BAY BANKS OF VIRGINIA INC - FORM 10-K

BAY BANKS OF VIRGINIA INC - FORM 10-K - March 28, 2016

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BAY BANKS OF VIRGINIA INC Reports

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EX-32.0 - EX-32.0 - BAY BANKS OF VIRGINIA INC	d97963dex320.htm
EX-14.0 - EX-14.0 - BAY BANKS OF VIRGINIA INC	d97963dex140.htm
EX-21.0 - EX-21.0 - BAY BANKS OF VIRGINIA INC	d97963dex210.htm
EX-31.1 - EX-31.1 - BAY BANKS OF VIRGINIA INC	d97963dex311.htm
EX-23.1 - EX-23.1 - BAY BANKS OF VIRGINIA INC	d97963dex231.htm
EX-31.2 - EX-31.2 - BAY BANKS OF VIRGINIA INC	d97963dex312.htm

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-K

ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE

SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended December 31, 2015

Commission file no: 0-22955

BAY BANKS OF VIRGINIA, INC.

(Exact name of registrant as specified in its charter)


VIRGINIA				54-1838100
(State or other jurisdiction of incorporation or organization)				(I.R.S. Employer Identification No.)

100 SOUTH MAIN STREET, KILMARNOCK, VIRGINIA				22482
(Address of principal executive offices)				(Zip Code)

Registrant’s telephone number, including area code: 804.435.1171

Securities registered under Section 12(b) of the Exchange Act: None

Securities registered under Section 12(g) of the Exchange Act:

Common Stock ($5.00 Par Value)

(Title of Class)

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

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. YES ¨ NO x

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 x NO ¨

Indicate by check mark whether registrant has submitted electronically and posted on its corporate Website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T(§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). YES x 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 the 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.

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

The aggregate market value of voting stock held by non-affiliates of the registrant at June 30, 2015, based on the closing sale price of the registrant’s common stock on June 30, 2015, was $25,224,492.

The number of shares outstanding of the registrant’s common stock as of March 1, 2016 was 4,774,856.

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the registrant’s definitive Proxy Statement for its Annual Meeting of Shareholders to be held on May 16, 2016 are incorporated by reference into Part III of this Form 10-K.

BAY BANKS OF VIRGINIA, INC.

INDEX

PART I


		Page

Item 1:	Business		3

Item 1A:	Risk Factors		9

Item 1B:	Unresolved Staff Comments		9

Item 2:	Properties		10

Item 3:	Legal Proceedings		10

Item 4:	Mine Safety Disclosures		10

PART II

Item 5:	Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities		10

Item 6:	Selected Financial Data		11

Item 7:	Management’s Discussion and Analysis of Financial Condition and Results of Operations		11

Item 7A:	Quantitative and Qualitative Disclosures About Market Risk		24

Item 8:	Financial Statements and Supplementary Data		25

Item 9:	Changes in and Disagreements with Accountants on Accounting and Financial Disclosure		60

Item 9A:	Controls and Procedures		60

Item 9B:	Other Information		60

PART III

Item 10:	Directors, Executive Officers and Corporate Governance		60

Item 11:	Executive Compensation		61

Item 12:	Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters		61

Item 13:	Certain Relationships and Related Transactions, and Director Independence		61

Item 14:	Principal Accounting Fees and Services		61

PART IV

Item 15:	Exhibits, Financial Statement Schedules		61

PART I

ITEM 1:

BUSINESS

GENERAL

Bay Banks of Virginia, Inc. (the “Company”) is a bank holding company that conducts substantially all of its operations through its subsidiaries, Bank of Lancaster (the “Bank”) and Bay Trust Company (the “Trust Company”). Bay Banks of Virginia, Inc. was incorporated under the laws of the Commonwealth of Virginia on June 30, 1997, in connection with the holding company reorganization of the Bank of Lancaster. The Bank opened for business in 1930 and has partnered with the communities it serves to ensure responsible growth and development since its organization.

The Bank is a state-chartered bank, headquartered in Kilmarnock, Virginia, and a member of the Federal Reserve System. The Bank has offices in Virginia throughout the Northern Neck and Middle Peninsulas and in the Greater Richmond area of central Virginia. It serves businesses, professionals and consumers with a wide variety of financial services, including retail and commercial banking, investment services, and mortgage banking. Products include checking accounts, savings accounts, money market accounts, cash management accounts, certificates of deposit, individual retirement accounts, commercial and industrial loans, residential mortgages, commercial mortgages, home equity loans, consumer installment loans, investment accounts, insurance, credit cards, online banking, telephone banking, and mobile banking.

The Bank currently has an office located in Kilmarnock, Virginia, three offices in the Richmond, Virginia metropolitan area, and one office each in White Stone, Warsaw, Montross, Callao, Burgess, Hartfield and Colonial Beach, Virginia. A substantial amount of the Bank’s deposits are interest bearing, and the majority of the Bank’s loan portfolio is secured by real estate. Deposits of the Bank are insured by the Deposit Insurance Fund of the Federal Deposit Insurance Corporation (the “FDIC”).

The Company’s marketplace includes the Northern Neck Peninsula of Virginia, Middlesex County, which is located across the Rappahannock River from the Northern Neck, and the Richmond, Virginia metropolitan area. The Northern Neck includes the counties of Lancaster, Northumberland, Richmond, and Westmoreland. The main demographic in the Company’s Northern Neck market is smaller, retired households with relatively high per capita incomes. Health care, tourism, and related services are the major employment sectors in the Northern Neck and Middlesex County. The Company expanded operations into the Richmond, Virginia market in 2014 with an eye toward higher density business and consumer demographics. The Company considers the city of Richmond and the counties of Henrico and Chesterfield, Virginia to be its service area in the Greater Richmond area. The city of Richmond serves as the capital of Virginia and the economic center of the Richmond-Petersburg metropolitan statistical area. The area reflects a generally high quality of life as exemplified by relatively low cost of living, minimal traffic congestion, a physically attractive topography, and a diverse economy that experiences neither the highs nor the lows of national business cycles.

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

The Company had total assets of $456.3 million, deposits of $359.9 million, and shareholders’ equity of $39.6 million as of December 31, 2015. Its headquarters are located in Kilmarnock, Virginia and its telephone number is 804-435-1171 or 800-435-1140. The Company’s website is www.baybanks.com. Information contained on the Company’s website is not a part of or incorporated into this report or any other filing the Company makes with the Securities and Exchange Commission (“SEC”).

Bay Services Company, Inc. The Bank has one wholly owned subsidiary, Bay Services Company, Inc., a Virginia corporation organized in 1994 (“Bay Services”). Bay Services owns an interest in a land title insurance agency, Bankers Title of Shenandoah, and an investment and insurance services company, Infinex Investments, Inc. Bankers Title of Shenandoah sells title insurance to mortgage loan customers, including customers of the Bank of Lancaster and the other financial institutions that have an ownership interest in the agency. Infinex Investments, Inc. provides the Bank’s non-deposit products department, Investment Advantage, with insurance and investment products for marketing within the Bank’s market areas.

Bay Trust Company. The Trust Company provides management services for personal and corporate trusts, including estate planning, estate settlement, and trust administration. Products include estate planning and settlement, revocable and irrevocable living trusts, testamentary trusts, custodial accounts, investment management accounts, and managed, as well as self-directed rollover Individual Retirement Accounts.

Through the Bank of Lancaster and Bay Trust Company, Bay Banks of Virginia provides a wide variety of financial services to its customers in its market areas. The primary products and services are summarized as follows.

Mortgage Loans on Real Estate. The Bank’s mortgage loans on real estate comprise the largest segment of its loan portfolio. The majority of the Bank’s real estate loans are mortgages on owner-occupied one-to-four family residential properties, including both fixed-rate and adjustable-rate structures. Residential mortgages are underwritten and documented within the guidelines of the regulations of the Board of Governors of the Federal Reserve System (the “Federal Reserve”). Home equity lines of credit are also offered. Construction loans with a twelve-month term are another component of the Bank’s portfolio. Underwritten at 80% loan to value, and to qualified builders and individuals, these loans are disbursed as construction progresses and verified by Bank inspection. The Bank also offers commercial loans that are secured by real estate. These mortgages are also typically written at a maximum of 80% loan to value.

The Company also offers secondary market residential loan origination. Through the Bank, customers may apply for home mortgages that are underwritten in accordance with the guidelines of either the Federal Home Loan Mortgage Corporation or the Federal National Mortgage Association (“FNMA” or “Fannie Mae”). These loans are then sold into the secondary market on a loan-by-loan basis, usually directly to FNMA. The Bank earns origination and servicing fees from this service.

Commercial and Industrial Loans. Commercial lending activities include small business loans, asset based loans, and other secured and unsecured loans and lines of credit. Commercial and industrial loans may entail greater risk than residential mortgage loans, and are therefore underwritten with strict risk management standards. Among the criteria for determining the borrower’s ability to repay is a cash flow analysis of the business and business collateral.

Consumer Loans. As part of its full range of services, the Bank’s consumer lending services include automobile and boat financing, home improvement loans, credit cards and unsecured personal loans. These consumer loans historically entail greater risk than loans secured by real estate, but also generate a higher return.

Consumer Deposit Services. Consumer deposit products include checking accounts, savings accounts, money market accounts, certificates of deposit, online banking, mobile banking and electronic statements. The Bank’s Golden Advantage program offers special products and services to customers age 55 and over, and the Extreme Banking program offers a suite of electronic products.

Commercial Banking Services. The Bank offers a variety of services to commercial customers. These services include analysis checking, cash management deposit accounts, wire services, direct deposit payroll service, online banking, telephone banking, remote deposit, and a full line of commercial lending options. The Bank also offers Small Business Administration loan products under the 504 Program, which provides long-term funding for commercial real estate and long-lived equipment. This allows commercial customers to obtain favorable rate loans for the development of business opportunities, while providing the Bank with a partial guarantee of the outstanding loan balance.

COMPETITION

The Company’s marketplace is highly competitive. The Company is subject to competition from a variety of commercial banks and financial service companies, large national and regional financial institutions, large regional credit unions, mortgage companies, consumer finance companies, mutual funds and insurance companies. Competition for loans and deposits is affected by numerous factors, including interest rates, institutional reputation, and the economy.

SUPERVISION AND REGULATION

Bank holding companies and banks are extensively regulated under both federal and state laws. The following description briefly addresses certain historic and current provisions of federal and state laws and certain regulations, proposed regulations and the potential impacts on the Company and the Bank. To the extent statutory or regulatory provisions or proposals are described in this report, the description is qualified in its entirety by reference to the particular statutory or regulatory provisions or proposals.

The Company

General. As a bank holding company registered under the Bank Holding Company Act of 1956 (the “BHCA”), the Company is subject to supervision, regulation, and examination by the Federal Reserve. The Company is also registered under the bank holding company laws of Virginia and is subject to supervision, regulation, and examination by the Virginia State Corporation Commission (the “SCC”).

Permitted Activities. A bank holding company is limited to managing or controlling banks, furnishing services to or performing services for its subsidiaries, and engaging in other activities that the Federal Reserve determines by regulation or order to be closely related to banking or managing or controlling banks. In determining whether a particular activity is permissible, the Federal Reserve must consider whether the performance of such an activity reasonably can be expected to produce benefits to the public that outweigh possible adverse effects. Possible benefits include greater convenience, increased competition, and gains in efficiency. Possible adverse effects include undue concentration of resources, decreased or unfair competition, conflicts of interest, and unsound banking practices. Despite prior approval, the Federal Reserve may order a bank holding company or its subsidiaries to terminate any activity or to terminate ownership or control of any subsidiary when the Federal Reserve has reasonable cause to believe that a serious risk to the financial safety, soundness or stability of any bank subsidiary of that bank holding company may result from such an activity.

Banking Acquisitions; Changes in Control. The BHCA requires, among other things, the prior approval of the Federal Reserve in any case where a bank holding company proposes to (i) acquire direct or indirect ownership or control of more than 5% of the outstanding voting stock of any bank or bank holding company (unless it already owns a majority of such voting shares), (ii) acquire all or substantially all of the assets of another bank or bank holding company, or (iii) merge or consolidate with any other bank holding company. In determining whether to approve a proposed bank acquisition, the Federal Reserve will consider, among other factors, the effect of the acquisition on competition, the public benefits expected to be received from the acquisition, the projected capital ratios and levels on a post-acquisition basis, and the acquiring institution’s performance under the Community Reinvestment Act of 1977 and its compliance with fair housing and other consumer protection laws.

Subject to certain exceptions, the BHCA and the Change in Bank Control Act, together with the applicable regulations, require Federal Reserve approval (or, depending on the circumstances, no notice of disapproval) prior to any person or company’s acquiring “control” of a bank or bank holding company. A conclusive presumption of control exists if an individual or company acquires the power, directly or indirectly, to direct the management or policies of an insured depository institution or to vote 25% or more of any class of voting securities of any insured depository institution. A rebuttable presumption of control exists if a person or company acquires 10% or more but less than 25% of any class of voting securities of an insured depository institution and either the institution has registered its securities with the Securities and Exchange Commission under Section 12 of the Securities Exchange Act of 1934 (the “Exchange Act”) or no other person will own a greater percentage of that class of voting securities immediately after the acquisition. The Company’s common stock is registered under Section 12 of the Exchange Act.

In addition, Virginia law requires prior approval from the SCC for (i) the acquisition of more than 5% of the voting shares of a Virginia bank or any holding company that controls a Virginia bank, or (ii) the acquisition by a Virginia bank holding company of a bank or its holding company domiciled outside Virginia.

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 Wall Street Reform and Consumer Protection Act (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.

Safety and Soundness. There are a number of obligations and restrictions imposed on bank holding companies and their subsidiary banks by law and regulatory policy that are designed to minimize potential loss to the depositors of such depository institutions and the FDIC insurance fund in the event of a depository institution default. For example, under the Federal Deposit Insurance Company Improvement Act of 1991, to avoid receivership of an insured depository institution subsidiary, a bank holding company is required to guarantee the compliance of any subsidiary bank that may become “undercapitalized” with the terms of any capital restoration plan filed by such subsidiary with its appropriate federal bank regulatory agency up to the lesser of (i) an amount equal to 5% of the institution’s total assets at the time the institution became undercapitalized, or (ii) the amount that is necessary (or would have been necessary) to bring the institution into compliance with all applicable capital standards as of the time the institution fails to comply with such capital restoration plan.

Under the Federal Deposit Insurance Act (“FDIA”), the federal bank regulatory agencies have adopted guidelines prescribing safety and soundness standards. These guidelines establish general standards relating to internal controls and information systems, internal audit systems, loan documentation, credit underwriting, interest rate exposure, asset growth and compensation, fees and benefits. In general, the guidelines require, among other things, appropriate systems and practices to identify and manage the risk and exposures specified in the guidelines.

Capital Requirements. The Federal Reserve imposes certain capital requirements on bank holding companies under the BHCA, including a minimum leverage ratio and a minimum ratio of “qualifying” capital to risk-weighted assets. These requirements are described below under “The Bank – Capital Requirements.” Subject to its capital requirements and certain other restrictions, the Company is able to borrow money to make a capital contribution to the Bank, and such loans may be repaid from dividends paid by the Bank to the Company.

Limits on Dividends and Other Payments. The Company is a legal entity, separate and distinct from its subsidiaries. A portion of the revenues of the Company may result from dividends paid to it by the Bank. There are various legal limitations applicable to the payment of dividends by the Bank to the Company and to the payment of dividends by the Company to its shareholders. The Bank is subject to various statutory restrictions on its ability to pay dividends to the Company. Under current regulations, prior approval from the Federal Reserve is required if cash dividends declared in any given year exceed net income for that year, plus retained net profits of the two preceding years. The payment of dividends by the Bank or the Company may be limited by other factors, such as requirements to maintain capital above regulatory guidelines. Bank regulatory agencies have the authority to prohibit the Bank or the Company from engaging in an unsafe or unsound practice in conducting their business. The payment of dividends, depending on the financial condition of the Bank, or the Company, could be deemed to constitute such an unsafe or unsound practice.

Under the FDIA, insured depository institutions such as the Bank, are prohibited from making capital distributions, including the payment of dividends, if, after making such distributions, the institution would become “undercapitalized” (as such term is used in the statute). Based on the Bank’s current financial condition, the Company does not expect this provision will have any impact on its ability to receive dividends from the Bank. The Company’s non-bank subsidiary, Bay Trust Company, may pay dividends to the Company on a non-regulated basis.

In addition to dividends it may receive from the Bank, the Company receives management fees from its affiliated companies for expenses incurred related to external financial reporting and audit fees, investor relations expenses, board of directors fees and legal fees related to corporate actions. These fees are charged to each subsidiary based upon various specific allocation methods measuring the estimated usage of such services by that subsidiary. The fees are eliminated from the financial statements in the consolidation process.

The Bank

General. The Bank is supervised and regularly examined by the Federal Reserve and the SCC. The various laws and regulations administered by the bank regulatory agencies affect corporate practices, such as the payment of dividends, incurrence of debt and acquisition of financial institutions and other companies; they also affect business practices, such as the payment of interest on deposits, the charging of interest on loans, types of business conducted and location of offices. Certain of these laws and regulations are referenced above under “The Company.”

Capital Requirements. The Federal Reserve and the other federal banking agencies have issued risk-based and leverage capital requirements applicable to U.S. banking organizations. Those regulatory agencies may from time to time require that a banking organization maintain capital above the minimum levels because of its financial condition or actual or anticipated growth.

On June 7, 2012, the Federal Reserve issued a series of proposed rules intended to revise and strengthen its risk-based and leverage capital requirements and its method for calculating risk-weighted assets. The rules were proposed to implement the Basel III regulatory capital reforms from the Basel Committee on Banking Supervision and certain provisions of the Dodd-Frank Act. The proposed 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”).

In July 2013, the Federal Reserve issued final rules that made the changes to its capital rules to align them with the Basel III regulatory capital framework and meet certain requirements of the Dodd-Frank Act. Effective January 1, 2015, the final rules require the Bank to comply with the following minimum capital ratios: (i) a new Common Equity Tier 1 capital ratio of 4.5% of risk-weighted assets; (ii) a Tier 1 capital ratio of 6.0% of risk-weighted assets (increased from the prior requirement of 4.0%); (iii) a total capital ratio of 8.0% of risk-weighted assets (unchanged from the prior requirement); and (iv) a leverage ratio of 4.0% of total assets (unchanged from the prior requirement). The following additional capital requirements related to the capital conservation buffer are being phased in over a four year period beginning January 1, 2016. When fully phased in on January 1, 2019, the rules will require the Bank to maintain (i) a minimum ratio of Common Equity Tier 1 to risk-weighted assets of at least 4.5%, plus a 2.5% “capital conservation buffer” (which is added to the 4.5% Common Equity Tier 1 ratio as that buffer is phased in, effectively resulting in a minimum ratio of Common Equity Tier 1 to risk-weighted assets of at least 7.0% upon full implementation), (ii) a minimum ratio of Tier 1 capital to risk-weighted assets of at least 6.0%, plus the 2.5% capital conservation buffer (which is added to the 6.0% Tier 1 capital ratio as that buffer is phased in, effectively resulting in a minimum Tier 1 capital ratio of 8.5% upon full implementation), (iii) a minimum ratio of total capital to risk-weighted assets of at least 8.0%, plus the 2.5% capital conservation buffer (which is added to the 8.0% total capital ratio as that buffer is phased in, effectively resulting in a minimum total capital ratio of 10.5% upon full implementation), and (iv) a minimum leverage ratio of 4.0%, calculated as the ratio of Tier 1 capital to average assets. The capital conservation buffer requirement is being phased in 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. 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 Bank maintained Common Equity Tier 1 capital of $39.0 million, Tier 1 capital of $39.0 million, risk weighted assets of $314.7 million, and total capital of $42.9 million. As of December 31, 2015, all ratios were in excess of the fully phased-in requirements, with the Common Equity Tier 1 ratio at 12.39% of risk-weighted assets, the Tier 1 capital ratio at 12.39% of risk-weighted assets, the total capital ratio at 13.64% of risk-weighted assets, and the Tier 1 leverage ratio at 9.11% of total assets.

Deposit Insurance. The deposits of the Bank are insured up to applicable limits by the Deposit Insurance Fund (“DIF”) of the FDIC and are subject to deposit insurance assessments to maintain the DIF. The deposit insurance assessment is equal to the Bank’s average total assets minus average tangible equity, pursuant to a rule issued by the FDIC as required by 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.

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.

Transactions with Affiliates. Pursuant to Sections 23A and 23B of the Federal Reserve Act and Regulation W, the authority of the Bank to engage in transactions with related parties or “affiliates” or to make loans to insiders is limited. Loan transactions with an affiliate generally must be collateralized and certain transactions between the Bank and its affiliates, including the sale of assets, the payment of money or the provision of services, must be on terms and conditions that are substantially the same, or at least as favorable to the Bank, as those prevailing for comparable nonaffiliated transactions. In addition, the Bank generally may not purchase securities issued or underwritten by affiliates.

