Freedom Bank of Virginia
Annual Report 2018

Plain-text annual report

Experience Innovation • Bank With Freedom 2018 ANNUAL REPORT Experience Innovation • Bank With Freedom Experience Innovation • Bank With Freedom Business Banking Personal Banking Mortgage Banking ABOUT THE BANK OUR VISION • Provide compelling ideas, relevant financial products, and exceptional service to our clients in the way they wish to be served • Focus on building lead relationships with businesses, real estate owners, and professionals with sales offices across Northern Virginia and the DC Metropolitan Service Area • Concentrate on industry verticals to deliver unique, sector-specific solutions and have market executives to engage local businesses and communities • Use innovative technology, a network of sales offices, and a team of experienced bankers to make banking functional and convenient for businesses and consumers OUR CORE VALUES • Freedom Bank’s innovative approach to banking starts with IDEAS based upon a keen understanding of client needs and market opportunities. > INNOVATION - Exhaust all options and take smart risks > DISCIPLINE - Act with unwavering integrity > EXPERIENCE - Deliver exceptional outcomes > ATTITUDE - Build relationships through teamwork and respect > SERVICE - Participate in our communities and industries • Our IDEAS help define the value we bring to lead client relationships and in the capabilities that we develop on our team or through partnering with best-in-class product providers. FINANCIAL HIGHLIGHTS SHAREHOLDERS EQUITY TIER 1 CAPITAL RATIO % 60 58 56 54 52 50 0 $59.1 $55.3 $52.0 2016 2017 2018 Rounded $MM as of December 31 % 15 10 5 0 12.35% 13.32% 14.73% 2016 2017 2018 As of December 31 Experience Innovation • Bank With Freedom 00DFDDFA LETTER TO OUR SHAREHOLDERS April 15, 2019 Dear Shareholders: On behalf of our directors and officers, we are pleased to present our 2018 Annual Report and to share the highlights of our financial performance and the development of a new strategic plan over the past year. We are both in new roles at the Bank this year which reflects the period of significant and exciting change across our board, management team and operating platform that has occurred. In 2018, we made huge strides to improve our operations and to invest in our people and technology in order to position our company for improved financial results going forward. The excitement about our future and the talent in place to capitalize on our opportunity are captured in the faces of our talented and diverse colleagues portrayed on the cover of this report. We would be remiss if we did not take a moment to recognize the efforts of several dedicated and talented Directors who have retired since the beginning of 2018 through the writing of this letter. Richard C. Litman, Craig S. Underhill, Alvin E. Nashman, Terry L. Collins, Robert Falese, Jr., and G. Thomas Collins Jr. have served admirably and we are grateful for their efforts on behalf of our shareholders. We are also excited to welcome a new class of energetic and diverse Directors during 2018 through the writing of this letter, including Brandon C. Park, Joseph J. Thomas, Lauren Friend McKelvey, Joseph M. English III, Kevin J. Kooman, and Maury Peiperl. Our proxy provides background information on these current and nominated Directors for election. Over our 17-year history, the Bank has returned 31.42% to its shareholders, as compared to 12.7% over the same time period for the KBW NASDAQ Bank Index as provided by S&P Global. However, recent results have been disappointing and the board recognized that there were important areas where the Bank could improve its performance after a period of rapid growth. The board, therefore, embarked on a corporate-wide restructuring in the second half of 2018 to create the new Freedom Bank. The balance sheet restructuring and efforts to reduce overhead expenses have positioned us to be much stronger financially at a time in our economy of great uncertainty. The new strategic plan adopted by the board this year has set up the company for the Bank’s next chapter of improving financial performance and returns to shareholders. The Bank undertook a conscious effort over the past twelve months to de-risk its balance sheet by growing total shareholder equity and increasing tier 1 capital ratios as graphically displayed on the charts contained on the adjacent page. Total shareholder equity at the end of 2018 reached $59.1 million up 6.9% over 2018, and, as a result, the Bank’s Tier 1 Capital Ratio increased to 14.7% at year-end 2018, a 10.9% increase over 2017 and well ahead of the 10% “well capitalized” regulatory requirement. We also bolstered the Bank’s allowance for loan losses to 1.15% of total loans, a 4.4% increase over the prior year and well ahead of peer. It is important to note that part of this improvement was the sale of 128,791 shares of common stock to our new CEO and certain existing investors via a contractual pre-emptive rights offering which raised $1.4 million of new capital for the Bank. This represents a strong show of support by current management and investors; and ensures that there is a strong alignment by management and the board with all shareholders. With this capital and the strong economic and demographic factors in the Northern Virginia banking market, the Bank has exceptional credit quality metrics, as well as excess capital by regulatory standards, which together provide abundant capacity for stable and steady growth. We have also begun to improve key fundamental elements of our franchise value by increasing “core deposits.” The level of core deposits is widely recognized as one of the most important financial metrics of community banks given A LETTER TO OUR SHAREHOLDERS 01 A LETTER TO OUR SHAREHOLDERS (CONT.) the greater stability and lower cost of funding. Non-interest bearing and interest checking deposits as a percent of total deposits increased to 19% as compared to 16% in 2017 and we now have 75.7% of our deposits deemed as core deposits (e.g. excluding brokered deposits and CDs over $250 thousand). Furthermore, in anticipation of the inevitable slowing of the investor real estate market, we have made a deliberate shift in emphasis in our loan portfolio to Commercial and Industrial loans and Owner Occupied Real Estate loans. These types of loans now comprise 46% of our total loans as compared to 39% last year. This has enabled us to reduce the concentration of Commercial Real Estate loans as a percentage of Tier 1 Capital to 182%, well below the regulatory threshold of 300%. As detailed on the inside front cover, the board has adopted a new strategic plan with the vision to provide compelling ideas, relevant financial products, and exceptional service to our clients in the way they wish to be served. There are many elements to this new compelling vision that are expressed in our new brand promise: Experience Innovation, Bank with Freedom. We have also revised our core values for all of our colleagues with the value statement Freedom Bank’s innovative approach to banking starts with IDEAS based upon a keen understanding of client needs and market opportunities. These values will enable us to drive a new model of the community bank of the future with seven key strategic initiatives focused on industry verticals, regional markets, lending products, treasury service products, capital market products, digital capabilities and M&A. We aspire to have these initiatives come together and build a banking franchise with great potential. Freedom Bank now possesses a strong team of banking professionals, enjoys a dynamic group of clients, and serves a robust set of communities, which together will enable us to deliver attractive shareholder returns over time. Sincerely, H. JASON GOLD Chairman of the Board JOSEPH J. THOMAS, CFA President & CEO 02 A LETTER TO OUR SHAREHOLDERS INDEPENDENT AUDITOR’S REPORT REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM To the shareholders and the board of directors of Freedom Bank of Virginia Opinion on the Consolidated Financial Statements We have audited the accompanying consolidated balance sheets of The Freedom Bank of Virginia (the “Company”) as of December 31, 2018 and 2017, and the related consolidated statements of operations, comprehensive income, stockholders’ equity and cash flows for the years ended December 31, 2018 and 2017, and the related notes (collectively referred to as the “financial statements”). In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of the Company as of December 31, 2018 and 2017, and the results of their operations and their cash flows for the years then ended, in conformity with accounting principles generally accepted in the United States of America. BASIS FOR OPINION These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on the Company’s financial statements based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (“PCAOB”) and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. We conducted our audits in accordance with the standards of the PCAOB and in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement whether due to error or fraud. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. As part of our audits we are required to obtain an understanding of internal control over financial reporting but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. Our audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion. We have served as the Company’s auditor since 2017. Gaithersburg, Maryland March 19, 2019 INDEPENDENT AUDITOR’S REPORT 03 FINANCIAL STATEMENTS BALANCE SHEETS December 31 2018 and 2017 ASSETS Cash and Due from Banks Interest Bearing Deposits with Banks Federal Funds Sold Securities Available-for-Sale Securities Held-to-Maturity Restricted Stock Investments Loans Held for Sale Loans Receivable Allowance for Loan Losses Net Loans Bank Premises and Equipment, net Accrued Interest Receivable Deferred Tax Asset Bank-Owned Life Insurance Other Assets TOTAL ASSETS 2018 $ 1,270,559 2017 $ 1,164,368 14,376,684 33,936,870 - 127,000 48,204,339 61,989,669 - 14,869,181 3,076,000 4,415,520 2,533,500 7,772,501 394,080,457 407,332,772 (4,572,393) (4,562,370) 389,508,064 402,770,402 1,748,935 1,229,534 1,247,513 12,401,317 1,336,522 1,595,575 1,643,427 974,614 2,338,146 1,407,079 $478,814,987 $533,122,332 NOTE: The Notes to Consolidated Financial Statements are an integral part of these statements. 04 FINANCIAL STATEMENTS LIABILITIES Deposits Demand Deposits Non-Interest Bearing Interest Bearing Savings Deposits Time Deposits Total Deposits Federal Home Loan Bank Advances Other Accrued Expenses Accrued Interest Payable TOTAL LIABILITIES STOCKHOLDERS' EQUITY Preferred Stock, $0.01 par value, 5,000,000 shares authorized; 0 shares issued and outstanding, 2018 and 2017 Common Stock, $0.01 par value, 25,000,000 shares: 23,000,000 shares voting and 2,000,000 shares non-voting Voting Common Stock: 6,423,602 and 5,866,765 shares issued and outstanding at December 31, 2018 and 2017, respectively (includes 115,000 and 0 unvested shares, respectively) Non-Voting Common Stock: 673,000 and 660,143 shares issued and outstanding at December 31, 2018 and 2017, respectively Additional Paid-in Capital Accumulated Other Comprehensive Loss, net Retained Earnings Total Stockholders’ Equity 2018 2017 $ 67,012,857 $ 69,942,247 128,403,358 184,271,412 3,023,239 2,273,760 202,292,311 209,493,201 400,731,765 465,980,620 17,142,857 10,428,571 1,607,491 218,537 1,256,202 162,749 $ 419,700,650 $ 477,828,142 - - 63,086 58,668 6,730 6,601 57,416,068 53,241,342 (1,124,101) (573,698) 2,752,554 2,561,277 59,114,337 55,294,190 TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY $478,814,987 $533,122,332 NOTE: The Notes to Consolidated Financial Statements are an integral part of these statements. FINANCIAL STATEMENTS 05 STATEMENTS OF OPERATIONS Years Ended December 31 2018 and 2017 INTEREST INCOME Interest and Fees on Loans Interest on Investment Securities Interest on Federal Funds Sold Total Interest Income INTEREST EXPENSE Interest on Deposits Interest on Borrowings Total Interest Expense 2018 $ 21,016,737 2017 $ 21,117,267 2,224,165 1,993,655 466 19,922 23,241,368 23,130,844 5,352,235 322,373 5,674,608 4,831,359 172,206 5,003,565 Net Interest Income 17,566,760 18,127,279 PROVISION FOR LOAN LOSSES Net Interest Income After Provision for Loan Losses NON-INTEREST INCOME Gain on Sale of Mortgage Loans Service Charges and Other Income Gain (Loss) on Sales of Investment Securities Increase in Cash Surrender Value of Bank-Owned Life Insurance Total Non-Interest Income NON-INTEREST EXPENSES Officers and Employee Compensation and Benefits Occupancy Expense Equipment and Depreciation Expense Insurance Expense Professional Fees Data and Item Processing Business Development Franchise Taxes Mortgage Fees and Settlements Other Operating Expense Total Non-Interest Expenses Income Before Income Taxes 406,000 30,000 17,160,760 18,097,279 3,168,195 279,132 (1,181,108) 4,314,314 251,128 17,943 63,171 56,420 2,329,390 4,639,805 11,654,250 10,916,694 1,098,985 1,002,240 664,284 438,813 2,108,033 1,249,830 245,294 553,238 498,411 830,158 556,024 363,673 1,682,060 930,667 225,535 492,508 711,797 770,775 19,341,296 17,651,973 148,854 5,085,111 NOTE: The Notes to Consolidated Financial Statements are an integral part of these statements. 