NATIONAL BANKSHARES INC 10-Q

Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations $ in thousands, except share and per share data   The purpose of this discussion and analysis is to provide information about the financial condition and results of operations of the Company.  Please refer to the financial statements and other information included in this report as well as the Company’s 2020 Annual Report on Form 10-K for an understanding of the following discussion and analysis. References in the following discussion and analysis to “we” or “us” refer to the Company unless the context indicates that the reference is to the Bank.   Cautionary Statement Regarding Forward-Looking Statements   We make forward-looking statements in this Form 10-Q that are subject to significant risks and uncertainties.  These forward-looking statements include statements regarding our profitability, liquidity, allowance for loan losses, interest rate sensitivity, market risk, growth strategy, and financial and other goals, and are based upon our management’s views and assumptions as of the date of this report.  The words “believes,” “expects,” “may,” “will,” “should,” “projects,” “contemplates,” “anticipates,” “forecasts,” “intends,” or other similar words or terms are intended to identify forward-looking statements. These forward-looking statements are based upon or are affected by factors that could cause our actual results to differ materially from historical results or from any results expressed or implied by such forward-looking statements. These factors include, but are not limited to, changes in:   ● interest rates,   ● general and local economic conditions,   ● the legislative/regulatory climate,   ● monetary and fiscal policies of the U.S. Government, including policies of the U.S. Treasury, the Office of the Comptroller of the Currency, the Federal Reserve, the Consumer Financial Protection Bureau and the Federal Deposit Insurance Corporation (“FDIC”), and the impact of any policies or programs implemented pursuant to financial reform legislation,   ● unanticipated increases in the level of unemployment in the Company’s market,   ● the quality or composition of the loan and/or investment portfolios,   ● demand for loan products,   ● deposit flows,   ● competition,   ● demand for financial services in the Company’s market,   ● the real estate market in the Company’s market,   ● laws, regulations and policies impacting financial institutions,   ● technological risks and developments, and cyber-threats, attacks or events,   ● the Company’s technology initiatives,   ● steps the Company takes in response to the COVID-19 pandemic, the severity and duration of the pandemic, the uncertainty regarding new variants of COVID-19 that have emerged, the speed and efficacy of vaccine and treatment developments, the impact of loosening or tightening of government restrictions, the pace of recovery as the pandemic subsides and the heightened impact it has on many of the risks described herein,   ● performance by the Company’s counterparties or vendors,   ● applicable accounting principles, policies and guidelines, and   ● business disruption and/or impact due to the coronavirus or similar pandemic diseases. These risks and uncertainties should be considered in evaluating the forward-looking statements contained in this report. We caution readers not to place undue reliance on those statements, which speak only as of the date of this report. This discussion and analysis should be read in conjunction with the description of our “Risk Factors” in Item 1A of the most recently filed Form 10-K.   Cybersecurity The Company considers cybersecurity risk to be one of the greatest risks to its business. We have deployed a multi-faceted approach to limit the risk and impact of unauthorized access to customer accounts and to information relevant to customer accounts. We use digital technology safeguards, internal policies and procedures, and employee training to reduce the exposure of our systems to cyber-intrusions. We do not offer online account openings or loan originations, limit the dollar amount of online banking transfers to other banks, do not permit customers to submit address changes or wire requests through online banking, require a special vetting process for commercial customers who wish to originate ACH transfers, and limit certain functionalities of mobile banking. The Company also requires assurances from key vendors regarding their cybersecurity.   37 Table of Contents   Further, the Company has a program to identify, mitigate and manage its cybersecurity risks.  The program includes penetration testing and vulnerability assessment, technological defenses such as antivirus software, patch management, firewall management, email and web protections, an intrusion prevention system, a cybersecurity insurance policy which covers some but not all losses arising from cybersecurity breaches, as well as ongoing employee training.  The costs of these measures were $95 for the three months ended June 30, 2021 and $95 for the three months ended June 30, 2020. For the six months ended June 30, 2021 and June 30, 2020, the expense was $193 and $188 respectively. These costs are included in various categories of noninterest expense. However, it is not possible to fully eliminate exposure. The potential for financial and reputational losses due to cyber-breaches is increased by the possibility of human error, unknown system susceptibilities, and the rising sophistication of cyber-criminals to attack systems, disable safeguards and gain access to accounts and related information. We maintain insurance for these risks but insurance policies are subject to exceptions, exclusions and terms whose applications have not been widely interpreted in litigation. Accordingly, insurance can provide less than complete protection against the losses that result from cybersecurity breaches and pursuing recovery from insurers can result in significant expense. In addition, some risks such as reputational damage and loss of customer goodwill, which can result from cybersecurity breaches, cannot be insured against.   Response to COVID-19 Pandemic The COVID-19 pandemic has affected the global economy for approximately 15 months. The Company has complied with national, state and local guidelines to help reduce the spread of the virus, including implementing social distancing measures for employees and customers. The Company’s business relies on positive relationships with customers. At this time, we feel our customer relationships remain strong and our team remains ready to provide banking services. All forms of customer service are now available without restriction. The Company has a robust business continuity plan, and partners with vendors whom we believe also have robust business continuity plans. In implementing its business continuity plan to address the COVID-19 pandemic, the Company has not incurred material expenditures and does not anticipate material expenditures. Further, all critical functions are cross-trained as part of our business continuity preparedness. Controls over cash and physical assets have remained in place and internal controls over financial reporting and disclosure have been maintained. The Company continues to monitor the impact of the pandemic on significant estimates, including the allowance for loan losses, valuation of goodwill and pension obligations. The impact to the allowance for loan losses is discussed under the “Asset Quality” section. Analysis as of June 30, 2021 did not indicate negative impacts to the valuation of goodwill or pension obligations.   Overview   National Bankshares, Inc. is a financial holding company that was organized in 1986 under the laws of Virginia and is registered under the Bank Holding Company Act of 1956. NBI common stock is listed on the Nasdaq Capital Market and is traded under the symbol “NKSH.” NBI has two wholly-owned subsidiaries, the National Bank of Blacksburg and National Bankshares Financial Services, Inc. NBB is a community bank and does business as National Bank from twenty-five office locations and one loan production office. NBB is the source of nearly all of the Company’s revenue. NBFS does business as National Bankshares Investment Services and National Bankshares Insurance Services. Income from NBFS is not significant at this time, nor is it expected to be so in the near future.   Non-GAAP Financial Measures   This report refers to certain financial measures that are computed under a basis other than U.S. GAAP (“non-GAAP”), including the net interest margin and the noninterest margin.             Return on Average Assets and Return on Average Equity The return on average assets and return on average equity are measures of profitability. The return on average assets and return on average equity are calculated by annualizing net income and dividing by average year-to-date assets or equity, respectively. When net income includes larger nonrecurring items, the annualization magnifies their effect. In order to reduce distortion within the ratios, the Company adjusts net income for larger non-recurring items prior to annualization, and then nets the items against the annualized net income. The reconciliation of adjusted annualized net income, which is not a measurement under U.S. GAAP, is reflected in the table below.   38 Table of Contents   The following table details the calculation of annualized net income for the return on average assets and the return on average equity:   $ in thousands   Three months ended June 30,     2021   2020 Net Income   $ 4,613     $ 2,982   Items deemed non-recurring by management:                 Securities gains, net of tax of ($13) in 2020     -       (49 ) Adjusted net income     4,613       2,933   Adjusted net income, annualized     18,503       11,796   Items deemed non-recurring by management:                 Add: Securities gains, net of tax of $13 in 2020     -       49   Annualized net income for ratio calculation   $ 18,503     $ 11,845     $ in thousands   Six months ended June 30,     2021   2020 Net Income   $ 9,379     $ 6,961   Items deemed non-recurring by management:                 Less: partnership income (1) , net of tax of ($98) in 2021 and ($65) in 2020     (369 )     (244 ) Securities gains, net of tax of ($1) in 2021 and ($17) in 2020     (4 )     (65 ) Adjusted net income     9,006       6,652   Adjusted net income, annualized     18,161       13,377   Items deemed non-recurring by management:                 Add: partnership income, net of tax of $98 in 2021 and $65 in 2020     369       244   Add: Securities gains, net of tax of $1 in 2021 and $17 in 2020     4       65   Annualized net income for ratio calculation   $ 18,534     $ 13,686       (1) During the first quarter of each year, the Company adjusts its basis in partnership interests. During 2021 and 2020, the adjustment resulted in recognition of a gain. During 2021, the Company also received a one-time payout from a partnership interest, recognized in income. Partnership income is removed from income prior to annualization in order to avoid distortion, and added back to income after annualization.   