Loans to executive officers, directors or to any person who directly or indirectly, or acting through or in concert with one or more persons, owns, controls or has the power to vote more than 10% of any class of voting securities of a bank (“10% Shareholders”), are subject to Sections 22(g) and 22(h) of the Federal Reserve Act and their corresponding regulations (Regulation O) and Section 13(k) of the Exchange Act relating to the prohibition on personal loans to executives (which exempts financial institutions in compliance with the insider lending restrictions of Section 22(h) of the Federal Reserve Act). Among other things, these loans must be made on terms substantially the same as those prevailing on transactions made to unaffiliated individuals and certain extensions of credit to those persons must first be approved in advance by a disinterested majority of the entire board of directors. Section 22(h) of the Federal Reserve Act prohibits loans to any of those individuals where the aggregate amount exceeds an amount equal to 15% of an institution’s unimpaired capital and surplus plus an additional 10% of unimpaired capital and surplus in the case of loans that are fully secured by readily marketable collateral, or when the aggregate amount on all of the extensions of credit outstanding to all of these persons would exceed the Bank’s unimpaired capital and unimpaired surplus. Section 22(g) of the Federal Reserve Act identifies limited circumstances in which the Bank is permitted to extend credit to executive officers.

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 FDIA, 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 Bank meets the definition of being “well capitalized” as of December 31, 2015.

As described above in “The Bank – Capital Requirements,” the new capital requirement rules issued by the Federal Reserve incorporate new requirements into the prompt corrective action framework.

Community Reinvestment Act (“CRA”). The Bank is subject to the requirements of the Community Reinvestment Act of 1977. The CRA imposes on financial institutions an affirmative and ongoing obligation to meet the credit needs of the local communities they serve, including low and moderate income neighborhoods. The CRA requires the appropriate federal banking agency, in connection with its examination of a bank, to assess the bank’s record in meeting such credit needs. Furthermore, such assessment is also required of banks that have applied, among other things, to merge or consolidate with or acquire the assets or assume the liabilities of an insured depository institution, or to open or relocate a branch. In the case of a bank holding company applying for approval to acquire a bank or another bank holding company, the record of each subsidiary bank of the applicant bank holding company is subject to assessment in considering the application. Under the CRA, institutions are assigned a rating of “outstanding,” “satisfactory,” “needs to improve,” or “substantial non-compliance.” The Bank received a “satisfactory” CRA rating in its most recent examination.

Privacy Legislation. Several laws, including the Right To Financial Privacy Act, and related regulations issued by the federal bank regulatory agencies, provide protections against the transfer and use of customer information by financial institutions. A financial institution must provide to its customers information regarding its policies and procedures with respect to the handling of customers’ personal information. Each institution must conduct an internal risk assessment of its ability to protect customer information. These privacy provisions generally prohibit a financial institution from providing a customer’s personal financial information to unaffiliated parties without prior notice and approval from the customer.

USA Patriot Act of 2001. In October 2001, the USA Patriot Act of 2001 (“Patriot Act”) was enacted in response to the September 11, 2001 terrorist attacks in New York, Pennsylvania, and Northern Virginia. The Patriot Act is intended to strengthen U.S. law enforcement and the intelligence communities’ abilities to work cohesively to combat terrorism. The Patriot Act contains anti-money laundering and financial transparency laws, and imposes various regulations, including standards for verifying customer identification at account opening, and rules to promote cooperation among financial institutions, regulators and law enforcement entities to identify persons who may be involved in terrorism or money laundering.

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.

Under the rules implementing the Volcker Rule, banking entities would have been prohibited from owning certain collateralized debt obligations (“CDOs”) backed by trust preferred securities (“TruPS”) as of July 21, 2015, which could have forced banking entities to recognize unrealized market losses based on the inability to hold any such investments to maturity. However, on January 14, 2014, the federal bank regulatory agencies issued an interim rule, effective April 1, 2014, exempting TruPS CDOs from the Volcker Rule if (i) the CDO was established prior to May 19, 2010, (ii) the banking entity reasonably believes that the offering proceeds of the CDO were used to invest primarily in TruPS issued by banks with less than $15 billion in assets, and (iii) the banking entity acquired the CDO on or before December 10, 2013. The Company currently does not have any impermissible holdings of TruPS CDOs under the interim final rule and, therefore, will not be required to divest of any such investments or change their accounting treatment. The Company is continuously monitoring its investments to ensure compliance as the various provisions of the Volcker Rule regulations become effective.

Consumer Financial Protection. The Bank is subject to a number of federal and state consumer protection laws that extensively govern its relationship with its customers. These laws include the Equal Credit Opportunity Act, the Fair Credit Reporting Act, the Truth in Lending Act, the Truth in Savings Act, the Electronic Fund Transfer Act, the Expedited Funds Availability Act, the Home Mortgage Disclosure Act, the Fair Housing Act, the Real Estate Settlement Procedures Act, the Fair Debt Collection Practices Act, the Service Members Civil Relief Act, laws governing flood insurance, federal and state laws prohibiting unfair and deceptive business practices, foreclosure laws ,and various regulations that implement some or all of the foregoing. 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, collecting loans and providing other services. If the Bank fails to comply with these laws and regulations, it may be subject to various penalties. Failure to comply with consumer protection requirements may also result in failure to obtain any required bank regulatory approval for merger or acquisition transactions the Bank may wish to pursue or being prohibited from engaging in such transactions even if approval is not required.

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.

Ability-to-Repay and Qualified Mortgage Rule. Pursuant to the Dodd-Frank Act, the CFPB issued a final rule on January 10, 2013 (effective on 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 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 Company and 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 and the Bank have not been made aware of any instances of non-compliance with the final guidance.

Effect of Governmental Monetary Policies

The Company’s operations are affected not only by general economic conditions but also by the policies of various regulatory authorities. In particular, the Federal Reserve regulates money and credit conditions and interest rates to influence general economic conditions. These policies have a significant impact on overall growth and distribution of loans, investments and deposits; they affect interest rates charged on loans or paid for time and savings deposits. Federal Reserve monetary policies have had significant effects on the operating results of commercial banks, including the Company, in the past and are expected to do so in the future.

Reporting Obligations under Securities Laws

The Company is subject to the periodic and other reporting requirements of the Exchange Act, including the filing of annual, quarterly and other reports with the SEC. The Company provides access to its SEC filings through the “Regulatory Filings” section of the Company’s website at www.baybanks.com. The Company’s SEC filings are posted and available at no cost on its website as soon as reasonably practicable after the reports are filed electronically with the SEC. The information on the Company’s website is not incorporated into this report or any other filing the Company makes with the SEC. The SEC maintains an Internet site that contains reports, proxy and information statements, and other information regarding issuers that file electronically with the SEC at www.sec.gov.

Employees

At December 31, 2015, the Company employed approximately 134 people of which 106 were considered full-time employees.

ITEM 1A:

RISK FACTORS

Not required.

ITEM 1B:

UNRESOLVED STAFF COMMENTS

Not required.

ITEM 2: PROPERTIES

The Company, through its subsidiaries, owns or leases buildings and office space that are used in the normal course of business. The headquarters of each of the Company, the Bank, and the Trust Company are located at 100 South Main Street, Kilmarnock, Virginia, in a building owned by the Bank.

Unless otherwise noted, the properties listed below are owned by the Company and its subsidiaries as of December 31, 2015.


Bank of Lancaster:		100 South Main Street, Kilmarnock, Virginia

		708 Rappahannock Drive, White Stone, Virginia

		432 North Main Street, Kilmarnock, Virginia (marketed for sale)

		4935 Richmond Road, Warsaw, Virginia

		15648 Kings Highway, Montross, Virginia

		18 Sandy Street, Callao, Virginia

		23 West Church Street, Kilmarnock, Virginia

		15104 Northumberland Highway, Burgess, Virginia

		680 McKenney Boulevard, Colonial Beach, Virginia

		11450 Robious Road, North Chesterfield, Virginia

		10880 General Puller Highway, Hartfield, Virginia (leased)

		5711 Patterson Avenue, Richmond, Virginia (leased)

		One Paragon Place, 6800 Paragon Place, Suite 650, Richmond, Virginia (leased)

ITEM 3: LEGAL PROCEEDINGS

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

ITEM 4: MINE SAFETY DISCLOSURES

Not applicable.

PART II

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

The Company’s common stock is quoted on the OTC Markets Group’s OTCQB tier under the symbol “BAYK” and transactions generally involve a small number of shares. There were 4,774,856 shares of the Company’s stock outstanding at the close of business on December 31, 2015, which were held by 607 shareholders of record.

The following table summarizes the high and low closing sales prices for the two years ended December 31, 2015. No dividends have been declared or paid in the last two years.


	Market Values
	2015				2014
	High		Low		High		Low
First Quarter	$	6.00	$	5.32	$	6.13	$	5.03
Second Quarter		6.15		5.70		6.13		5.70
Third Quarter		5.85		5.61		5.85		5.20
Fourth Quarter		5.97		5.50		5.50		5.05

A discussion of certain restrictions and limitations on the ability of the Bank to pay dividends to the Company, and the ability of the Company to pay dividends to shareholders of its common stock, is set forth in Part I, Item 1, Business, of this Form 10-K under the heading “Supervision and Regulation.”

The dividend type, amount and timing are established by the Board of Directors. In making its decisions regarding the payment of dividends on the Company’s common stock, the Board considers operating results, financial condition, capital adequacy, regulatory requirements, shareholder return, and other factors.

On December 17, 2014, the Company announced a share repurchase program pursuant to which it is authorized to repurchase up to 240,892 shares of its common stock. The share repurchase program was authorized to last through December 31, 2015. On November 12, 2015, the Board of Directors extended the share repurchase program until December 31, 2016. A total of 43,000 shares have been repurchased as of December 31, 2015. No share repurchases were made during the fourth quarter of 2015.

ITEM 6: SELECTED FINANCIAL DATA


(Dollars in thousand, except per share amounts)	As of and for the Year Ended December 31,
	2015			2014			2013			2012			2011
Operations:
Net interest income	$	13,219		$	11,935		$	10,614		$	10,454		$	10,323
Provision for loan losses		1,597			611			776			1,895			495
Noninterest income		3,359			3,681			4,726			4,492			2,965
Noninterest expense		14,802			12,618			12,943			12,143			12,467
Tax (benefit) expense		(187	)		557			399			210			(24	)

Net income	$	366		$	1,830		$	1,222		$	698		$	350

Share Data:
Basic income per share	$	0.08		$	0.38		$	0.25		$	0.27		$	0.13
Diluted income per share		0.08			0.38			0.25			0.27			0.13
Cash dividends per common share		—			—			—			—			—
Weighted average common shares:
Basic		4,791,722			4,818,377			4,816,859			2,610,856			2,607,034
Diluted		4,805,318			4,829,581			4,819,343			2,612,787			2,607,097
Balance Sheet:
Assets	$	456,296		$	390,486		$	331,135		$	334,798		$	315,212
Loans, net of allowance		343,323			295,242			247,912			235,746			233,501
Allowance for loan losses		4,223			3,205			2,925			3,094			3,189
Deposits		359,858			307,585			268,346			275,175			265,518
Total liabilities		416,727			351,248			293,999			298,213			287,197
Total stockholders’ equity⁽¹⁾		39,569			39,238			37,136			36,585			28,015
Profitability Measures:
Return on average assets		0.09	%		0.53	%		0.37	%		0.22	%		0.11	%
Return on average equity		0.92	%		4.76	%		3.32	%		2.16	%		1.26	%
Net interest margin		3.48	%		3.85	%		3.53	%		3.61	%		3.46	%
Yield on earning assets		4.26	%		4.54	%		4.46	%		4.78	%		4.85	%
Cost of funds		0.81	%		0.72	%		0.96	%		1.18	%		1.41	%
Capital Ratios:
Total equity to assets		8.67	%		10.05	%		11.21	%		10.93	%		8.89	%
Tier 1 leverage ratio		8.84	%		10.35	%		10.93	%		10.93	%		7.97	%
Asset Quality:
Nonperforming assets to total assets		1.82	%		1.22	%		2.01	%		2.69	%		2.46	%
Net charge-offs to average loans		0.18	%		0.12	%		0.39	%		0.83	%		0.22	%
Allowance for loan losses to loans		1.22	%		1.07	%		1.17	%		1.29	%		1.35	%
Classified assets to Tier 1 capital plus allowance for loan losses		25.80	%		21.72	%		29.57	%		37.54	%		52.92	%

Note:

(1)	In 2012, the Company raised $9.35 million gross in a private placement of 2,200,000 shares of its common stock.

ITEM 7: MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following discussion provides information about the major components of the results of operations and financial condition, liquidity and capital resources of Bay Banks of Virginia, Inc., and its subsidiaries. This discussion and analysis should be read in conjunction with the Consolidated Financial Statements and Notes to Consolidated Financial Statements presented in Item 8, Financial Statements and Supplementary Data, in this Form 10-K.

EXECUTIVE SUMMARY

Net income for 2015 was $366 thousand compared to $1.8 million for 2014. Results for 2015 are highlighted by the success of the Company’s expansion into the Richmond, Virginia market and the completion of a $7.0 million subordinated debt offering in May 2015. In March 2015, the Bank opened a third retail branch in the Richmond market in Chesterfield County. Deposits in Richmond branches now account for 20% of the Company’s total deposits as of December 31, 2015. In June 2015, the Bank converted its Hartfield, Virginia loan production office into a retail office. This office is located in Middlesex County. Core earnings and growth remain priorities. The capital position remains solid.

Earnings were negatively impacted by fraud perpetrated by one of the Bank’s commercial borrowers. This borrower pleaded guilty in a federal court to “Willful Failure to Collect or Pay Over Employment Tax” and admitted to regularly and deliberately creating false financial statements for submission to financial institutions in order to encourage banks to lend new funds to his companies, or to enable the renewal of existing loans. As a result, $691 thousand of impairment reserves were added to the allowance for loan losses as of December 31, 2015.

The Richmond market is expected to contribute positively to income in 2016 after earnings of approximately $729 thousand were invested in the Richmond market during 2015. Reduced income from investment services and a gain on the sale of a former branch office in 2014 also contributed to the year over year decline in net income from 2014 to 2015.

Total assets have grown by $65.8 million, or 16.9%, during 2015, to $456.3 million. Net interest income, which management considers to be a component of core earnings, grew by $1.3 million, or 10.8%, in 2015 compared to 2014. Return on average assets was 0.09% for 2015 compared to 0.53% for 2014. Return on average equity was 0.92% for 2015 compared to 4.76% for 2014.

The in-house loan portfolio grew by $48.8 million, or 16.5%, during 2015. Loans originated and sold to Fannie Mae generated growth of $6.9 million in the portfolio of loans serviced for Fannie Mae since December 31, 2014. The servicing portfolio totals $71.6 million as of December 31, 2015 compared to $64.7 million as of December 31, 2014.

In April 2015, the Bank consolidated the branch operations of its three Lancaster County, Virginia offices into two offices, with all Kilmarnock branch operations now based in the main office of the Bank. The branch consolidation is expected to save the Company approximately $85 thousand annually. As of January 2016, a sales contract for the branch office building, located at 432 N. Main Street, Kilmarnock, Virginia, is pending.

The net interest margin decreased to 3.48% for 2015 compared to 3.85% for 2014. As this low interest rate environment continues, loan and investment yields continue to decline, but increased loan balances have resulted in increased interest income, resulting in the improved net interest income noted above.

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

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

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 its statements is, to a significant extent, financial information that is 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. For example, historical loss factors are one factor in determining the inherent loss that may be present in the loan portfolio. Actual losses could differ significantly from the historical factors used. In addition, GAAP itself may change from one previously acceptable method to another method. Although the economics of transactions would be the same, the timing of events that would impact those transactions could change.

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

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

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

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

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

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

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

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

include: (1) non-accruing Special mention, Substandard and Doubtful loans in excess of $250,000; (2) Substandard and Doubtful loans in excess of $500,000; (3) Special Mention loans in excess of $500,000 if any of the loans in the relationship are more than 30 days past due or if the borrower has filed for bankruptcy; and (4) all troubled debt restructurings (“TDRs”). A specific allowance arises when the discounted cash flows (or collateral value or observable market price) of the impaired loan is lower than the carrying value of that loan. The general component collectively evaluates smaller commercial loans, residential mortgages and consumer loans, grouped into segments and classes. Historical loss experience is calculated and applied to each segment or class, then adjusted for qualitative factors. Qualitative factors include changes in the local and national economic outlook, including unemployment, interest rates, inflation rates and real estate trends; the level and trend of past due and nonaccrual loans; strength of policies and procedures; and oversight of credit risk and quality of underwriting. These qualitative adjustments reflect management’s judgment of risks inherent in the segments. An unallocated component is maintained if needed to cover uncertainties that could affect management’s estimate of probable losses. The unallocated component of the allowance reflects the margin of imprecision inherent in the underlying assumptions used in the methodologies for estimating specific and general losses in the portfolio. Changes in the allowance for loan losses and the related provision expense can materially affect net income.

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

The general component of the ALL calculation collectively evaluates groups of loans in segments or classes, as noted above. The segments are: (1) Mortgage loans on real estate; (2) Commercial and industrial loans; and (3) Consumer and other loans. The segment for Mortgage loans on real estate is disaggregated into the following classes: (1) Construction, land and land development; (2) Farmland; (3) Residential first mortgages; (4) Residential revolving and junior mortgages; (5) Commercial mortgages (non-owner-occupied); and (6) Commercial mortgages (owner-occupied). Loans in segment 1 are secured by real estate. Loans in segments 2 and 3 are secured by other types of collateral or are unsecured. A given segment or class may not reflect the purpose of a loan. For example, a business owner may provide his residence as collateral for a loan to his company, in which case the loan would be grouped in a residential mortgage class. Historical loss factors are calculated for the prior 19 quarters by segment and class, and then applied to the current balances in each segment and class. Finally, qualitative factors are applied to each segment and class.

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

The summation of the specific, general and unallocated components results in the total estimated ALL. Management may also include an unallocated component to cover uncertainties in the level of probable losses. This estimate is inherently subjective and actual losses could be greater or less than the estimates.

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

MORTGAGE SERVICING RIGHTS (“MSRs”). MSRs are included on the consolidated balance sheet and recorded at fair value on an ongoing basis. Changes in the fair value of the MSRs are recorded in the results of operations. A fair value analysis of MSRs is performed on a quarterly basis. A valuation model, which utilizes a discounted cash flow analysis using interest rates and prepayment assumptions currently quoted for comparable instruments and a discount rate, is used to determine fair value.

GOODWILL. The Company has goodwill relating to the purchase of five branches during the years 1994 through 2000. Goodwill is tested annually for impairment. The test performed using financial information as of September 30, 2015 found no impairment. No events that impact long-term enterprise value occurred between the date of our annual test and December 31, 2015 that would indicate the existence of impairment.

OVERVIEW

2015 Compared to 2014

Bay Banks of Virginia, Inc. recorded net income for 2015 of $366 thousand, or $0.08 per basic and diluted share, as compared to $1.8 million, or $0.38 per basic and diluted share in 2014. This is a decrease in net income of $1.5 million. Net interest income for 2015 was $13.2 million, as compared to $11.9 million for 2014, an increase of 10.8%. Provision expense for loan losses was $1.6 million in 2015 compared to $611 thousand in 2014. Non-interest income decreased 8.8% to $3.4 million in 2015 from $3.7 million in 2014. Non-interest expense was $14.8 million in 2015 compared to $12.6 million in 2014.

Performance as measured by the Company’s return on average assets was 0.09% for 2015 compared to 0.53% for 2014. Performance as measured by return on average equity was 0.92% for 2015 compared to 4.76% for 2014. The table below details certain financial and statistical information for the Company relating to income and returns.

Return on Equity & Assets


(Dollars in thousands, except per share amounts)
Years Ended December 31,	2015			2014			2013
Net Income	$	366		$	1,830		$	1,222
Average Total Assets		416,872			343,838			332,894
Return on Average Assets		0.09	%		0.53	%		0.37	%
Average Equity	$	39,740		$	38,418		$	36,861
Return on Average Equity		0.92	%		4.76	%		3.32	%
Cash Dividends declared per share	$	—		$	—		$	—
Average Shares Outstanding		4,791,722			4,818,377			4,816,859
Average Diluted Shares Outstanding		4,805,318			4,829,581			4,819,343
Net Income per Share	$	0.08		$	0.38		$	0.25
Net Income per Diluted Share		0.08			0.38			0.25
Cash Dividend Payout Ratio		0.0	%		0.0	%		0.0	%
Average Equity to Average Assets Ratio		9.53	%		11.17	%		11.07	%

RESULTS OF OPERATIONS

Net Interest Income

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

The following table shows details of yields on interest-earning assets (e.g. loans), costs of interest-bearing liabilities (e.g. deposits) and the resulting net interest margins for the years ended December 31, 2015 and 2014.