06 FINANCIAL STATEMENTS INCOME TAX EXPENSE (BENEFIT) NET INCOME 2018 2017 (42,423) 2,389,792 $ 191,277 $ 2,695,319 EARNINGS PER COMMON SHARE – BASIC $ 0.03 $ 0.41 EARNINGS PER COMMON SHARE – DILUTED $ 0.03 $ 0.39 WEIGHTED-AVERAGE COMMON SHARES OUTSTANDING – BASIC WEIGHTED-AVERAGE COMMON SHARES OUTSTANDING – DILUTED 6,751,251 6,518,614 6,948,844 6,833,739 STATEMENTS OF COMPREHENSIVE INCOME Years Ended December 31 2018 and 2017 Net Income Other Comprehensive Income (Loss): Unrealized holding gains (losses) on securities available-for-sale arising during the year, net of taxes of $413,173 and ($27,347) in 2018 and 2017, respectively Losses (gains) on sales of securities available-for-sale, net of taxes of ($248,033) and $6,101 in 2018 and 2017, respectively Amortization of unrealized losses on securities transferred from available-for-sale to held-to-maturity net of taxes of $18,830 and $1,477 in 2018 and 2017, respectively 2018 2017 $ 191,277 $ 2,695,319 (1,554,314) 53,084 933,075 (11,842) 70,836 2,868 Total Other Comprehensive Income (Loss): (550,403) 44,110 COMPREHENSIVE INCOME (LOSS) $ (359,126) $ 2,739,429 NOTE: The Notes to Consolidated Financial Statements are an integral part of these statements. FINANCIAL STATEMENTS 07 STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY Years Ended December 31 2018 and 2017 Voting and Non-Voting SHARES OF COMMON STOCK COMMON STOCK ADDITIONAL PAID-IN CAPITAL ACCUMULATED OTHER COMPREHENSIVE INCOME (LOSS) RETAINED EARNINGS (DEFICIT) TOTAL STOCKHOLDERS' EQUITY BALANCE, DEC. 31, 2016 6,179,272 $ 61,793 $48,708,431 $ (523,402) $3,760,022 $52,006,844 Net income Other comprehensive income Reclassification of stranded tax effects from changes in tax rate - - - - - - - - - 5% stock dividend 310,424 3,104 3,985,366 Stock warrants exercised Stock options exercised Stock-based compensation 28,463 8,749 - 285 255,882 87 - 65,826 225,837 - 2,695,319 2,695,319 44,110 - 44,110 (94,406) 94,406 - - - - (3,988,470) - - - - - 256,167 65,913 225,837 BALANCE, DEC. 31, 2017 6,526,908 65,269 53,241,342 $ (573,698) 2,561,277 55,294,190 Net income Other comprehensive loss - - - - - - Stock options exercised 315,903 3,159 2,241,842 Issuance of common stock 128,791 1,288 1,428,292 Restricted stock - vested 10,000 100 (100) Stock-based compensation - stock options Stock-based compensation - restricted stock - - - - 130,672 374,020 - 191,277 191,277 (550,403) - - - - - - - - - - - (550,403) 2,245,001 1,429,580 - 130,672 374,020 BALANCE, DEC. 31, 2018 6,981,602 $ 69,816 $57,416,068 $ (1,124,101) $2,752,554 $59,114,337 NOTE: The Notes to Consolidated Financial Statements are an integral part of these statements. 08 FINANCIAL STATEMENTS STATEMENTS OF CASH FLOWS Years Ended December 31 2018 and 2017 CASH FLOWS FROM OPERATING ACTIVITIES Net income Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization Provision for loan losses Net amortization of available-for-sale securities Net amortization of held-to-maturity securities (Gains) losses on sales of investment securities Gain on sale of mortgage loans Loans held for sale originated Proceeds from the sale of loans held for sale Stock-based compensation expense Gain on sale of other real estate owned Deferred income tax expense (benefit) Increase in cash surrender value of bank-owned life insurance (Increase) decrease in: Accrued interest receivable Other assets Increase (decrease) in: Other accrued expenses Accrued interest payable 2018 2017 $ 191,277 $ 2,695,319 289,809 406,000 720,630 122,324 257,284 30,000 538,559 171,008 1,181,108 (17,943) (3,168,195) (4,314,314) (120,543,245) (161,044,213) 127,068,421 165,074,220 504,692 (4,097) 225,837 - (126,589) 1,290,933 (63,171) (56,420) 413,893 70,557 351,289 55,788 (291,608) (328,372) (342,741) (12,323) Net cash provided by Operating Activities 7,470,491 3,875,226 CASH FLOWS FROM INVESTING ACTIVITIES Net change in federal funds sold Purchase of bank-owned life insurance Net change in interest bearing deposits with banks Loan (originations) payments, net Purchase of available-for-sale securities Maturities, calls and paydowns of securities available-for-sale Proceeds from sales of securities available-for-sale Proceeds from sale of other real estate owned Purchase (sale) of restricted stock investments, net Acquisition of bank premises and equipment 127,000 23,981,000 (10,000,000) - 19,433,143 11,688,552 (7,015,763) 7,907,679 25,041,821 1,171,882 (542,500) (443,169) (29,578,538) 613,658 (48,817,670) 6,411,284 9,032,629 - 1,184,900 (413,979) Net cash provided (used) in Investing Activities 47,368,645 (37,586,716) NOTE: The Notes to Consolidated Financial Statements are an integral part of these statements. FINANCIAL STATEMENTS 09 STATEMENTS OF CASH FLOWS Years Ended December 31 2018 and 2017 CASH FLOWS FROM FINANCING ACTIVITIES (Decrease) increase in deposits, net Advances from the Federal Home Loan Bank 2018 2017 $ (65,248,855) $ 66,588,391 39,000,000 6,000,000 Repayment of advances from the Federal Home Loan Bank (32,285,714) (39,285,715) Proceeds from stock options Proceeds from stock warrants Proceeds from sale of stock, net 2,245,001 - 1,429,580 65,913 256,167 - Net cash provided (used) in Financing Activities (54,859,988) 33,624,756 Net increase (decrease) in cash and due from banks 106,191 (86,734) Cash and due from banks, beginning of year 1,164,368 1,251,102 CASH AND DUE FROM BANKS, END OF YEAR $ 1,270,559 $ 1,164,368 NONCASH INVESTING ACTIVITY Unrealized gain (loss) on securities available-for-sale, net $ (786,379) $ 66,833 Transfer of securities from held-to-maturity to available-for-sale $ 5,072,984 $ - Unrealized, unamortized loss on securities remaining prior to transfer to available-for-sale, net $ 89,666 $ - Loans transferred to other real estate owned $ 1,167,785 $ - SUPPLEMENTAL INFORMATION Cash paid during the year for interest Cash paid during the year for income taxes $ 5,618,820 $ 5,015,888 $ - $ 1,346,000 NOTE: The Notes to Consolidated Financial Statements are an integral part of these statements. 10 FINANCIAL STATEMENTS NOTES TO FINANCIAL STATEMENTS DECEMBER 31, 2018 AND 2017 1. Nature of Operations and Summary of Significant Accounting Policies The accounting and reporting policies of The Freedom Bank of Virginia (the Bank) conform to generally accepted accounting principles in the United States of America (GAAP) and reflect practices of the banking industry. The policies are summarized below. NATURE OF OPERATIONS AND PRINCIPLES OF CONSOLIDATION The consolidated financial statements include the accounts of The Freedom Bank of Virginia and its formerly wholly-owned subsidiary, FBV Capital Advisors Inc. (FBVCA), a broker-dealer in securities, together referred to as “the Bank”. The Freedom Bank of Virginia is a state chartered bank and a member of the Federal Reserve and is subject to the rules and regulations of the Virginia State Banking Commission, the Federal Reserve and the Federal Deposit Insurance Corporation (FDIC). The Bank provides banking services at its branch offices in Vienna, Fairfax, Chantilly and Reston, Virginia, and serves customers primarily in the Northern Virginia area. The Bank was in organization during the period January 27, 2000 through July 22, 2001, and opened for business on July 23, 2001. In September 2018, FBVCA was sold through a stock purchase agreement. The Bank recorded $22,900 and $24,723 in legal fees related to the transaction for the year ended December 31, 2018 and 2017, respectively. Additionally, the Bank recorded a gain on sale of approximately $38,000 for the year ended December 31, 2018. All intercompany balances and transactions in 2017 have been eliminated in consolidation. USE OF ESTIMATES The preparation of financial statements in conformity with generally accepted accounting principles in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenue and expenses during the reporting period. Significant estimates affecting the Bank’s financial statements relate to the allowance for loan losses, the valuation of the deferred tax assets and other-than-temporary impairment assessments for investment securities. Actual results could differ from those estimates. INTEREST BEARING DEPOSIT WITH BANKS The Bank maintains interest bearing deposits with other institutions. Interest bearing deposits are valued at cost. Interest income is recorded as interest income on investment securities. INVESTMENT SECURITIES Investment securities are classified as either held-to-maturity, available-for-sale or trading securities. In determining such classification, securities that the Bank has the positive intent and ability to hold to maturity are classified as held-to-maturity and are carried at amortized cost. Securities classified as available-for-sale are carried at estimated fair value with unrealized gains and losses included in stockholders’ equity on an after tax basis. Trading securities are carried at estimated fair value with unrealized gains and losses included in non-interest income. The amortization of premiums and accretion of discounts are recognized in interest income using methods approximating the interest method over the period to maturity. Declines in the fair value of individual held-to-maturity and available-for-sale securities below their cost that are deemed to be other than temporary result in write-downs of the individual securities to their fair value. The related write-downs are included in earnings as realized losses. Gains and losses on sales of securities are recorded on the trade date and are determined using the specific-identification method. Federal Reserve Bank stock, Federal Home Loan Bank (FHLB) stock, and Community Bankers Bank stock are considered restricted investment securities, are carried at cost and are evaluated annually for impairment. The stock is required in order to be a member or for borrowings. LOANS AND LOAN FEES Loans that management has the intent and ability to hold for the foreseeable future, or until maturity or pay-off, generally are stated at the principal amount outstanding, less the allowance for loan losses and net deferred loan fees. Interest on loans is generally computed using the simple interest method. FINANCIAL STATEMENTS 11 Loan origination and commitment fees, as well as certain direct origination costs, are deferred and amortized as a yield adjustment over the lives of the related loans using the interest method. Amortization of deferred loan fees is discontinued when a loan is placed on non-accrual status. The accrual of interest on mortgage and commercial loans is discontinued at the time the loan is 90 days delinquent, unless the credit is well secured and in process of collection. Other personal loans are typically charged off no later than 180 days past