Net Interest Margin The Company uses the net interest margin to measure profit on interest generating activities, as a percentage of total interest-earning assets. The net interest margin is calculated by dividing annualized taxable equivalent net interest income by total average earning assets. Because a portion of interest income earned by the Company is nontaxable, the tax equivalent net interest income is considered in the calculation of this ratio. Tax equivalent net interest income is calculated by adding the tax benefit realized from interest income that is nontaxable to total interest income then subtracting total interest expense. The tax rate utilized in calculating the tax benefit is 21%. The reconciliation of tax equivalent net interest income, which is not a measurement under U.S. GAAP, to net interest income, is reflected in the table below.   39 Table of Contents     $ in thousands   Three months ended June 30,     2021   2020 GAAP measures:                 Interest and fees on loans   $ 8,466     $ 8,419   Interest on interest-bearing deposits     39       14   Interest and dividends on securities - taxable     1,910       1,863   Interest on securities - nontaxable     482       454   Total interest income   $ 10,897     $ 10,750                     Interest on deposits   $ 834     $ 1,598   Net interest income   $ 10,063     $ 9,152                     Non-GAAP measures:                 Tax benefit on nontaxable loan income   $ 78     $ 120   Tax benefit on nontaxable securities income     160       137   Total tax benefit on nontaxable interest income   $ 238     $ 257   Total tax equivalent net interest income   $ 10,301     $ 9,409   Total tax equivalent net interest income, annualized   $ 41,317     $ 37,843     $ in thousands   Six months ended June 30,     2021   2020 GAAP measures:                 Interest and fees on loans   $ 17,016     $ 16,885   Interest on interest-bearing deposits     67       231   Interest and dividends on securities - taxable     3,693       4,219   Interest on securities - nontaxable     1,003       803   Total interest income   $ 21,779     $ 22,138                     Interest on deposits   $ 1,689     $ 3,394   Net interest income   $ 20,090     $ 18,744                     Non-GAAP measures:                 Tax benefit on nontaxable loan income   $ 153     $ 243   Tax benefit on nontaxable securities income     331       233   Total tax benefit on nontaxable interest income   $ 484     $ 476   Total tax equivalent net interest income   $ 20,574     $ 19,220   Total tax equivalent net interest income, annualized   $ 41,489     $ 38,651     40 Table of Contents   Efficiency Ratio The efficiency ratio is computed by dividing noninterest expense by the sum of net interest income on a tax-equivalent basis and noninterest income, excluding certain items management deems unusual or non-recurring. The tax rate used to calculate fully taxable equivalent basis is 21%. This is a non-GAAP financial measure that the Company believes provides investors with important information regarding operational efficiency. The components of the efficiency ratio calculation are summarized in the following table.   $ in thousands   Three months ended June 30,     2021   2020 Noninterest expense   $ 6,447     $ 6,077                     Taxable-equivalent net interest income   $ 10,301     $ 9,409   Noninterest income     1,941       1,745   Less: realized securities gains     -       (62 ) Total income for ratio calculation   $ 12,242     $ 11,092                     Efficiency ratio     52.66 %     54.79 %   $ in thousands   Six months ended June 30,     2021   2020 Noninterest expense   $ 12,983     $ 12,544                     Taxable-equivalent net interest income   $ 20,574     $ 19,220   Noninterest income     4,275       3,880   Less: partnership income     (467 )     (309 ) Less: realized securities gains     (5 )     (82 ) Total income for ratio calculation   $ 24,377     $ 22,709                     Efficiency ratio     53.26 %     55.24 %   Noninterest Margin The Company uses the noninterest margin to evaluate net noninterest expense. A lower noninterest margin indicates more effective expense management in relation to noninterest income generation. The noninterest margin is calculated as noninterest expense less noninterest income (excluding realized securities gain/loss, net), annualizing the difference, and dividing by average year-to-date assets. The annualization process excludes significant one-time items to prevent distortion. The reconciliation of adjusted noninterest income and adjusted noninterest expense, which are not measurements under GAAP, is reflected in the table below.       Three months ended June 30,     2021   2020 Noninterest expense under GAAP   $ 6,447     $ 6,077                     Noninterest income under GAAP   $ 1,941     $ 1,745   Less: realized securities gains     -       (62 ) Noninterest income for ratio calculation, non-GAAP   $ 1,941     $ 1,683                     Net noninterest expense, non-GAAP   $ 4,506     $ 4,394   Net noninterest expense, non-GAAP, annualized   $ 18,074     $ 17,673                     Average assets   $ 1,609,876     $ 1,393,227                     Noninterest margin     1.12 %     1.27 %   41 Table of Contents       Six months ended June 30,     2021   2020 Noninterest expense under GAAP   $ 12,983     $ 12,544                     Noninterest income under GAAP   $ 4,275     $ 3,880   Less: partnership income (1)     (467 )     (309 ) Less: realized securities gains     (5 )     (82 ) Noninterest income for ratio calculation, non-GAAP   $ 3,803     $ 3,489                     Net noninterest expense, non-GAAP   $ 9,180     $ 9,055   Net noninterest expense, non-GAAP, annualized   $ 18,512     $ 18,210   Add back: partnership income     467       309   Net noninterest expense, non-GAAP, annualized, adjusted   $ 18,979     $ 18,519                     Average assets   $ 1,570,610     $ 1,352,827                     Noninterest margin     1.21 %     1.37 %     (1) During the first quarter of each year, the Company adjusts its basis in partnership interests. During 2021 and 2020, the adjustment resulted in recognition of a gain. During 2021, the Company also received a one-time payout from a partnership interest, recognized in income. Partnership income is removed from income prior to annualization in order to avoid distortion, and added back to income after annualization.   Critical Accounting Policies   General             The Company’s financial statements are prepared in accordance with U.S. GAAP. The financial information contained within our statements is, to a significant extent, based on measures of the financial effects of transactions and events that have already occurred. A variety of factors could affect the ultimate value obtained when earning income, recognizing an expense, recovering an asset or relieving a liability. Although the economics of the Company’s transactions may not change, the timing of events that would impact the transactions could change. Presented below is a discussion of accounting policies that are the most important to the portrayal and understanding of the Company’s financial condition and results of operations. The Critical Accounting Policies require management’s most difficult, subjective, and complex judgments about matters that are inherently uncertain. If conditions occur that differ from our assumptions, depending upon the severity of such differences, the Company’s financial condition or results of operations may be materially impacted. The Company evaluates its critical accounting estimates and assumptions on an ongoing basis and updates them as needed.   Allowance for Loan Losses The allowance for loan losses is an estimate of probable losses inherent in our loan portfolio. The allowance is funded by the provision for loan losses, reduced by charge-offs of loans and increased by recoveries of previously charged-off loans. The determination of the allowance is based on two accounting principles, ASC Topic 450-20 (Contingencies) which requires that losses be accrued when occurrence is probable and the amount of the loss is reasonably estimable, and ASC Topic 310-10 (Receivables) which requires accrual of losses on impaired loans if the recorded investment exceeds fair value. Probable losses are accrued through two calculations, individual evaluation of impaired loans and collective evaluation of the remainder of the portfolio.   Impaired loans Impaired loans are identified through the Company’s credit risk rating process. Nonaccrual loan relationships that meet the Company’s balance threshold of $250 are designated impaired. Other loan relationships that meet the Company’s balance threshold of $250 and for which the Company does not expect to collect according to the note’s contractual terms are also designated impaired. All TDRs are impaired loans.   42 Table of Contents   TDRs TDRs are impaired loans and are measured for impairment under the same valuation methods as other impaired loans. In the ordinary course of business, the Company grants modification requests when deemed appropriate. Modifications may be granted for competitive reasons or to strengthen repayment prospects for borrowers who may or may not be experiencing financial difficulty. The Company reviews all modifications to determine whether, at the time of the modification, the borrower is experiencing financial difficulty and whether the Company provided a concession that it would not otherwise consider. Loans with modifications that meet these criteria are designated TDR. The CARES Act, the CAA as well as regulatory agencies, provided guidance allowing banks to forego TDR designation for COVID-19 related accommodations to loans that met certain criteria. Under the legislation, short-term modifications to loans that were not more than 30 days past due as of December 31, 2019 are not considered for TDR designation. In accordance with the guidance, the Company did not designate TDR status for modifications to loans impacted by the pandemic that met the criteria. Additional tracking mechanisms implemented at the beginning of the pandemic continue to aid the Company in monitoring COVID-19 related modifications. When the Company grants subsequent modifications to a loan that received a COVID-19 modification, in accordance with accounting guidance, it considers whether the totality of the accommodations along with the evaluation of borrower financial difficulty, exceed the criteria provided by the CARES Act and/or result in TDR status. Every modification is reviewed for TDR indicators with additional evaluation and documentation requirements for all COVID-19 related modifications to loans over $250.   Individual evaluation Impaired loans are individually evaluated at each reporting date. If the fair value of an impaired loan is less than the loan’s recorded investment, the deficit is accrued to the allowance for loan losses as a specific allocation.   