Average Balances, Income and Expense, Yields and Rates


(Fully taxable equivalent basis)
Years ended December 31,	2015							2014							2013
(Dollars in Thousands)	Average Balance		Income/ Expense		Yield/ Cost			Average Balance		Income/ Expense		Yield/ Cost			Average Balance		Income/ Expense		Yield/ Cost
INTEREST EARNING ASSETS:
Taxable Investments	$	30,450	$	617		2.03	%	$	21,380	$	382		1.79	%	$	24,468	$	448		1.83	%
Tax-Exempt Investments (1)		18,545		597		3.22	%		18,129		568		3.13	%		16,238		494		3.04	%

Total Investments		48,995		1,214		2.48	%		39,509		950		2.40	%		40,706		942		2.31	%
Gross Loans (2)		319,597		15,202		4.76	%		266,016		13,352		5.02	%		240,964		12,617		5.24	%
Interest-bearing Deposits		16,430		38		0.23	%		9,569		23		0.24	%		22,925		57		0.25	%
Federal Funds Sold		1,100		1		0.09	%		319		—		—			599		1		0.17	%

Total Interest Earning Assets	$	386,122	$	16,455		4.26	%	$	315,413	$	14,325		4.54	%	$	305,194	$	13,617		4.46	%
INTEREST-BEARING LIABILITIES:
Savings Deposits	$	42,716	$	76		0.18	%	$	43,416	$	68		0.16	%	$	45,625	$	88		0.19	%
NOW Deposits		41,030		61		0.15	%		42,258		63		0.15	%		41,394		76		0.18	%
Time Deposits => $100,000		55,713		844		1.51	%		44,879		784		1.75	%		45,729		1,010		2.21	%
Time Deposits < $100,000		57,228		819		1.43	%		51,230		790		1.54	%		56,174		1,053		1.87	%
Time Deposits - Wholesale		6,900		28		0.40	%		2,154		9		0.44	%		—		—		0.00	%
Money Market Deposit Accounts		63,830		557		0.87	%		30,187		128		0.42	%		28,147		141		0.50	%

Total Deposits		267,417		2,385		0.89	%		214,124		1,842		0.86	%		217,069		2,368		1.09	%
Federal Funds Purchased		578		6		1.03	%		94		1		0.58	%		58		—		0.00	%
Securities Sold Under Repurchase Agreements		7,612		12		0.15	%		7,538		9		0.12	%		8,482		16		0.19	%
Subordinated Notes		4,046		279		6.50	%		—		—		0.00	%		—		—		0.00	%
FHLB Advances		32,713		352		1.08	%		22,239		345		1.55	%		15,000		450		3.00	%

Total Interest-Bearing Liabilities	$	312,366	$	3,034		0.97	%	$	243,995	$	2,197		0.90	%	$	240,609	$	2,834		1.18	%
Net interest income and net interest margin			$	13,421		3.48	%			$	12,128		3.85	%			$	10,783		3.53	%
Non-interest-bearing deposits	$	61,825		—		0.00	%	$	59,551		—		0.00	%	$	54,012		—		0.00	%
Total cost of funds						0.81	%						0.72	%						0.96	%
Net interest spread						3.45	%						3.82	%						3.50	%

Notes:

(1)	Income and yield is tax-equivalent assuming a federal tax rate of 34%.

(2)	Includes Visa credit card program, nonaccrual loans, and fees.

Net interest income increase to $13.4 million in 2015 from $12.1 million in 2014, as the increase in interest income exceeded the increase in interest expense. Interest income for 2015, on a tax-equivalent basis, was $16.5 million, an increase of $2.1 million from 2014 due mainly to increased loan balances. Interest expense for 2015 was $3.0 million, an increase of $837 thousand compared to 2014, due primarily to increases in money market deposit accounts and the issuance of $7.0 million of subordinated debt bearing interest at a rate of 6.50% per year. The annualized net interest margin was 3.48% and 3.85% for 2015 and 2014, respectively. As long as this low interest rate environment continues, it is expected that loan yields will continue to decline as higher yielding loans pay down or mature and new loans are made at lower rates.

The net interest spread, which is the difference between the annualized yield on earning assets and the total cost of funds, decreased to 3.45% for 2015, compared to 3.82% for 2014.

The increase in average total earning assets is due mainly to the $53.6 million increase in average loans. Investment yields increased eight basis points in 2015 compared to 2014 while loan yields have declined 26 basis points. Loan growth offset the decline in loan yields. With the current low interest rate environment, any growth in net interest income will need to be generated from loan growth.

The increase in average interest-bearing liabilities was due mainly to the increase of $53.3 million in deposits, $10.5 million in FHLB advances and the issuance of the $7.0 million of subordinated debt. The cost of interest-bearing deposits increased to 0.89% in 2015 from 0.86% in 2014. The cost of FHLB advances declined to 1.08% in 2015 compared to 1.55% in 2014. In May 2015, the Company issued $7.0 million of 6.50% 10-year subordinated debt. Average non-interest-bearing deposits grew $2.3 million during 2015. Total cost of funds was 0.81% in 2015 compared to 0.72% in 2014.

Volume and Rate Analysis of Changes in Net Interest Income


Years Ended December 31,	2015 vs. 2014									2014 vs. 2013
(Dollars in Thousands)	Increase (Decrease)									Increase (Decrease)
	Due to Changes in:									Due to Changes in:
	Volume (1)			Rate (1)			Total			Volume (1)			Rate (1)			Total
Earning Assets:
Taxable investments	$	201		$	34		$	235		$	(68	)	$	2		$	(66	)
Tax-exempt investments (2)		12			16			28			59			15			74
Gross Loans		2,590			(740	)		1,850			1,403			(668	)		735
Interest-bearing deposits		17			(1	)		16			(33	)		(1	)		(34	)
Federal funds sold		1			—			1			(1	)		—			(1	)

Total interest earning assets	$	2,821		$	(691	)	$	2,130		$	1,360		$	(652	)	$	708

Interest-Bearing Liabilities:
NOW checking	$	(2	)	$	—		$	(2	)	$	1		$	(14	)	$	(13	)
Savings deposits		(1	)		9			8			(5	)		(15	)		(20	)
Money market accounts		221			209			430			10			(23	)		(13	)
Time deposits < $100,000		89			(60	)		29			(87	)		(176	)		(263	)
Time deposits => $100,000		182			(122	)		60			(21	)		(205	)		(226	)
Time deposits - Wholesale		17			1			18			9			—			9
Federal funds purchased		5			—			5			1			—			1
Securities sold under repurchase agreements		—			3			3			(1	)		(6	)		(7	)
Subordinated notes		279			—			279			—			—			—
FHLB advances		131			(124	)		7			165			(270	)		(105	)

Total interest-bearing liabilities	$	921		$	(84	)	$	837		$	72		$	(709	)	$	(637	)

Change in net interest income	$	1,900		$	(607	)	$	1,293		$	1,288		$	57		$	1,345

Notes:

(1)	Changes caused by the combination of rate and volume are allocated based on the percentage caused by each.

(2)	Income and yields are reported on a tax-equivalent basis, assuming a federal tax rate of 34%.

As indicated in the volume and rate analysis, the growth in loans in 2015 was the primary driver of improved net interest income. The increase in interest expense was also driven mainly by increases in funding balances, namely the new subordinated notes and increase in money market accounts. The sustained low interest rate environment has led to compression of the net interest margin.

Interest Sensitivity

The Company employs a variety of measurement techniques to identify and manage its exposure to changing interest rates and subsequent changes in liquidity. The Company utilizes simulation models that estimate the effect of interest rate changes on net interest income and the economic value of equity. Beginning in 2013, the Company engaged an asset-liability management consultant to assist with the management of interest rate risk, liquidity risk and balance sheet strategy. The Bank’s Asset Liability Committee (the “ALCO”) is responsible for monitoring interest rate risk and is composed of appointed members from management and the Board of Directors. Through the use of simulations, the ALCO reviews the overall magnitude of interest rate risk and then formulates policy with which to manage asset growth, funding sources, pricing, and off-balance sheet commitments. These decisions are based on management’s plans for growth, expectations regarding future interest rate movements, economic conditions both locally and nationally, and other business and risk factors.

The simulation models indicate that the Bank’s balance sheet is neutral to asset sensitive, which management believes is favorable in the current low interest rate environment. This means that as rates rise, interest-earning assets should reprice as fast or faster than interest-bearing liabilities, allowing interest income to rise as fast or faster than interest expense. Thus, net interest income should remain stable or grow. Moderate growth in the balance sheet is expected to assure continued growth in net interest income.

Non-Interest Income

Non-interest income for 2015 totaled $3.4 million, a decrease of $322 thousand, or 8.8%, compared to $3.7 million for 2014. The difference in non-interest income was primarily driven by the following changes:

Decreases:

•

In 2014, the Company sold a former branch office for a gain of $138 thousand.

•

Non-deposit fee income declined $198 thousand.

•

Losses on foreclosed properties increased $68 thousand.

Increases:

•

Secondary market lending fees increased $100 thousand resulting from the larger Fannie Mae loan portfolio and the increase in the fair value of the related mortgage servicing rights.

Non-Interest Expense

For 2015, non-interest expenses totaled $14.8 million, an increase of $2.2 million, or 17.3%, compared to $12.6 million for 2014. The increase in non-interest expense was primarily the result of the following increases:

•

$1.5 million in salary and benefits which included a $421 thousand increase related to the new branches in Richmond and $143 thousand in severance expense.

•

$327 thousand in occupancy expense of which $229 thousand were related to the Richmond branches.

•

$137 thousand in accounting, auditing and strategic planning expenses.

•

$54 thousand in FDIC assessments resulting from higher deposit balances.

Income Taxes

Income tax (benefit) expense was $(187) thousand in 2015 compared to $557 thousand in 2014. This is directly attributable to the Company’s decline in pretax income and the relationship of tax-exempt income to pretax income. Income tax (benefit) expense corresponds to an effective rate of (104.2)% and 23.3% for the years ended December 31, 2015 and 2014, respectively. This change in the tax rate is primarily the result of tax-exempt income. Refer to Note 15 to the Consolidated Financial Statements in Item 8 of this Form 10-K for a reconciliation between the amounts of income tax expense computed using the federal statutory income tax rate and actual income tax expense. Also included in Note 15 to the Consolidated Financial Statements in Item 8 of this Form 10-K is information regarding deferred taxes for 2015 and 2014.

FINANCIAL CONDITION

Loans

Per the following table, which does not include deferred loan costs and fees, the loan portfolio grew during 2015 with balances increasing by 16.5% to $347.2 million as of December 31, 2015, compared to December 31, 2014 balances of $298.1 million. Mortgage loans on real estate represent the largest category, comprising 88.4% of the loan portfolio at December 31, 2015. Of these balances, 1-4 family residential loans, which comprise the majority of real estate loan balances at $190.9 million, increased by $30.2 million, or 18.8%. Other loans secured by real estate, the majority of which are commercial in nature, increased by $19.2 million, or 35.6%, and represent 21.0% of the loan portfolio at year-end 2015 as compared to 18.1% at year-end 2014. Construction and land loans decreased $919 thousand, or 2.1%. Commercial and industrial loan balances increased by $1.1 million, or 3.2%, and represented 10.1% of total loans at year-end 2015 as compared to 11.4% at year-end 2014. Consumer and other loans decreased by $334 thousand, or 6.2% in 2015, and represented 1.5% of total loans at year-end 2015 as compared to 1.8% at year-end 2014.

Types of Loans


As of December 31,	2015					2014					2013					2012					2011
(Dollars in thousands)	Amount		% of Total			Amount		% of Total			Amount		% of Total			Amount		% of Total			Amount		% of Total
Mortgage loans on real estate:
Construction and land loans	$	42,129		12.1	%	$	43,048		14.4	%	$	31,839		12.7	%	$	29,024		12.2	%	$	27,642		11.7	%
Secured by farmland		1,030		0.3	%		1,128		0.4	%		1,262		0.5	%		1,443		0.6	%		1,526		0.6	%
Secured by 1-4 family residential		190,902		55.0	%		160,667		53.9	%		138,502		55.3	%		133,437		56.0	%		135,379		57.4	%
Other real estate loans		73,042		21.0	%		53,860		18.1	%		48,803		19.5	%		47,055		19.8	%		44,045		18.7	%
Commercial and industrial loans		35,104		10.1	%		34,002		11.4	%		23,939		9.6	%		20,525		8.6	%		18,983		8.0	%
(not secured by real estate)
Consumer and other		5,015		1.5	%		5,349		1.8	%		5,986		2.4	%		6,653		2.8	%		8,329		3.6	%

Total	$	347,222		100.0	%	$	298,054		100.0	%	$	250,331		100.0	%	$	238,137		100.0	%	$	235,904		100.0	%

Notes:

Deferred loan costs and fees not included.

Allowance for loan losses not included.

Loan Maturity Schedule of Selected Loans

As of December 31, 2015


			Construction,
	Commercial and		Land and
(Dollars in thousands)	Industrial		Land Development
Within one year	$	11,965	$	20,747
Variable Rate
One to Five Years		1,249		197
After Five Years		195		311

Total Variable Rate		1,444		508

Fixed Rate
One to Five Years		10,901		14,235
After Five Years		10,794		6,639

Total Fixed Rate		21,695		20,874

Total Maturities	$	35,104	$	42,129

Asset Quality – Provision and Allowance for Loan Losses

The provision for loan losses is a charge against earnings that is necessary to maintain the allowance for loan losses at a level consistent with management’s evaluation of the loan portfolio’s inherent risk. For a detailed description of the ALL calculation, refer to Note 2 of the Consolidated Financial Statements in Item 8 of this Form 10-K.

As shown in the following table, the provision for loan losses was $1.6 million in 2015 compared to $611 thousand in 2014. After net charge-offs of $579 thousand, the ALL is $4.2 million as of December 31, 2015 compared to $3.2 million as of December 31, 2014. The increase in the provision expense and ALL is due primarily to additional impairment reserves for one commercial borrower who pleaded guilty in a federal court to “Willful Failure to Collect or Pay Over Employment Tax” and admitted to regularly and deliberately creating false financial statements for submission to financial institutions in order to encourage banks to lend new funds to his companies, or to enable the renewal of existing loans. Refer to Note 25 to the Consolidated Financial Statements in Item 8 of this Form 10-K for more detail. This level of net charge-offs represents 0.18% of average loans compared to 0.12% in 2014. As of December 31, 2015, management considered the allowance for loan losses to be sufficient to cover estimated potential loss exposure inherent in the loan portfolio.

Allowance for Loan Losses


	Years Ended December 31,
	2015			2014			2013			2012			2011
(Dollars in thousands)
Balance, beginning of period	$	3,205		$	2,925		$	3,094		$	3,189		$	3,231
Loans charged off:
Mortgage Loans on Real Estate		(521	)		(313	)		(879	)		(1,798	)		(349	)
Commercial and industrial		(9	)		—			(17	)		(388	)		(11	)
Consumer and other (including Visa program)		(128	)		(79	)		(132	)		(189	)		(217	)

Total loans charged off		(658	)		(392	)		(1,028	)		(2,375	)		(577	)

Recoveries of loans previously charged off:
Mortgage Loans on Real Estate		27			36			68			289			1
Commercial and industrial		—			—			1			18			—
Consumer and other (including Visa program)		52			25			14			78			39

Total recoveries		79			61			83			385			40

Net charge offs		(579	)		(331	)		(945	)		(1,990	)		(537	)
Provision for loan losses		1,597			611			776			1,895			495

Balance, end of period	$	4,223		$	3,205		$	2,925		$	3,094		$	3,189

Average loans outstanding during the period	$	319,597		$	266,016		$	240,964		$	240,557		$	240,832

Ratio of net charge-offs during the period to average loans outstanding during the period		0.18	%		0.12	%		0.39	%		0.83	%		0.22	%

As of December 31, 2015, the ratio of the allowance for loan losses to total loans was 1.22% as compared to 1.07% as of December 31, 2014.

Allocation of the Allowance for Loan Losses


Years Ended December 31,	2015				2014				2013				2012				2011
(Dollars in Thousands)
Mortgage Loans on Real Estate	$	3,502	1.01	%	$	2,778	0.93	%	$	2,466	0.98	%	$	2,572	1.08	%	$	2,714	1.15	%
Commercial and industrial		599	0.17	%		323	0.11	%		256	0.10	%		262	0.11	%		282	0.12	%
Consumer and other		122	0.04	%		104	0.03	%		203	0.09	%		252	0.11	%		185	0.08	%
Unallocated		—	0.00	%		—	0.00	%		—	0.00	%		8	0.00	%		8	0.00	%

Total	$	4,223	1.22	%	$	3,205	1.07	%	$	2,925	1.17	%	$	3,094	1.30	%	$	3,189	1.35	%

Non-Performing Assets

As of December 31, 2015, non-performing assets as a percentage of total assets was 1.8%, compared to 1.2% at year-end 2014. The coverage ratio of allowance to total non-performing loans decreased to 65.6% at year-end 2015 from 162.9% at year-end 2014 due primarily to the increase in non-accruing loans. OREO, including solely foreclosed properties, at year-end 2015 was $1.9 million compared to $2.8 million at year-end 2014. The year-end 2015 figure represents three residences, seven lots, two former convenience stores, a former restaurant and three commercial business properties. The Company sold 12 OREO properties with a total value of $1.1 million in 2015 for total losses of $107 thousand, and four properties with a total value of $460 thousand from four borrowers were added through foreclosure. After foreclosure, management periodically performs valuations and the real estate is carried at the lower of carrying amount or fair value less estimated costs to sell. As a result, in addition to losses on sales, the Company wrote down OREO property values by $288 thousand in 2015. Included in other assets is one residential property and one commercial property, with a value of $1.1 million. These properties were not obtained as a result of a foreclosure and are being marketed for sale.

During 2015, non-accruing loan balances increased by $4.5 million. Of the $6.4 million in non-accruing balances, $2.8 million are residential mortgages. The net increase in non-accruing loan balances from 2014 to 2015 was comprised of $5.1 million in new non-accruing loans less $20 thousand in charge-offs, $129 thousand of foreclosures, $164 thousand of upgrades and $341 thousand in paydowns. Components of non-performing assets and related ratios are shown in the following table.

Non-Performing Assets


	As of December 31,
(Dollars in Thousands)	2015			2014			2013			2012			2011
Loans past due 90 days or more and still accruing	$	11		$	14		$	18		$	126		$	60
Non-accruing loans		6,433			1,954			2,754			5,730			5,417

Total non-performing loans		6,444			1,968			2,772			5,856			5,477

Other real estate owned		1,870			2,791			3,897			3,151			2,280

Total non-performing assets	$	8,314		$	4,759		$	6,669		$	9,007		$	7,757

Allowance for loan losses	$	4,223		$	3,205		$	2,925		$	3,094		$	3,189

Allowance to non-performing loans		65.6	%		162.9	%		105.5	%		52.8	%		58.2	%
Non-performing assets to total assets		1.8	%		1.2	%		2.0	%		2.7	%		2.5	%

There were 16 TDRs with an aggregate balance of $3.5 million at December 31, 2015, 14 TDRs with an aggregate balance of $2.5 million at December 31, 2014 and 14 TDRs with an aggregate balance of $2.5 million at December 31, 2013.

For more detailed information on non-accrual, past due and impaired loans and policies, refer to Note 2, Note 5 and Note 6 of the Consolidated Financial Statements in Item 8 of this Form 10-K.

Securities

As of December 31, 2015, investment securities totaled $59.8 million, an increase of 40.4% as compared to 2014 year-end balances of $42.6 million.

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


(Dollars in thousands)
			Gross		Gross
Available-for-sale securities	Amortized		Unrealized		Unrealized			Fair
December 31, 2015	Cost		Gains		(Losses)			Value
Corporate bonds	$	3,950	$	—	$	(5	)	$	3,945
U.S. Government agencies		21,375		69		(156	)		21,288
State and municipal obligations		28,599		313		(55	)		28,857
Certificates of deposits		5,704		31		—			5,735

	$	59,628	$	413	$	(216	)	$	59,825


			Gross		Gross
Available-for-sale securities	Amortized		Unrealized		Unrealized			Fair
December 31, 2014	Cost		Gains		(Losses)			Value
U.S. Government agencies	$	16,969	$	33	$	(37	)	$	16,965
State and municipal obligations		23,335		226		(160	)		23,401
Certificates of deposits		2,232		8		(2	)		2,238

	$	42,536	$	267	$	(199	)	$	42,604


			Gross		Gross
Available-for-sale securities	Amortized		Unrealized		Unrealized			Fair
December 31, 2013	Cost		Gains		(Losses)			Value
U.S. Government agencies	$	9,383	$	11	$	(86	)	$	9,308
State and municipal obligations		27,690		109		(1,242	)		26,557
Certificates of deposits		1,736		9		—			1,745
Auction rate security		912		—		—			912

	$	39,721	$	129	$	(1,328	)	$	38,522

The Company currently classifies the entire investment portfolio as available-for-sale in order that it may be considered a source of liquidity, if necessary. Securities available-for-sale are carried at fair market value, with after-tax unrealized gains or losses disclosed as a component of comprehensive income. The after-tax unrealized gains or losses are recorded as a portion of other comprehensive income in the equity of the Company, but have no impact on earnings until such time as the gain or loss is realized, typically at the time of sale. As of December 31, 2015, the Company had accumulated other comprehensive gains net of deferred tax related to securities available-for-sale of $107 thousand as compared to $45 thousand at year-end 2014.

The investment portfolio shows a net unrealized gain of $197 thousand on December 31, 2015, compared to $68 thousand on December 31, 2014. The lower interest rate environment in 2015 compared to 2014 resulted in higher fair values, since bond prices are inversely proportional to bond rates.

The Company seeks to diversify its assets to minimize risk by maintaining a large portion of its investment portfolio in securities issued by states and political subdivisions. Many of these types of securities also provide tax benefits. Mortgage-backed securities and collateralized mortgage obligations held in the investment portfolio provide liquidity via cashflows, and are solely issued by agencies of the U.S. government. The Company owns no derivatives, and participates in no hedging activities.

For more information on the Company’s investment portfolio, please refer to Note 4 of the Consolidated Financial Statements in Item 8 of this Form 10-K.

