of the period covered by this report was carried out under the supervision and with the participation of the management of Fauquier Bankshares, Inc., including the Chief Executive Officer and the Chief Financial Officer. Based on such an evaluation, the Chief Executive Officer and the Chief Financial Officer concluded the Company's disclosure controls and procedures were effective as of the end of such period.

The Company regularly assesses the adequacy of its internal control over financial reporting and enhances its controls in response to internal control assessments and internal and external audit and regulatory recommendations.  There have not been any significant changes in the Company's internal control over financial reporting or in other factors that have materially affected or are reasonably likely to materially affect, such controls during the quarter ended December 31, 2015.

There have been no material changes to the quantitative and qualitative disclosures made in the Company's Annual Report on Form 10-K for the year ended December 31, 2015.

Management's Report on Internal Control Over Financial Reporting
The management of Fauquier Bankshares, Inc. ("Management") is responsible for establishing and maintaining adequate internal control over financial reporting (as defined in Rule 13a-15(f) of the Exchange Act). Management's internal control over financial reporting is a process designed under the supervision of the Company's Chief Executive Officer and Chief Financial Officer to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles in the United States of America.

As of December 31, 2015, Management has assessed the effectiveness of the internal control over financial reporting based on the criteria for effective internal control over financial reporting established in "Internal Control-Integrated Framework" issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on the assessment, Management determined that it maintained effective internal control over the financial reporting as of December 31, 2015, based on the 2013 framework criteria.

No changes were made in Management's internal control over financial reporting during the year ended December 31, 2015 that have materially affected, or that are reasonably likely to materially affect, Management's internal control over financial reporting.

ITEM 9B. OTHER INFORMATION
 
None.

ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE

Information concerning the Company required by this item is contained in the Company's definitive proxy statement for the 2016 annual meeting of shareholders to be held on May 17, 2016 (the "2016 proxy statement") under the captions "Election of Four Class II Directors and One Class III Director," "Meetings and Committees of the Board of Directors," and "Section 16(a) Beneficial Ownership Reporting Compliance," and is incorporated herein by reference.

The Company has adopted a Code of Business Conduct and Ethics that applies to the directors, executive officers and employees of the Company and the Bank. Please see Exhibit 14 in the exhibit list contained in Part IV, Item 15 of this Form 10-K.
89


ITEM 11. EXECUTIVE COMPENSATION

The information relating to executive and director compensation is contained in the Company's 2016 proxy statement under the captions "Directors' Compensation" and "Executive Compensation" and is incorporated herein by reference.

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS

The information regarding security ownership required by this item is contained in the Company's 2016 proxy statement under the caption "Security Ownership of Certain Beneficial Owners and Management," and is incorporated herein by reference.

The following table sets forth information as of December 31, 2015 with respect to compensation plans under which equity securities of the Company are authorized for issuance:

Equity Compensation Plan Information
 
Plan Category
 
Number of securities to
be issued upon exercise of outstanding options,
warrants and rights
(a)
       
Weighted–average
exercise price of outstanding options,
warrants and rights (b)
   
Number of securities remaining available for future issuance under equity compensation plans (excluding securities reflected in column (a)
 
Equity compensation plans approved by security holders
   
33,443
 
(1) 
$
14.74
     
184,765
   (2) 
 
                               
Equity compensation plans not approved by security holders
   
-
                 
-
      
 
                                
Total
   
33,443
       
$
14.74
     
184,765
      
 
(1) Consists of shares underlying performance-based stock rights that were granted under the Stock Incentive Plan approved by security holders on May 19, 2009.

(2) Consists of 350,000 shares available to be granted in the form of options, restricted stock or stock appreciation rights under the Stock Incentive Plan approved by security holders on May 19, 2009.

For additional information concerning the material features of the Company's equity compensation plans please see Note 12 of our Notes to Consolidated Financial Statements contained in Item 8 of this Form 10-K.

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE

Information required by this item is contained in the Company's 2016 proxy statement under the captions "Meetings and Committees of the Board of Directors" and "Related Party Transactions," and is incorporated herein by reference.

ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES

Information required by this item is contained in the Company's 2016 proxy statement under the captions "Principal Accountant Fees" and "Pre-Approval Policies," and is incorporated herein by reference.
90


ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES
 
(a) (1) -Financial Statements

The following consolidated financial statements of Fauquier Bankshares, Inc. and subsidiaries are filed as part of this document under Item 8. Financial Statements and Supplementary Data.

Report of Independent Registered Public Accounting Firm
Consolidated Balance Sheets - December 31, 2015 and December 31, 2014
Consolidated Statements of Operations - Years ended December 31, 2015, 2014, and 2013
Consolidated Statements of Comprehensive Income (Loss) - Years ended December 31, 2015, 2014, and 2013
Consolidated Statements of Changes in Shareholders' Equity -Years ended December 31, 2015, 2014, and 2013
Consolidated Statements of Cash Flows - Years ended December 31, 2015, 2014, and 2013
Notes to Consolidated Financial Statements -Years ended December 31, 2015, 2014, and 2013

(a) (2) -Financial Statement Schedules

All schedules to the consolidated financial statements required by Article 9 of Regulation S-X are omitted since they are either not applicable or the required information is set forth in the consolidated financial statements or notes thereto.

(a) (3) -Exhibits

91

The following exhibits are filed as part of this Form 10-K and this list includes the Exhibit Index.
 
Exhibit
Number
Exhibit
Description
3.1
Articles of Incorporation of Fauquier Bankshares, Inc., as amended, incorporated by reference to Exhibit 3.1 to Form 10-K filed March 15, 2010.
 
 
3.2
Bylaws of Fauquier Bankshares, Inc., as amended and restated, incorporated by reference to Exhibit 3.2 to Form 8-K filed February 22, 2016.
 
 
10.1
Fauquier Bankshares, Inc. Omnibus Stock Ownership and Long-Term Incentive Plan, as amended and restated effective January 1, 2000, incorporated by reference to Exhibit 4.B to Form S-8 filed October 15, 2002.
 
 
10.1.1
Form of Restricted Stock Grant Agreement for Employee, incorporated by reference to Exhibit 10.1.1 to Form 8-K filed February 16, 2005.
 
 
10.1.2
Form of Restricted Stock Grant Agreement for Non-Employee Director, incorporated by reference to Exhibit 10.1.2 to Form 8-K filed February 16, 2005.
 
 
10.2
Fauquier Bankshares, Inc. Director Deferred Compensation Plan, as adopted effective May 1, 1995, incorporated by reference to Exhibit 4.C to Form S-8 filed October 15, 2002.
 
 
10.3
Fauquier Bankshares, Inc. Stock Incentive Plan, incorporated by reference to Exhibit 99.0 to Form S-8 filed August 21, 2009.
 
 
10.3.1
Form of Incentive Stock Option Agreement relating to Fauquier Bankshares, Inc. Stock Incentive Plan, incorporated by reference to Exhibit 10.4.1 to Form 10-K filed March 15, 2010.
 
 
10.3.2
Form of Nonstatutory Stock Option Agreement relating to Fauquier Bankshares, Inc. Stock Incentive Plan, incorporated by reference to Exhibit 10.4.2 to Form 10-K filed March 15, 2010.
 
 
10.3.3
Form of Restricted Stock Award Agreement relating to Fauquier Bankshares, Inc. Stock Incentive Plan, incorporated by reference to Exhibit 10.4.3 to Form 10-K filed March 15, 2010.
 
 
10.4
Change of Control Agreement, dated November 27, 2000, between Fauquier Bankshares, Inc. and Eric P. Graap, incorporated by reference to Exhibit 10.8 to Form 10-K filed March 25, 2003.
 
 
 
10.4.1
First Amendment, dated December 31, 2008, to Change of Control Agreement, dated November 27, 2000, between Fauquier Bankshares, Inc. and Eric P. Graap, incorporated by reference to Exhibit 10.4.1 to Form 10-K filed March 16, 2009.
 