Cash flow method Fair value measurement under the cash flow method incorporates assumptions specific to each loan for expected cash flows, timing of cash flows and the discount rate. For TDR loans, the discount rate used is the rate immediately prior to the modification that resulted in a TDR.   Collateral method Fair value under the collateral method is based upon the “as-is” value of independent appraisals or evaluations. Appraisals must conform to the Uniform Standards of Professional Appraisal Practice and are prepared by an independent third-party appraiser who is certified and licensed and who is approved by the Company. Appraisals may incorporate market analysis, comparable sales analysis, cash flow analysis and market data pertinent to the property to determine market value. Evaluations are prepared by third party providers and reviewed by employees of the Company who are independent of the loan origination, operation, management and collection functions. Evaluations provide a property’s market value based on the property’s current physical condition and characteristics and the economic market conditions that affect the collateral’s market value. Multiple sources of data contribute to the estimate of market value, including physical inspection, independent third-party automated tools, comparable sales analysis and local market information. Updated appraisals or evaluations are ordered when the loan becomes impaired if the appraisal or evaluation on file is more than 24 months old. Appraisals and evaluations are reviewed for propriety and reasonableness and may be discounted if the Company determines that the value exceeds reasonable levels. If an updated appraisal or evaluation has been ordered but has not been received by a reporting date, the fair value may be based on the most recent available appraisal or evaluation, discounted for age. The appraisal or evaluation value for a collateral-dependent loan for which recovery is expected solely from the sale of collateral is reduced by estimated selling costs.   Charge-off Estimated losses on collateral-dependent loans, as well as any other impairment loss considered uncollectible, are charged against the allowance for loan losses. Impairment losses that are not considered uncollectible or for loans that are not collateral-dependent are accrued in the allowance. Impaired loans with partial charge-offs are maintained as impaired until the remaining balance is satisfied.   Nonaccrual Status of Impaired Loans Impaired loans that are not TDRs and for which fair value measurement indicates an impairment loss are designated nonaccrual. A TDR loan that maintains current status for at least six months may accrue interest.   Collectively-evaluated loans Credit loss on collectively-evaluated loans is estimated by applying to current class balances the class historical charge-off rates and percentages for qualitative factors that affect credit risk. Additional allocations are provided for loans within each class rated special mention or classified and for loans designated high risk.   43 Table of Contents   Risk rating Risk ratings indicate credit quality and are assigned through the Company’s credit review function for larger loans and selective review of loans that fall below credit review thresholds. Loans that do not indicate heightened risk are rated as “pass.” All loans secured by real estate and all consumer loans are risk rated “classified” when they become 75 days past due. Commercial loans are rated “special mention” when they appear to have elevated credit risk indicated by possible deterioration in the borrower’s financial condition or collateral. Commercial loans not secured by real estate receive a rating of “classified” when they exhibit frequent or persistent delinquency exceeding 75 days or indicate a higher level of weakness in borrower financial condition. Qualitative factor allocations for pass-rated loans increased by 50% for special mention loans and doubled for classified loans.   High risk loans High risk loans include junior liens, interest only and high loan to value loans. High risk loans within each class are analyzed and allocated additional reserves based on current trends.   Standard allocations The analysis of certain factors results in standard allocations to all segments and classes. These factors include the risk from changes in lending policies, loan officers’ average years of experience, and economic factors including unemployment levels, bankruptcy rates, interest rate environment, and competition/legal/regulatory environments. Qualitative factors incorporate economic data targeted to the Company’s market. If market–specific information is not available on a timely basis, regional or national information that historically shows a high degree of correlation to market data may be used. Also applied to all segments and classes is an economic factor implemented to address COVID-19 uncertainty: national unemployment filings. Since local data is not available timely and historical analysis determined that local unemployment filings were closely correlated to national unemployment filings, the Company elected to allocate based upon national unemployment filings.   Allocations specific to each class Factors analyzed for each class, with resultant allocations based upon the level of risk assessed for each class, include the risk from changes in loan review, levels of past due loans, levels of nonaccrual loans, current class balance as a percentage of total loans, loans that received COVID-related modifications at are still in the modification period, and the percentage of high risk loans within the class.   Nonaccrual status The Company reviews loans with certain risk indicators to determine whether the loans should be placed on nonaccrual status, including loans that exceed 90 days past due, loans rated classified, loans with a non-COVID 19 related modification that provides relief from payments of interest or principle for more than 90 days. Loans in nonaccrual are reviewed on an individual loan basis to determine whether future payments are reasonably assured. To satisfy this criteria, the Company’s evaluation must determine that the underlying cause of the original delinquency or weakness that indicated nonaccrual status has been resolved, such as receipt of new guarantees, increased cash flows that cover the debt service or other resolution. Nonaccrual loans that demonstrate reasonable assurance of future payments and that have made at least six consecutive payments in accordance with repayment terms and timeframes may be returned to accrual status.   Sales, Purchases and Reclassification of Loans The Company finances mortgages under “best efforts” contracts with mortgage purchasers. The mortgages are designated as held for sale upon initiation. There have been no major reclassifications from portfolio loans to held for sale. Mortgages held for sale are not included in the calculation of the allowance for loan losses. Occasionally, the Company purchases or sells participations in loans. All participation loans purchased met the Company’s normal underwriting standards at the time the participation was entered. Participation loans are included in the appropriate portfolio balances to which the allowance methodology is applied.   Unallocated Surplus In addition to funding the allowance for loan losses based upon data analysis, the Company has the option to fund an unallocated surplus in excess to the calculated requirement, based upon management judgement. The Company’s policy permits an unallocated surplus of between 0% and 5% of the calculated requirement.   Estimation of the allowance for loan losses The estimation of the allowance involves analysis of internal and external variables, methodologies, assumptions and our judgment and experience. Key judgments used in determining the allowance for loan losses include internal risk rating determinations, market and collateral values, discount rates, loss rates, and our view of current economic conditions. These judgments are inherently subjective and our actual losses could be greater or less than the estimate. Future estimates of the allowance could increase or decrease based on changes in the financial condition of individual borrowers, concentrations of various types of loans, economic conditions or the markets in which collateral may be sold. The estimate of the allowance accrual determines the amount of provision expense and directly affects our financial results.   44 Table of Contents   The estimate of the allowance for June 30, 2021 considered market conditions as of June 30, 2021 where possible, and the most recent available information when data was not available as of June 30, 2021, portfolio conditions and levels of delinquencies at June 30, 2021, and net charge-offs in the eight quarters prior to the quarter ended June 30, 2021. Some of the available economic data lags the reporting date by one to three months. Delinquency levels at June 30, 2021 are lower than they might otherwise have been due to modifications granted to qualifying borrowers in accordance with regulatory guidance and legislative provisions in the CARES Act and CAA, including loan payment extensions, interest only periods and rate reductions to borrowers. Past due status will not occur during the period in which a payment is extended. Providing an interest only period affords borrowers lower payments during the interest only period. When extension periods and interest only periods expire, there may be increases in past dues that will increase the requirement for the allowance for loan loss. Management used its best judgement and efforts in incorporating possible impacts as of June 30, 2021 in estimating the allowance for loan losses, but if the current economic challenges worsen, the ultimate amount of loss could vary from that estimate. For additional discussion of the allowance, see Note 3 to the consolidated financial statements and “Asset Quality,” and “Provision and Allowance for Loan Losses.”   Goodwill Goodwill is subject to at least an annual assessment for impairment by applying a fair value based test. The Company contracts with a third party valuation expert to perform impairment testing in the fourth quarter of each year. The Company’s most recent impairment test was performed using data from September 30, 2020. Accounting guidance provides the option of performing preliminary assessment of qualitative factors before performing more substantial testing for impairment. The Company opted not to perform the preliminary assessment. The Company’s goodwill impairment analysis considered three valuation techniques appropriate to the measurement. The first technique uses the Company’s market capitalization as an estimate of fair value; the second technique estimates fair value using current market pricing multiples for companies comparable to the Company; while the third technique uses current market pricing multiples for change-of-control transactions involving companies comparable to the Company. The analysis did not result in an impairment assessment. Certain key judgments were used in the valuation measurement. Goodwill is held by the Company’s bank subsidiary. The bank subsidiary is 100% owned by the Company, and no market capitalization is available. Because most of the Company’s assets are comprised of the subsidiary bank’s equity, the Company’s market capitalization was used to estimate the Bank’s market capitalization. Other judgments include the assumption that the companies and transactions used as comparables for the second and third technique were appropriate to the estimate of the Company’s fair value, and that the comparable multiples are appropriate indicators of fair value, and compliant with accounting guidance.   