Investment Maturities and Average Yields

As of December 31, 2015


	One Year or
(Dollars in Thousands)	Less or			One to Five			Five to Ten			Over Ten
	No Maturity			Years			Years			Years
U.S. Government and Agencies:
Book Value	$	1,452		$	10,429		$	9,028		$	502
Market Value		1,452			10,391			8,945			500
Weighted average yield		2.23	%		1.65	%		2.30	%		2.62	%
States and Municipal Obligations:
Book Value	$	1,400		$	8,854		$	16,339		$	2,005
Market Value		1,401			8,933			16,517			2,006
Weighted average yield		2.57	%		2.61	%		3.62	%		3.92	%
Certificates of Deposit:
Book Value	$	1,488		$	4,216		$	—		$	—
Market Value		1,488			4,247			—			—
Weighted average yield		0.61	%		1.85	%		0.00	%		0.00	%
Corporate Bonds:
Book Value	$	—		$	—		$	3,950		$	—
Market Value		—			—			3,945			—
Weighted average yield		0.00	%		0.00	%		6.20	%		0.00	%
Restricted Securities:
Book Value	$	—		$	—		$	—		$	2,731
Market Value		—			—			—			2,731
Weighted average yield		0.00	%		0.00	%		0.00	%		1.44	%
Total Securities:
Book Value	$	4,340		$	23,499		$	29,317		$	5,238
Market Value		4,341			23,571			29,407			5,237
Weighted average yield		1.79	%		2.05	%		3.56	%		2.50	%

Notes:

Yields on tax-exempt securities have been computed on a tax-equivalent basis.

Deposits

During 2015, average total deposits increased 19.6% to $329.2 million as compared to average total 2014 deposits of $273.7 million. Average non-interest bearing demand deposits increased 3.8%, average NOW accounts decreased 2.9%, average savings accounts decreased 3.9%, average money market deposits increased 114.5% and average time deposits increased 22.0%. These deposit increases raised the cost of deposit funds five basis points. The increase in money market accounts were primarily in the Richmond, Virginia market resulting from special promotional rates.

Average Deposits and Rates


Years Ended December 31,	2015					2014					2013
(Dollars in thousands)	Average Balance		Yield/ Rate			Average Balance		Yield/ Rate			Average Balance		Yield/ Rate
Non-interest bearing Demand Deposits	$	61,825		0.00	%	$	59,551		0.00	%	$	54,012		0.00	%
Interest bearing Deposits:
NOW Accounts		41,030		0.15	%		42,258		0.15	%		41,394		0.18	%
Regular Savings		42,716		0.18	%		43,416		0.16	%		45,625		0.19	%
Money Market Deposit Accounts		63,830		0.87	%		30,187		0.42	%		28,147		0.50	%
Time Deposits - Retail
CD’s $100,000 or more		55,713		1.51	%		44,879		1.75	%		45,729		2.21	%
CD’s less than $100,000		57,228		1.43	%		51,230		1.54	%		56,174		1.87	%
Time Deposits - Wholesale		6,900		0.40	%		2,154		0.44	%		—		0.00	%

Total Interest bearing Deposits		267,417		0.89	%		214,124		0.86	%		217,069		1.09	%

Total Average Deposits	$	329,242		0.72	%	$	273,675		0.67	%	$	271,081		0.87	%

Maturity Schedule of Time Deposits of $100,000 and over


As of December 31,	2015		2014		2013
(In thousands)
3 months or less	$	12,898	$	6,429	$	4,277
3-6 months		5,010		2,481		2,457
6-12 months		7,462		17,005		8,869
Over 12 months		36,362		30,775		28,417

Totals	$	61,732	$	56,690	$	44,020

CAPITAL RESOURCES

Capital resources represent funds, earned or obtained, over which a financial institution can exercise greater long-term control in comparison with deposits and borrowed funds. The adequacy of the Company’s capital is reviewed by management on an ongoing basis with reference to size, composition, and quality of the Company’s resources and consistency with regulatory requirements and industry standards. Management seeks to maintain a capital structure that will assure an adequate level of capital to support anticipated asset growth and to absorb potential losses, yet allow management to effectively leverage its capital to maximize return to shareholders. The Company’s capital, also known as equity, is comprised mainly of outstanding stock and retained earnings. Capital can be increased with a variety of stock offerings or through earnings. Management believes the capital level at December 31, 2015, is sufficient to support growth and acquisition opportunities.

The parent company obtains its operating funds primarily through management fees paid by the Bank and Trust Company. The parent company could also receive dividends from its subsidiaries.

During 2015, the Bank was required to maintain minimum amounts of capital per Federal Reserve capital guidelines. The minimum total capital to risk weighted assets ratio was 8.0%, the minimum Tier 1 capital to risk weighted assets ratio was 6.0% and the minimum Tier 1 capital to adjusted average assets ratio (leverage ratio) was 4.0%. In addition, effective January 1, 2015, a new Common Equity Tier 1 capital ratio of 4.5% of risk-weighted assets was established. As of December 31, 2015, the Bank maintained Common Equity Tier 1 capital of $39.0 million, Tier 1 capital of $39.0 million, risk weighted assets of $314.7 million and total capital of $42.9 million. As of December 31, 2014, the Bank maintained Tier 1 capital of $33.2 million, risk weighted assets of $274.1 million, and total capital of $36.4 million. As of December 31, 2015, all ratios were in excess of the fully phased-in requirements of the Basel III regulatory capital framework, with the Common Equity Tier 1 ratio at 12.39% of risk-weighted assets, the Tier 1 capital ratio at 12.39% of risk-weighted assets, the total capital ratio at 13.64% of risk-weighted assets and the Tier 1 leverage ratio at 9.11% of total assets.

For more detailed information, refer to Note 16 of the Consolidated Financial Statements in Item 8 of this Form 10-K.

Total capital, before accumulated other comprehensive income, increased by 0.5% to $40.3 million as of December 31, 2015 as compared to $40.2 million as of December 31, 2014. Accumulated other comprehensive loss was $776 thousand as of December 31, 2015 compared to accumulated other comprehensive loss of $921 thousand as of December 31, 2014. The reduction in the loss is due primarily to an increase in unrealized gains on securities and a reduction in actuarial losses on the Company’s pension and post-retirement benefit plan assets.

LIQUIDITY

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

At December 31, 2015, liquid assets totaled $55.7 million or 12.1% of total assets, an increase from $45.8 million and 11.7% at December 31, 2014. Additional sources of liquidity available to the Company include its capacity to borrow additional funds when necessary. The Bank maintains federal funds lines with regional banks totaling approximately $21.5 million. In addition, the Bank has total borrowing capacity with the FHLB of $84.5 million, with $40.5 million immediately available as of December 31, 2015.

The table below presents selected information on short-term borrowings:


(Dollars in Thousands)
Years Ended December 31,	2015			2014			2013
Balance outstanding at year-end	$	7,161		$	6,012		$	9,118
Maximum balance at any month end during the year		10,491			9,164			11,355
Average balance for the year		7,612			7,538			8,482
Weighted average rate for the year		0.15	%		0.12	%		0.19	%
Weighted average rate on borrowings at year end		0.14	%		0.12	%		0.11	%

The impact of contractual obligations includes seven FHLB advances and time deposits. With regards to the FHLB advances, a $5 million LIBOR-based floating rate advance which matured in May 2015 and was replaced with a $5 million fixed rate advance, which matured in February 2016. In June 2015, a $5 million fixed rate advance was replaced with a $5 million LIBOR-based floating rate advance maturing in September 2016, and a $5 million fixed rate advance was repaid. An advance matured on October 20, 2015 and was replaced with a $5 million, 0.52% fixed rate credit advance maturing on October 20, 2016. In December 2015, two new $5 million advances were drawn that mature in 2017. The advance that matured on February 22, 2016 was repaid. For details on these advances, please refer to Note 14 of the Consolidated Financial Statements in Item 8 of this Form 10-K.

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

Time deposits mature as follows: 2016 - $56.7 million; 2017 - $12.7 million; 2018 - $36.5 million; 2019 - $4.4 million; and 2020 - $17.1 million. Refer to Note 9 of the Consolidated Financial Statements in Item 8 of this Form 10-K.

The following table presents the Company’s contractual obligations and scheduled payment amounts, excluding interest, due at various intervals over the next five years and beyond as of December 31, 2015:


(Dollars in thousands)	Payments Due by Period
			Less than
	Total		1 year		1-3 years		3-5 years		Over 5 years
FHLB advances	$	40,000	$	20,000	$	10,000	$	10,000	$	—
Subordinated debt		7,000		—		—		—		7,000
Securities sold under repurchase agreements (1)		7,161		7,161		—		—		—
Operating leases		389		163		198		28		—

Total	$	54,550	$	27,324	$	10,198	$	10,028	$	7,000

Note:

(1)	Refer to Note 2 to the Consolidated Financial Statements

As of December 31, 2015, the Company was not aware of any other known trends, events or uncertainties that have or are reasonably likely to have a material impact on liquidity. As of December 31, 2015, the Company has no material commitments or long-term debt for capital expenditures.

OFF BALANCE SHEET COMMITMENTS

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

Off Balance Sheet Arrangements


	December 31, 2015		December 31, 2014		December 31, 2013
(In thousands)
Total Loan Commitments Outstanding	$	42,713	$	36,443	$	37,279
Standby-by Letters of Credit		473		355		329
Low income housing tax credit fund		499		—		—

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

STATEMENT REGARDING FORWARD-LOOKING STATEMENTS

This report contains statements concerning the Company’s expectations, plans, objectives, future financial performance and other statements that are not historical facts. These statements may constitute “forward-looking statements” as defined by federal securities laws. These statements may address issues that involve estimates and assumptions made by management, risks and uncertainties, and actual results could differ materially from historical results or those anticipated by such statements. Factors that could have a material adverse effect on the

operations and future prospects of the Company include, but are not limited to, changes in: interest rates, general economic conditions, the legislative/regulatory climate, monetary and fiscal policies of the U.S. Government, including policies of the U.S. Treasury and the Federal Reserve, the quality or composition of the loan or investment portfolios, demand for loan products, deposit flows, competition, demand for financial services in the Company’s market areas, acquisitions and dispositions, and accounting principles, policies and guidelines. These risks and uncertainties should be considered in evaluating the forward-looking statements contained herein, and readers are cautioned not to place undue reliance on such statements, which speak only as of the date they are made.

ITEM 7A: QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Not required.

ITEM 8: FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

The following information is included on the pages indicated:

Bay Banks of Virginia, Inc.


Report of Independent Registered Public Accounting Firm			26
Consolidated Balance Sheets			27
Consolidated Statements of Income			28
Consolidated Statements of Comprehensive Income			29
Consolidated Statements of Changes in Shareholders’ Equity			30
Consolidated Statements of Cash Flows			31
Notes to Consolidated Financial Statements			32

LOGO

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Shareholders and Board of Directors

Bay Banks of Virginia, Inc.

We have audited the accompanying consolidated balance sheets of Bay Banks of Virginia, Inc. and subsidiaries (the “Company”) as of December 31, 2015 and 2014, and the related consolidated statements of income, comprehensive income, changes in shareholders’ equity and cash flows for the years then ended. These consolidated financial statements are the responsibility of the Company’s management. 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 audits to obtain reasonable assurance about whether the financial statements are free of material misstatement. We were not engaged to perform an audit of the Company’s internal control over financial reporting. Our audits 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 provide 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 Bay Banks of Virginia, Inc. and subsidiaries as of December 31, 2015 and 2014, and the results of their operations and their cash flows for the years then ended, in conformity with accounting principles generally accepted in the United States of America.

/s/ Dixon Hughes Goodman LLP

Asheville, North Carolina

March 28, 2016

BAY BANKS OF VIRGINIA, INC.

CONSOLIDATED BALANCE SHEETS


	December 31, 2015			December 31, 2014
(Dollars in thousands)
ASSETS
Cash and due from banks	$	4,969		$	6,181
Interest-bearing deposits		15,330			14,784
Federal funds sold		271			119
Securities available-for-sale, at fair value		59,825			42,604
Restricted securities		2,731			2,430
Loans receivable, net of allowance for loan losses of $4,223 and $3,205		343,323			295,242
Loans held for sale		270			—
Premises and equipment, net		11,646			11,882
Accrued interest receivable		1,318			1,197
Other real estate owned, net		1,870			2,791
Bank owned life insurance		7,595			7,348
Goodwill		2,808			2,808
Mortgage servicing rights		658			596
Other assets		3,682			2,504

Total assets	$	456,296		$	390,486

LIABILITIES
Noninterest-bearing deposits	$	65,842		$	63,308
Savings and interest-bearing demand deposits		166,628			122,502
Time deposits		127,388			121,775

Total deposits		359,858			307,585
Securities sold under repurchase agreements		7,161			6,012
Federal Home Loan Bank advances		40,000			35,000
Subordinated debt, net of issuance costs		6,844			—
Other liabilities		2,864			2,651

Total liabilities		416,727			351,248

SHAREHOLDERS’ EQUITY
Common stock ($5 par value; authorized - 10,000,000 shares; outstanding - 4,774,856 and 4,817,856 shares, respectively)		23,874			24,089
Additional paid-in capital		2,812			2,777
Retained earnings		13,659			13,293
Accumulated other comprehensive loss, net		(776	)		(921	)

Total shareholders’ equity		39,569			39,238

Total liabilities and shareholders’ equity	$	456,296		$	390,486

See Notes to Consolidated Financial Statements

BAY BANKS OF VIRGINIA, INC.

CONSOLIDATED STATEMENTS OF INCOME


	For the year ended
	December 31,
(Dollars in thousands, except share and per share amounts)	2015			2014
INTEREST INCOME
Loans, including fees	$	15,202		$	13,352
Securities:
Taxable		623			382
Tax-exempt		394			375
Federal funds sold		1			—
Interest-bearing deposit accounts		33			23

Total interest income		16,253			14,132

INTEREST EXPENSE
Deposits		2,385			1,842
Federal funds purchased		6			1
Securities sold under repurchase agreements		12			9
Subordinated debt		279			—
FHLB advances		352			345

Total interest expense		3,034			2,197

Net interest income		13,219			11,935

Provision for loan losses		1,597			611

Net interest income after provision for loan losses		11,622			11,324

NON-INTEREST INCOME
Income from fiduciary activities		798			831
Service charges and fees on deposit accounts		917			974
VISA-related fees		217			255
Non-deposit product income		369			567
Other service charges and fees		553			533
Secondary market lending fees		551			451
Bank owned life insurance income		247			219
Net gains (losses) on sale of securities available for sale		42			(25	)
Other real estate losses		(395	)		(327	)
Net (losses) gains on the disposal of fixed assets		(6	)		137
Other income		66			66

Total non-interest income		3,359			3,681

NON-INTEREST EXPENSES
Salaries and employee benefits		8,001			6,458
Occupancy expense		1,819			1,492
Software maintenance		631			524
Bank franchise tax		219			189
VISA expense		135			170
Telephone expense		136			210
FDIC assessments		301			247
Foreclosure property expense		68			131
Consulting expense		303			329
Other expense		3,189			2,868

Total non-interest expenses		14,802			12,618

Net income before income taxes		179			2,387
Income tax (benefit) expense		(187	)		557

Net income	$	366		$	1,830

Basic Earnings Per Share
Average basic shares outstanding		4,791,722			4,818,377
Earnings per share, basic	$	0.08		$	0.38
Diluted Earnings Per Share
Average diluted shares outstanding		4,805,318			4,829,581
Earnings per share, diluted	$	0.08		$	0.38

See Notes to Consolidated Financial Statements.

BAY BANKS OF VIRGINIA, INC.

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME


	For the twelve months ended
	December 31,
(Dollars in thousands)	2015			2014
Net income	$	366		$	1,830
Other comprehensive income (loss):
Unrealized gains (losses) on securities:
Net unrealized holding gains arising during the period		136			1,242
Deferred tax expense		(46	)		(422	)
Reclassification of net securities (gains) losses and impairments recognized in net income		(42	)		25
Deferred tax expense (benefit)		14			(9	)

Unrealized gains adjustment, net of tax		62			836

Defined benefit pension plan:
Net pension loss		(98	)		(792	)
Deferred tax benefit		37			270
Reclassification of pension expense		76			37
Deferred tax benefit		(29	)		(13	)

Defined benefit pension plan adjustment, net of tax		(14	)		(498	)

Post retirement benefit plan:
Net postretirement gain (loss)		147			(130	)
Deferred tax (expense) benefit		(50	)		44
Reclassification of postretirement expense		—			—
Deferred tax benefit		—			—

Post retirement benefit plan adjustment, net of tax		97			(86	)

Total other comprehensive income		145			252

Comprehensive income	$	511		$	2,082

See Notes to Consolidated Financial Statements.

BAY BANKS OF VIRGINIA, INC.

CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY


												Accumulated
	Shares of						Additional					Other			Total
	Common			Common			Paid-in			Retained		Comprehensive			Shareholders’
	Stock			Stock			Capital			Earnings		Income (Loss)			Equity
(Dollars in thousands, except shate data or amounts)
Balance January 1, 2014		4,817,856		$	24,089		$	2,757		$	11,463	$	(1,173	)	$	37,136
Net income		—			—			—			1,830		—			1,830
Other comprehensive income		—			—			—			—		252			252
Stock compensation expense		—			—			20			—		—			20

Balance December 31, 2014		4,817,856			24,089			2,777			13,293		(921	)		39,238
Net income		—			—			—			366		—			366
Other comprehensive income		—			—			—			—		145			145
Stock repurchase		(43,000	)		(215	)		(28	)		—		—			(243	)
Stock compensation expense		—			—			63			—		—			63

Balance December 31, 2015		4,774,856		$	23,874		$	2,812		$	13,659	$	(776	)	$	39,569

See Notes to Consolidated Financial Statements.

BAY BANKS OF VIRGINIA, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS


	Year Ended December 31,
(Dollars in thousands)	2015			2014
Cash Flows From Operating Activities
Net income	$	366		$	1,830
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation		998			792
Net amortization and accretion of securities		389			363
Amortization of subordinated debt issuance costs		10			—
Provision for loan losses		1,597			611
Stock compensation expense		63			20
Deferred income tax (expense) benefit		(490	)		58
(Gain) loss on securities available-for-sale		(42	)		25
Increase in OREO valuation allowance		288			235
Loss on sale of other real estate		107			92
Loss (gain) on disposal of fixed assets		6			(137	)
Mortgage servicing rights		(62	)		(17	)
Loan originations for sale to FNMA		(14,317	)		(10,503	)
Loan sales to FNMA		14,326			10,951
Gain on loans sold to FNMA		(279	)		(252	)
Increase in cash surrender value of life insurance		(247	)		(219	)
(Increase) decrease in accrued income and other assets		(477	)		246
Increase (decrease) in other liabilities		351			(92	)

Net cash provided by operating activities		2,587			4,003

Cash Flows From Investing Activities
Proceeds from maturities and principal paydowns of available-for-sale securities		4,051			4,529
Proceeds from sales and calls of available-for-sale securities		13,540			3,810
Purchase of bank owned life insurance		—			(2,000	)
Purchases of available-for-sale securities		(35,066	)		(11,542	)
Purchases of restricted securities		(301	)		(792	)
(Increase) decrease in federal funds sold		(152	)		1
Loan (originations) and principal collections, net		(49,958	)		(47,533	)
Proceeds from sale of other real estate		805			371
Purchases of premises and equipment		(1,185	)		(2,014	)
Proceeds from the sale of premises and equipment		—			311

Net cash used in investing activities		(68,266	)		(54,859	)

Cash Flows From Financing Activities
Increase in demand, savings, and other interest-bearing deposits		46,660			13,949
Net increase in time deposits		5,613			25,289
Repurchase of common stock		(243	)		—
Net increase (decrease) in securities sold under repurchase agreements		1,149			(3,106	)
Issuance of subordinated debt, net		6,834			—
Increase in Federal Home Loan Bank advances		5,000			20,000

Net cash provided by financing activities		65,013			56,132

Net (decrease) increase in cash and due from banks		(666	)		5,276
Cash and due from banks at beginning of period		20,965			15,689

Cash and due from banks at end of period	$	20,299		$	20,965

Supplemental Schedule of Cash Flow Information
Cash paid for:
Interest	$	2,864		$	2,215

Income taxes		812			351

Non-cash investing and financing:
Unrealized gain on investment securities		94			1,268

Change in fair value of pension and post-retirement obligation		125			(885	)

Loans transferred to other real estate owned		460			197

Loans originated to facilitate sale of OREO		181			605

Changes in deferred taxes resulting from OCI transactions		(74	)		(130	)

See Notes to Consolidated Financial Statements.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Note 1. Organization and Presentation

Organization. Bay Banks of Virginia, Inc. (the “Company”) is a bank holding company that conducts substantially all of its operations through its two active subsidiaries, the Bank of Lancaster and Bay Trust Company.

The Bank of Lancaster (the “Bank”) is a state-chartered bank and a member of the Federal Reserve System. It serves businesses, professionals and consumers on the Northern Neck and Middle Peninsulas of Virginia and the Greater Richmond, Virginia market. The Bank has branch offices in the Virginia counties of Chesterfield, Henrico, Lancaster, Middlesex, Northumberland, Richmond, Westmoreland, and in the City of Richmond, Virginia. Each branch office offers a full range of deposit and loan products to its retail and commercial customers. A substantial amount of the Bank’s deposits are interest bearing. The majority of the Bank’s loan portfolio is secured by real estate.