due. In all cases, loans are placed on non-accrual or charged off at an earlier date if collection of principal or interest is considered doubtful. All interest accrued but not collected for loans that are placed on non-accrual status or charged off is reversed against interest income. The interest on these loans is accounted for on the cash basis or cost-recovery method, until qualifying for return to accrual status. Loans are returned to accrual status when all the principal and interest amounts contractually due are brought current and future payments are reasonably assured. LOANS HELD-FOR-SALE Loans held for sale consist primarily of residential mortgage loans, which are secured by one-to-four family residential real estate. Loans held for sale are carried at the lower of aggregate cost, net of purchase discounts or premiums, deferred fees, and deferred origination costs, or fair value. The Bank sells its mortgage loans forward to investors and the estimated fair value is largely dependent upon the terms of these outstanding loan purchase commitments, as well as movement in market interest rates. ALLOWANCE FOR LOAN LOSSES The allowance for loan losses is maintained at a level that, in management’s judgment, is adequate to absorb probable losses inherent in the loan portfolio. The amount of the allowance is based on management’s ongoing evaluation of the collectability of the loan portfolio, including the nature of the portfolio, credit concentrations, trends in historical loss experience, specific impaired loans, economic conditions, and other risks inherent in the portfolio. The allowance consists of two basic components: the specific allowance and the pooled allowance. The specific allowance component is used to individually establish an allowance for loans considered impaired. A loan is considered impaired when, based on current information and events, it is probable that the Bank will be unable to collect the scheduled payments of principal or interest when due, according to the contractual terms of the loan agreement. Allowances for impaired loans are generally determined based on collateral values or the present value of estimated cash flows. Although management uses available information to recognize losses on loans, because of uncertainties associated with local economic conditions, collateral values, and future cash flows on impaired loans, it is reasonably possible that a material change could occur in the allowance for loan losses in the near term. However, the amount of the change that is reasonably possible cannot be estimated. 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 allowance relating to impaired loans are charged or credited to the provision for loan losses. Past due status is determined based on contractual terms. The pooled component is used to estimate the losses inherent in the pools of non-impaired loans. These loans are then also segregated by loan type and allowance factors are assigned by management based on delinquencies, loss history, trends in volume and terms of loans, effects of changes in lending policy, the experience and depth of management, national and local economic trends, concentrations of credit, results of the loan review system and the effect of external factors (i.e., competition and regulatory requirements). Current economic conditions take into account the average unemployment rate for the Northern Virginia area and for the nation, with the most significance given to the local data. The allowance factors assigned differ by loan type. BANK PREMISES AND EQUIPMENT Bank premises and equipment are stated at cost, less accumulated depreciation and amortization. Leasehold improvements are amortized over the shorter of the asset life or lease term using the straight-line method. Furniture and equipment are depreciated over estimated useful lives of three to seven years using the straight-line method. The Bank depreciates premises and equipment using accelerated methods for income tax reporting. The Bank amortizes software over three years using the straight-line method. Expenditures for maintenance, repairs and improvements under $1,000 are charged to earnings. When bank premises or equipment are sold or otherwise disposed of, the cost and related accumulated depreciation or amortization are removed from the accounts, and the effect is reflected in current earnings. OTHER REAL ESTATE OWNED Real estate properties acquired through or in lieu of loan foreclosures are initially recorded at the fair value less estimated selling cost at the date of foreclosure. Any write-downs based on the asset’s fair value at the date of acquisition are charged to the allowance for loan losses. After foreclosure, valuations are periodically performed by management and property held for sale is carried at the lower of the new cost basis or fair value less cost to sell. Impairment losses on property to be held and used are measured as the amount by which the carrying amount of a property exceeds its fair value. Costs of significant property improvements are capitalized, whereas costs relating to holding property are expensed. The portion of interest costs relating to development of real estate is capitalized. Valuations are periodically performed by management, and any subsequent write downs are recorded as a charge to non-interest expense, if necessary, to reduce the carrying value of a property to the lower of its cost or fair value less cost to sell. The Bank had no other real estate owned at December 31, 2018 and 2017. 12 FINANCIAL STATEMENTS BANK-OWNED LIFE INSURANCE The Bank has entered into bank-owned single premium life insurance policies that are maintained by two counterparties. Under the bank-owned life insurance policies, executives or other key individuals are the insured and the Bank is the owner and beneficiary of each policy. As such, the insured has no claim to either the insurance policy, cash value, or a portion of the policy’s death proceeds. The increase in the cash surrender value over time is recorded as other income. The Bank monitors the financial strength and condition of both counterparties. STOCKHOLDERS' EQUITY On May 29, 2017, the Bank declared a 5% stock dividend, effective for stockholders of record on June 23, 2017. All references to share and per share amounts in the financial statements have been restated to reflect the stock dividend. The rights, preferences, and privileges of the voting and non-voting common stock shall be in all respects and for all purposes identical except with respect to voting power. The holders of voting common stock shall exclusively possess all voting power and each share is entitled to one vote. The holders of non-voting common stock have no voting power. Holders of common stock are entitled to receive an equal amount of dividends per share when declared from time to time by the Board of Directors. Shares of non-voting common stock may be converted into shares of voting common stock at the option of the holder in accordance with the provisions outlined in the amended articles of incorporation. Shares of preferred stock may be issued in one or more series. Authority is expressly vested in the Board of Directors to cause the preferred stock to be issued in one or more series and, to the fullest extent permitted by law, to fix and determine the preferences, limitations and relative rights of the shares of any series of preferred stock so established and provide for the issuance of shares thereof. Comprehensive income represents all changes in equity that result from recognized transactions and other economic events of the period. Other comprehensive income (loss) refers to revenues, expenses, gains and losses that under accounting principles generally accepted in the United States of America are included in comprehensive income but excluded from net income, such as unrealized gains and losses on certain investments in debt and equity securities. INCOME TAXES Income taxes are provided for the tax effects of the transactions reported in the financial statements and consist of taxes currently due plus deferred taxes related primarily to the difference between the basis of the allowance for loan losses. The deferred tax assets and liabilities represent the future tax return consequences of those differences, which will either be taxable or deductible when the assets and liabilities are recovered or settled. Deferred tax assets and liabilities are reflected at income tax rates applicable to the period in which the deferred tax assets or liabilities are expected to be realized or settled. As changes in tax laws or rates are enacted, deferred tax assets and liabilities are adjusted through the provision for income taxes. A valuation allowance is recorded if, based upon the evidence available, it is more likely than not some portion or all of the net deferred tax assets will not be realized. The Bank files an income tax return in the U.S. Federal jurisdiction. The Bank pays state franchise tax in lieu of state income taxes. The Bank is not currently under audit by any income tax jurisdiction. The income tax returns of the Bank for 2015, 2016 and 2017 are subject to examination by income taxing authorities, generally for three years after they were filed. The Bank has no uncertain tax positions that qualify for either recognition or disclosure in the financial statements, and no interest and penalties have been recorded in the accompanying financial statements related to uncertain tax positions. The results for the year ended December 31, 2017 include the effect of the Tax Cuts and Jobs Act (“the Act”), which was signed into law on December 22, 2017. The Act became effective January 1, 2018 and among other things, permanently lowered the federal corporate income tax rate to 21% from the maximum rate prior to the passage of the Act of 35%. When the federal corporate income tax rate changes, U.S. GAAP requires companies to re-measure their deferred tax assets and deferred tax liabilities, including those accounted for in accumulated other comprehensive income, as of the date of enactment, and record the corresponding effects as income tax expense. As a result of the permanent reduction in the corporate income tax rate, the Bank recognized in the fourth quarter of 2017 a provisional $603,331 reduction in the value of its net deferred tax asset and recorded a corresponding incremental income tax expense of $603,331 in its consolidated results of operations. EARNINGS PER SHARE (EPS) Basic EPS is computed by dividing income available to common stockholders by the weighted-average number of common shares outstanding for the year. Diluted EPS reflects the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock or resulted in the issuance of common stock that then shared in the earnings of the Bank. Potential common shares that may be issued by the Bank relate solely to stock options outstanding during the period and are determined using the treasury stock method. The following shows the weighted average number of shares used in computing earnings per common share and the effect on the weighted average number of shares of potentially dilutive common stock. The number of common shares for all periods have been retroactively restated to reflect the effects of the 5% stock dividend declared on May 29, 2017. FINANCIAL STATEMENTS 13 Average number of common shares outstanding Effect of dilutive options Average number of common shares outstanding used to calculate diluted earnings per common share 2018 2017 6,751,251 6,518,614 197,593 315,125 6,948,844 6,833,739 Stock options for 19,873 and 1,500 shares of common stock were not considered in computing diluted earnings per common share for 2018 and 2017, respectively, because they were antidilutive. Non-vested restricted common shares, which carry all rights and privileges of a common share with respect to the stock, including the right to vote, were included in the basic and diluted per common share calculations. STOCK-BASED COMPENSATION The Bank recognizes the cost of