 
10.5
Form of the Executive Survivor Income Agreement, dated on or about May 9, 2003, between The Fauquier Bank and each of Randy K. Ferrell and Eric P. Graap, incorporated by reference to Exhibit 10.13 to Form 10-Q filed August 14, 2003.
 
 
10.6
Employment Agreement, dated January 19, 2005, between Fauquier Bankshares, Inc., The Fauquier Bank and Randy K. Ferrell, as amended, incorporated by reference to Exhibit 10.9 to Form 10-K filed March 16, 2009.
   
10.7
Employment Agreement, dated November 7, 2011, between Fauquier Bankshares, Inc., The Fauquier Bank and Eric P. Graap, incorporated by reference to Exhibit 10.1 to Form 10-Q filed November 14, 2011.
 
 
10.8
Fauquier Bankshares, Inc. Supplemental Executive Retirement Plan, as amended and restated October 21, 2010, incorporated by reference to Exhibit 10.15 to Form 10-Q filed November 8, 2010.
 
 
10.8.1
Form of Participation Agreement for Fauquier Bankshares, Inc. Supplemental Executive Retirement Plan, incorporated by reference to Exhibit 10.15.1 to Form 10-Q filed November 8, 2010.
 
 
10.9
Base Salaries for Named Executive Officers.
 
 
14
Code of Business Conduct and Ethics, incorporated by reference to Exhibit 14 to Form 10-Q filed August 11, 2006.
 
 
21
Subsidiaries of the Fauquier Bankshares, Inc., incorporated herein by reference to Part I of this Form 10-K.
 
 
23.1
Consent of Smith Elliott Kearns & Company, LLC.
 
 
31.1
Certification of CEO pursuant to Rule 13a-14(a).
 
 
31.2
Certification of CFO pursuant to Rule 13a-14(a).
 
 
32.1
Certification of CEO pursuant to 18 U.S.C. Section 1350.
 
 
32.2
Certification of CFO pursuant to 18 U.S.C. Section 1350.
 
 
101.00
The following materials from the Company's 10-K Report for the period ended December 31, 2015, formatted in XBRL: (i) the Consolidated Balance Sheets, (ii) the Consolidated Statements of Income, (iii) the Consolidated Statements of Comprehensive Income (iv) the Consolidated Statements of Changes in Shareholders' Equity, (v) the  Consolidated Statements of Cash Flows and (vi) the Notes to the  Consolidated Financial Statements.

92

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
 
FAUQUIER BANKSHARES, INC.
(Registrant)
 
/s/ Randy K. Ferrell
Randy K. Ferrell
President & Chief Executive Officer
Dated:  March 18, 2016
 
/s/ Eric P. Graap
Eric P. Graap
Executive Vice President & Chief Financial Officer
Dated: March 18, 2016

Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.

SIGNATURE
TITLE
DATE
 
 
 
/s/ John B. Adams, Jr.
Chairman, Director
March 18, 2016
John B. Adams, Jr.
 
 
 
 
 
/s/ Randy K. Ferrell
Chief Executive Officer, Director
March 18, 2016
Randy K. Ferrell
(principal executive officer)
 
 
 
 
/s/ Marc J. Bogan
President, Director
March 18, 2016
Marc J. Brogan
   
     
/s/ Eric P. Graap
Executive Vice President, Chief Financial Officer, Director
March 18, 2016
Eric P. Graap
(principal financial and accounting officer)
 
     
/s/ Donna D. Flory
Director
March 18, 2016
Donna D. Flory
   
 
 
 
/s/  Randolph D. Frostick
Director
March 18, 2016
Randolph D. Frostick
 
 
 
 
 
/s/ Jay B. Keyser
Director
March 18, 2016
Jay B. Keyser
 
 
 
 
 
/s/ Randolph T. Minter
Vice Chairman, Director
March 18, 2016
Randolph T. Minter
   
     
/s/ Brian S. Montgomery
Director
March 18, 2016
Brian S. Montgomery
 
 
 
 
 
/s/ P. Kurt Rodgers
Director
March 18, 2016
P. Kurt Rodgers
 
 
 
 
 
/s/ Sterling T. Strange III
Director
March 18, 2016
Sterling T. Strange III
 
 
     

93