Bay Trust Company (the “Trust Company”) provides management services for personal and corporate trusts, including estate planning, estate settlement, and trust administration from its main office in Kilmarnock, Virginia. Products include revocable and irrevocable living trusts, testamentary trusts, custodial accounts, investment management accounts and managed, as well as self-directed, rollover Individual Retirement Accounts.

Basis of Presentation. The consolidated financial statements of the Company include the accounts of Bay Banks of Virginia, Inc. and its subsidiaries, Bank of Lancaster and Bay Trust Company. All significant intercompany balances and transactions have been eliminated in consolidation.

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

Note 2. Significant Accounting Policies

Use of estimates

The preparation of the consolidated financial statements in conformity with U.S. generally accepted accounting principles (“GAAP”) requires management to make estimates and assumptions. The amounts recorded in the consolidated financial statements may be affected by those estimates and assumptions. Actual results may vary 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, the measurement of fair value of foreclosed real estate, deferred taxes, impairment testing of goodwill, projected pension and post-retirement obligations and fair value measurements.

Cash and cash equivalents

For purposes of the consolidated statements of cash flows, cash and cash equivalents include cash and balances due from banks, all of which mature within ninety days.

Interest-bearing deposits in banks

Interest-bearing deposits in banks are carried at cost, which mature within one year, and include deposits with the Federal Reserve Bank of Richmond.

Securities

Investments in debt and equity securities with readily determinable fair values are classified as either held to maturity, available-for-sale, or trading, based on management’s intent. Currently, all of the Company’s investment securities are classified as available-for-sale. Securities available-for-sale are carried at estimated fair value with the corresponding unrealized gains and losses excluded from earnings and reported in other comprehensive income. A gain or loss is recognized in earnings on the settlement date based on the amortized cost of the specific security sold. Purchase premiums and discounts are recognized in interest income via amortization or accretion, respectively, using the interest method over the terms of the securities.

Impairment of securities occurs when the fair value of a security is less than its amortized cost. For debt securities, impairment is considered other-than-temporary and recognized in its entirety in net income if (i) there is evidence of credit related impairment; (ii) the Company intends to sell the security or (iii) it is more-likely-than-not that the Company will be required to sell the security before recovery of its amortized cost basis. If, however, the Company does not intend to sell the security and it is not more-likely-than-not that it will be required to sell the security before recovery, the Company must determine what portion of the impairment is attributable to a credit loss, which occurs when the amortized cost basis of the security exceeds the present value of the cash flows expected to be collected from the security. If there is a credit loss, the loss must be recognized in net income and the remaining portion of impairment must be recognized in other

comprehensive income. For equity securities, impairment is considered to be other-than-temporary based on the Company’s ability and intent to hold the investment until a recovery of fair value. Other-than-temporary impairment of an equity security results in a write-down that must be included in net income. The Company regularly reviews each investment security for other-than-temporary impairment based on criteria that include the extent to which cost exceeds market price, the duration of that market decline, the financial health of and specific prospects for the issuer, the Company’s best estimate of the present value of cash flows expected to be collected from debt securities, the Company’s intention with regard to holding the security to maturity and the likelihood that it would be required to sell the security before recovery.

Securities sold under repurchase agreements

Securities sold under repurchase agreements, which are classified as secured borrowings, generally mature within one year from the transaction date. Securities sold under repurchase agreements are reflected at the amount of cash received in connection with the transaction. The Company is required to provide collateral based on the value of the underlying cash.

Loans

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

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

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

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

Troubled debt restructuring (“TDR”)

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

Allowance for loan losses (“ALL”)

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

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

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

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

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

The ALL consists of specific, general, and unallocated components. The specific component is determined by identifying impaired loans (as described below) then evaluating each one to calculate the amount of impairment. Impaired loans measured for impairment generally include: (1) non-accruing Special mention, Substandard and Doubtful loans in excess of $250,000; (2) Substandard and Doubtful loans in excess of $500,000; (3) Special Mention loans in excess of $500,000 if any of the loans in the relationship are more than 30 days past due or if the borrower has filed for bankruptcy; and (4) all TDRs. A specific allowance arises when the discounted cash flows (or collateral value or observable market price) of the impaired loan is lower than the carrying value of that loan. The general component collectively evaluates smaller commercial loans, residential mortgages and consumer loans, grouped into segments and classes. Historical loss experience is calculated and applied to each segment or class, then adjusted for qualitative factors. Qualitative factors include changes in the local and national economic outlook, including unemployment, interest rates, inflation rates and real estate trends; the level and trend of past due and nonaccrual loans; strength of policies and procedures; and oversight of credit risk and quality of underwriting. These qualitative adjustments reflect management’s judgment of risks inherent in the segments. An unallocated component is maintained if needed to cover uncertainties that could affect management’s estimate of probable losses. The unallocated component of the allowance reflects the margin of imprecision inherent in the underlying assumptions used in the methodologies for estimating specific and general losses in the portfolio. Changes in the allowance for loan losses and the related provision expense can materially affect net income.

Mortgage servicing rights (“MSRs”)

MSRs are included on the consolidated balance sheet and recorded at fair value on an ongoing basis. Changes in the fair value of the MSRs are recorded in the results of operations. A fair value analysis of MSRs is performed on a quarterly basis.

Premises and equipment, net

Land is carried at cost. Premises and equipment are carried at cost less accumulated depreciation. Depreciation is computed by the straight-line method over the estimated useful lives of the premises and equipment. Estimated useful lives range from 10-40 years for buildings, and from 3-10 years for furniture, fixtures and equipment. Maintenance and repairs are charged to expense as incurred, and major improvements are capitalized.

Other real estate owned, net

Real estate properties acquired through, or in lieu of, loan foreclosure are marketed for sale and are initially recorded at the lesser of the fair value on the date of foreclosure less estimated selling costs or carrying value of the loan. After acquisition, management acquires new valuations at least every two years. Revenue and expenses related to the operation or maintenance of foreclosed properties are included in expenses from foreclosed assets and changes in the valuation allowance are included in other real estate gains (losses).

Goodwill

Goodwill is related to unidentifiable intangible assets arising from the acquisition of five branches during the years 1994 through 2000. Goodwill is tested annually for impairment. If impairment exists, the amount of impairment would result in a charge to expense.

Income taxes

Deferred income tax assets and liabilities are determined using the liability (or 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 ultimately be 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 to be 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 sheets along with any associated interest and penalties that would be payable to the taxing authorities upon examination. Interest and penalties, if any, associated with unrecognized tax benefits are classified as additional income taxes in the statements of income.

The Company evaluates its deferred tax assets quarterly to determine if those assets will be recovered and if a valuation allowance is needed. At December 31, 2015, the Company determined no valuation allowance related to its deferred tax assets was necessary.

Pension benefits

The Company has a non-contributory cash balance benefit pension plan which was frozen in 2012. The plan covers employees who had become vested in the plan by the date it was frozen. The balances for those employees in the plan receive interest credits.

Postretirement benefits

The Company provides certain health care benefits for all retired employees who meet eligibility requirements.

Trust assets and income

Customer assets held by the Trust Company, other than cash on deposit at the Bank, are not included in these financial statements, since such items are not assets of the Bank or the Trust Company. Trust fees are recorded on the accrual basis.

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. Potential common shares that may be issued by the Company relate solely to outstanding stock options. Refer to Note 19.

Off-balance-sheet financial instruments

In the ordinary course of business, the Company enters into off-balance-sheet financial agreements such as home equity lines of credit, overdraft protection lines of credit, unsecured lines of credit, commitments under credit card arrangements, construction loan commitments and standby letters of credit. Such financial instruments are recorded in the financial statements when they are funded or related fees are incurred or received.

Significant group concentration of credit risk

Most of the Company’s business activity is with customers located in the Virginia counties of Lancaster, Northumberland, Richmond, Westmoreland, Middlesex, Chesterfield and Henrico. The Company makes residential, commercial and consumer loans and a significant amount of the loan portfolio is comprised of real estate mortgage loans, which are secured primarily by single-family residences. The adequacy of collateral on real estate mortgage loans is highly dependent on changes in real estate values.

Advertising

Advertising costs are expensed as incurred and totaled $213 thousand and $237 thousand for the years ended December 31, 2015 and 2014, respectively.

Comprehensive income

Comprehensive income consists of net income and other comprehensive income. Other comprehensive income includes unrealized gains or losses on securities available-for-sale and changes in the actuarial gain or loss of the pension and postretirement plans. The cumulative position of the items in comprehensive income resides in shareholders’ equity as accumulated other comprehensive income. Refer to Note 24.

Fair value of financial instruments

Fair values of financial instruments are estimated using relevant market information and other assumptions, as more fully disclosed in Note 21. Fair value estimates involve uncertainties and matters of significant judgment. Changes in assumptions or in market conditions could significantly affect the estimates.

Transfers of financial assets

Transfers of financial assets are accounted for as sales when control over the assets has been surrendered. Control over transferred assets is deemed to be surrendered when: (1) the assets have been isolated from the Company – put presumptively beyond 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.

Stock-based compensation plans

Authoritative accounting guidance requires companies to recognize the cost of employee services received in exchange for awards of equity instruments, such as stock options and restricted stock, based on the fair value of those awards at the date of grant. This cost is recognized over the vesting period of the respective awards.

Recent Accounting Pronouncements.

In January 2016, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2016-01, Financial Instruments – Overall (Subtopic 825-10) which requires equity investments, other than those accounted for using the equity method, to be measured at fair value through earnings. There will no longer be an available-for-sale classification measured (changes in fair value reported in other comprehensive income) for equity securities with readily determinable fair values. The cost method is also eliminated for equity instruments without a readily determinable fair value. For these investments, companies can elect to record the investment at cost, less impairment, plus or minus subsequent adjustments for observable price changes. This election only applies to equity investments that do not qualify for the net asset value practical expedient. Public companies will be required to use the exit price when measuring the fair value of financial instruments measured at amortized cost for disclosure purposes. In addition, the ASU requires financial assets and financial

liabilities to be presented separately in the notes to the financial statements, grouped by measurement category and form of financial asset. The classification and measurement guidance is effective for periods beginning after December 15, 2017. The Company is evaluating the impact that ASU 2016-01 will have on its consolidated financial statements.

In April 2015, the FASB issued ASU 2015-03, Interest – Imputation of Interest (Subtopic 835-30) which requires that debt issuance costs related to a recognized debt liability be presented in the balance sheet as a direct deduction of 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. ASU 2015-03 is effective for periods beginning after December 15, 2015. The Company has adopted the guidance during the second quarter of 2015 and it did not have a material impact on the Company’s consolidated financial statements.

In February 2015, the FASB issued ASU No. 2015-02, Consolidation (Topic 810): Amendments to the Consolidation Analysis. The amendments modify the evaluation reporting organizations must perform to determine if certain legal entities should be consolidated as variable interest entities (“VIEs”). Specifically, the amendments: (1) modify the evaluation of whether limited partnerships and similar legal entities are VIEs or voting interest entities; (2) eliminate the presumption that a general partner should consolidate a limited partnership; (3) affect the consolidation analysis of reporting entities that are involved with VIEs, particularly those that have fee arrangements and related party relationships; and (4) provide a scope exception from consolidation guidance for reporting entities with interests in legal entities that are required to comply with or operate in accordance with requirements that are similar to those in Rule 2a-7 of the Investment Company Act of 1940 for registered money market funds. ASU No. 2015-02 is effective for interim and annual reporting periods beginning after December 15, 2015. ASU No. 2015-02 is not expected to have a material impact on the Company’s consolidated financial statements.

In January 2015, the FASB issued ASU 2015-01, Income Statement – Extraordinary and Unusual Items. ASU 2015-01 eliminates the concept of extraordinary items. However, the presentation and disclosure requirements for items that are either unusual in nature or infrequent in occurrence remain and will be expanded to include items that are both unusual in nature and infrequent in occurrence. ASU 2015-01 is effective for periods beginning after December 15, 2015. ASU 2015-01 is not expected to have a material impact on the Company’s consolidated financial statements.

In June 2014, the FASB issued ASU 2014-11, Transfers and Servicing (Topic 860): Repurchase-to-Maturity Transactions, Repurchase Financings, and Disclosures. This ASU aligns the accounting for repurchase-to-maturity transactions and repurchase agreements executed as a repurchase financing with the accounting for other typical repurchase agreements. The new guidance eliminates sale accounting for repurchase-to-maturity transactions and supercedes the guidance under which a transfer of a financial asset and a contemporaneous repurchase financing could be accounted for on a combined basis as a forward agreement. The amendments in the ASU also require a new disclosure for transactions economically similar to repurchase agreements in which the transferor retains substantially all of the exposure to the economic return on the transferred financial assets throughout the term of the transaction. Additional disclosures will be required for the nature of collateral pledged in repurchase agreements and similar transactions accounted for as secured borrowings. The amendments in this ASU are effective for the first interim or annual period beginning after December 15, 2014. However, the disclosure for transactions accounted for as secured borrowings is required to be presented for annual periods beginning after December 15, 2014, and interim periods beginning after March 15, 2015. Early adoption is not permitted. The adoption of the new guidance did not have a material impact on the Company’s consolidated financial statements.

In May 2014, the FASB issued ASU 2014-09, Revenue from Contracts with Customers (Topic 606). The amendments in this ASU modify the guidance companies use to recognize revenue from contracts with customers for transfers of goods or services and transfers of nonfinancial assets, unless those contracts are within the scope of other standards. The ASU requires that entities apply a specific method to recognize revenue reflecting the consideration expected from customers in exchange for the transfer of goods and services. The guidance also requires new qualitative and quantitative disclosures, including information about contract balances and performance obligations. Entities are also required to disclose significant judgments and changes in judgments for determining the satisfaction of performance obligations. Most revenue associated with financial instruments, including interest and loan origination fees, is outside the scope of the guidance. ASU 2014-09 is effective for annual reporting periods beginning after December 15, 2017. The Company is evaluating the impact that ASU 2014-09 will have on its consolidated financial statements.

In January 2014, the FASB issued ASU 2014-04, Receivables – Troubled Debt Restructurings by Creditors (Subtopic 310-4): Reclassification of Residential Real Estate Collateralized Consumer Mortgage Loans upon Foreclosure. The amendment clarifies that an in-substance repossession or foreclosure occurs, and a creditor is considered to have received physical possession of residential real estate property collateralizing a consumer mortgage loan, either upon (1) the creditor obtaining legal title to the residential real estate property upon completion of a foreclosure or (2) the borrower conveying all interest in the residential real estate property to the creditor to satisfy that loan through completion of a deed in lieu of foreclosure or through a similar legal agreement. The amendment also requires interim and annual disclosure of both (1) the amount of foreclosed residential real estate property held by the creditor and (2) the recorded investment in consumer mortgage loans collateralized by residential real estate property that are in the process of foreclosure according to local requirements of the applicable jurisdiction. Companies should apply this amendment for fiscal years and interim periods beginning after December 15, 2014. The Company adopted the new guidance during the first quarter of 2014. The adoption did not have a material impact on the Company’s consolidated financial statements. Disclosures are included in Note 6.

Note 3. Goodwill

The Company has goodwill relating to the purchase of five branches during the years 1994 through 2000. The balance of the goodwill at both December 31, 2015 and 2014, as reflected on the consolidated balance sheets, was $2.8 million. Management determined that these purchases qualified as acquisitions of businesses and that the related unidentifiable intangibles were goodwill. Goodwill is tested annually for impairment. The test performed using financial information as of September 30, 2015 found no impairment. No events occurred between the date of the annual test and December 31, 2015 that would indicate the existence of impairment.

Note 4. Investment Securities

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


(Dollars in thousands)
			Gross		Gross
Available-for-sale securities	Amortized		Unrealized		Unrealized			Fair
December 31, 2015	Cost		Gains		(Losses)			Value
Corporate bonds	$	3,950	$	—	$	(5	)	$	3,945
U.S. Government agencies		21,375		69		(156	)		21,288
State and municipal obligations		28,599		313		(55	)		28,857
Certificates of deposits		5,704		31		—			5,735

	$	59,628	$	413	$	(216	)	$	59,825


			Gross		Gross
Available-for-sale securities	Amortized		Unrealized		Unrealized			Fair
December 31, 2014	Cost		Gains		(Losses)			Value
U.S. Government agencies	$	16,969	$	33	$	(37	)	$	16,965
State and municipal obligations		23,335		226		(160	)		23,401
Certificates of deposits		2,232		8		(2	)		2,238

	$	42,536	$	267	$	(199	)	$	42,604

The cost of securities sold is based on actual net cost. Gross realized gains and gross realized losses, as well as proceeds on sales and calls of securities, were as follows:


	For the years ended December 31,
(Dollars in thousands)	2015			2014
Gross realized gains	$	68		$	8
Gross realized losses		(26	)		(33	)

Net realized gains (losses)	$	42		$	(25	)

Aggregate proceeds	$	13,540		$	3,810

The aggregate amortized cost and market values of the investment securities portfolio by contractual maturity at December 31, 2015 are shown below:


(Dollars in thousands)	Amortized Cost		Fair Value
Due in one year or less	$	4,339	$	4,341
Due after one year through five years		27,449		27,516
Due after five through ten years		25,333		25,462
Due after ten years		2,507		2,506

	$	59,628	$	59,825

Average yields (taxable equivalent) on securities were 2.48% and 2.40% for the years ended December 31, 2015 and 2014, respectively.

Securities with a market value of $8.6 million and $8.5 million at December 31, 2015 and 2014, respectively, were pledged as collateral for repurchase agreements and for other purposes as required by law. As of December 31, 2015 and 2014, all the securities pledged to repurchase agreements were state and municipal obligations. All the repurchase agreements had remaining contractual maturities that were overnight and continuous. Securities sold under repurchase agreements were $7.2 million and $6.0 million as of December 31, 2015 and December 31, 2014, respectively, and included in liabilities on the consolidated balance sheets. The securities pledged to each agreement are reviewed daily and can be changed at the option of the Bank with minimal risk of loss due to fair value.

Securities in an unrealized loss position at December 31, 2015 and 2014, by duration of the unrealized loss, are shown below. The unrealized loss positions were directly related to interest rate movements as there is minimal credit risk exposure in these investments. All agency securities, states and municipal securities and certificates of deposit are investment grade or better and their losses are considered temporary. The corporate bonds are subordinated debt notes issued by financial institutions. Management does not intend to sell the securities and does not expect to be required to sell the securities. All amortized cost bases are expected to be recovered. Bonds with unrealized loss positions at

December 31, 2015 included five federal agencies, one corporate bond and 17 municipals. Bonds with unrealized loss positions at December 31, 2014 included 29 municipals, 13 federal agencies and three certificates of deposit.


(Dollars in thousands)	Less than 12 months					12 months or more					Total
	Fair		Unrealized			Fair		Unrealized			Fair		Unrealized
December 31, 2015	Value		Loss			Value		Loss			Value		Loss
Corporate bonds	$	495	$	(5	)	$	—	$	—		$	495	$	(5	)
U.S. Government agencies		13,871		(141	)		1,619		(15	)		15,490		(156	)
States and municipal obligations		2,566		(17	)		3,281		(38	)		5,847		(55	)

Total temporarily impaired securities	$	16,932	$	(163	)	$	4,900	$	(53	)	$	21,832	$	(216	)


	Less than 12 months					12 months or more					Total
	Fair		Unrealized			Fair		Unrealized			Fair		Unrealized
December 31, 2014	Value		Loss			Value		Loss			Value		Loss
U.S. Government agencies	$	1,499	$	(4	)	$	3,532	$	(33	)	$	5,031	$	(37	)
States and municipal obligations		412		(5	)		9,006		(155	)		9,418		(160	)
Certificates of deposit		742		(2	)		—		—			742		(2	)

Total temporarily impaired securities	$	2,653	$	(11	)	$	12,538	$	(188	)	$	15,191	$	(199	)

The following table summarizes cumulative credit-related other-than temporary impairment losses recognized on the one auction rate security held by the Company (no other-than-temporary-impairment was recognized for the years ended December 31, 2015 and 2014):


	For the year ended
(Dollars in thousands)	December 31, 2014
Balance, beginning of the period	$	288
Impairment losses recognized during the period		—
Realized losses from sales		(288	)

Balance, end of period	$	—

The Company held one South Carolina Student Loan Corporation auction rate security with a face amount of $1.2 million. During the second quarter of 2013, the South Carolina Student Loan Corporation made a tender and exchange offer with regards to these auction rate securities with the provision that 50% of the security holders were required to accept the tender offer in order for it to be consummated. The tender offer was not accepted by the required 50% of security holders. As a result of the tender and exchange offer, the Company determined that the value of this auction rate security was other than temporarily impaired. The market value of the security was estimated based on Level 3 inputs (refer to Note 21). The Company recognized an other-than-temporary impairment charge of $288 thousand in income related to this security during 2013. In the first quarter of 2014, the Company sold this auction rate security for $912 thousand.

