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Section 1: 10-K

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

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

For the fiscal year ended December 31, 2015

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

For the transition period from _____________to_____________

Commission File No.: 000-25805

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

DOCUMENTS INCORPORATED BY REFERENCE

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


TABLE OF CONTENTS

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

1

ITEM 1. BUSINESS

GENERAL

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

THE FAUQUIER BANK

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

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

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

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

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

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

LENDING ACTIVITIES

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

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

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

LOANS SECURED BY REAL ESTATE

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

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

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

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


COMMERCIAL LOANS

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

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

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

DEPOSIT ACTIVITIES

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

INVESTMENTS

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

GOVERNMENT SUPERVISION AND REGULATION

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

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


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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

7

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

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

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

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

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

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

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

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


COMPETITION

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

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

ITEM 1A. RISK FACTORS

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

ITEM 1B. UNRESOLVED STAFF COMMENTS

None.
10


ITEM 2. PROPERTIES

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

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


ITEM 3. LEGAL PROCEEDINGS

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

ITEM 4. MINE SAFETY DISCLOSURES

Not applicable.

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

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

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

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

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

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


ITEM 6. SELECTED FINANCIAL DATA

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

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

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


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

CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS

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

CRITICAL ACCOUNTING POLICIES

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

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

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


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

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

EXECUTIVE OVERVIEW

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

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

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


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

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

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

Earnings

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

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

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


 
NET INTEREST INCOME AND EXPENSE

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

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

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

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

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

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

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


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

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

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

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

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

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

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


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

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

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


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

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


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

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

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

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

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

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


 
ASSET QUALITY

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

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

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

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

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

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

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

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

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

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

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

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

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

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


Loan Portfolio

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

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

Non-Performing Assets and Loans Contractually Past Due

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

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


 
ANALYSIS OF LOAN LOSS EXPERIENCE

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

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

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

Analysis of Allowance for Loan Losses
 
 
 
Years ended December 31,
 
(Dollars in thousands)
 
2015
   
2014
   
2013
   
2012
   
2011
 
 
 
   
   
   
   
 
Allowance for loan losses, January 1,
 
$
5,391
   
$
6,667
   
$
6,258
   
$
6,728
   
$
6,307
 
 
                                       
Secured by real estate:
                                       
Construction and land
   
17
     
313