Pension Plan The Company’s actuary determines plan obligations and annual pension plan expense using a number of key assumptions. Key assumptions may include the discount rate, the estimated return on plan assets and the anticipated rate of compensation increases. Changes in these assumptions in the future, if any, or in the method under which benefits are calculated, may impact pension assets, liabilities or expense.   Performance Summary   The following table presents the Company’s key performance ratios for the three and six months ended June 30, 2021 and June 30, 2020. Income and expense items are annualized for the ratios, except for basic and fully diluted earnings per share.       Three Months Ended     June 30, 2021   June 30, 2020 Return on average assets (1)     1.15 %     0.85 % Return on average equity (1) (4)     9.77 %     6.13 % Basic and fully diluted earnings per share (4)   $ 0.74     $ 0.46   Net interest margin (2)     2.72 %     2.90 % Noninterest margin (3)     1.12 %     1.27 % Efficiency ratio (5)     52.66 %     54.79 %   45 Table of Contents   The following table presents the Company’s key performance ratios for the six months ended June 30, 2021 and June 30, 2020 and the year ended December 31, 2020. The measures for June 30, 2021 and June 30, 2020 are annualized, except for basic and fully diluted earnings per share.       Six Months Ended June 30, 2021   Six Months Ended June 30, 2020   Twelve Months Ended December 31, 2020 Return on average assets (1)     1.18 %     1.01 %     1.15 % Return on average equity (1) (4)     9.63 %     7.15 %     8.21 % Basic and fully diluted earnings per share (4)   $ 1.49     $ 1.07     $ 2.48   Net interest margin (2)     2.80 %     3.05 %     2.98 % Noninterest margin (3)     1.21 %     1.37 %     1.22 % Efficiency ratio (5)     53.26 %     55.24 %     53.46 %   (1) Return on average assets and return on average equity are non-GAAP measures. Components of U.S. GAAP net income that are deemed non-recurring by management are removed prior to annualizing the adjusted net income. The adjusted net income is annualized. Items deemed non-recurring by management are added back to the annualized adjusted net income, and the total is divided by average assets for return on average assets, or divided by average equity for return on average equity. See “Non-GAAP Financial Measures” above. (2) Net interest margin is a non-GAAP measure. Tax advantaged portions of net interest income are adjusted to their fully-taxable equivalent basis and divided by average earning assets. See “Non-GAAP Financial Measures” above. (3) Noninterest margin is a non-GAAP measure. Noninterest income is adjusted for items deemed by management to be non-recurring and securities gains and losses. Adjusted noninterest income is subtracted from noninterest expense and the difference is annualized, then non-recurring items are added back and the sum is divided by average year-to-date assets. See “Non-GAAP Financial Measures” above. (4) During the three months ended June 30, 2021, the Company repurchased 150,130 shares under its publicly announced stock repurchase plan. The repurchase reduced shareholders equity by $5,363 during the second quarter. During the six months ended June 30, 2021, the Company repurchased 261,962 shares under its publicly announced stock repurchase plan. The repurchase reduced shareholders equity by $9,354 during the first six months of 2021. See “Non-GAAP Financial Measures” above. (5) The efficiency ratio is a non-GAAP financial measure that the Company believes provides investors with important information regarding operational efficiency. Such information is not prepared in accordance with GAAP and should not be viewed as a substitute for GAAP. See “Non-GAAP Financial Measures” above.   Growth   NBI’s key assets and liabilities and their growth from December 31, 2020 are shown in the following table.       June 30, 2021   December 31, 2020   Percent Change Interest-bearing deposits   $ 150,708     $ 120,725       24.84 % Securities and restricted stock     618,601       548,021       12.88 % Loans, net     797,117       760,318       4.84 % Deposits     1,449,624       1,297,143       11.76 % Total assets     1,661,652       1,519,673       9.34 %   46 Table of Contents   Asset Quality   Key indicators of the Company’s asset quality are presented in the following table.       June 30, 2021   June 30, 2020   December 31, 2020 Nonperforming loans   $ 3,822     $ 3,830     $ 3,685   Loans past due 90 days or more, and still accruing     28       237       17   Other real estate owned     1,007       1,553       1,553   Allowance for loan losses to loans net of unearned income and deferred fees and costs     1.00 %     1.05 %     1.10 % Allowance for loan losses to loans net of unearned income and deferred fees and costs, excluding SBA PPP loans     1.04 %     1.13 %     1.16 % Net charge-off ratio     0.12 %     0.10 %     0.05 % Ratio of nonperforming assets to loans, net of unearned income and deferred fees and costs, plus other real estate owned     0.60 %     0.68 %     0.68 % Ratio of allowance for loan losses to nonperforming loans     211.33 %     216.92 %     230.15 %   The Company’s risk analysis at June 30, 2021 determined an allowance for loan losses of $8,077 or 1.00% of loans net of unearned income and deferred fees and costs. Included in loans net of unearned income and deferred fees and costs are $29,922 in Paycheck Protection Program loans. Because PPP loans are guaranteed by the U.S. Small Business Administration, they are not included in the calculation for the allowance for loan losses. If the PPP loans are removed from loans net of unearned income and deferred fees and costs, the allowance ratio is 1.04%. The allowance at December 31, 2020 was $8,481 or 1.10% of loans net of unearned income and deferred fees and costs. Excluding PPP loans, the ratio of the allowance to loans net of unearned income and deferred fees and costs at December 31, 2020 was 1.16%. The determination of the appropriate level for the allowance for loan losses resulted in a provision of $54 for the six months ended June 30, 2021, compared with a provision of $1,831 for the six month period ended June 30, 2020. To determine the appropriate level of the allowance for loan losses, the Company considers credit risk for certain loans designated as impaired and for non-impaired (“collectively evaluated”) loans.   Individually Evaluated Impaired Loans Individually evaluated impaired loans at June 30, 2021 were $6,774 gross and $6,776 net of unearned income and deferred fees and costs. There were no specific allocations to the allowance for loan losses. At December 31, 2020, individually evaluated impaired loans totaled $4,903 gross and $4,905 net of unearned income and deferred fees and costs, with specific allocations to the allowance for loan losses totaling $75. The specific allocation is determined based on criteria particular to each impaired loan. The impact of the COVID-19 pandemic continues to present uncertainty and may lead to additional loans designated as impaired in future quarters. Cash flow assumptions associated with impaired loans measured under the cash flow method may be impacted if borrowers are further distressed by the economic impacts of the pandemic, resulting in lower measurements and higher funding requirements for the allowance for loan losses. Real estate activity in the Company’s market over the most recent 12 months has been robust. However if the real estate market changes, collateral values for impaired loans measured under the collateral method could decline and may result in charge-offs.   Collectively Evaluated Loans Collectively evaluated loans totaled $800,432 gross and $798,418 net of unearned income and deferred fees and costs, with an allowance of $8,077 or 1.01% of collectively-evaluated loans net of unearned income and deferred fees and costs at June 30, 2021. Excluding PPP loans, the collectively evaluated allowance ratio was 1.05% at June 30, 2021. At December 31, 2020, collectively evaluated loans totaled $765,124 gross and $763,894 net of unearned income and deferred fees and costs, with an allowance of $8,406 or 1.10%. Excluding PPP loans, the collectively evaluated allowance ratio was 1.16% at December 31, 2020. Collectively evaluated loans are divided into classes based upon risk characteristics. In order to calculate the allowance for collectively evaluated loans, the Company applies to each loan class a historical net charge-off rate for the class, adjusted for qualitative factors that influence credit risk. Qualitative factors evaluated for impact to credit risk include economic measures, asset quality indicators, loan characteristics, and changes to internal Company policies and changes in management.   47 Table of Contents   Net Charge-Offs Increases in the net charge-off rate increase the required allowance for collectively-evaluated loans, while decreases in the net charge-off rate decrease the required allowance for collectively-evaluated loans. Charge-off rates are calculated and applied on a class level. On a portfolio level, net charge-offs were $458 for the six months ended June 30, 2021, or 0.12% of average loans. Net charge-offs for the six months ended June 30, 2020 were $386 or 0.10% of average loans, while net charge-offs for the 12 months ended December 31, 2020 were $373 or 0.05% of average loans. The 8-quarter average historical loss rate was 0.07% as of June 30, 2021, 0.07% as of December 31, 2020 and 0.09% as of June 30, 2020.   