The Company’s investment in Federal Home Loan Bank of Atlanta (“FHLB”) stock totaled $2.0 million and $1.9 million at December 31, 2015 and December 31, 2014, respectively, and are included in restricted securities on the consolidated balance sheets. The Company also had an investment in Federal Reserve Bank of Richmond (“FRB”) stock which totaled $505 thousand and $382 thousand at December 31, 2015 and December 31, 2014. The investments in both FHLB and FRB stock are required investments related to the Bank’s membership with the FHLB and FRB. These securities do not have a readily determinable fair value as their ownership is restricted, and they lack an active market for trading. Additionally, per charter provisions related to the FHLB and FRB stock, all repurchase transactions of such stock must occur at par. Accordingly, these securities are carried at cost, and are periodically evaluated for impairment. The Company’s determination as to whether its investment in FHLB and FRB stock is impaired is based on management’s assessment of the ultimate recoverability of its par value rather than recognizing temporary declines in its value. The determination of whether the decline affects the ultimate recoverability of the investments is influenced by available information regarding various factors. These factors include, among others, the significance of the decline in net assets of the issuing banks as compared to the capital stock amount reported by these banks, and the length of time a decline has persisted; commitments by such banks to make payments required by law or regulation and the level of such payments in relation to the operating performance of the issuing bank; and the overall liquidity position of the issuing bank. Based on its most recent analysis of publicly available information regarding the financial condition of the issuing banks, management concluded that no impairment existed in the carrying value of FHLB and FRB stock.

Note 5. Loans

The following is a summary of the balances of loans:


(Dollars in thousands)	December 31, 2015			December 31, 2014
Mortgage loans on real estate:
Construction, Land and Land Development	$	42,129		$	43,048
Farmland		1,030			1,128
Commercial Mortgages (Non-Owner Occupied)		29,086			20,534
Commercial Mortgages (Owner Occupied)		43,956			33,326
Residential First Mortgages		164,405			135,267
Residential Revolving and Junior Mortgages		26,497			25,400
Commercial and Industrial loans		35,104			34,002
Consumer Loans		5,015			5,349

Total loans		347,222			298,054
Net unamortized deferred loan costs		324			393
Allowance for loan losses		(4,223	)		(3,205	)

Loans, net	$	343,323		$	295,242

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


			90 Days or
	30-89		More Past				Total Past
(Dollars in thousands)	Days		Due and				Due and				Total
December 31, 2015	Past Due		Still Accruing		Nonaccruals		Nonaccruals		Current		Loans
Mortgage Loans on Real Estate:
Construction, Land and Land Development	$	93	$	—	$	672	$	765	$	41,364	$	42,129
Farmland		—		—		—		—		1,030		1,030
Commercial Mortgages (Non-Owner Occupied)		264		—		—		264		28,822		29,086
Commercial Mortgages (Owner Occupied)		133		—		2,350		2,483		41,473		43,956
Residential First Mortgages		1,304		—		2,841		4,145		160,260		164,405
Residential Revolving and Junior Mortgages		70		—		277		347		26,150		26,497
Commercial and Industrial		10		—		285		295		34,809		35,104
Consumer Loans		32		11		8		51		4,964		5,015

Total	$	1,906	$	11	$	6,433	$	8,350	$	338,872	$	347,222


			90 Days or
	30-89		More Past				Total Past
	Days		Due and				Due and				Total
December 31, 2014	Past Due		Still Accruing		Nonaccruals		Nonaccruals		Current		Loans
Mortgage Loans on Real Estate:
Construction, Land and Land Development	$	64	$	—	$	669	$	733	$	42,315	$	43,048
Farmland		—		—		—		—		1,128		1,128
Commercial Mortgages (Non-Owner Occupied)		—		—		—		—		20,534		20,534
Commercial Mortgages (Owner Occupied)		—		—		566		566		32,760		33,326
Residential First Mortgages		1,270		—		359		1,629		133,638		135,267
Residential Revolving and Junior Mortgages		6		—		31		37		25,363		25,400
Commercial and Industrial		96		—		228		324		33,678		34,002
Consumer Loans		66		14		101		181		5,168		5,349

Total	$	1,502	$	14	$	1,954	$	3,470	$	294,584	$	298,054

Note 6. Allowance for Loan Losses

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


	Mortgage			Commercial			Consumer
	Loans on			and			and other
(Dollars in thousands)	Real Estate			Industrial			Loans			Total
For the Twelve Months Ended December 31, 2015
Beginning Balance	$	2,778		$	323		$	104		$	3,205
(Charge-offs)		(521	)		(9	)		(128	)		(658	)
Recoveries		27			—			52			79
Provision		1,218			285			94			1,597

Ending Balance	$	3,502		$	599		$	122		$	4,223

Individually evaluated for impairment	$	1,256		$	278		$	—		$	1,534
Collectively evaluated for impairment		2,246			321			122			2,689

	Mortgage			Commercial			Consumer
	Loans on			and			and Other
(Dollars in thousands)	Real Estate			Industrial			Loans			Total
For the Twelve Months Ended December 31, 2014
Beginning Balance	$	2,465		$	256		$	204		$	2,925
(Charge-offs)		(313	)		—			(79	)		(392	)
Recoveries		36			—			25			61
Provision		590			67			(46	)		611

Ending Balance	$	2,778		$	323		$	104		$	3,205

Individually evaluated for impairment	$	665		$	—		$	11		$	676
Collectively evaluated for impairment		2,113			323			93			2,529

Loan receivables evaluated for impairment individually and collectively by segment as of December 31, 2015 and 2014 are as follows:


	Mortgage		Commercial		Consumer
(Dollars in thousands)	Loans		and		and Other
	on Real Estate		Industrial		Loans		Total
As of December 31, 2015
Individually evaluated for impairment	$	10,542	$	284	$	—	$	10,826
Collectively evaluated for impairment		296,561		34,820		5,015		336,396

Total Gross Loans	$	307,103	$	35,104	$	5,015	$	347,222

As of December 31, 2014
Individually evaluated for impairment	$	6,842	$	—	$	16	$	6,858
Collectively evaluated for impairment		251,861		34,002		5,333		291,196

Total Gross Loans	$	258,703	$	34,002	$	5,349	$	298,054

Internal risk rating grades are shown in the following table.


	Construction,				Commercial		Commercial
	Land and				Mortgages		Mortgages		Commercial
(Dollars in thousands)	Land				(Non-Owner		(Owner		and
As of December 31, 2015	Development		Farmland		Occupied)		Occupied)		Industrial		Total
Grade:
Pass	$	34,692	$	1,030	$	24,258	$	33,023	$	29,383	$	122,386
Watch		5,337		—		4,564		4,968		5,202		20,071
Special mention		1,119		—		—		2,687		148		3,954
Substandard		981		—		264		3,278		371		4,894
Doubtful		—		—		—		—		—		—

Total	$	42,129	$	1,030	$	29,086	$	43,956	$	35,104	$	151,305


	Construction,				Commercial		Commercial
	Land and				Mortgages		Mortgages		Commercial
	Land				(Non-Owner		(Owner		and
As of December 31, 2014	Development		Farmland		Occupied)		Occupied)		Industrial		Total
Grade:
Pass	$	34,913	$	1,128	$	16,426	$	23,967	$	31,041	$	107,475
Watch		5,649		—		3,770		4,430		2,492		16,341
Special mention		1,403		—		—		2,789		154		4,346
Substandard		1,083		—		338		2,140		315		3,876
Doubtful		—		—		—		—		—		—

Total	$	43,048	$	1,128	$	20,534	$	33,326	$	34,002	$	132,038

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


			Residential
(Dollars in thousands)	Residential		Revolving
As of December 31, 2015	First		and Junior		Consumer
PAYMENT ACTIVITY STATUS	Mortgages (1)		Mortgages (2)		Loans (3)		Total
Performing	$	161,564	$	26,220	$	4,996	$	192,780
Nonperforming		2,841		277		19		3,137

Total	$	164,405	$	26,497	$	5,015	$	195,917


			Residential
	Residential		Revolving
As of December 31, 2014	First		and Junior		Consumer
PAYMENT ACTIVITY STATUS	Mortgages (4)		Mortgages (5)		Loans (6)		Total
Performing	$	134,908	$	25,369	$	5,234	$	165,511
Nonperforming		359		31		115		505

Total	$	135,267	$	25,400	$	5,349	$	166,016

Notes:

(1)	Residential First Mortgages which have been assigned a risk rating grade of Substandard totaled $3.9 million as of December 31, 2015.

(2)	Residential Revolving and Junior Mortgages which have been assigned a risk rating grade of Substandard totaled $372 thousand as of December 31, 2015.

(3)	No Consumer Loans have been assigned a risk rating grade of Substandard as of December 31, 2015.

(4)	Residential First Mortgages which have been assigned a risk rating grade of Substandard totaled $2.1 million as of December 31, 2014.

(5)	Residential Revolving and Junior Mortgages which have been assigned a risk rating grade of Substandard totaled $219 thousand as of December 31, 2014.

(6)	Consumer Loans which have been assigned a risk rating grade of Substandard totaled $1 thousand as of December 31, 2014.

The following tables show the Company’s recorded investment and the customers’ unpaid principal balances for impaired loans, with the associated allowance amount, if applicable, as of December 31, 2015 and 2014, along with the average recorded investment and interest income recognized for the years ended December 31, 2015 and 2014.


(Dollars in thousands)	As of December 31, 2015						As of December 31, 2014
IMPAIRED LOANS
	Recorded		Customers’ Unpaid		Related		Recorded		Customers’ Unpaid		Related
	Investment		Principal Balance		Allowance		Investment		Principal Balance		Allowance
With no related allowance:
Construction, Land and Land Development	$	445	$	451	$	—	$	450	$	452	$	—
Residential First Mortgages		3,130		3,166		—		1,568		1,584		—
Residential Revolving and Junior Mortgages (1)		233		233		—		50		50		—
Commercial Mortgages (Non-owner occupied)		264		264		—		264		264		—
Commercial Mortgages (Owner occupied)		1,352		1,390		—		1,887		1,916		—
Commercial and Industrial		—		—		—		—		—		—
Consumer (2)		—		—		—		5		5		—

		5,424		5,504		—		4,224		4,271		—

With an allowance recorded:
Construction, Land and Land Development		262		290		120		277		292		144
Residential First Mortgages		2,507		2,507		308		2,173		2,173		437
Residential Revolving and Junior Mortgages (1)		258		259		150		173		173		84
Commercial Mortgages (Non-owner occupied)		—		—		—		—		—		—
Commercial Mortgages (Owner occupied)		2,091		2,348		678		—		—		—
Commercial and Industrial		284		285		278		—		—		—
Consumer (2)		—		—		—		11		11		11

		5,402		5,689		1,534		2,634		2,649		676

Total Impaired Loans:
Construction, Land and Land Development		707		741		120		727		744		144
Residential First Mortgages		5,637		5,673		308		3,741		3,757		437
Residential Revolving and Junior Mortgages (1)		491		492		150		223		223		84
Commercial Mortgages (Non-owner occupied)		264		264		—		264		264		—
Commercial Mortgages (Owner occupied)		3,443		3,738		678		1,887		1,916		—
Commercial and Industrial		284		285		278		—		—		—
Consumer (2)		—		—		—		16		16		11

	$	10,826	$	11,193	$	1,534	$	6,858	$	6,920	$	676

Notes:

(1)	Junior mortgages include equity lines.

(2)	Includes credit cards.


	For the Year Ended				For the Year Ended
	December 31, 2015				December 31, 2014
	Average		Interest		Average		Interest
	Recorded		Income		Recorded		Income
(Dollars in thousands)	Investment		Recognized		Investment		Recognized
With no related allowance:
Construction, Land and Land Development	$	448	$	—	$	451	$	3
Residential First Mortgages		2,077		74		1,148		49
Residential Revolving and Junior Mortgages (1)		87		5		10		—
Commercial Mortgages (Non-owner occupied)		264		16		264		16
Commercial Mortgages (Owner occupied)		1,099		28		1,911		79
Commercial and Industrial		—		—		—		—
Consumer (2)		—		—		6		—

		3,975		123		3,790		147

With an allowance recorded:
Construction, Land and Land Development		270		5		168		4
Residential First Mortgages		1,900		90		2,184		100
Residential Revolving and Junior Mortgages (1)		204		11		174		9
Commercial Mortgages (Non-owner occupied)		—		—		—		—
Commercial Mortgages (Owner occupied)		1,343		39		—		—
Commercial and Industrial		130		2		—		—
Consumer (2)		—		—		24		2

		3,847		147		2,550		115

Total
Construction, Land and Land Development		718		5		619		7
Residential First Mortgages		3,977		164		3,332		149
Residential Revolving and Junior Mortgages (1)		291		16		184		9
Commercial Mortgages (Non-owner occupied)		264		16		264		16
Commercial Mortgages (Owner occupied)		2,442		67		1,911		79
Commercial and Industrial		130		2		—		—
Consumer (2)		—		—		30		2

	$	7,822	$	270	$	6,340	$	262

Notes:

(1)	Junior mortgages include equity lines.

(2)	Includes credit cards.

Smaller non-accruing loans and non-accruing loans that are not graded because they are included in homogenous pools generally do not meet the criteria for impairment testing, and are therefore excluded from impaired loan disclosures. At December 31, 2015 and 2014, non-accruing loans excluded from impaired loan disclosure totaled $95 thousand and $663 thousand, respectively. If interest on these non-accruing loans had been accrued, such income would have approximated $5 thousand and $32 thousand during the years ended December 31, 2015 and 2014, respectively.

Loans modified as TDRs are considered impaired and are individually evaluated for the amount of impairment in the ALL. The following table presents, by segments of loans, information related to loans modified as TDRs during the years ended December 31, 2015 and 2014.


	For the Year Ended						For the Year Ended
	December 31, 2015						December 31, 2014
			Pre-Modification		Post-Modification				Pre-Modification		Post-Modification
(Dollars in thousands)			Outstanding		Outstanding				Outstanding		Outstanding
	Number of		Recorded		Recorded		Number of		Recorded		Recorded
TROUBLED DEBT RESTRUCTURINGS	Loans		Investment		Investment		Loans		Investment		Investment
Construction, land and land development ⁽¹⁾		—	$	—	$	—		2	$	282	$	277
Residenital first mortages ⁽¹⁾		2		988		986		—		—		—
Residential revolving and junior mortgages ⁽¹⁾		—		—		—		1		50		50
Commercial mortgages (Owner occupied) ⁽²⁾		1		105		124		—		—		—

Notes:

(1)	Modifications were an extention of the loan terms.

(2)	Modifications were capitalization of the interest.

For the Year Ended

December 31, 2015

December 31, 2014

TROUBLED DEBT RESTRUCTURINGS

Number of

Recorded

Number of

Recorded

THAT SUBSEQUENTLY DEFAULTED

Loans

Investment

Loans

Investment

Residential revolving and junior mortgages

—

Commerical mortgages (Owner occupied)

124

255

Of the TDRs restructured in 2015 and 2014 which did not subsequently default, all are performing. The loan that defaulted in 2015 was charged-off. Of the three loans that defaulted in 2014, one loan in the amount of $75 thousand was charged-off. There were 16 TDRs with an aggregate balance of $3.5 million and 14 TDRs with an aggregate balance of $2.5 million outstanding as of December 31, 2015 and December 31, 2014.

Note 7. Other Real Estate Owned, Net

Other real estate owned (“OREO”) is presented net of a valuation allowance for losses. An analysis of the valuation allowance on OREO is shown below.


	Years ended
	December 31,
(Dollars in thousands)	2015			2014
Balance, beginning of year	$	626		$	538
Provision for losses		288			235
Charge-offs		(293	)		(147	)

Balance, end of period	$	621		$	626

Expenses applicable to OREO include the following:


	Years ended
	December 31,
(Dollars in thousands)	2015		2014
Net loss on sales of real estate	$	107	$	92
Provision for losses		288		235
Operating expenses, net of income		68		131

Total expenses	$	463	$	458

The following table details the properties included in OREO as of December 31, 2015 and December 31, 2014. There were no collateralized consumer residential mortgage loans in the process of foreclosure as of December 31, 2015.


	As of December 31, 2015				As of December 31, 2014
	No. of		Carrying		No. of		Carrying
(Dollars in thousands)	Properties		Value		Properties		Value
Residential		3	$	540		10	$	1,559
Land lots		7		413		13		587
Convenience store		2		191		2		234
Restaurant		1		55		1		107
Commerical properties		3		671		1		304

Total		16	$	1,870		27	$	2,791

Included in other assets as of December 31, 2015, is one residential property purchased in 2013 from a related party with a value of $724 thousand and a former branch, which was closed April 30, 2015, with a value of $403 thousand. Included in other assets as of December 31, 2014 is the aforementioned residential property with a value of $771 thousand.

Note 8. Premises and Equipment, net

Components of premises and equipment included in the balance sheets at December 31, 2015 and 2014 were as follows:


	2015			2014
(Dollars in thousands)
Land and improvements	$	2,350		$	2,004
Buildings and improvements		12,232			13,032
Furniture and equipment		10,069			9,703

Total cost		24,651			24,739
Less accumulated depreciation		(13,005	)		(12,857	)

Premises and equipment, net	$	11,646		$	11,882

Depreciation expense for the years ended December 31, 2015 and 2014 totaled $998 thousand and $792 thousand, respectively.

Note 9. Deposits

The aggregate amount of time deposits in denominations of $250,000 or more at December 31, 2015 and 2014 was $20.3 million and $16.5 million, respectively.

At December 31, 2015, the scheduled maturities of time deposits are as follows (in thousands):


2016	$	56,692
2017		12,717
2018		36,506
2019		4,397
2020		17,076
Thereafter		—

	$	127,388

At December 31, 2015 and 2014, overdraft demand deposits reclassified to loans totaled $56 thousand and $85 thousand, respectively.

At December 31, 2015 and 2014, the Company had wholesale deposits of $15.5 million and $8.0 million, respectively.

Note 10. Employee Benefit Plans

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

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

The following tables provide the reconciliation of changes in the benefit obligations and fair value of assets and a statement of funded status for the pension plan and postretirement plan of the Company. In 2014, the $755 thousand net loss related to pension benefits and the $130 thousand net loss related to post retirement benefits was primarily due to the increase in the discount rate assumption to 4% in 2014 from 5% in 2013 and longer assumed lives of participants resulting from updated mortality tables for 2014.


	Pension Benefits						Postretirement Benefits
(Dollars in thousands)	2015			2014			2015			2014
Change in benefit obligation
Benefit obligation, beginning of year	$	3,546		$	2,737		$	771		$	607
Service cost		—			—			23			15
Interest cost		131			142			30			30
Actuarial loss (gain)		(104	)		721			(147	)		130
Benefit payments		(85	)		(54	)		(9	)		(11	)
Settlement gain		—			—			—			—

Benefit obligation, end of year		3,488			3,546			668			771

Change in plan assets
Fair value of plan assets, beginning of year		2,897			2,820			—			—
Actual return on plan assets		(6	)		131			—			—
Employer contributions		—			—			9			11
Benefits payments		(85	)		(54	)		(9	)		(11	)

Fair value of plan assets, end of year		2,806			2,897			—			—

Funded status at the end of the year	$	(682	)	$	(649	)	$	(668	)	$	(771	)

Amounts recognized in accumulated other comprehensive loss (income)
Net loss (gain)	$	1,402		$	1,380		$	(65	)	$	83
Prior service cost		—			—			—			—
Net obligation at transition		—			—			—			—

Amount recognized	$	1,402		$	1,380		$	(65	)	$	83

Components of net periodic benefit cost (gain)
Service cost	$	—		$	—		$	23		$	15
Interest cost		131			142			30			30
Expected (return) on plan assets		(196	)		(202	)		—			—
Amortization of prior service cost		—			—			—			—
Amortization of net obligation at transition		—			—			—			—
Recognized net loss due to settlement		—			—			—			—
Recognized net actuarial loss		76			37			—			—

Net periodic benefit (gain) cost		11			(23	)		53			45

Other changes in plan assets and benefit obligations recognized in accumulated other comprehensive (income) loss
Net loss (gain)		22			755			(147	)		130
Amortization of prior service cost		—			—			—			—
Amortization of net obligation at transition		—			—			—			—

Total recognized in other comprehensive loss/(income)		22			755			(147	)		130

Total recognized in net periodic benefit cost and other comprehensive loss/(income)	$	33		$	732		$	(94	)	$	175


Weighted-average assumptions as of December 31:	2015			2014			2015			2014
Discount rate used for Net Periodic Pension Cost		4.00	%		5.00	%		4.00	%		5.00	%
Discount Rate used for Disclosure		4.25	%		4.00	%		4.25	%		4.00	%
Expected return on plan assets		7.50	%		7.50	%		N/A			N/A
Rate of compensation increase		N/A			N/A			N/A			N/A
Rate of compensation increase for net periodic pension cost		N/A			N/A			N/A			N/A
Expected future interest crediting rate		3.00	%		3.00	%		N/A			N/A

The accumulated benefit obligation for the cash balance pension plan was $3.5 million at both December 31, 2015 and 2014, respectively.

Estimated future benefit payments for the pension and postretirement plans are as follows (in thousands):


	Pension		Postretirement
2016	$	509	$	18
2017		209		20
2018		38		22
2019		362		24
2020		410		27
2021 and thereafter		1,381		170

Long-term rate of return. The pension plan sponsor selects the assumption for the expected long-term rate of return on assets in consultation with their investment advisors and actuary. This rate is intended to reflect the average rate of earnings expected to be earned on the funds invested or to be invested to provide plan benefits. Historical performance is reviewed, especially with respect to real rates of return (net of inflation), for the major asset classes held or anticipated to be held by the trust, and for the trust itself. Undue weight is not given to recent experience that may not continue over the measurement period, with higher significance placed on current forecasts of future long-term economic conditions.