employee services received in exchange for an award of equity instruments in the financial statements over the period the employee is required to perform the services in exchange for the award (presumptively the vesting period). The Bank also measures the cost of employee services received in exchange for an award based on the grant- date fair value of the award. STATEMENTS OF CASH FLOWS The Bank considers all cash and amounts due from banks, excluding interest-bearing deposits in other banks and Federal funds sold, to be cash equivalents for purposes of the statements of cash flows. The Freedom Bank of Virginia periodically has bank deposits, including short-term investments, in excess of Federally insured limits. OFF-BALANCE SHEET CREDIT RELATED FINANCIAL INSTRUMENTS In the ordinary course of business, the Bank has entered into commitments to extend credit, including commitments under credit card arrangements, commercial letters of credit, and standby letters of credit. Such financial instruments are recorded when they are funded. RECENT ACCOUNTING PRONOUNCEMENTS ASU 2014-09 In May 2014, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) 2014-09, Revenue from Contracts with Customers. The standard’s core principle is that a company will recognize revenue when it transfers promised goods or services to customers in an amount that reflects the consideration to which the company expects to be entitled in exchange for those goods or services. This standard also includes expanded disclosure requirements that result in an entity providing users of the financial statements with comprehensive information about the nature, amount, timing, and uncertainty of revenue and cash flows arising from the entity’s contracts with customers. ASU 2014-09 is effective for public business entities for fiscal years beginning after December 15, 2017. The Bank evaluated the overall impact on affected revenue streams and any related contracts, including asset management fees, gains and losses on the sale of real estate, deposit related fees and interchange fees. Based on this evaluation, the Bank determined that ASU 2014-09 did not materially change the method in which revenue from impacted revenue streams was previously recognized. The Bank applied the guidance using a modified retrospective approach. This approach requires the application of the new guidance to uncompleted contracts at the date of adoption. Periods prior to the date of adoption were not retrospectively revised as the impact on uncompleted contracts at the date of adoption was not material. ASU 2016-01 In January 2016, the FASB issued ASU 2016-01: Financial Instruments – Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities. The amendments in ASU 2016-01, among other things: 1) Requires equity investments (except those accounted for under the equity method of accounting, or those that result in consolidation of the investee) to be measured at fair value with changes in fair value recognized in net income. 2) Requires public business entities to use the exit price notion when measuring the fair value of financial instruments for disclosure purposes. 3) Requires separate presentation of financial assets and financial liabilities by measurement category and form of financial asset (i.e., securities or loans and receivables). 4) Eliminates the requirement for public business entities to disclose the method(s) and significant assumptions used to estimate the fair value that is required to be disclosed for financial instruments measured at amortized cost. The amendments in this ASU are effective for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years. The amendments related to equity securities without readily determinable fair values were applied prospectively to equity investments that exist as of the date of the adoption of the amendments. ASU 2016-01 requires the use of exit price rather than entrance price in determining the fair value of loans not measured at fair value on a non-recurring basis in the consolidated balance sheets. See Note 12 – Fair Value Measurements for information regarding the change in the valuation of these loans. The adoption of ASU 2016-01 did not have a material impact on the Bank’s financial statements. 14 FINANCIAL STATEMENTS ASU 2016-02 In February 2016, the FASB issued ASU 2016-02, Leases (Topic 842). Among other things, in the amendments in ASU 2016-02, lessees will be required to recognize the following for all leases (with the exception of short-term leases) at the commencement date: (1) A lease liability, which is a lessee’s obligation to make lease payments arising from a lease, measured on a discounted basis; and (2) A right-of-use asset, which is an asset that represents the lessee’s right to use, or control the use of, a specified asset for the lease term. Under the new guidance lessor accounting is largely unchanged. Certain targeted improvements were made to align, where necessary, lessor accounting with the lessee accounting model and Topic 606, Revenue from Contracts with Customers. The amendments in this ASU are effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. Early application is permitted upon issuance. Lessees (for capital and operating leases) and lessors (for sales-type, direct financing, and operating leases) must apply a modified retrospective transition approach for leases existing at, or entered into after, the beginning of the earliest comparative period presented in the financial statements. The modified retrospective approach would not require any transition accounting for leases that expired before the earliest comparative period presented. Lessees and lessors may not apply a full retrospective transition approach. The FASB made subsequent amendments to Topic 842 in July 2018 through ASU 2018-10 (“Codification Improvements to Topic 842, Leases”) and ASU 2018-11 (“Leases (Topic 842): Targeted Improvements”). Among these amendments is the provision in ASU 2018-11 that provides entities with an additional (and optional) transition method to adopt the new lease standard. Under this transition method, an entity initially applies the new leases standard at the adoption date and recognizes a cumulative-effect adjustment to the opening balance of retained earnings in the period of adoption. Consequently, an entity’s reporting for the comparative periods presented in the financial statements in which it adopts the new leases standard will continue to be in accordance with current GAAP (Topic 840, Leases). The effect of adopting this standard on January 1, 2019 was an approximately $3.75 million increase in assets and liabilities on our balance sheet. ASU 2016-13 In June 2016, the FASB issued ASU 2016-13, Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments. The guidance in ASU 2016-13 replaces the current incurred loss impairment methodology, with a methodology that reflects expected credit losses and requires consideration of a broader range of reasonable and supportable information to estimate credit losses. ASU 2016-13 is effective for public business entities for fiscal years beginning after December 15, 2019, with early adoption permitted for fiscal years beginning after December 15, 2018. The Bank began archiving core loan data beginning in January 2018 in anticipation of the implementation of the new standard. Additionally, a third-party vendor was engaged to begin running parallel models starting in the first quarter of 2019. The Bank is currently in the process of evaluating the impact of adoption of this ASU on the financial statements. ASU 2018-02 During February 2018, the FASB issued ASU 2018-02: Income Statement – Reporting Comprehensive Income (Topic 220): Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income. The amendments provide financial statement preparers with an option to reclassify stranded tax effects within accumulated other comprehensive income to retained earnings in each period in which the effect of the change in the U.S. federal corporate income tax rate in the Tax Cuts and Jobs Act (or portion thereof) is recorded. The amendments are effective for all organizations for fiscal years beginning after December 15, 2018, and interim periods within those fiscal years. Early adoption is permitted. Organizations should apply the proposed amendments either in the period of adoption or retrospectively to each period (or periods) in which the effect of the change in the U.S. federal corporate income tax rate in the Tax Cuts and Jobs Act is recognized. The Bank has elected to reclassify the stranded income tax effects from the Tax Cuts and Jobs Act in the financial statements for the period ending December 31, 2017. The amount of this reclassification in 2017 was $94,406. RECLASSIFICATION Certain items in the 2017 financial statements have been reclassified to conform to the 2018 financial statement presentation. SUBSEQUENT EVENTS The date to which events occurring after December 31, 2018, the date of the most recent balance sheet, have been evaluated for possible adjustment to the financial statements or disclosure is March 19, 2019, which is the date on which the financial statements were available to be issued. 2. Restriction of Cash and Due from Banks The Bank is required to maintain reserve funds in cash or on deposit with the Federal Reserve. The required reserve at December 31, 2018 and 2017 was $1,737,000 and $2,740,000, respectively. FINANCIAL STATEMENTS 15 3. Investments The amortized cost and fair values of securities as shown in the balance sheets of the Bank are as follows: DEC. 31, 2018 Available-for-sale Corporate notes AMORTIZED COST GROSS UNREALIZED GAINS GROSS UNREALIZED LOSSES FAIR VALUE $ 3,758,201 $ 22,592 $ (84,964) $ 3,695,829 Mortgage backed securities 35,789,803 15,956 (895,425) 34,910,334 Municipal securities SBA loan pools Total Available-for-sale Held-to-maturity Municipal securities 5,070,380 5,008,870 49,627,254 - 2,828 41,376 (354,836) (129,066) 4,715,544 4,882,632 (1,464,291) 48,204,339 - - - - TOTAL INVESTMENT SECURITIES $ 49,627,254 $ 41,376 $ (1,464,291) $ 48,204,339 DEC. 31, 2017 Available-for-sale Corporate notes Mortgage backed securities Municipal securities SBA loan pools Total Available-for-sale Held-to-maturity Municipal securities AMORTIZED COST GROSS UNREALIZED GAINS GROSS UNREALIZED LOSSES FAIR VALUE $ 3,761,254 $ 15,238 $ (31,217) $ 3,745,275 37,471,255 15,551,471 5,842,225 289 25,841 - (585,034) 36,886,510 (26,610) (35,043) 15,550,702 5,807,182 62,626,205 41,368 (677,904) 61,989,669 14,869,181 62,660 (79,897) 14,851,944 TOTAL INVESTMENT SECURITIES $ 77,495,386 $ 104,028 $ (757,801) $ 76,841,613 The amortized cost and estimated fair value of debt securities at December 31, 2018, by contractual maturity, are as follows: Amounts maturing in: 1 year or less After 1 year - 5 years After 5 years - 10 years After 10 years AVAILABLE-FOR-SALE AMORTIZED COST FAIR VALUE $ - $ - 1,505,797 1,462,222 4,381,522 4,335,916 7,950,132 7,495,867 13,837,451 13,294,005 Mortgage backed securities 35,789,803 34,910,334 $49,627,254 $48,204,339 Expected maturities will differ from contractual maturities because issuers may have the right to call or prepay obligations with or without call or prepayment penalties. At December 31, 2018 and 2017, U.S. Government and agency securities and mortgage backed securities with carrying values of $0 and $20,395,555, respectively, were pledged to secure public deposits and for other purposes required or permitted by law. 16 FINANCIAL STATEMENTS Information pertaining to securities with gross unrealized losses at December 31, 2018, aggregated by investment category and length of time that individual securities have been in a continuous loss position, is as follows: Available-for-sale Corporate notes LESS THAN 12 MONTHS OVER 12 MONTHS GROSS UNREALIZED LOSSES FAIR VALUE GROSS UNREALIZED LOSSES FAIR VALUE $ 51,190 $ 451,981 $ 33,774 $ 966,226 Mortgage backed securities 19,300 3,433,339 876,125 29,833,703 Municipal securities - - 354,836 4,715,544 SBA loan pools TOTALS 10,986 889,985 118,080 3,367,115 $ 81,476 $ 4,775,305 $ 1,382,815 $ 38,882,588 Management evaluates securities for other-than-temporary impairment on at least a quarterly basis, and more frequently when economic or market concerns warrant such evaluation. Consideration is given to (1) the length of time and the extent to which the fair value has been less than cost, (2) the financial condition and near-term prospects of the issuer, and (3) the intent and ability of the Bank to retain its investment in the issuer for a period of time sufficient to allow for any anticipated recovery in fair value. At December 31, 2018, 6 debt securities with an unrealized loss for less than one year and 57 debt securities with an unrealized loss for greater than one year depreciated approximately 3.2 percent from the Bank’s amortized cost basis. 