Economic Factors Economic factors influence credit risk and impact the allowance for loan loss. The Company considers economic indicators within its market area, including: unemployment, business and personal bankruptcy filings, the residential vacancy rate and the inventory of new and existing homes. The Company sources economic data pertinent to its market from the most recently available publications. However, some economic indicators lag the report date by one to three months. In periods of low volatility, lagging indicators are accepted as reasonably representative of current conditions. The COVID-19 pandemic has introduced significant uncertainty which results in the need for greater timeliness in information. At the beginning of the pandemic, the Company implemented a qualitative factor for national unemployment filings to represent current economic data. Unemployment filings for the Company’s market area is not available on a timely basis, however national data is available on a timely basis and historical analysis shows a strong correlation between national and local unemployment filings. National unemployment claims escalated sharply beginning in the latter half of March 2020. Weekly claims peaked at the beginning of April 2020 and have fallen since, but for the six months ended June 30, 2021, are almost three times pre-pandemic levels. The Company assessed this as a significant impact to credit risk at June 30, 2021, but lower than at December 31, 2020. The Company continues to monitor the most recently available economic indicators for its market and their effect on credit risk. As of June 30, 2021, the unemployment rate for the Company’s market area was measured as of April 30, 2021 and decreased from the measurement available at December 31, 2020, decreasing the allocation to the allowance for loan losses. Business and personal bankruptcy filing data was available as of March 2021. Higher bankruptcy filings indicate heightened credit risk and increase the allowance for loan losses, while lower bankruptcy filings have a beneficial impact on credit risk. Compared with data available at December 31, 2020, business bankruptcies were slightly lower and resulted in a slightly lower allocation, while personal bankruptcies were slightly higher and resulted in a slightly higher allocation. Residential vacancy rates and housing inventory impact the Company’s residential construction customers and the consumer real estate market. Higher levels increase credit risk. The residential vacancy rate at June 30, 2021 was measured as of the first quarter of 2021 and while still lower than normal levels, worsened slightly from the data incorporated into the December 31, 2020 calculation, resulting in a higher allocation. Housing inventory data was available as of June 30, 2021. Levels are historically low but were slightly higher than those at December 31, 2020, resulting in a slightly higher allocation.   Asset Quality Indicators Asset quality indicators, including past due levels, nonaccrual levels and internal risk ratings, are evaluated at the class level. Loans past due and loans designated nonaccrual indicate heightened credit risk. Increases in past due and nonaccrual loans increase the required level of the allowance for loan losses and decreases in past due and nonaccrual loans reduce the required level of the allowance for loan losses. Accruing loans past due 30-89 days were 0.14% of total loans net of unearned income and deferred fees and costs at June 30, 2021, a decrease from 0.19% at December 31, 2020. Accruing loans past due 90 days or more were 0.00% of total loans, net of unearned income and deferred fees and costs at June 30, 2021 and December 31, 2020. Nonaccrual loans at June 30, 2021 were 0.47% of total loans net of unearned income and deferred fees and costs, slightly lower than 0.48% at December 31, 2020. Loans rated special mention and classified (together, “criticized assets”) indicate heightened credit risk. Higher levels of criticized assets increase the required level of the allowance for collectively-evaluated loans, while lower levels of criticized assets reduce the required level of the allowance for collectively-evaluated loans. Collectively evaluated loans rated special mention were $5,276 at June 30, 2021, slightly lower than $8,035 at December 31, 2020. Collectively evaluated loans rated classified were $618 at June 30, 2021, an increase from $473 at December 31, 2020. The Company provided COVID-19 related accommodations to qualifying borrowers. The Company followed its normal risk rating practices and in keeping with the regulatory guidance, did not automatically downgrade the risk rating on loans that received COVID-19 accommodations. Without the regulatory provision, additional loans may have been included in past due data and criticized assets as of June 30, 2021.   48 Table of Contents   Other Factors The Company considers other factors that impact credit risk, including the interest rate environment, the competitive, legal and regulatory environments, changes in lending policies and loan review, changes in management, and high risk loans, as well as a factor to measure the risk from loans that received a COVID-19 modification and then received a subsequent COVID-19 modification. The interest rate environment impacts variable rate loans. If interest rates increase, the payment on variable rate loans increases, which may increase credit risk. The interest rate environment is at a low level as of June 30, 2021, unchanged from the level at December 31, 2020. The low level of interest rates indicates no additional credit risk. The competitive, legal and regulatory environments were evaluated for changes that would impact credit risk. Higher competition for loans increases credit risk, while lower competition decreases credit risk. Competition remained at similar levels to those at December 31, 2020. The legal and regulatory environments remain in a similar posture to that at December 31, 2020. Lending policies, loan review procedures and management’s experience influence credit risk. Since December 31, 2020, there have been no changes that affect credit risk to the Company’s lending policies or loan review procedures, or changes in management’s experience. Levels of high risk loans are considered in the determination of the level of the allowance for loan loss. A decrease in the level of high risk loans within a class decreases the required allocation for the loan class, and an increase in the level of high risk loans within a class increases the required allocation for the loan class. Total high risk loans decreased $12,047 or 10.64% from the level at December 31, 2020, resulting in a decreased allocation. In light of COVID-19 related modifications, the Company considers the impact to credit risk of certain loans granted COVID-19 related modifications. The loans captured in the analysis were granted COVID-19 related modifications subsequent to initial COVID-19 related modifications that remained in their modification period at the reporting date and were flagged by credit review procedures for additional monitoring. The loans within this population at June 30, 2021 decreased significantly from December 31, 2020, resulting in a decreased allocation.   Unallocated Surplus The unallocated surplus at June 30, 2021 is $373 or 4.8% in excess of the calculated requirement. The unallocated surplus at December 31, 2020 was $396 or 4.9% in excess of the calculated requirement. The surplus provides some mitigation of the uncertainty surrounding the impact of COVID-19.   Conclusion The calculation of the appropriate level for the allowance for loan losses incorporates analysis of multiple factors and requires management’s prudent and informed judgment. The most recently available data showed improvements that decreased the required level of the allowance for loan losses at June 30, 2021 from December 31, 2020 including loans considered high risk, business bankruptcy filings, the unemployment rate and certain loans with COVID-19 related modifications. Other indicators showed worsening from levels at December 31, 2020 and increased the required level of the allowance for loan losses, including some asset quality indicators. Continued high national unemployment filings contributed to the allowance for loan losses. The Company also maintained its unallocated surplus at 4.8% to mitigate some of the uncertainty caused by the pandemic. Based on analysis of historical indicators, asset quality and economic factors, management believes the level of allowance for loan losses is reasonable for the credit risk in the loan portfolio as of June 30, 2021. Please refer to Note 3: Allowance for Loan Losses, Nonperforming Assets and Impaired Loans for further information on collectively evaluated loans, individually evaluated impaired loans and the unallocated portion of the allowance for loan losses.   Other Real Estate Owned   The following table discloses the OREO in physical possession and in process at each reporting date:   Other Real Estate Owned (1)   June 30, 2021     June 30, 2020     December 31, 2020   Real estate construction   $ 957     $ 1,443     $ 1,443   Consumer real estate     50       110       110   Total other real estate owned   $ 1,007     $ 1,553     $ 1,553                             Loans in process of foreclosure   $ 140     $ 273     $ 1,344     (1)  Net of valuation allowance.   49 Table of Contents   OREO decreased $546 when the balance at June 30, 2021 is compared with the balance at December 31, 2020 and June 30, 2020. As of June 30, 2021, loans in in various stages of foreclosure totaled $140 and were secured by residential real estate. Loans currently in process of foreclosure may impact OREO in future quarters. It is not possible to accurately predict the future total of OREO because property sold at foreclosure may be acquired by third parties and OREO properties are regularly marketed and sold. The Company continues to monitor risk levels within the loan portfolio, including any effect on collateral values from the COVID-19 pandemic. As of June 30, 2021, the effect of the COVID-19 pandemic has not impacted real estate values in the Company’s market and has not impacted current OREO values.   Modifications and TDRs   In the ordinary course of business the Company modifies loan terms on a case-by-case basis, including consumer and commercial loans, for a variety of reasons. Modifications may include rate reductions, payment extensions of varying lengths of time, a change in amortization term or method or other arrangements. Payment extensions allow borrowers temporary payment relief and result in extending the original contractual maturity by the number of months for which the extension was granted. The Company may grant payment extensions to borrowers who have demonstrated a willingness and ability to repay their loan but who are experiencing consequences of a specific unforeseen temporary hardship. If the temporary event is not expected to impact a borrower’s ability to repay the debt, and if the Company expects to collect all amounts due including interest accrued at the contractual interest rate for the extension period at contractual maturity, the modification is not designated a TDR. Modifications to consumer loans generally involve short-term payment extensions to accommodate specific, temporary circumstances. Modifications to commercial loans may include, but are not limited to, changes in interest rate, maturity, amortization and financial covenants. If the modified terms are consistent with competitive market conditions and representative of terms the borrower could otherwise obtain in the open market, the modified loan is not categorized as a TDR. The Company codes modifications to assist in identifying TDRs. During the six months ended June 30, 2021, the Company provided 454 modifications for competitive reasons to loans totaling $47,573. The modifications were not TDRs and were not related to COVID-19. For the six months ended June 30, 2020, the Company provided non-TDR modifications for competitive reasons to 583 loans totaling $89,899. For the twelve months ended December 31, 2020, the Company provided non-TDR modifications for competitive reasons to 1,047 loans totaling $152,681.   