Because assets are held in a qualified trust, anticipated returns are not reduced for taxes. Further, solely for this purpose, the plan is assumed to continue in force and not terminate during the period during which assets are invested. However, consideration is given to the potential impact of current and future investment policy, cash flow into and out of the trust, and expenses (both investment and non-investment) typically paid from plan assets (to the extent such expenses are not explicitly estimated within periodic cost).

The fair value of the Company’s pension plan assets by asset category are as follows:


(Dollars in thousands)			Fair Value Measurements at December 31, 2015 Using
Description	Balance		Level 1		Level 2		Level 3
Defined benefit plan assets:
Cash and cash equivalents	$	3	$	3	$	—	$	—
Mutual funds - fixed income		1,119		1,119		—		—
Mutual funds - equity		1,684		1,684		—		—

Total defined benefit plan assets	$	2,806	$	2,806	$	—	$	—


			Fair Value Measurements at December 31, 2014 Using
Description	Balance		Level 1		Level 2		Level 3
Defined benefit plan assets:
Cash and cash equivalents	$	4	$	4	$	—	$	—
Mutual funds - fixed income		1,139		1,139		—		—
Mutual funds - equity		1,754		1,754		—		—

Total defined benefit plan assets	$	2,897	$	2,897	$	—	$	—

The trust fund is sufficiently diversified to maintain a reasonable level of risk without imprudently sacrificing return, with a targeted asset allocation of 40% fixed income and 60% equities. The investment manager of the fund selects investment fund managers with demonstrated experience and expertise, and funds with demonstrated historical performance, for the implementation of the plan’s investment strategy. The investment manager will consider both actively and passively managed investment strategies and will allocate funds across the asset classes to develop an efficient investment structure.

It is the responsibility of the trustee to administer the investments of the trust within reasonable costs, being careful to avoid sacrificing quality. These costs include, but are not limited to, management and custodial fees, consulting fees, transaction costs and other administrative costs chargeable to the trust.

In November 2015, the Company announced a voluntary early retirement plan to employees over 55 years of age and with a minimum of 10 years of service. There were five employees who elected to participate in the plan with a total cost of $134 thousand recognized during 2015.

The Company expects to make no contributions to its pension plan for the 2016 plan year.

Postretirement benefits plan. For measurement purposes, the assumed annual rate of increase in per capita health care costs of covered benefits is 8% in 2016, 8% in 2017, 6% in 2018, 6% in 2019, and 5% in 2020 and thereafter. If assumed health care cost trend rates were increased by one percentage point each year, the accumulated postretirement benefit obligation at December 31, 2015 would be unchanged and the aggregate of the service and interest cost components of net periodic postretirement benefit cost for the year ended December 31, 2015 would be increased by $36. If assumed health care cost trend rates were decreased by one percentage point each year, the accumulated postretirement benefit obligation at December 31, 2015 would be unchanged and the aggregate of the service and interest cost components of net periodic postretirement benefit cost for the year ended December 31, 2015 would be decreased by $33.

The Company expects to contribute $18 thousand to its postretirement plan in 2016. In addition, as of December 31, 2015 and 2014, the Company paid approximately $9 thousand and $11 thousand, respectively, for employees who retired.

401(k) retirement plan. Substantially all employees are eligible to participate in the Company’s 401(k) retirement plan beginning the first of the month following their hire date. Prior to August 14, 2014, employees were eligible to participate in the plan after six months of service. Employees may contribute up to the maximum established by the Internal Revenue Service. As of March 15, 2015, employees are eligible to participate the month following their hire date and the Company matches 100% of the first 3% and 50% of the next 3% of an employee’s contributions. Additional contributions can be made at the discretion of the Company’s Board of Directors. Contributions to this plan amounted to $176 thousand and $110 thousand for the years ended December 31, 2015 and 2014, respectively.

Note 11. Financial Instruments with Off-Balance Sheet Risk

In the normal course of business, the Company offers various financial products to its customers to meet their credit and liquidity needs. These instruments involve elements of credit and interest rate risk in excess of the amount recognized in the consolidated balance sheets. The Company’s exposure to credit loss in the event of nonperformance by the other party to the financial instruments for commitments to extend credit and standby letters of credit written is represented by the contractual amount of these instruments. The Company uses the same credit policies in making commitments and conditional obligations as it does for on-balance sheet instruments. The amount of collateral obtained, if deemed necessary by the Company, is based on credit evaluation of the customer.

Subject to its normal credit standards and risk monitoring procedures, the Company makes contractual commitments to extend credit. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since many of the commitments may expire without being completely drawn upon, the total commitment amounts do not necessarily represent future cash requirements. At December 31, 2015 and 2014, the Company had outstanding loan commitments approximating $42.7 million and $36.4 million, respectively.

Conditional commitments are issued by the Company in the form of performance stand-by letters of credit, which guarantee the performance of a customer to a third party. At December 31, 2015 and 2014, commitments under outstanding performance stand-by letters of credit aggregated $473 thousand and $355 thousand, respectively. The credit risk of issuing letters of credit is essentially the same as that involved in extending loan facilities to customers.

Note 12. Restrictions on Cash and Due from Banks

The Board of Governors of the Federal Reserve System (the “Federal Reserve”) requires banks to maintain cash reserves against certain categories of deposit liabilities. At both December 31, 2015 and 2014, the aggregate amount of daily average required reserves for the final weekly reporting period was $25 thousand.

Note 13. Other Borrowings

Securities sold under repurchase agreements were $7.2 million and $6.0 million as of December 31, 2015 and December 31, 2014, respectively, and included in liabilities on the consolidated balance sheets. Securities sold under agreements to repurchase are secured transactions with customers, generally mature the day following the day sold and can be changed at the option of the Bank with minimal risk of loss due to fair value. During 2015 and 2014, the average rates of the repurchase agreements were 0.15% and 0.12%, respectively. Unused lines of credit with nonaffiliated banks, excluding FHLB, totaled $21.5 million and $20.3 million as of December 31, 2015 and 2014, respectively. Draws upon these lines have time limits varying from two to four consecutive weeks. The banks providing these lines can change the interest rates on these lines daily. The lines renew annually and are tested periodically each year.

Note 14. Debt

As of December 31, 2015 and December 31, 2014, the Bank had $40 million and $35 million of outstanding FHLB debt, respectively, consisting of seven and six advances, respectively. A $5 million advance with a LIBOR-based floating rate, which matured in May 2015, was replaced with a $5 million fixed rate advance, which matured in February 2016. In June 2015, a $5 million fixed rate advance was replaced with a $5 million LIBOR-based floating rate advance maturing in September 2016, and a $5 million fixed rate advance was repaid. An advance matured on October 20, 2015 and was replaced with a $5 million, 0.52% fixed rate credit advance maturing on October 20, 2016. In December 2015, two new $5 million fixed rate advances which mature in 2017 were drawn. The advance that matured on February 22, 2016 was paid off.

The seven advances are shown in the following table.


					Current			Maturity
Description	Balance		Originated		Interest Rate			Date
Adjustable Rate Hybrid	$	10,000,000		4/12/2013		2.70060	%		4/13/2020
Fixed Rate Credit		5,000,000		10/20/2014		0.47000	%		4/20/2016
Fixed Rate Credit		5,000,000		5/20/2015		0.37000	%		2/22/2016
Adjustable Rate Credit		5,000,000		6/18/2015		0.55250	%		9/19/2016
Fixed Rate Credit		5,000,000		10/20/2015		0.52000	%		10/20/2016
Fixed Rate Credit		5,000,000		12/21/2015		0.99000	%		6/15/2017
Fixed Rate Credit		5,000,000		12/22/2015		1.08000	%		9/15/2017

	$	40,000,000

Advances on the FHLB lines are secured by a blanket lien on qualified 1 to 4 family residential real estate loans. Immediate available credit, as of December 31, 2015, was $40.5 million against a total line of credit of $84.5 million.

As of December 31, 2015 and December 31, 2014, the Company had $40.0 million and $35.0 million, respectively, in FHLB debt outstanding with a weighted average interest rate of 1.17% and 0.96%, respectively.

Subordinated Debt

On May 28, 2015, the Company entered into a Purchase Agreement with 29 accredited investors under which the Company issued an aggregate of $7,000,000 of subordinated notes (the “Notes”) to the accredited investors. The Notes have a maturity date of May 28, 2025. The Notes bear interest, payable on the 1st of March and September of each year, commencing September 1, 2015, at a fixed interest rate of

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


(Dollars in thousands)	Balance as of
(Dollars in thousands)	December 31, 2015
6.5% Subordinated Debt	$	7,000
Less: Issuance costs		(156	)

	$	6,844

Note 15. Income Taxes

The Company files income tax returns in the U.S. federal jurisdiction and the Commonwealth of Virginia. The Commonwealth of Virginia does not charge an income tax for regulated banking institutions.

The (benefit) expense for income taxes consisted of the following (in thousands):


Year ended December 31,	2015			2014
Current	$	303		$	499
Deferred		(490	)		58

	$	(187	)	$	557

The reasons for the differences between the statutory Federal income tax rates and the effective tax rates are summarized as follows:


	2015			2014
Statutory rate		34.0	%		34.0	%
Increase (decrease) resulting from:
Tax exempt interest		-116.9	%		-8.3	%
Bank owned life insurance		-46.8	%		-3.1	%
Other, net		25.5	%		0.7	%

		-104.2	%		23.3	%

The components of the net deferred tax assets and liabilities included in other liabilities are as follows (in thousands):


December 31,	2015			2014
Deferred tax assets
Allowance for loan losses	$	985		$	661
Interest on non-accrual loans		89			47
Other real estate		419			397
Pension plan		233			222
Postretirement benefits		227			262
Deferred compensation		162			141
Stock-based compensation		31			25
Other		20			11

Total deferred tax assets		2,166			1,766

Deferred tax liabilities
Unrealized gains on available-for-sale securities		(55	)		(23	)
Depreciation		(171	)		(218	)
Amortization of goodwill		(955	)		(928	)
Net deferred loan fees and costs		(110	)		(134	)
Other		(64	)		(67	)

Total deferred tax (liabilities)		(1,355	)		(1,370	)

Net deferred tax assets	$	811		$	396

Note 16. Regulatory Requirements and Restrictions

The Company (on a consolidated basis) and Bank are subject to various regulatory capital requirements administered by the Commonwealth of Virginia and Federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory and possibly additional discretionary, actions by regulators that, if undertaken, could have a direct material effect on the Company and Bank’s financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Company and 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 capital amounts and classifications are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors. Prompt corrective action provisions are not applicable to bank holding companies.

Quantitative measures established by regulation to ensure capital adequacy required the Company and the Bank during 2015 to maintain minimum amounts and ratios (set forth in the table below) of total common equity Tier 1 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 as of December 31, 2015 and 2014, the Company and the Bank met all capital adequacy requirements to which they were subject.

As of December 31, 2015, the most recent notification from the Federal Reserve categorized the Bank as well capitalized under the framework for prompt corrective action. To be categorized as well capitalized on such date, an institution must maintain minimum total risk-based, common equity Tier 1 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 Bank’s category.

In July 2013, the Federal Reserve issued final rules that made 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. 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). The following additional capital requirements related to the capital conservation buffer will be phased in over a four year period beginning January 1, 2016. When fully phased in on January 1, 2019, the rules will require the Bank to maintain (i) a minimum ratio of Common Equity Tier 1 to risk-weighted assets of at least 4.5%, plus a 2.5% “capital conservation buffer” (which is added to the 4.5% Common Equity Tier 1 ratio as that buffer is phased in, effectively resulting in a minimum ratio of Common Equity Tier 1 to risk-weighted assets of at least 7.0% upon full implementation), (ii) a minimum ratio of Tier 1 capital to risk-weighted assets of at least 6.0%, plus the 2.5% capital conservation buffer (which is added to the 6.0% Tier 1 capital ratio as that buffer is phased in, effectively resulting in a minimum Tier 1 capital ratio of 8.5% upon full implementation), (iii) a minimum ratio of total capital to risk-weighted assets of at least 8.0%, plus the 2.5% capital conservation buffer (which is added to the 8.0% total capital ratio as that buffer is phased in, effectively resulting in a minimum total capital ratio of 10.5% upon full implementation), and (iv) a minimum leverage ratio of 4.0%, calculated as the ratio of Tier 1 capital to average assets. The capital conservation buffer requirement 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. The capital conservation buffer is designed to absorb losses during periods of economic stress. Banking institutions with a ratio of Common Equity Tier 1 to risk-weighted assets above the minimum but below the conservation buffer will face constraints on dividends, equity repurchases and compensation based on the amount of the shortfall.

The Company’s and the Bank’s actual capital amounts and ratios as of December 31, 2015 and December 31, 2014, are presented in the following tables:


											Minimum
											To Be Well
											Capitalized Under
						Minimum					Prompt Corrective
	Actual					Capital Requirement					Action Provisions
(Dollars in Thousands)	Amount		Ratio			Amount		Ratio			Amount		Ratio
As of December 31, 2015:
Total Risk Based Capital (to Risk Weighted Assets)
Consolidated	$	49,305		15.54	%	$	25,380		8.00	%		N/A		N/A
Bank of Lancaster		42,923		13.64	%		25,176		8.00	%	$	31,471		10.0	%
Tier 1 Capital (to Risk Weighted Assets)
Consolidated		38,492		12.13	%		19,035		6.00	%		N/A		N/A
Bank of Lancaster		38,986		12.39	%		18,882		6.00	%	$	25,176		8.0	%
Common Equity Tier 1 Capital (to Risk Weighted Assets)
Consolidated		38,492		12.13	%		14,276		4.50	%		N/A		N/A
Bank of Lancaster		38,986		12.39	%		14,162		4.50	%	$	20,456		6.5	%
Tier 1 Capital (to Average Assets)
Consolidated		38,492		8.84	%		17,420		4.00	%		N/A		N/A
Bank of Lancaster		38,986		9.11	%		17,125		4.00	%	$	21,406		5.0	%

											Minimum
											To Be Well
											Capitalized Under
						Minimum					Prompt Corrective
	Actual					Capital Requirement					Action Provisions
(Dollars in Thousands)	Amount		Ratio			Amount		Ratio			Amount		Ratio
As of December 31, 2014:
Total Risk Based Capital (to Risk Weighted Assets)
Consolidated	$	41,445		15.02	%	$	22,074		8.00	%		N/A		N/A
Bank of Lancaster		36,446		13.30	%		21,927		8.00	%	$	27,409		10.0	%
Tier 1 Capital (to Risk Weighted Assets)
Consolidated		38,240		13.86	%		11,037		4.00	%		N/A		N/A
Bank of Lancaster		33,241		12.13	%		10,964		4.00	%	$	16,445		6.0	%
Tier 1 Capital (to Average Assets)
Consolidated		38,240		10.36	%		14,770		4.00	%		N/A		N/A
Bank of Lancaster		33,241		9.07	%		14,664		4.00	%	$	18,329		5.0	%

Bank Dividends

One source of funds available to the Company is the payment of dividends by the Bank. Banking regulations limit the amount of dividends that may be paid without prior approval from the Bank’s regulators.

Note 17. Employee Stock Ownership Plan

The Company has a noncontributory Employee Stock Ownership Plan (“ESOP”) for the benefit of all eligible employees who have completed twelve months of service and who have attained the age of 21 years. Contributions to the plan are at the discretion of the Company’s Board of Directors. Contributions are allocated proportionately based on the covered compensation of each participant compared to the aggregate covered compensation of all participants for the plan year. Allocations are limited to 25% of eligible participant compensation. Participant accounts are 30% vested after two years, 40% vested after three years with vesting increasing 20% each year thereafter, until 100% vested. The plan had 122,522 allocated shares as of December 31, 2015. Contributions to the plan were $50 thousand and $3 thousand in 2015 and 2014, respectively. There were no dividends on the Company’s stock held by the ESOP in 2015 and 2014. Shares held by the ESOP are considered outstanding for purposes of computing earnings per share.

Note 18. Stock-Based Compensation Plans

On June 28, 2013, the Company registered a new stock-based compensation plan with the Securities and Exchange Commission, which suspended all other plans. There are 349,500 shares available for grant under this plan at December 31, 2015. Unissued shares are generally used for exercises of stock options and restricted stock grants.

Stock-based compensation expense related to stock awards during 2015 and 2014 was $63 thousand and $20 thousand, respectively. There was no unrecognized compensation expense related to stock options as of December 31, 2015. A total of 28,500 options and 7,000 options were granted and vested during 2015 and 2014, respectively. Compensation expense for stock options is the estimated fair value of options granted using the Black-Scholes Model amortized on a straight-line basis over the vesting period of the award. The expected volatility is based on historical volatility of the Company’s stock price. The risk-free interest rates for the periods within the contractual life of the awards are based on the U.S. Treasury yield curve in effect at the time of the grant. The expected life is based on historical exercise experience. The dividend yield assumption is based on the Company’s history and expectation of dividend payouts. The fair value of options granted during 2015 was $2.17 and $2.28. The fair value of options granted during 2014 was $2.75.

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


	For the twelve months ended December 31,
	2015	2014
Risk free interest rate (5 year Treasury)	1.52% - 1.68%	1.74%
Expected dividend yield	0%	0%
Expected term (years)	5	5
Expected volatility	40.6% - 47.1%	51.4%

Stock option plan activity for 2015 and 2014 is summarized below:


						Weighted Average
				Weighted Average		Remaining		Aggregate
				Exercise		Contractual		Intrinsic
	Shares			Price		Life (in years)		Value (1)
Options outstanding, January 1, 2014		191,002		$	7.35		6.8
Granted		7,000			5.99
Forfeited		(344	)		5.90
Exercised		—			—
Expired		(7,239	)		14.65

Options outstanding, December 31, 2014		190,419			7.02		6.2	$	32,718

Granted		28,500			5.65
Forfeited		—			—
Exercised		—			—
Expired		(7,734	)		14.43

Options outstanding, December 31, 2015		211,185		$	6.57		6.0	$	81,248

Options exercisable, December 31, 2015		211,185		$	6.57		6.0	$	81,248

(1)

The aggregate intrinsic value of a stock option in the table above represents the total pre-tax intrinsic value (the amount by which the current market value of the underlying stock exceeds the exercise price of the option) that would have been received by the option holders had all option holders exercised their options on December 31, 2015 and 2014. This amount changes based on changes in the market value of the Company’s common stock.

Note 19. Earnings per Share

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


	December 31, 2015				December 31, 2014
	Average		Per share		Average		Per share
	Shares		Amount		Shares		Amount
Basic earnings per share		4,791,722	$	0.08		4,818,377	$	0.38
Effect of dilutive securities:
Stock options		13,596				11,204

Diluted earnings per share		4,805,318	$	0.08		4,829,581	$	0.38

For the years ended 2015 and 2014, options on 89,473 and 68,707 shares, respectively, were not included in computing diluted earnings per share because their effects were anti-dilutive.

Note 20. Related Parties

The Company has entered into transactions with its directors and principal officers of the Company, their immediate families and affiliated companies in which they are the principal stockholders (related parties). The aggregate amount of loans to such related parties was $2.6 million and $2.9 million at December 31, 2015 and 2014, respectively. All such loans, in the opinion of management, were made in the normal course of business on the same terms, including interest rate, collectability and collateral, as those prevailing at the time for comparable transactions.


(Dollars in thousands
Balance, January 1, 2015	$	2,874
New loans and extensions to existing loans		268
Repayments and other reductions		(572	)

Balance, December 31, 2015	$	2,570

Unfunded commitments to extend credit to related parties were $1.6 million and $1.5 million at December 31, 2015 and 2014, respectively.

The Company maintains deposit accounts with some related parties. The aggregate amount of these deposit accounts at December 31, 2015 and 2014 amounted to $499 thousand and $374 thousand, respectively.

On May 28, 2015, the Company issued $7.0 million of 6.50% subordinated debt (refer to Note 14). Related parties bought principal note amounts of $285 thousand. As of December 31, 2015, the Company owed these related parties $291 thousand in principal and accrued interest with regard to the subordinated debt.

Note 21. Fair Value Measurements

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

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


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

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

Level 3 –		Valuation is based on model-based techniques that use one or more significant inputs or assumptions that are unobservable in the market.

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

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

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

Mortgage servicing rights: MSRs are recorded at fair value on a recurring basis, with changes in fair value recorded in the results of operations. A model is used to determine fair value, which establishes pools of performing loans, calculates cash flows for each pool and applies a discount rate to each pool. Loans are segregated into 14 pools based on each loan’s term and seasoning (age). All loans have fixed interest rates. Cash flows are then estimated by utilizing assumed service costs and prepayment speeds. Service costs were assumed to be $6.00 per loan as of December 31, 2015 and $5.75 per loan as of December 31, 2014. Prepayment speeds are determined primarily based on the average interest rate of the loans in each pool. The prepayment scale used is the Public Securities Association (“PSA”) model, where “100% PSA” means prepayments are zero in the first month, then increase by 0.2% of the loan balance each month until reaching 6.0% in month 30. Thereafter, the 100% PSA model assumes an annual prepayment of 6.0% of the remaining loan balance. The average PSA speed

assumption in the fair value model is 163% and 184% as of December 31, 2015 and December 31, 2014, respectively. A discount rate of 11.0% was then applied to each pool as of December 31, 2015 and 10.0% as of December 31, 2014. This discount rate is intended to represent the estimated market yield for the highest quality grade of comparable servicing. MSRs are classified as Level 3.