34 of the securities are secured by Federal agency mortgage backed securities or U.S. Treasury obligations and direct obligations of U.S. Government agencies, 3 of the securities are corporate bonds, 15 are private-label collateralized mortgage obligations, and 11 of the securities are municipal bonds. These unrealized losses relate principally to current interest rates for similar types of securities. In analyzing an issuer’s financial condition, management considers whether the securities are issued by the Federal government or its agencies, whether downgrades by bond rating agencies have occurred, and the results of reviews of the issuer’s financial condition. As management has the ability to hold debt securities until maturity, or for the foreseeable future if classified as available-for-sale, management feels that the unrealized losses on the securities are not deemed to be other-than-temporary. During the year, the Bank transferred 29 municipal securities from held-to-maturity to available-for-sale. Based on changes in the current rate environment, management elected this change in an effort to more effectively manage the investment portfolio, including subsequently selling some securities that were formerly classified as held-to-maturity. The amortized cost of the securities that were transferred totaled $14.5 million and the net unrealized loss related to these securities totaled $608,000 on the date of transfer. This one was a one-time transfer, done in accordance with ASU 2017-02, and management does not believe that it has tainted its held to maturity classification. The Bank received $25,041,821 in proceeds from available-for-sale securities during the year ended December 31, 2018. As a result, the Bank recognized $0 million in gross gains and $1,181,108 in gross losses for the year ended December 31, 2018. Restricted investments consist of the following at December 31: Federal Reserve Bank stock Federal Home Loan Bank stock Community Bankers Bank stock TOTALS 2018 2017 $ 1,710,300 $ 1,571,300 1,299,700 66,000 896,200 66,000 $ 3,076,000 $ 2,533,500 FINANCIAL STATEMENTS 17 4. Loans Receivable Loans receivable include the following at December 31: Commercial and industrial Real estate - commercial Real estate - construction Real estate - residential Consumer and other Subtotals Deferred loan fees, net TOTALS 2018 2017 $ 76,919,421 $ 64,153,229 191,543,985 202,399,170 32,335,250 38,721,639 67,991,855 81,752,643 25,506,991 20,754,304 394,297,502 407,780,985 (217,045) (448,213) $ 394,080,457 $ 407,332,772 Commercial and industrial loans: The commercial lending portfolio consists primarily of commercial and industrial loans for the financing of accounts receivable, property, plant and equipment. Commercial loans typically are made on the basis of the borrower’s ability to repay the loan from the cash flow from its business and are secured by business assets, such as commercial real estate, accounts receivable, equipment and inventory, the values of which may fluctuate over time and generally cannot be appraised with as much precision as residential real estate. To manage these risks, the Bank’s policy is to secure commercial loans originated with both the assets of the business, which are subject to the risks described above, and other additional collateral and guarantees that may be available. Real estate - commercial loans: Commercial real estate loans are primarily secured by various types of commercial real estate, including office, retail, warehouse, industrial and other non-residential types of properties and are made to the owners and/or occupiers of such property. The repayment of loans secured by income-producing properties is typically dependent upon the successful operation of a business or real estate project, and thus may be subject to adverse conditions in the commercial real estate market or in the general economy. The Bank generally requires personal guarantees or endorsements with respect to these loans and loan-to-value ratios for commercial real estate loans, which generally do not exceed 80 percent. Real estate – construction loans: This portfolio consists of commercial and residential construction loans secured by real estate. The loans are secured by property and generally made with a loan-to-as-built and loan-to-as-completed value not exceeding 75 percent. Real estate - residential and home equity loans: This portfolio consists of residential first and second mortgage loans and home equity lines of credit and term loans secured primarily by the residences of borrowers. Residential mortgage loans and home equity lines of credit secured by owner-occupied property generally are made with a loan-to-value ratio of up to 80 percent. Consumer loans: This portfolio consists of car loans, boat loans, loans secured by stock and unsecured loans. The consumer loans are generally made to borrowers with a minimum credit score of 700 and a maximum debt to income ratio of 40%. An analysis of the allowance for possible loan losses based on type or loan segment, which identifies certain loans that are evaluated for individual or collective impairment, as of December 31 is as follows: YEAR 2018 Allowance for Loan Losses COMMERCIAL & INDUSTRIAL REAL ESTATE - COMMERCIAL REAL ESTATE - CONSTRUCTION REAL ESTATE - RESIDENTIAL CONSUMER TOTAL Beginning balance $ 767,017 $ 2,464,708 $ 864,183 $ 368,319 $ 98,143 $ 4,562,370 Charge-offs Recoveries Provision Reclassification1 Ending Balance - - - - (191,453) - - - (165,249) (356,702) 525 525 67,109 8,437 (220,624) 321,285 229,793 406,000 - - - (39,000) - (39,800) $ 834,126 $ 2,473,145 $ 452,106 $ 649,804 $ 163,212 $ 4,572,393 Individually evaluated for impairment - - - - - - Collectively evaluated for impairment 834,126 2,473,145 452,106 649,804 163,212 4,572,393 1 The reclassification in the current year relates to the removal of a reserve that was originally posted for the mortgage loans held- for-sale portfolio. This reserve is now recorded in Other Liabilities on the Balance Sheet 18 FINANCIAL STATEMENTS Loans Receivable Ending Balance $ 76,919,421 $191,543,985 $ 32,335,250 $ 67,991,855 $ 25,506,991 $394,297,502 Individually evaluated for impairment $ 1,185,111 $ 3,185,852 $ 500,000 $ 2,824,302 - $ 7,695,265 Collectively evaluated for impairment 75,734,310 188,358,133 31,835,250 65,167,553 25,506,991 386,602,237 YEAR 2017 Allowance for Loan Losses COMMERCIAL & INDUSTRIAL REAL ESTATE - COMMERCIAL REAL ESTATE - CONSTRUCTION REAL ESTATE - RESIDENTIAL CONSUMER TOTAL Beginning balance $ 542,229 $ 2,311,155 $ 838,328 $ 402,615 $ 55,754 $ 4,150,081 Charge-offs Recoveries Provision - 96,189 - - (283,530) 569,630 - - - - 128,599 153,553 (260,245) (34,296) 42,389 (283,530) 665,819 30,000 Ending Balance $ 767,017 $ 2,464,708 $ 864,183 $ 368,319 $ 98,143 $ 4,562,370 Individually evaluated for impairment 28,529 - - Collectively evaluated for impairment 738,488 2,464,708 864,183 115,000 253,319 - 143,529 98,143 4,418,841 Loans Receivable Ending Balance $ 64,153,229 $202,399,170 $ 38,721,639 $ 81,752,643 $ 20,754,304 $407,780,985 Individually evaluated for impairment $ 125,625 $ 1,479,649 $ - $ 640,943 $ - $ 2,246,217 Collectively evaluated for impairment 64,027,604 200,919,521 38,721,639 81,111,700 20,754,304 405,534,768 An analysis of non-accrual and past due loans is as follows at December 31: YEAR 2018 30-59 DAYS PAST DUE 60-89 DAYS PAST DUE 90 DAYS OR MORE PAST DUE TOTAL PAST DUE CURRENT TOTAL LOANS RECEIVABLE NONACCRUAL LOANS Commercial and industrial $ 355,727 $ 220,352 $ - $ 576,079 $ 76,343,342 $ 76,919,421 $ 503,794 Real estate - commercial - Real estate - construction 1,575,669 Real estate - residential 853,813 - - - - - - - 191,543,985 191,543,985 - 500,000 2,075,669 30,259,581 32,335,250 500,000 - - 853,813 67,138,042 67,991,855 1,808,766 - 25,506,991 25,506,991 - $ 2,785,209 $ 220,352 $ 500,000 $ 3,505,561 $390,791,941 $394,297,502 $ 2,812,560 Consumer TOTALS YEAR 2017 Commercial and industrial $ - $ 125,625 $ - $ 125,625 $ 64,027,604 $ 64,153,229 $ 125,625 Real estate - commercial Real estate - construction Real estate - residential Consumer TOTALS - - - - - - - - - - - - 202,399,170 202,399,170 38,721,639 38,721,639 - - 540,500 540,500 81,212,143 81,752,643 540,500 - - 20,754,304 20,754,304 - $ - $ 125,625 $ 540,500 $ 666,125 $407,114,860 $407,780,985 $ 666,125 FINANCIAL STATEMENTS 19 An analysis of impaired loans based on loan segment is as follows at December 31: YEAR 2018 With no related allowance recorded: RECORDED INVESTMENT UNPAID PRINCIPAL BALANCE RELATED ALLOWANCE FOR LOAN LOSSES AVERAGE RECORDED INVESTMENT INTEREST INCOME RECOGNIZED Commercial and industrial $ 1,185,111 $ 1,308,693 $ - $ 1,195,950 $ 63,687 Real Estate - commercial Real Estate - construction Real Estate - residential Consumer With an allowance recorded: Commercial and industrial Real Estate - commercial Real Estate - construction Real Estate - residential Consumer TOTAL 3,185,852 3,185,852 500,000 500,000 2,824,302 2,848,237 - - - - - - - - - - - - Commercial and industrial 1,185,111 1,308,693 Real Estate - commercial 3,185,852 3,185,852 Real Estate - construction 500,000 500,000 Real Estate - residential 2,824,302 2,848,237 Consumer - - - - - - - - - - - - - - - - 3,231,715 500,000 3,289,832 147,545 16,389 199,735 - - - - - - - - - - - - 1,195,950 3,231,715 500,000 3,289,832 - 63,687 147,545 16,389 199,735 - $ 7,695,265 $ 7,842,782 $ - $ 8,217,497 $ 427,356 YEAR 2017 With no related allowance recorded: RECORDED INVESTMENT UNPAID PRINCIPAL BALANCE RELATED ALLOWANCE FOR LOAN LOSSES AVERAGE RECORDED INVESTMENT INTEREST INCOME RECOGNIZED Commercial and industrial $ - $ - $ - $ - $ - Real Estate - commercial Real Estate - construction Real Estate - residential Consumer With an allowance recorded: Commercial and industrial Real Estate - commercial Real Estate - construction Real Estate - residential Consumer TOTAL 1,479,649 1,479,649 - - 104,443 104,443 - - - - - - 1,489,050 71,712 - 116,779 - - 6,961 - 125,625 125,625 28,529 134,028 5,635 - - - - - - - - 536,500 536,500 115,000 657,084 - - - - Commercial and industrial 125,625 125,625 28,529 134,028 Real Estate - commercial 1,479,649 1,479,649 - - - - 1,489,050 - 640,943 640,943 115,000 773,863 - - - - $ 2,246,217 $ 2,246,217 $ 143,529 $ 2,396,941 $ 84,308 Real Estate - construction Real Estate - residential Consumer 20 FINANCIAL STATEMENTS - - - - 5,635 71,712 - 6,961 - No additional funds are committed to be advanced in connection with the impaired loans. One of the most significant factors in assessing the Bank’s loan portfolio is the risk rating. The Bank uses the following risk ratings to manage the credit quality of its loan portfolio: pass, special mention, substandard, doubtful and loss. Special mention loans are those loans that have potential weakness that deserves management’s close attention. These loans have potential weaknesses that may result in deterioration of the repayment prospects for the loan or the Bank’s credit position at some future date. Substandard loans are inadequately protected by current sound worth, paying capacity of the borrower, or pledged collateral. Doubtful loans have all the inherent weaknesses in the substandard classification and collection or liquidation in full is