COVID-19 Modifications The COVID-19 pandemic has negatively impacted a significant number of the Company’s borrowers, and may continue to adversely impact some borrowers for the foreseeable future. Since the pandemic began in March 2020, the Company provided modifications related to COVID-19 financial difficulty, including payment extensions and interest only periods. The CARES Act, the CAA and regulatory guidance specify criteria that, if met, provide an election not to designate the loans as TDRs. The TDRs designated during the three months ended June 30, 2021 resulted from COVID-19 related modifications that did not meet the legal and regulatory criteria to avoid designation as TDR. All of the Company’s other COVID-19 related modifications met the criteria and were not designated TDR. The Company followed its normal risk rating and nonaccrual designation procedures and did not automatically downgrade or designate as nonaccrual if the loan was modified for COVID-19 related difficulty. The following tables provide information regarding COVID-19 related modifications for the three and six months ended June 30, 2021 and June 30, 2020, and the 12 months ended December 31, 2020.       Three Months Ended June 30,     2021   2020 Modifications To Borrowers Experiencing COVID-19 Related Financial Difficulty   Number   Amount (in thousands)   Number   Amount (in thousands) Payment extensions (1)     3     $ 4,262       206     $ 51,123   Interest-only period for amortizing loans (1)     -       -       23       36,242   Rate reductions (2)     -       -       4       425   Total     3     $ 4,262       233     $ 87,790     50 Table of Contents       Six Months Ended June 30,     2021   2020 Modifications To Borrowers Experiencing COVID-19 Related Financial Difficulty   Number   Amount (in thousands)   Number   Amount (in thousands) Payment extensions (1)     34     $ 16,336       269     $ 83,027   Interest-only period for amortizing loans (1)     8       22,135       23       36,242   Rate reductions (2)     -       -       5       442   Total     42     $ 38,471       297     $ 119,711     Twelve Months Ended December 31, 2020 Modifications To Borrowers Impacted by the COVID-19 Pandemic   Number   Amount (in thousands) Payment extensions (1)     350     $ 121,676   Interest-only period for amortizing loans (1)     31       59,982   Rate reductions (2)     5       442   Maturity date extension     2       729   Total     388     $ 182,829       (1) Payment extensions and interest-only periods are governed by agreements that specify expiration dates.   (2) Rate reductions were granted to qualifying loans and are permanent for the remaining term of the loan. Rate reductions were provided to alleviate COVID-19 hardship and also to remain competitive in the current low interest rate environment.   Methodology A loan that received multiple modifications as part of one request, for instance, a rate reduction and a payment extension, is presented only under one modification category. A loan that was modified pursuant to a first request and then was modified subsequently pursuant to a separate request is included for each of the requests. For example, a loan that received a payment extension under a first request and a rate reduction under a second request is counted in the rate reduction category and again in the payment extension category.   Loans Remaining Within the Modification Period at June 30, 2021 Of the loans modified for pandemic related hardships, 5 loans remained in their modification period at June 30, 2021: one loan totaling $1 thousand remained in deferral and another four loans totaling $5.7 million remained on interest-only payments. To account for the possible increase in credit risk from loans that have not emerged from their modification period, the Company provided an allocation to the allowance for loan losses.   TDR Designation Modifications of loan terms to borrowers experiencing financial difficulty are made in an attempt to protect as much of the Company’s investment in the loan as possible. Restructuring generally results in a loan with either lower payments or a maturity extended beyond that originally required, and is expected to result in a lower risk of loss associated with nonperformance than the pre-modified loan. The Company restructured loan terms for certain qualified financially distressed borrowers who agreed to work in good faith and demonstrated the ability to make the restructured payments. The determination of whether a modification should be designated a TDR requires consideration of all facts and circumstances surrounding the transaction. With the exception of borrowers affected by COVID-19 who fall under the legislative provisions discussed above, modifications in which the borrower is experiencing financial difficulty and for which the Company makes a concession to the original contractual loan terms are designated TDRs. Concessions may include one or a combination of the following: a reduction of the stated interest rate below market rate for loans of similar terms and credit quality, an extension of the maturity date at an interest rate below a comparable market rate, restructuring an amortizing loan to interest only for a period, or forgiveness of principal or accrued interest. All TDR loans are individually evaluated for impairment for purposes of determining the allowance for loan losses. TDR loans that do not demonstrate current payments for at least six months are maintained on nonaccrual until the borrower demonstrates sustained repayment history under the restructured terms and continued repayment is not in doubt. Otherwise, interest income is recognized using a cost recovery method. The Company’s TDRs were $6,120 at June 30, 2021, an increase from $4,249 at December 31, 2020. Accruing TDR loans amounted to $3,011 at June 30, 2021 and $1,410 at December 31, 2020. The following tables present the past due status of TDRs as of the dates indicated.   51 Table of Contents       TDR Status as of June 30, 2021             Accruing             Total TDR Loans   Current   30-89 Days Past Due   90+ Days Past Due   Nonaccrual Consumer real estate   $ 192     $ 192     $ -     $ -     $ -   Commercial real estate     5,610       2,818       -       -       2,792   Commercial non-real estate     317       -       -       -       317   Consumer non-real estate     1       1       -       -       -   Total TDR Loans   $ 6,120     $ 3,011     $ -     $ -     $ 3,109         TDR Status as of December 31, 2020             Accruing             Total TDR Loans   Current   30-89 Days Past Due   90+ Days Past Due   Nonaccrual Consumer real estate   $ 194     $ 194     $ -     $ -     $ -   Commercial real estate     3,202       -       363       -       2,839   Commercial non-real estate     851       188       663       -       -   Consumer non-real estate     2       1       -       1       -   Total TDR Loans   $ 4,249     $ 383     $ 1,026     $ 1     $ 2,839     Please refer to Note 3: Allowance for Loan Losses, Nonperforming Assets and Impaired Loans for information on TDRs.           Net Interest Income   The net interest income analysis for the three and six months ended June 30, 2021 and 2020 follows:       Three Months Ended     June 30, 2021   June 30, 2020     Average Balance   Interest     Average Yield/ Rate   Average Balance   Interest   Average Yield/ Rate Interest-earning assets:                                                 Loans (1)(2)(3)(5)(6)   $ 790,533     $ 8,544       4.34 %   $ 765,281     $ 8,539       4.49 % Taxable securities (7)(8)     505,784       1,910       1.51 %     389,051       1,863       1.93 % Nontaxable securities (2)(7)     80,329       642       3.21 %     57,595       591       4.13 % Interest-bearing deposits     143,812       39       0.11 %     91,425       14       0.06 % Total interest-earning assets   $ 1,520,458     $ 11,135       2.94 %   $ 1,303,352     $ 11,007       3.40 % Interest-bearing liabilities:                                                 Interest-bearing demand deposits   $ 795,934     $ 718       0.36 %   $ 653,254     $ 958       0.59 % Savings deposits     189,560       44       0.09 %     157,199       118       0.30 % Time deposits     89,564       72       0.32 %     120,646       522       1.74 % Total interest-bearing liabilities   $ 1,075,058     $ 834       0.31 %   $ 931,099     $ 1,598       0.69 % Net interest income and interest rate spread           $ 10,301       2.63 %           $ 9,409       2.71 % Net yield on average interest‑earning assets                     2.72 %                     2.90 %   52 Table of Contents       Six Months Ended     June 30, 2021   June 30, 2020     Average Balance   Interest     Average Yield/ Rate   Average Balance   Interest   Average Yield/ Rate Interest-earning assets:                                                 Loans (1)(2)(4)(5)(6)   $ 780,415     $ 17,169       4.44 %   $ 748,316     $ 17,128       4.60 % Taxable securities (7)(8)     486,978       3,693       1.53 %     393,444       4,219       2.16 % Nontaxable securities (2)(7)     81,357       1,334       3.31 %     47,445       1,036       4.39 % Interest-bearing deposits     131,629       67       0.10 %     79,004       231       0.59 % Total interest-earning assets   $ 1,480,379     $ 22,263       3.03 %   $ 1,268,209     $ 22,614       3.59 % Interest-bearing liabilities:                                                 Interest-bearing demand deposits   $ 779,321     $ 1,436       0.37 %   $ 641,860     $ 2,073       0.65 % Savings deposits     182,121       91       0.10 %     152,272       240       0.32 % Time deposits     88,837       162       0.37 %     123,457       1,081       1.76 % Total interest-bearing liabilities   $ 1,050,279     $ 1,689       0.32 %   $ 917,589     $ 3,394       0.74 % Net interest income and interest rate spread           $ 20,574       2.71 %           $ 19,220       2.85 % Net yield on average interest‑earning assets                     2.80 %                     3.05 %   (1) Loans are net of unearned income and deferred fees and costs. (2) Interest on nontaxable loans and securities is computed on a fully taxable equivalent basis using a Federal income tax rate of 21%. (3) For the three months ended June 30, 2021, interest income includes loan fees of $386, of which $344 was related to the PPP loans. For the three months ended June 30, 2020, interest income includes loan fees of $251, of which $225 was related to the PPP loans. (4) For the six months ended June 30, 2021, interest income includes loan fees of $944 of which $894 was related to the PPP loans. For the six months ended June 30, 2020, interest income includes loan fees of $272, of which $225 was related to PPP loans. (5) Nonaccrual loans are included in average balances for yield computations. (6) Includes loans held for sale. (7) Daily averages are shown at amortized cost. (8) Includes restricted stock.   