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


(Dollars in thousands)			Fair Value Measurements at December 31, 2015 Using
Description	Balance		Level 1		Level 2		Level 3
Securities available-for-sale:
Corporate bonds	$	3,945	$	—	$	—	$	3,945
U. S. Government agencies		21,288		1,216		20,072		—
State and municipal obligations		28,857		—		28,857		—
Certificates of deposit		5,735		—		5,487		248

Total securities available-for-sale:	$	59,825	$	1,216	$	54,416	$	4,193

Mortgage servicing rights	$	658	$	—	$	—	$	658
Defined benefit plan assets:
Cash and cash equivalents	$	3	$	3	$	—	$	—
Mutual funds - fixed income		1,119		1,119		—		—
Mutual funds - equity		1,684		1,684		—		—

Total defined benefit plan assets	$	2,806	$	2,806	$	—	$	—


			Fair Value Measurements at December 31, 2014 Using
Description	Balance		Level 1		Level 2		Level 3
Securities available-for-sale:
U. S. Government agencies	$	16,965	$	845	$	16,120	$	—
State and municipal obligations		23,401		—		23,401		—
Certificates of deposit		2,238		—		2,238		—

Total securities available-for-sale:	$	42,604	$	845	$	41,759	$	—

Mortgage servicing rights	$	596	$	—	$	—	$	596

Defined benefit plan assets:
Cash and cash equivalents	$	4	$	4	$	—	$	—
Mutual funds - fixed income		1,139		1,139		—		—
Mutual funds - equity		1,754		1,754		—		—

Total defined benefit plan assets	$	2,897	$	2,897	$	—	$	—

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


			Corporate			Certificates of
(Dollars in thousands)	MSRs		Bonds			Deposit
Balance, January 1, 2015	$	596	$	—		$	—
Purchases		—		3,950			248
Impairments		—		—			—
Fair value adjustments		62		(5	)		—
Sales		—		—			—

Balance, December 31, 2015	$	658	$	3,945		$	248

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

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

Impaired Loans: Loans are designated as impaired when, in the judgment of management based on current information and events, it is probable that all amounts due according to the contractual terms of the loan agreement will not be collected. The measurement of loss associated with impaired loans can be based on either the observable market price of the loan or the fair value of the collateral. Collateral may be in the form of real estate or business assets including equipment, inventory, and accounts receivable. Any given loan may have

multiple types of collateral. The vast majority of the collateral is real estate. The value of real estate collateral is determined utilizing a market valuation approach based on an appraisal conducted by an independent, licensed appraiser outside of the Company using observable market data (Level 2). However, if the collateral value is significantly adjusted due to differences in the comparable properties, or is discounted by the Company because of marketability, then the fair value is considered Level 3. The value of business equipment is based upon an outside appraisal if deemed significant, or the net book value on the applicable business’ financial statements if not considered significant. Likewise, values for inventory and accounts receivables collateral are based on financial statement balances or aging reports (Level 3). Impaired loans allocated to the ALL are measured at fair value on a nonrecurring basis. Any fair value adjustments are recorded in the period incurred as provision for loan losses on the Consolidated Statements of Income.

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

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


			Fair Value Measurements at December 31, 2015 Using
(Dollars in thousands)	Balance as of
Description	December 31, 2015		Level 1		Level 2		Level 3
Impaired Loans, net	$	3,868	$	—	$	—	$	3,868
Other real estate owned, net		1,870		—		—		1,870

			Fair Value Measurements at December 31, 2014 Using
	Balance as of
Description	December 31, 2014		Level 1		Level 2		Level 3
Impaired Loans, net	$	1,958	$	—	$	—	$	1,958
Other real estate owned, net		2,791		—		—		2,791

The following table displays quantitative information about Level 3 Fair Value Measurements as of December 31, 2015:

Range

Balance as of

Valuation

Unobservable

(Weighted

(Dollars in thousands)

December 31, 2015

Technique

Input

Average)

Impaired Loans, net

3,868

Discounted appraised value

Selling Cost

10% - 25% (13%)

Lack of Marketability

50% - 60% (51%)

Other real estate owned, net

1,870

Discounted appraised value

Selling Cost

3% - 13% (4%)

Lack of Marketability

10% - 20% (12%)

The following table displays quantitative information about Level 3 Fair Value Measurements as of December 31, 2014:

Range

Balance as of

Valuation

Unobservable

(Weighted

(Dollars in thousands)

December 31, 2014

Technique

Input

Average)

Impaired Loans, net

1,958

Discounted appraised value

Selling Cost

10% - 20% (10%)

Lack of Marketability

25% - 75% (53%)

Other real estate owned, net

2,791

Discounted appraised value

Selling Cost

3% - 13% (5%)

Lack of Marketability

7% - 20% (11%)

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


					Fair Value Measurements at December 31, 2015 Using
(Dollars in thousands)	Balance as of		Fair Value as of
Description	December 31, 2015		December 31, 2015		Level 1		Level 2		Level 3
Financial Assets:
Cash and due from banks	$	4,969	$	4,969	$	4,969	$	—	$	—
Interest-bearing deposits		15,330		15,330		15,330		—		—
Federal funds sold		271		271		271		—		—
Securities available-for-sale		59,825		59,825		1,216		54,416		4,193
Restricted securities		2,731		2,731		—		—		2,731
Loans, net		343,323		347,500		—		—		347,500
Loans held for sale		270		270		—		—		270
Accrued interest receivable		1,318		1,318		—		1,318		—
Mortgage servicing rights		658		658		—		—		658
Financial Liabilities:
Non-interest-bearing liabilities	$	65,842	$	65,842	$	65,842	$	—	$	—
Savings and other interest-bearing deposits		166,628		166,628		—		166,628		—
Time deposits		127,388		127,433		—		—		127,433
Securities sold under repurchase agreements		7,161		7,161		—		7,161		—
FHLB advances		40,000		40,855		—		40,855		—
Subordinated debt		6,844		7,000		—		—		7,000
Accrued interest payable		318		318		—		318		—

					Fair Value Measurements at December 31, 2014 Using
(Dollars in thousands)	Balance as of		Fair Value as of
Description	December 31, 2014		December 31, 2014		Level 1		Level 2		Level 3
Financial Assets:
Cash and due from banks	$	6,181	$	6,181	$	6,181	$	—	$	—
Interest-bearing deposits		14,784		14,784		14,784		—		—
Federal funds sold		119		119		119		—		—
Securities available-for-sale		42,604		42,604		845		41,759		—
Restricted securities		2,430		2,430		—		—		2,430
Loans, net		295,242		300,481		—		—		300,481
Accrued interest receivable		1,197		1,197		—		1,197		—
Mortgage servicing rights		596		596		—		—		596
Financial Liabilities:
Non-interest-bearing liabilities	$	63,308	$	63,308	$	63,308	$	—	$	—
Savings and other interest-bearing deposits		122,502		122,502		—		122,502		—
Time deposits		121,775		122,662		—		—		122,662
Securities sold under repurchase agreements		6,012		6,012		—		6,012		—
FHLB advances		35,000		35,951		—		35,951		—
Accrued interest payable		149		149		—		149		—

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

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

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

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

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

Time deposits are presented at estimated fair value by discounting the future cash flows using interest rates offered for deposits of similar remaining maturities.

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

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

The fair value of commitments to extend credit is estimated using the fees currently charged to enter similar agreements, taking into account the remaining terms of the agreements and the present credit worthiness of the counter parties. For fixed-rate loan commitments, fair value also considers the difference between current levels of interest rates and the committed rates. The fair value of standby letters of credit is based on fees currently charged for similar agreements or on the estimated cost to terminate them or otherwise settle the obligations with the counter parties at the reporting date. At December 31, 2015 and December 31, 2014, the fair value of loan commitments and standby letters of credit was immaterial and therefore, they are not included in the table above.

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

Note 22. Leases

The Company has long-term leases for three retail branches and office equipment. Lease expense for 2015 and 2014 was $168 thousand and $103 thousand, respectively. Pursuant to the terms of these leases, the following is a schedule, by year, of future minimum lease payments required under the long-term non-cancelable lease agreements (in thousands).


2016	$	163
2017		115
2018		83
2019		28
2020		—
Thereafter		—

	$	389

Note 23. Condensed Financial Information of Parent Company

Financial information pertaining only to Bay Banks of Virginia, Inc. is as follows:


(Dollars in thousands)
	December 31, 2015		December 31, 2014
Condensed Balance Sheets
Assets
Cash and due from non-affiliated banks	$	149	$	2,445
Interest-bearing deposits		1,902		—
Securities available-for-sale, at fair value		2,480		—
Investments in subsidiaries		41,591		35,625
Other assets		1,920		1,732

Total assets	$	48,042	$	39,802

Liabilities and Shareholders’ Equity
Liabilities
Subordinated debt	$	6,844	$	—
Deferred directors’ compensation		477		414
Other liabilities		1,152		150

Total liabilities		8,473		564

Total shareholders’ equity		39,569		39,238

Total liabilities and shareholders’ equity	$	48,042	$	39,802


(Dollars in thousands)
	Years ended December 31,
	2015			2014
Condensed Income Statements
Interest income	$	6		$	—
Interest expense		279			—

Net interest expense		(273	)		—
Non-interest income		629			641
Non-interest expense		839			622

(Loss) income before income taxes and equity in undistributed earnings of subsidiaries		(483	)		19
Income tax (benefit) expense		(28	)		5

Income (loss) before equity in undistributed earnings of subsidiaries		(455	)		14

Equity in undistributed earnings of subsidiaries		821			1,816

Net income	$	366		$	1,830


(Dollars in thousands)
	Years ended December 31,
	2015			2014
Condensed Statements of Cash Flows
Cash Flows from Operating Activities:
Net income	$	366		$	1,830
Adjustments to reconcile net income to net cash provided by operating activities:
Amortization of debt issuance costs		10			—
Stock-based compensation		63			20
Equity in undistributed earnings of subsidiaries		(821	)		(1,816	)
Increase in other assets		(187	)		(467	)
Net change in deferred directors’ compensation		63			77
Increase in other liabilities		1			17

Net cash used in operating activities		(505	)		(339	)

Cash Flows from Investing Activities:
Purchase of securities available-for-sale		(2,480	)		—
Investment in subsidiaries		(4,000	)		(1,100	)

Net cash used in investing activities		(6,480	)		(1,100	)

Cash Flows from Financing Activities:
Proceeds from the issuance of subordinated debt		6,834			—
Repurchase of common stock		(243	)		—

Net cash provided by financing activities		6,591			—

Net decrease in cash and due from banks		(394	)		(1,439	)
Cash and cash equivalents at January 1		2,445			3,884

Cash and cash equivalents at December 31	$	2,051		$	2,445

As of December 31, 2015, the Company had accrued a capital contribution to the Bank of $1.0 million. This accrual was settled on January 4, 2016.

Note 24. Accumulated Other Comprehensive Income

The balances in accumulated other comprehensive income (loss) are shown in the following table (dollars in thousands):


	Net Unrealized			Pension and			Accumulated Other
	Gains (Losses)			Post-retirement			Comprehensive
	on Securities			Benefit Plans			Income (Loss)
Balance January 1, 2014	$	(791	)	$	(382	)	$	(1,173	)
Change in net unrealized holding gains on securities, before reclassification, net of tax expense of $422		820			—			820
Reclassification for previously unrealized net losses recognized in income, net of tax benefit of $9		16			—			16
Net loss on pension and postretirement plans, net of tax benefit of $301		—			(584	)		(584	)

Balance December 31, 2014		45			(966	)		(921	)

Change in net unrealized holding gains on securities, before reclassification, net of tax expense of $46		90			—			90
Reclassification for previously unrealized net gains recognized in income, net of tax expense of $14		(28	)		—			(28	)
Net gain on pension and postretirement plans, net of tax expense of $42		—			83			83

Balance at December 31, 2015	$	107		$	(883	)	$	(776	)

Reclassification for previously unrealized gains and impairments on securities and pension and postemployment related costs are reported in the consolidated statements of income as follows:


	Accumulated Other Comprehensive Income (Loss)
	Reclassification for the Year Ended
	December 31, 2015
	Holding gains (losses)			Pension and
(Dollars in thousands)	on securities			postemployment costs
Net gains on sale of securities available-for-securities	$	42		$	—
Salaries and employee benefits		—			(76	)
Tax (expense) benefit		(14	)		29

Impact on net income	$	28		$	(47	)


	Accumulated Other Comprehensive Income (Loss)
	Reclassification for the Year Ended
	December 31, 2014
	Holding gains (losses)			Pension and
(Dollars in thousands)	on securities			postemployment costs
Net losses on sale of securities available-for-securities	$	(25	)	$	—
Salaries and employee benefits		—			(37	)
Tax (expense) benefit		9			13

Impact on net income	$	(16	)	$	(24	)

Note 25. Subsequent Event

On February 23, 2016, one of the Bank’s commercial borrowers pleaded guilty in a federal court to “Willful Failure to Collect or Pay Over Employment Tax” and admitted to regularly and deliberately creating false financial statements for submission to financial institutions in order to encourage banks to lend new funds to his companies, or to enable the renewal of existing loans. The Bank had five loans to this borrower totaling $2.2 million, all of which have been placed on nonaccrual status, classified as substandard and evaluated for impairment as of December 31, 2015. On March 16 and 17, 2016, the Bank foreclosed on related properties used as collateral for certain of the loans. An additional $691 thousand of impairment reserves have been added to the allowance for loan losses effective December 31, 2015.

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

None.

ITEM 9A: CONTROLS AND PROCEDURES

Evaluation of Disclosure Controls and Procedures

As of the end of the period to which this report relates, the Company has carried out an evaluation, under the supervision and with the participation of the Company’s management, including the Company’s Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of the Company’s disclosure controls and procedures pursuant to Rule 13a-14 of the Exchange Act. In designing and evaluating its disclosure controls and procedures, management recognized that disclosure controls and procedures, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that objectives of the disclosure controls and procedures are met. The design of any disclosure controls and procedures is also based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential conditions. Based upon their evaluation, the Company’s Chief Executive Officer and Chief Financial Officer concluded that the Company’s disclosure controls and procedures are effective in timely alerting them to material information relating to the Company (including its consolidated subsidiaries) required to be included in the Company’s periodic SEC filings as of December 31, 2015.

Management’s Report on Internal Control over Financial Reporting

Management is responsible for establishing and maintaining adequate internal control over financial reporting as defined in Rule 13a-15(f) of the Exchange Act. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

Management assessed the effectiveness of the Company’s internal control over financial reporting as of December 31, 2015. In making this assessment, management used the criteria set forth by the Committee of Sponsoring Organizations, a.k.a. COSO (2013). Based on the assessment using those criteria, management concluded that the internal control over financial reporting was effective as of December 31, 2015.

This Annual Report on Form 10-K does not include an attestation report from the Company’s registered public accounting firm regarding internal control over financial reporting. Management’s report is not subject to attestation by the Company’s registered public accounting firm pursuant to the rules of the SEC that permit the Company to provide only management’s report in this annual report.

ITEM 9B: OTHER INFORMATION

None.

PART III

ITEM 10: DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE

All required information is detailed in the Company’s 2016 definitive proxy statement for the annual meeting of shareholders (“Definitive Proxy Statement”), which is expected to be filed with the SEC within the required time period, and is incorporated herein by reference.

The Company has adopted a Chief Executive Officer and Chief Financial Officer Code of Ethics applicable to the Company’s Chief Executive Officer and Chief Financial Officer. A copy of the code is filed as Exhibit 14.0 to this report and may be obtained without charge by written request to the Company’s Corporate Secretary.

ITEM 11: EXECUTIVE COMPENSATION

Information on executive and director compensation is provided in the Definitive Proxy Statement and is incorporated herein by reference.

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

Information on security ownership of certain beneficial owners and management and related stockholder matters is provided in the Definitive Proxy Statement, and is incorporated herein by reference.

The following table summarizes information, as of December 31, 2015, relating to the Company’s stock-based compensation plans, pursuant to which grants of options to acquire shares of common stock have been and may be granted from time to time.

Number of Shares

To be Issued

Upon Exercise

Of Outstanding

Weighted-Average

Number of Shares

Options,

Exercise Price of

Remaining Available

Warrants and

Outstanding Options,

fur Future Issuance Under

At December 31, 2015

Rights (1)

Warrants and Rights

Equity Compensation Plan

Equity compensation plans approved by shareholders

211,185

(1)

6.57

349,500

Equity compensation plans not approved by shareholders

—

Total

211,185

6.57

349,500

(1)	Consists entirely of shares of common stock underlying previously granted stock options that have not been exercised. All of these options were granted pursuant to the Company’s stock-based compensation plans.

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

Information on certain relationships and related transactions, and director independence, are detailed in the Definitive Proxy Statement and incorporated herein by reference.

ITEM 14: PRINCIPAL ACCOUNTING FEES AND SERVICES

Information on principal accounting fees and services is provided in the Definitive Proxy Statement and is incorporated herein by reference.

PART IV

ITEM 15: EXHIBITS, FINANCIAL STATEMENT SCHEDULES.

(a)1.

Financial Statements are included in Part II, Item 8, Financial Statements and Supplementary Data

(a)2.

All required tables are included in Part II, Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations

(a)3.

Exhibits:


No.		Description

3.1		Articles of Incorporation, as amended, of Bay Banks of Virginia, Inc. (Incorporated by reference to previously filed Form 10-K for the year ended December 31, 2002).

3.2		Bylaws, as amended, of Bay Banks of Virginia, Inc. (Incorporated by reference to previously filed Form 8-K filed on March 28, 2014).


No.		Description

4.1		Form of 6.50% Subordinated Note (Incorporated by reference to previously filed Form 8-K filed on June 2, 2015).

10.1		Employment Agreement dated October 6, 2011, among Bay Banks of Virginia, Inc., Bank of Lancaster and Randal R. Greene (Incorporated by reference to previously filed Form 8-K filed on October 10, 2011).

10.2		Management Continuity Agreement, dated as of January 10, 2014, by and between Bay Banks of Virginia, Inc. and Deborah M. Evans (Incorporated by reference to previously filed Form 8-K filed on January 15, 2014).

10.3		Management Continuity Agreement, dated as of January 10, 2014, by and between Bay Banks of Virginia, Inc. and Douglas F. Jenkins, Jr. (Incorporated by reference to previously filed Form 8-K filed on January 15, 2014).

10.4		1998 Non-Employee Directors Stock Option Plan (Incorporated by reference to previously filed Form 10-K for the year ended December 31, 1999).

10.5		2003 Incentive Stock Option Plan (Incorporated by reference to previously filed Form S-8, Commission File Number 333-112947, previously filed on February 19, 2004).

10.6		2008 Non-Employee Directors Stock Option Plan (Incorporated by reference to previously filed Form S-8, Commission File Number 333-155370, previously filed on November 14, 2008).

10.7		Bay Banks of Virginia, Inc. 2013 Stock Incentive Plan (Incorporated by reference to previously filed Form S-8, Commission File Number 333-189688, previously filed on June 28, 2013).

10.8		Form of Subordinated Note Purchase Agreement, dated May 28, 2015, by and among Bay Banks of Virginia, Inc. and several lenders (Incorporated by reference to previously filed Form 8-K filed on June 2, 2015).

11.0		Statement re: Computation of per share earnings. (Incorporated by reference to Note 19 of the 2015 Consolidated Financial Statements included herein).

14.0		Code of Ethics (filed herewith).

21.0		Subsidiaries of the Company (filed herewith).

23.1		Consent of Dixon Hughes Goodman LLP (filed herewith).

31.1		Section 302 Certification (filed herewith).

31.2		Section 302 Certification (filed herewith).

32.0		Section 906 Certification (filed herewith).

101		The following materials from the Company’s Annual Report on Form 10-K for the year ended December 31, 2015, formatted in Extensible Business Reporting Language (XBRL): (i) Consolidated Balance Sheets as of December 31, 2015 and 2014, (ii) Consolidated Statements of Income for the years ended December 31, 2015 and 2014, (iii) Consolidated Statements of Comprehensive Income for the years ended December 31, 2015 and 2014; (iv) Consolidated Statements of Changes in Shareholders’ Equity for the years ended December 31, 2015 and 2014, (v) Consolidated Statements of Cash Flows for the years ended December 31, 2015 and 2014, and (vi) Notes to Consolidated Financial Statements.

SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) 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, on the 28th day of March, 2016.


Bay Banks of Virginia, Inc.
(registrant)

By:		/s/ Randal R. Greene
Randal R. Greene
President and Chief Executive Officer

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 indicated, on the 28th day of March, 2016.

PRINCIPAL EXECUTIVE OFFICER:

/s/ Randal R. Greene

Randal R. Greene

Director, President and Chief Executive Officer

PRINCIPAL FINANCIAL AND ACCOUNTING OFFICER:

/s/ Deborah M. Evans

Deborah M. Evans

Senior Vice President and Chief Financial Officer

DIRECTORS:

/s/ Robert F. Hurliman

Robert F. Hurliman

Chairman, Board of Directors

Director

/s/ Kenneth O. Bransford, Jr.

Kenneth O. Bransford, Jr.

Director

/s/ C. Dwight Clarke

C. Dwight Clarke

Director

/s/ Elizabeth H. Crowther, Ed.D.

Elizabeth H. Crowther, Ed.D.

Director

/s/ Richard A. Farmar, III

Richard A. Farmar, III

Director

/s/ Julien G. Patterson

Julien G. Patterson

Director

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