highly questionable. Loss loans are considered uncollectible and of such little value that continuance as an active asset is not warranted. All other loans not rated are considered to have a pass rating. An analysis of the credit quality indicators is as follows at December 31: YEAR 2018 PASS SPECIAL MENTION SUBSTANDARD DOUBTFUL LOSS Commercial and industrial $ 74,858,816 $ 1,025,857 $ 1,034,748 $ - $ - Real estate - commercial 184,916,352 3,441,781 3,185,852 Real estate - construction 31,835,250 - 500,000 62,471,813 25,506,991 2,671,805 2,848,237 - - - - - - - - - - $ 379,589,222 $ 7,139,443 $ 7,568,837 $ - $ - Real estate - residential Consumer TOTALS YEAR 2017 Commercial and industrial $ 63,394,410 $ 633,194 $ - $ 125,625 $ - Real estate - commercial 199,175,861 1,743,660 1,479,649 Real estate - construction 38,721,639 Real estate - residential Consumer TOTALS 81,111,699 20,725,029 - 82,272 29,275 - 558,672 - - - - - - - - - $ 403,128,638 $ 2,488,401 $ 2,038,321 $ 125,625 $ - A loan modification is classified as a troubled debt restructuring (TDR) if both of the following exist: 1) the borrower is experiencing financial difficulty, and 2) the Bank has granted a concession to the borrower. The assessment of whether the above conditions exist is subjective and requires management’s judgment. TDRs are typically modified through reductions in interest rates, reduction in payments, changing the payment terms or through extensions in term maturity. As of December 31, 2018 and December 31, 2017, the Bank had a recorded investment in troubled debt restructurings of $534,405 and $230,068, respectively. The Bank allocated $0 and $28,529 of specific allowance for those loans at December 31, 2018 and December 31, 2017. The Bank modified three loans during the year ended December 31, 2018 which were classified as TDRs. Concessions granted to borrowers include changes in interest rates, maturity dates and/or payment amounts or some combination of each. There were two credits classified as a TDR in the prior year which defaulted during the year ended December 31, 2018. These two credits were charged off in full and recognized through the allowance for loan loss reserve. The Bank has entered into transactions with certain directors, executive officers, significant stockholders and their affiliates. Such transactions were made in the ordinary course of business on substantially the same terms and conditions, including interest rates and collateral, as those prevailing at the same time for comparable transactions with other customers and did not, in the opinion of management, involve more than normal credit risk or present other unfavorable features. The aggregate amount of loans outstanding to such related parties was $2,660,871 and $1,463,571 at December 31, 2018 and 2017, respectively. New loans made to such related parties amounted to $3,106,500, and repayments amounted to $1,490,186 in 2018. FINANCIAL STATEMENTS 21 5. Bank Premises and Equipment Bank premises and equipment include the following: Furniture and equipment Leasehold improvements Construction in progress Software Total Cost Less accumulated depreciation 2018 2017 $ 1,802,846 $ 1,475,882 1,452,819 1,181,317 18,720 185,303 240,760 118,560 3,459,688 3,016,519 (1,710,753) (1,420,944) NET BANK PREMISES AND EQUIPMENT $ 1,748,935 $ 1,595,575 Depreciation and amortization of bank premises and equipment charged to expense amounted to $289,809 and $257,284 in 2018 and 2017, respectively. 6. Deposits The following are time deposits maturing in years ending December 31: 2019 2020 2021 2022 2023 TOTAL $ 122,156,615 44,246,614 28,289,152 5,744,181 1,855,749 $ 202,292,311 Time deposits in denominations that meet or exceed the FDIC minimum limit of $250,000 or more totaled $83,457,849 and $66,371,688 at December 31, 2018 and 2017, respectively. The Bank held related party deposits of approximately $6,442,635 and $7,083,000 at December 31, 2018 and 2017, respectively. 7. Borrowings and Advances The Bank’s borrowings from the Federal Home Loan Bank of Atlanta (FHLB) were $17.1 million and $10.4 million at December 31, 2018 and 2017, respectively. At December 31, 2018 and 2017, the weighted average rates on FHLB advances were 2.05% and 1.77%, respectively. These advances were secured by a blanket collateral agreement with the FHLB pledging the Bank’s portfolio of residential first mortgage loans with a collateral value of $79.4 million and $41.9 million. FHLB advances are subject to prepayment penalties. During the year ended December 31, 2018 and 2017, the Company prepaid no FHLB advances. Callable advances are callable at the option of the FHLB. If an advance is called, the Bank has the option to pay off the advance without penalty, re-borrow funds on different terms, or convert the advance to a three-month floating rate advance tied to LIBOR. The Bank did not have any callable FHLB advances at December 31, 2018 or 2017. Advances from the FHLB are summarized by year of maturity and weighted average interest rate at December 31, 2018: 2019 2020 2021 2022 TOTAL 22 FINANCIAL STATEMENTS AMOUNT WEIGHTED AVERAGE RATE $ 5,500,000 4,500,000 3,000,000 4,142,857 $ 17,142,857 2.37% 2.13% 1.34% 2.05% 8. Income Taxes Year-end deferred tax assets and liabilities were due to the following: 2018 2017 Deferred tax assets Allowance for loan losses Unearned loan fees and costs, net Accrued compensation Non-accrual loan interest Unrealized losses on securities Stock options Restricted stock Net operating loss carryforward Other Deferred Tax Liabilities Depreciation Interest rate lock Net deferred tax assets Income tax expense (benefit) was as follows: Current tax expense Deferred tax expense (benefit) Deferred tax asset adjustment for enacted change in tax rate $ 852,944 $ 820,195 45,579 114,418 6,000 298,812 - 52,903 193,941 11,803 94,125 52,500 11,690 152,502 52,734 - - - 1,576,400 1,183,746 304,636 24,251 328,887 200,868 8,264 209,132 $ 1,247,513 $ 974,614 2018 $ 84,166 (126,589) - 2017 $ 1,098,859 687,602 603,331 $ (42,423) $ 2,389,792 Income tax expense for 2017 included a downward adjustment of net deferred tax assets in the amount of $603,331, recorded as a result of the enactment of the Tax Cuts and Jobs Act on December 22, 2017. The Bank’s marginal tax rate prior to the enactment was 34%. Effective January 1, 2018, the Bank’s tax rate is 21%. Effective tax rates differ from the federal statutory rate of 21% for 2018 and 34% for 2017, which is applied to income before income taxes due to the following: Federal statutory rate times financial statement income Effect of: Tax-exempt income, net of disallowance Earnings from bank-owned life insurance Deferred tax asset adjustment for enacted change in tax rate Stock compensation Other 2018 $ 31,259 2017 $ 1,728,938 (111,618) (13,266) - (69,659) 120,861 (138,966) (19,183) 603,331 68,786 146,886 $ (42,423) $ 2,389,792 9. Capital Requirements The Bank is subject to various regulatory capital requirements administered by Federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect on the Bank’s financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Bank must meet specific capital guidelines that involve quantitative measures of their assets, liabilities and certain off-balance sheet items as calculated under regulatory accounting practices. The Bank’s capital amounts and classification under the prompt corrective action guidelines are also subject to qualitative judgments by the regulators about components, risk weightings and other factors. FINANCIAL STATEMENTS 23 Quantitative measures established by regulation to ensure capital adequacy require the Bank to maintain minimum amounts and ratios as of January 1, 2015, of total capital, Tier 1 capital and common equity Tier 1 capital to risk-weighted assets (as defined in the regulations), and Tier 1 capital to adjusted average total assets (as defined). Prior to January 1, 2015, minimum amounts and ratios of total capital, Tier 1 capital and Tier 1 capital to adjusted average total assets (as defined), were required. Management believes, as of December 31, 2018 and, 2017, that the Bank meets all the capital adequacy requirements to which it is subject. As of December 31, 2018, the Bank was categorized as well capitalized under the regulatory framework for prompt corrective action. To remain categorized as well capitalized, the Bank will have to maintain minimum total risk-based, Tier 1 risk-based, CET1 and Tier 1 leverage ratios as disclosed in the following table. There are no conditions or events since the most recent notification that management believes have changed the Bank’s prompt corrective action category. The Bank’s actual capital amounts and ratios as of December 31, 2018 and 2017 are as follows: ACTUAL FOR CAPITAL ADEQUACY PURPOSES MINIMUM TO BE WELL CAPITALIZED UNDER PROMPT CORRECTIVE ACTION PROVISIONS AMOUNT RATIO AMOUNT RATIO AMOUNT RATIO $64,810,831 15.85% $32,712,769 8.00% $40,890,961 10.00% $60,238,439 14.73% $24,534,577 6.00% $32,712,769 8.00% $60,238,439 14.73% $18,400,932 4.50% $26,579,125 6.50% $60,238,439 12.16% $19,821,838 4.00% $24,777,298 5.00% $60,370,258 14.41% $33,508,352 8.00% $41,885,440 10.00% $55,807,888 13.32% $25,131,264 6.00% $33,508,352 8.00% $55,807,888 13.32% $18,848,448 4.50% $27,225,536 6.50% $55,807,888 10.19% $21,916,680 4.00% $27,395,850 5.00% DEC. 31, 2018 Total Capital (to Risk Weighted Assets) Tier 1 Capital (to Risk Weighted Assets) Common Equity Tier 1 Capital (to Risk Weighted Assets) Tier 1 Capital (to Adjusted Average Assets) DEC. 31, 2017 Total Capital (to Risk Weighted Assets) Tier 1 Capital (to Risk Weighted Assets) Common Equity Tier 1 Capital (to Risk Weighted Assets) Tier 1 Capital (to Adjusted Average Assets) 10. Stock Option & Equity Plan In 2007, the Bank established the 2007 stock option and equity plan (the Plan) for executives, other employees, officers, directors and consultants. Shares have been reserved for issuance by the Bank upon the grant of stock options or restricted stock awards. Shares issued under the Plan may be granted at not less than 100 percent of the fair market value at the grant date. The shareholders approved increasing the number of authorized shares by 200,000 and 200,000 at the August 2018 and March 2016 annual meetings, respectively. The authorized and granted options under the Plan are as follows at December 31, 2018: 2007 Plan AUTHORIZED GRANTED 1,075,280 979,761 VESTED 828,957 The stock options shall not be exercisable more than ten years after the date such option is granted. Shares typically vest over periods ranging from one to four years. At December 31, 2018, there was approximately $103,944 in unrecognized compensation expense related to non-vested stock options that are expected to be recognized over a weighted average 24 FINANCIAL STATEMENTS period of 0.77 years. At December 31, 2017, there was approximately $246,000 in unrecognized compensation expense related to non-vested share-based compensation. Amounts and the number of options have been retrospectively adjusted for the 5% stock dividend that was effective on, June 23, 2017. The Bank canceled and reissued stock options granted in 2007. The following summarizes the option activity under the Plan: OUTSTANDING, DECEMBER 31, 2016 Grants Exercised Canceled or expired OUTSTANDING, DECEMBER 31, 2017 Grants Exercised Canceled or expired OUTSTANDING, DECEMBER 31, 2018 NUMBER OF SHARES WEIGHTED AVERAGE EXERCISE PRICE 698,392 42,186 (8,749) (35,050) 696,779 - (315,903) (50,427) 330,449 $ 6.92 10.16 7.53 8.81 7.01 - 7.11 8.69 $ 6.67 There were no stock options granted during the year ended December 31, 2018. The weighted average remaining contractual life of options outstanding as of December 31, 2018 is 4.00 years. Stock-based compensation cost is measured at the grant date based on the fair value of the award and is recognized as expense on a straight-line basis over the requisite service period, which is the vesting period. The Bank uses the Black-Scholes option pricing model to determine the fair value of stock options. The fair value of the stock based payment awards is affected by the price of the stock and a number of financial assumptions and variables. These variables include the risk-free interest rate, expected dividend rate, expected stock price volatility and the expected life of the options. The expected volatility is based on the average of the historical volatility of peer institutions and the Bank. The risk-free interest rate is the implied yield available on U.S. Treasury bonds with a remaining term equal to the expected term of the options granted. The expected life is based on the average of the contracted life and vesting schedule for the options granted. The dividend yield assumption is based on expected dividend payouts of zero. In 2018, 125,000 voting common shares of restricted stock were granted to two executives in connection with their overall compensation plan. 50,000 shares were granted September 25, 2018 as part of a performance-based restricted stock agreement at a value of $12.21 for the first 10,000 shares. All subsequent shares will be valued upon the determination of future performance criteria. These restricted shares vest in accordance with tranches over five performance periods, March 15, 2019, March 15, 2020, March 15, 2021, March 15, 2022, and March 15, 2023. 