The net interest margin for the three and six month periods ended June 30, 2021 declined when compared with the comparable periods of 2020. The decline is due to high levels of loan re-finance activity, spurred by the Federal Reserve rate cuts in March 2020. Also impacted by the Federal Reserve rate cuts were investment opportunities in the bond market. Replacing matured and called securities and investing excess liquidity from customer deposits resulted in lower yields for taxable and nontaxable securities. Further, uncertainty surrounding the length of time that customer deposits, bolstered by federal stimulus aid, will remain with the Bank resulted in a higher balance in interest-bearing deposits, which provides the lowest yielding investment opportunity. The Company reacted to the Federal Reserve rate cuts by reducing offering rates on deposits. The Company’s yield on earning assets and cost of funds are largely dependent on the interest rate environment. Fees and interest income from PPP loans helped increase the net interest margin. For the three months ended June 30, 2021, PPP loans increased average loans by $37,937, and provided $98 in interest and $344 in fee recognition. For the six months ended June 30, 2021, PPP loans increased average loans by $38,079 and provided $198 in interest and $894 in fee recognition. If PPP loans are excluded, the net interest margin for the three months ended June 30, 2021 would have been 2.60% and for the six months ended June 30, 2021 would have been 2.66%. Net deferred fees that will be recognized over the life of the PPP loans at June 30, 2021 were $1,591.   Provision and Allowance for Loan Losses   The provision for loan losses was $4 and $54 for the three and six month periods ended June 30, 2021, respectively, compared with $1,352 and $1,831 for the three and six month periods ended June 30, 2020, respectively. The provision for the three and six months ended June 30, 2020 was increased by the addition of a qualitative factor to reflect the impact of the beginning of the pandemic. This and other factors have improved significantly during 2021, resulting in lower provision in 2021. The provision for loan losses is the result of a detailed analysis to estimate an adequate allowance for loan losses. See “Asset Quality” for additional information. .   53 Table of Contents   Noninterest Income       Three Months Ended           June 30, 2021   June 30, 2020   Percent Change Service charges on deposits   $ 471     $ 377       24.93 % Other service charges and fees     43       37       16.22 % Credit and debit card fees, net     479       386       24.09 % Trust fees     434       387       12.14 % BOLI income     210       219       (4.11 )% Gain on sale of mortgage loans     74       157       (52.87 )% Other income     230       120       91.67 % Realized securities gain, net     -       62       (100.00 )%       Six Months Ended           June 30, 2021   June 30, 2020   Percent Change Service charges on deposits   $ 940     $ 959       (1.98 )% Other service charges and fees     84       76       10.53 % Credit and debit card fees, net     913       692       31.94 % Trust fees     849       821       3.41 % BOLI income     416       440       (5.45 )% Gain on sale of mortgage loans     211       251       (15.94 )% Other income     857       559       53.31 % Realized securities gain, net     5       82       (93.90 )%   Service charges on deposit accounts increased $94 when the three month periods ended June 30, 2021 and June 30, 2020 are compared, primarily due to increases in NSF and overdraft fee income and ATM fee income. When the six month periods ended June 30, 2021 and June 30, 2020 are compared, service charges on deposits decreased $19, primarily due to lower NSF and overdraft fee income. NSF and overdraft activity declined at the beginning of the COVID-19 pandemic in 2020 and has begun to increase in 2021. Other service charges and fees increased $6 and $8 for the three and six month periods ended June 30, 2021 compared with the same periods ended June 30, 2020. Other service charges include charges for official checks, income from the sale of checks to customers, safe deposit box rent, fees for letters of credit and the income earned from commissions on the sale of credit life, accident and health insurance. Credit and debit card fees are presented net of interchange expense. Credit and debit card fees increased $93 and $221 for the three and six month periods ended June 30, 2021 when compared with the same periods last year. Credit and debit card fees are based on volume and other factors. Income from trust fees increased $47 and $28 for the three and six month periods ended June 30, 2021 when compared with the same periods ended June 30, 2020. Trust income varies depending on the total assets held in trust accounts, the type of accounts under management and financial market conditions. BOLI income decreased $9 and $24 when the three and six month periods ended June 30, 2021 and June 30, 2020 are compared. The Company purchased an additional $5 million in BOLI investments during June, 2021. Gain on sale of mortgage loans decreased $83 and $40 when the three and six month periods ended June 30, 2021 and June 30, 2020 are compared. The Federal Reserve cut interest rates in March, 2020 in response to the pandemic, which spurred a high level of real estate refinance and purchase financing activity. This activity is beginning to normalize in 2021. Other income includes revenue from investment and insurance sales, adjustments to partnership bases and other miscellaneous components. These areas fluctuate with market conditions and competitive factors. Other income increased $110 for the three month periods ended June 30, 2021 when compared with the same period ended June 30, 2020 due to increased commissions on securities sales, a one-time bonus payment from a vendor and an increase in dividends on a partnership investment. When the six month periods are compared, other income increased $298, primarily due to increased commissions on securities sales, dividends, a one-time commission and a one-time bonus payment. The Company did not have a gain or loss on securities during the three months ended June 30, 2021, and realized a gain on securities of $5 during the six months ended June 30, 2021. During 2020, the Company realized a gain of $62 for the three months ended June 30, 2020 and $82 during the six month period ended June 30, 2020.   54 Table of Contents   Noninterest Expense       Three Months Ended           June 30, 2021   June 30, 2020   Percent Change Salaries and employee benefits   $ 3,952     $ 3,498       12.98 % Occupancy, furniture and fixtures     443       458       (3.28 )% Data processing and ATM     786       806       (2.48 )% FDIC assessment     93       40       132.50 % Net (gains on) costs of other real estate owned     1       (4 )     125.00 % Franchise taxes     357       335       6.57 % Other operating expenses     815       944       (13.67 )%       Six Months Ended           June 30, 2021   June 30, 2020   Percent Change Salaries and employee benefits   $ 7,858     $ 7,371       6.61 % Occupancy, furniture and fixtures     931       908       2.53 % Data processing and ATM     1,564       1,597       (2.07 )% FDIC assessment     176       40       340.00 % Net costs of other real estate owned     38       18       111.11 % Franchise taxes     692       678       2.06 % Other operating expenses     1,724       1,932       (10.77 )%   Total noninterest expense increased $370 or 6.09% when the three month periods ended June 30, 2021 and June 30, 2020 are compared, and increased $439 or 3.50% when the six month period ended June 30, 2021 is compared with the same period of 2020. Salaries and employee benefits increased $454 when the three month periods ended June 30, 2021 and June 30, 2020 are compared and increased $487 when the six month period ended June 30, 2021 is compared with the same period in 2020. This expense category includes employee salaries, payroll taxes, insurance and fringe benefits, ESOP contribution accruals, the service component of net periodic pension cost, and salary continuation expenses. The service component of net periodic pension cost increased $248 when the three and six month periods ended June 30, 2021 and June 30, 2020 are compared. Occupancy, furniture and fixtures expense decreased $15 when the three month periods ended June 30, 2021 and June 30, 2020 are compared, and increased $23 when the six month periods ended June 30, 2021 and June 30, 2020 are compared. Data processing and ATM expense decreased $20 and $33 when the three and six month periods ended June 30, 2021 are compared with the same periods in 2020.  Federal Deposit Insurance (“FDIC”) assessment expense increased $53 and $136 when the three and six month periods ended June 30, 2021 are compared with the same periods of 2020. The FDIC assessment is accrued based on a method provided by the FDIC. The calculation is based on average assets divided by average tangible equity and incorporates risk-based factors to determine the amount of the assessment. During the third quarter of 2019, the FDIC notified the Bank that it was eligible to use small bank assessment credits. The credits fully offset the Bank’s September 30, 2019, December 31, 2019 and March 31, 2020 assessment payments, and partially offset the June 30, 2020 assessment. Net costs of OREO increased $5 and $20 when the three and six month periods ended June 30, 2021 are compared with the same periods in 2020. The cost of OREO includes maintenance costs as well as valuation write-downs and gains and losses on the sale of properties. The expense varies with the number of properties, the maintenance required and changes in the real estate market. OREO properties are accounted for at fair value less cost to sell upon foreclosure and are thereafter periodically appraised to determine market value. Declines in market value are recognized through valuation expense. Franchise tax expense increased $22 when the three month periods ended June 30, 2021 and June 30, 2020 are compared. Franchise tax expense increased $14 when the six month periods ended June 30, 2021 and June 30, 2020 are compared. Franchise tax is primarily based on capital levels of the subsidiary bank, and is also affected by investment levels in securities issued by U.S. government agencies. The category of other operating expenses includes noninterest expense items such as professional services, stationery and supplies, telephone costs, postage, charitable donations, losses and other expenses. Other operating expense decreased $129 and $208 when the three and six month periods ended June 30, 2021 are compared with the same periods ended June 30, 2020. The decrease in other operating expense stemmed primarily from a lower non-service pension cost and cost control measures.   