50,000 shares were granted September 25, 2018 as part of a time-based restricted stock agreement at a value of $12.21. These restricted shares cliff vest over a five year period beginning December 15, 2018. As of December 31, 2018, 10,000 of the time-based restricted shares have vested. 25,000 shares were granted October 1, 2018 as part of a performance-based restricted stock agreement at a value of $12.05 for the first 5,000 shares. All subsequent shares will be valued upon the determination of future performance criteria. These restricted shares vest in accordance with tranches over the same five performance periods noted above. For the years ended December 31, 2018 and 2017, the Bank recognized $382,592 and $225,837 in stock-based compensation expense, respectively. 11. Operating Leases In December 2015, the Bank exercised its third five-year option for the branch facility located at 502 Maple Avenue in Vienna, Virginia. The agreement provides for a term of five years ending December 2020. The total base annual lease payments for the base year of the third extension are $85,223, increasing a maximum of five percent per annum thereafter. The lease agreement includes approximately 1,862 square feet on the ground floor for the branch facility. The lease agreement includes additional rent payments based on a pro rata portion of annual taxes and common area maintenance charges. In October 2004, the Bank entered into a lease for its headquarters and an additional branch facility at 10555 Main Street in Fairfax, Virginia. The agreement provided for an initial lease term of ten years commencing January 1, 2005 and ending December 31, 2014. In December 2014, the Bank entered into an updated agreement that separated the headquarters and branch space. The headquarters space lease for 2,405 square feet was extended for an additional year ending December 31, 2015. Total base annual payments under the one-year extension are $225,855 for both the headquarters and branch space. The lease for this space was again extended through October 31, 2016, at which point the space was vacated. Monthly lease payments under the extension were $7,015. The agreement included additional rent payments based on a pro rata portion of annual taxes, common area maintenance charges, and utilities. FINANCIAL STATEMENTS 25 The updated lease agreement for the branch is for an initial lease term of ten years commencing January 1, 2016 and ending December 31, 2025. Total base annual lease payments are $125,895 for the first year, increasing 3 percent per annum thereafter. The agreement includes additional rent payments based on a pro rata portion of annual taxes, common area maintenance charges, and utilities. The Bank has the right to renew the branch lease for two periods of five additional years as provided for in the lease. The lease agreement for the branch space is for 3,597 square feet. In September 2015, the Bank entered into a new lease agreement for suites on the second and sixth floors at 10555 Main Street in Fairfax, Virginia. The agreement provides for an initial lease term of eight years commencing January 1, 2016 and ending December 31, 2023. Total base annual lease payments are $352,806 for the first year, increasing three percent per annum thereafter. The lease agreement is for 13,189 square feet. The agreement includes the option to renew the lease for two periods of five additional years at the then current market rate. The agreement includes additional rent payments based on a pro rata portion of annual taxes, common area maintenance charges, and utilities. In November 2013, the Bank entered into a lease for an additional branch facility at 11700 Plaza America Drive in Reston, Virginia. The agreement provides for an initial lease term of 10 years commencing May 1, 2014 and ending April 30, 2024 with the option to extend the term for two additional periods of five years each. Total base annual lease payments are $80,576 for the first year, increasing 2.75% per annum thereafter. The lease agreement is for 2,518 square feet. The agreement includes additional rent payments based on a pro rata portion of annual taxes, common area maintenance charges, and utilities. In February 2017, the Bank entered into a lease agreement for office space in Chantilly, Virginia. The agreement provides for an initial lease term of three years commencing March 1, 2017 through February 28, 2020 with the option to extend the term for an additional three years. Total base annual payments are $161,400 for the first year increasing 3% per annum thereafter. The lease agreement is for 6,725 square feet. The agreement includes additional rent payments based on a pro rata portion of annual taxes, common area maintenance charges, and utilities. In June 2017, the Bank entered into a lease agreement for additional office space in Chantilly, Virginia. The agreement provides for an initial lease term of five years commencing December 1, 2017 through November 30, 2022 with the option to extend the term for an additional two terms of five years each. Total base annual payments are $33,360 for the first year increasing 2.5% per annum thereafter. The lease agreement is for 1,112 square feet. The agreement includes additional rent payments based on a pro rata portion of annual taxes, common area maintenance charges, and utilities. The following are the future minimum lease payments at December 31, 2018: YEAR ENDING DECEMBER 31 2019 2020 2021 2022 2023 Thereafter $ 889,986 912,570 863,428 701,143 682,420 513,999 $ 4,563,546 Rent expense amounted to $913,935 and $823,706 for the years ended December 31, 2018 and 2017, respectively. 12. Fair Value Measurements Fair value is defined as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. U.S. GAAP requires that valuation techniques maximize the use of observable inputs and minimize the use of unobservable inputs. U.S. GAAP also establishes a fair value hierarchy which prioritizes the valuation inputs into three broad levels. Based on the underlying inputs, each fair value measurement in its entirety is reported in one of the three levels. These levels are: Level 1 – inputs to the valuation methodology are based upon unadjusted quoted prices for identical assets or liabilities in active markets that the Bank has the ability to access. Level 2 – inputs to the valuation methodology include: quoted prices for similar assets or liabilities in active markets, quoted prices for identical or similar assets or liabilities in markets that are not active, inputs other than quoted prices that are observable for the asset or liability, and market-corroborated inputs. If the asset or liability has a specified (contractual) term, the Level 2 input must be observable for substantially the full term of the asset or liability. Level 3 – inputs to the valuation methodology are unobservable and significant to the fair value measurement. Level 3 assets and liabilities measured at fair value are based on one or more of three valuation techniques (market, cost, or income approach). The market approach evaluates prices and other relevant information generated by market transactions involving identical or comparable assets or liabilities. The cost approach evaluates the amount that would be required to replace the 26 FINANCIAL STATEMENTS service capacity of an asset (i.e., replacement cost). The income approach uses techniques that convert future amounts to a single present amount based on market expectations (including present value techniques, option-pricing models, and lattice models). The asset’s or liability’s fair value measurement level within the fair value hierarchy is based on the lowest level of any input that is significant to the fair value measurement. Valuation techniques used need to maximize the use of observable inputs and minimize the use of unobservable inputs. The following describes the valuation techniques used by the Bank to measure certain financial assets and liabilities recorded at fair value on a recurring basis in the financial statements: SECURITIES AVAILABLE-FOR-SALE: Securities available-for-sale are recorded at fair value on a recurring basis. Fair value measurement is based upon quoted market prices, when available (Level 1). If quoted market prices are not available, fair values are measured utilizing independent valuation techniques of identical or similar securities for which significant assumptions are derived primarily from or corroborated by observable market data. Third party vendors compile prices from various sources and may determine the fair value of identical or similar securities by using pricing models that considers observable market data (Level 2). LOANS HELD-FOR-SALE: The Bank originates fixed rate residential loans on a servicing released basis in the secondary market. Loans closed but not yet settled with an investor, are carried in the Bank’s loans held for sale portfolio. These loans are fixed rate residential loans that have been originated in the Bank’s name and have closed. Virtually all of these loans have commitments to be purchased by investors at a locked-in price with the investors on the same day that the loan was locked in with the Bank’s customers. Therefore, these loans present very little market risk for the Bank and are classified as Level 2. The carrying amount of these loans approximates fair value. The following table presents the balances of financial assets and liabilities measured at fair value on a recurring basis as of December 31: QUOTED PRICES IN ACTIVE MARKETS FOR IDENTICAL ASSETS (LEVEL 1) SIGNIFICANT OTHER OBSERVABLE INPUTS (LEVEL 2) SIGNIFICANT UNOBSERVABLE INPUTS (LEVEL 3) FAIR VALUE 2018 Available-for-sale securities $ 48,204,339 $ - $ 48,204,339 $ - Loans held for sale 4,415,520 - $ 4,415,520 - $ 52,619,859 $ - $ 52,619,859 $ - 2017 Available-for-sale securities $ 61,989,669 $ - $ 61,989,669 $ - Loans held for sale 7,772,501 - $ 7,772,501 - $ 69,762,170 $ - $ 69,762,170 $ - Certain financial assets are measured at fair value on a nonrecurring basis in accordance with GAAP. Adjustments to the fair value of these assets usually result from the application of lower-of-cost-or-market accounting or write-downs of individual assets. The following describes the valuation techniques used by the Bank to measure certain financial assets recorded at fair value on a nonrecurring basis in the financial statements: IMPAIRED LOANS: Loans are designated as impaired when, in the judgment of management based on current information and events, it is probable that all amounts due according to the contractual terms of the loan agreement will not be collected. The measurement of loss associated with impaired loans can be based on either the observable market price of the loan or the fair value of the collateral. Fair value is measured based on the value of the collateral securing the loans. Collateral may be in the form of real estate or business assets, including equipment, inventory and accounts receivable. The vast majority of the collateral is real estate. The value of real estate collateral is determined utilizing an income or market valuation approach based on an appraisal conducted by an independent, licensed appraiser outside of the Bank using observable market data (Level 2). However, if the collateral is a house or building in the process of construction, or if an appraisal of the real estate property is over two years old, then the fair value is considered Level 3. The value of business equipment is based upon an outside appraisal if deemed significant, or the net book value on the applicable business’ financial statements if not considered significant using observable market data. Likewise, values for inventory and accounts FINANCIAL STATEMENTS 27 receivable collateral are based on financial statement balances or aging reports (Level 3). Impaired loans allocated to the allowance for loan losses are measured at fair value on a nonrecurring basis. Any fair value adjustments are recorded in the period incurred as provision for possible loan losses on the statements of operations. The following table summarizes the Bank’s financial assets that were measured at fair value on a nonrecurring basis as of December 31: QUOTED PRICES IN ACTIVE MARKETS FOR IDENTICAL ASSETS (LEVEL 1) SIGNIFICANT OTHER OBSERVABLE INPUTS (LEVEL 2) SIGNIFICANT UNOBSERVABLE INPUTS (LEVEL 3) FAIR VALUE 2018 Impaired loans 2017 Impaired loans $ - $ - $ - $ - $ 518,596 $ - $ - $ 518,596 There were no financial assets measured at fair value on a non-recurring basis as of December 31, 2018. The following table presents quantitative information about Level 3 fair value measurements for financial assets measured at fair value on a non- recurring basis as of December 31, 2017: FAIR VALUE MEASUREMENTS AT DECEMBER 31, 2017 FAIR VALUE VALUATION TECHNIQUE(S) UNOBSERVABLE INPUTS RANGE OF INPUTS Impaired loans $ 518,596 Appraisals Discount to reflect current market conditions and estimated selling costs 10% - 15% FASB ASC 825, Financial Instruments, requires disclosure about fair value of financial instruments, including those financial assets and financial liabilities that are not required to be measured and reported at fair value on a recurring or nonrecurring basis. ASC 825 excludes certain financial instruments and all nonfinancial instruments from its disclosure requirements. Accordingly, the aggregate fair value amounts presented may not necessarily represent the underlying fair value of the Bank. Additionally, in accordance with ASU 2016-01, which the Bank adopted on January 1, 2018 on a prospective basis, the Bank uses the exit price notion, rather than the entry price notion, in calculating the fair values of financial instruments not measured at fair value on a recurring basis. FAIR VALUE MEASUREMENTS AT DECEMBER 31, 2018 USING CARRYING AMOUNT LEVEL 1 LEVEL 2 LEVEL 3 TOTAL Financial assets Cash and due from banks $ 1,270,559 $ 1,270,559 $ - $ - $ 1,270,559 Interest bearing deposits with banks 14,376,684 14,376,684 Federal funds sold - Securities available-for-sale 48,204,339 Securities held-to-maturity Loans held for sale Loans receivable, net - 4,415,520 389,508,064 - - - - - Accrued interest receivable 1,229,534 1,229,534 - - 48,204,339 - 4,415,520 - - Bank-owned life insurance 12,401,317 - 12,401,317 - - - - - 14,376,684 - 48,204,339 - 4,415,520 390,930,000 390,930,000 - - 1,229,534 12,401,317 TOTAL FINANCIAL ASSETS $471,406,017 $ 16,876,777 $ 65,021,176 $390,930,000 $472,827,953 Financial liabilities Demand deposits Time deposits $198,439,454 $198,439,454 $ - $ - $198,439,454 Federal Home Loan Bank advances 17,142,857 202,292,311 - - 201,319,000 17,170,803 Accrued interest payable 218,537 218,537 - - - - 201,319,000 17,170,803 218,537 TOTAL FINANCIAL LIABILITIES $418,093,159 $198,657,991 $218,489,803 $ - $417,147,794 28 FINANCIAL STATEMENTS FAIR VALUE MEASUREMENTS AT DECEMBER 31, 2017 USING CARRYING AMOUNT LEVEL 1 LEVEL 2 LEVEL 3 TOTAL Financial assets Cash and due from banks $ 1,164,368 $ 1,164,368 $ - $ - $ 1,164,368 Interest bearing deposits with banks 33,936,870 33,936,870 Federal funds sold 127,000 127,000 Securities available-for-sale Securities held-to-maturity Loans held for sale Loans receivable, net 61,989,669 14,869,181 7,772,501 402,770,402 - - - - Accrued interest receivable 1,643,427 1,643,427 - - 61,989,669 14,851,944 7,772,501 - - Bank-owned life insurance 2,338,146 - 2,338,146 - - - - - 33,936,870 127,000 61,989,669 14,851,944 7,772,501 398,360,000 398,360,000 - - 1,643,427 2,338,146 TOTAL FINANCIAL ASSETS $526,611,564 $ 36,871,665 $ 86,952,260 $398,360,000 $522,183,925 Financial liabilities Demand deposits Time deposits $256,487,419 $256,487,419 $ - $ - $256,487,419 Federal Home Loan Bank advances 10,428,571 209,493,201 - - 209,039,000 10,454,643 Accrued interest payable 162,749 162,749 - - - - 209,039,000 10,454,643 162,749 TOTAL FINANCIAL LIABILITIES $476,571,940 $256,650,168 $219,493,643 $ - $476,143,811 13. Financial Instruments with Off-Balance Sheet Risk In the normal course of business, the Bank has outstanding commitments and contingent liabilities, such as commitments to extend credit and standby letters of credit, which are not included in the accompanying financial statements. The Bank’s exposure to credit loss in the event of nonperformance by the other party to the financial instruments for commitments to extend credit and standby letters of credit is represented by the contractual or notional amount of those instruments. The Bank uses the same credit policies in making such commitments as it does for instruments that are included in the balance sheets. Financial instruments whose contract amount represents credit risk were approximately as follows: Commitments to extend credit Standby letters of credit 2018 2017 $ 71,394,000 $ 95,568,000 $ 2,446,000 $ 2,372,000 Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The Bank evaluates each customer’s creditworthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary by the Bank upon extension of credit, is based on management’s credit evaluation. Collateral held varies, but may include accounts receivable, inventory, property and equipment, and income-producing commercial properties. Standby letters of credit are conditional commitments issued by the Bank to guarantee the performance of a customer to a third party. Standby letters of credit generally have fixed expiration dates or other termination clauses and may require payment of a fee. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers. The Bank’s policy for obtaining collateral, and the nature of such collateral, is essentially the same as that involved in making commitments to extend credit. The Bank had one financial letter of credit drawn during 2018. The total commitment for this letter of credit is $155,000. The letter of credit is secured by a second deed of trust on owner-occupied real estate which is subordinate to a first deed of trust held by the Bank. The Bank has not incurred any losses on its commitments in 2018 or 2017. 14. Deferred Benefits The Bank has a contributory 401(k) savings plan covering substantially all employees, which allows eligible employees to FINANCIAL STATEMENTS 29 contribute up to 100 percent of their compensation, subject to the limits established by the IRS for 401(k) contributions. The Board of Directors may elect to approve to match a portion of each employee’s contribution. The Bank elected to make a discretionary contribution of approximately $235,000 and $226,000 in 2018 and 2017 for employee service rendered in 2017 and 2016, respectively. There was no accrual for a discretionary contribution made during the year ended December 31, 2018. The Bank has deferred compensation plans for its directors, and its executives. Under the directors’ plan, a director may elect to defer all or a portion of any director-related fees, including fees for serving on board committees. Under the executives’ plan, certain employees may defer all or a portion of their compensation, including any bonus compensation. 15. Accumulated Other Comprehensive Loss The following table presents the changes in accumulated other comprehensive loss, by category, net of tax, for the periods indicated: Unrealized Gains (Losses) on Available-for-Sale Securities Unrealized Losses on Securities Transferred from Available-for-Sale to Held-to Maturity Accumulated Other Comprehensive Loss) BALANCE AT DECEMBER 31, 2016 $ (461,355) $ (62,047) $ (523,402) Amortization of transferred securities, net of tax of $1,477 Reclassification for (gains) losses on sales net of tax of $6,101 Unrealized gains net of tax of $27,347 Reclassification of stranded tax effects from change in tax rate - (11,842) 53,084 (82,749) 2,868 - - (11,657) 2,868 (11,842) 53,084 (94,406) BALANCE AT DECEMBER 31, 2017 $ (502,862) $ (70,836) $ (573,698) Unrealized gains (losses) net of tax of $413,173 (1,554,314) Reclassification for (gains) losses on sales net of tax of $248,033 933,075 - - Amortization of transferred securities, net of tax of $18,830 - 70,836 (1,554,314) 933,075 70,836 BALANCE AT DECEMBER 31, 2018 $ (1,124,101) $ - $ (1,124,101) 16. Legal Contingencies Various legal claims can arise from time to time in the normal course of business which, in the opinion of management, will have no material effect on the Bank’s financial statements. 17. Related Party Transactions In 2017, the Bank began using a brokerage firm, at which one of the Bank’s directors is a principal, through which it offers benefits such as payroll services and health and dental insurance for employees of the Bank. The brokerage firm receives commission payments directly from the benefit providers and the Bank pays no fees to the brokerage firm. Also, in 2018 and 2017, the Bank obtained legal services from two separate law firms, for which one of its directors was a partner. 30 FINANCIAL STATEMENTS SHAREHOLDER & COMPANY INFORMATION BOARD OF DIRECTORS H. JASON GOLD CHAIRMAN JOHN T. ROHRBACK VICE CHAIRMAN CYNTHIA CARTER ATWATER DIRECTOR JOSEPH J. THOMAS PRESIDENT AND CEO ROBERT D. FALESE JR. DIRECTOR BRANDON C. PARK DIRECTOR LAUREN FRIEND MCKELVEY DIRECTOR EXECUTIVE OFFICERS & SENIOR LEADERSHIP TEAM JOSEPH J. THOMAS PRESIDENT AND CEO SHAUN E. MURPHY EXECUTIVE VICE PRESIDENT & CHIEF OPERATING AND CREDIT OFFICER RAJ MEHRA EXECUTIVE VICE PRESIDENT & CHIEF FINANCIAL OFFICER RICHARD A. HUTCHISON EXECUTIVE VICE PRESIDENT & CHIEF MORTGAGE OFFICER KATHLEEN S. CROSON EXECUTIVE VICE PRESIDENT & CHIEF BANKING OFFICER SHAREHOLDER & COMPANY INFORMATION 31 CORPORATE HEADQUARTERS The Freedom Bank of Virginia 10555 Main Street Fairfax, VA 22030 703-242-5300 TRANSFER AGENT American Stock Transfer & Trust Company Shareholder Services – Admin 5 Team 6201 Fifteenth Avenue Brooklyn, NY 11219 718-921-8300 www.astfinancial.com INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM Dixon Hughes Goodman LLP Gaithersburg, Maryland COMMON STOCK The Freedom Bank of Virginia Common stock is traded on the OTC Markets Group (OTCQX) under the symbol FDVA NOTICE OF ANNUAL MEETING The Annual Meeting of Shareholders will be held on Tuesday, May 28, 2019 – 1 p.m. at The Freedom Bank of Virginia Corporate Headquarters 10555 Main Street, Suite 600 Fairfax, VA 22030 32 SHAREHOLDER & COMPANY INFORMATION OUR IDEAS EMPOWER EMPLOYEES TO BENEFIT CLIENTS Experience Innovation • Bank With Freedom CHANTILLY FAIRFAX RESTON VIENNA 4500 Daly Drive, Suite 240 Chantilly, VA 20151 10555 Main Street, Suite 100 Fairfax, VA 22030 11700 Plaza America Drive, Suite 110 Reston, VA 22190 502 Maple Avenue West Vienna, VA 22180 571-395-4000 703-242-5300 703-663-2300 703-667-4170 MORTGAGE DIVISION PRINCE WILLIAM COUNTY 4211 Pleasant Valley Road Chantilly, VA 20151 703-766-6400 703-667-4166 OTCQX : FDVA 00DFDDF

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