55 Table of Contents   Income Tax   Income tax expense was $940 for the three months ended June 30, 2021 and $486 for the same period of 2020. For the six months ended June 30, 2021 and 2020, income tax expense was $1,949 and $1,288 respectively. The Company’s federal statutory tax rate is 21%. The Company’s effective tax rate was 16.93% and 17.21% for the three and six month periods ended June 30, 2021, compared with 14.01% and 15.61% for the three and six month periods ended June 30, 2020.   Balance Sheet   Year-to-date daily averages for the major balance sheet categories are as follows:   Assets   June 30, 2021   December 31, 2020   Percent Change Interest-bearing deposits   $ 131,629     $ 81,639       61.23 % Securities available for sale and restricted stock     575,087       474,934       21.09 % Loans, net     771,276       760,641       1.40 % Total assets     1,570,610       1,403,671       11.89 %                           Liabilities and stockholders ’ equity                         Noninterest-bearing demand deposits   $ 307,524     $ 248,392       23.81 % Interest-bearing demand deposits     779,321       669,383       16.42 % Savings deposits     182,121       158,334       15.02 % Time deposits     88,837       112,463       (21.01 )% Stockholders’ equity     192,477       195,768       (1.68 )%   Securities   Securities available for sale are measured at fair value on a recurring basis. Market conditions at June 30, 2021 are reflected in the presentation of securities available for sale. While we do not expect significant changes in future judgements or methodologies used to determine the fair value of the securities portfolio, market volatility associated with the COVID-19 pandemic, or any future national or global concern, will impact the value of securities. Management regularly monitors the quality of the securities portfolio and closely follows the uncertainty in the economy and the volatility of financial markets.  The value of individual securities will be written down if the decline in fair value is considered to be other than temporary based upon the totality of circumstances. See Note 4: Securities for additional information.   Loans       June 30, 2021   December 31, 2020   Percent Change Real estate construction loans   $ 48,569     $ 42,266       14.91 % Consumer real estate loans     196,214       181,782       7.94 % Commercial real estate loans     404,636       393,115       2.93 % Commercial non real estate loans     73,522       78,771       (6.66 )% Public sector and IDA     52,370       40,983       27.78 % Consumer non real estate     31,895       33,110       (3.67 )% Less: unearned income and deferred fees and costs     (2,012 )     (1,228 )     63.84 % Loans, net of unearned income and deferred fees and costs   $ 805,194     $ 768,799       4.73 %   The Company’s loans, net of unearned income and deferred fees and costs, increased $36,395 or 4.73% from $768,799 at December 31, 2020 to $805,194 at June 30, 2021. Real estate construction, consumer real estate, commercial real estate and public sector and IDA loans increased from December 31, 2020. Included in commercial non real estate loans are PPP loans of $31,514 at June 30, 2021 and $36,903 at December 31, 2020. Excluding PPP loans, commercial non real estate loans increased $141.   56 Table of Contents   Deposits       June 30, 2021   December 31, 2020   Percent Change Noninterest-bearing demand deposits   $ 332,944     $ 276,793       20.29 % Interest-bearing demand deposits     838,254       763,293       9.82 % Saving deposits     190,094       167,475       13.51 % Time deposits     88,332       89,582       (1.40 )% Total deposits   $ 1,449,624     $ 1,297,143       11.76 %   Total deposits increased $152,481 or 11.76% from $1,297,143 at December 31, 2020 to $1,449,624 at June 30, 2021. The increase is due in large part to government stimulus funds received by municipal depositors and other depositors. Deposits do not include any brokered deposits.   Liquidity   Liquidity measures the Company’s ability to meet its financial commitments at a reasonable cost. Demands on the Company’s liquidity include funding additional loan demand and accepting withdrawals of existing deposits. The Company has diverse liquidity sources, including customer and purchased deposits, customer repayments of loan principal and interest, sales, calls and maturities of securities, Federal Reserve discount window borrowing, short-term borrowing, and FHLB advances. At June 30, 2021, the Bank did not have discount window borrowings, short-term borrowings, or FHLB advances.  To assure that short-term borrowing is readily available, the Company tests accessibility annually. The Company considers its security portfolio for typical liquidity needs, within accounting, legal and strategic parameters. Portions of the securities portfolio are pledged to meet state requirements for public funds deposits. Discount window borrowings also require pledged securities. Increased/decreased liquidity from public funds deposits or discount window borrowings results in increased/decreased liquidity from pledging requirements. The Company monitors public funds pledging requirements and unpledged available-for-sale securities accessible for liquidity needs. Regulatory capital levels at the subsidiary bank determine the Bank’s ability to use purchased deposits and the Federal Reserve discount window. At June 30, 2021, the Bank is considered well capitalized and does not have any restrictions on purchased deposits or borrowing ability at the Federal Reserve discount window. The Company monitors factors that may increase its liquidity needs. Some of these factors include deposit trends, large depositor activity, maturing deposit promotions, interest rate sensitivity, maturity and repricing timing gaps between assets and liabilities, the level of unfunded loan commitments, loan growth and share repurchase activity within the Company’s own stock. At June 30, 2021, the Company’s liquidity is sufficient to meet projected trends in these areas. To monitor and estimate liquidity levels, the Company performs stress testing under varying assumptions on credit sensitive liabilities and the sources and amounts of balance sheet and external liquidity available to replace outflows. The Company’s Contingency Funding Plan sets forth avenues for rectifying liquidity shortfalls. At June 30, 2021, the analysis indicated adequate liquidity under the tested scenarios. The Company utilizes several other strategies to maintain sufficient liquidity. Loan and deposit growth are managed to keep the loan to deposit ratio within the Company’s own target range of 65% to 75%. At June 30, 2021, the loan to deposit ratio was 55.55%. The investment strategy takes into consideration the term of the investment, and securities in the available for sale portfolio are laddered based upon projected funding needs. The Company’s liquidity position was strong prior to the COVID-19 pandemic and has increased due to government stimulus payments received by depositors. Further, securities with an amortized cost of $1,289 will mature within one year or less, and up to $116,909 may be called. The Company continues to monitor liquidity as the impact of the pandemic evolves.   Capital Resources   Total stockholders’ equity at June 30, 2021 was $191,235, a decrease of $9,372 or 4.67%, from the $200,607 at December 31, 2020. Shareholders equity was impacted by payment of $4,319 in dividends and $9,354 in share repurchases. The Company repurchased 261,962 shares under a program approved by the Company’s Board of Directors on May 13, 2020 for up to 1,000,000 shares. On May 12, 2021, the Board of Directors approved the repurchase of up to 1,000,000 additional shares of the Company’s common stock. The authorization began June 1, 2021 and expires May 31, 2022.   57 Table of Contents   The Company’s subsidiary bank is subject to various capital requirements administered by banking agencies. Risk based capital ratios for the Bank are shown in the following tables.       NBB   Regulatory Capital Minimum Ratios   Regulatory Capital Minimum Ratios with Capital Conservation Buffer Common Equity Tier I Capital Ratio     18.69 %     4.50 %     7.00 % Tier I Capital Ratio     18.69 %     6.00 %     8.50 % Total Capital Ratio     19.54 %     8.00 %     10.50 % Leverage Ratio     11.54 %     4.00 %     4.00 %   Risk-based capital ratios are calculated in compliance with FDIC rules based on Basel III capital requirements. Banks are subject to an additional capital conservation buffer in order to make capital distributions or discretionary bonus payments. The Bank’s ratios are well above the required minimums and the capital conservation buffer at June 30, 2021.   Off-Balance Sheet Arrangements   In the normal course of business, NBB extends lines of credit and letters of credit to its customers. Depending on their needs, customers may draw upon lines of credit at any time in any amount up to a pre-approved limit. Standby letters of credit are issued for two purposes. Financial letters of credit guarantee payments to facilitate customer purchases. Performance letters of credit guarantee payment if the customer fails to complete a specific obligation. Historically, the full approved amount of letters and lines of credit has not been drawn at any one time. The Company has developed plans to meet a sudden and substantial funding demand. These plans include accessing a line of credit with a correspondent bank, borrowing from the FHLB, selling available for sale investments or loans and raising additional deposits. The Company sells mortgages on the secondary market. Our agreement with the purchaser provides for strict underwriting and documentation requirements. Violation of the representations and warranties of the agreement would entitle the purchaser to recourse provisions. The Company has determined that its risk in this area is not significant because of a low volume of secondary market mortgage loans and high underwriting standards. The Company estimates a potential loss reserve for recourse provisions that is not material as of June 30, 2021. To date, no recourse provisions have been invoked. If funds were needed, the Company would access the same sources as noted above for funding lines and letters of credit. There were no material changes in off-balance sheet arrangements during the six months ended June 30, 2021, except for normal seasonal fluctuations in the total of mortgage loan commitments.   Contractual Obligations   The Company had no finance lease or purchase obligations and no long-term debt at June 30, 2021.   58 Table of Contents