NATIONAL BANKSHARES INC 10-Q

Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations $ in thousands, except 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 2021 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,   ● performance by the Company’s counterparties or vendors,   ● applicable accounting principles, policies and guidelines,   ● business disruption and/or impact due to the coronavirus or similar pandemic diseases, and   ● the duration and severity of the COVID-19 pandemic, the uncertainty regarding new variants of COVID-19, the efficacy of vaccine and treatment developments, the impact of loosening or tightening of government restrictions, and the heightened impact it has on many of the risks described herein,   ● geopolitical conditions, including acts or threats of terrorism and/or military conflicts, or actions taken by the U.S. or other governments in response to acts or threats of terrorism and/or military conflicts, negatively impacting business and economic conditions in the U.S. and abroad. 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. The Company also requires assurances from key vendors regarding their cybersecurity. We control functionalities of online and mobile banking to reduce risk. We do not offer online account openings or loan originations. We do not permit customers to submit address changes or wire requests through online banking, and we limit the dollar amount of online banking transfers to other banks. We require a special vetting process for commercial customers who wish to originate ACH transfers.            32 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 cost of these measures was $95 for the three months ended September 30, 2022 and $80 for the three months ended September 30, 2021. For the nine months ended September 30, 2022 and September 30, 2021, the expense was $282 and $273 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 since the first quarter of 2020. The Company has a robust business continuity plan, and partners with vendors whom we believe also have robust business continuity plans. The Company has not incurred material expenditures and does not anticipate material expenditures to maintain business continuity. Critical functions are cross-trained, controls over cash and physical assets are functioning and internal controls over financial reporting have been maintained.   Critical Accounting Policies   General           The Company’s consolidated financial statements are prepared in accordance with 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 satisfying 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. 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. There have been no changes since December 31, 2021. Please refer to the Company’s 2021 Form 10-K, Note 1: Summary of Significant Accounting Policies for additional information on the Company’s accounting policies.   Allowance for Loan Losses The Company evaluates the allowance each quarter through a methodology that estimates losses on individual impaired loans and evaluates the effect of numerous factors on the credit risk of groups of homogeneous loans (collectively-evaluated loans).   Impaired loans Impaired loans are identified through the Company’s credit risk rating process. Generally, impaired loans have risk ratings that indicate higher risk, such as “classified” or “special mention.” Nonaccrual loan relationships that meet the Company’s balance threshold of $250 are designated impaired. The Company also designates as impaired other loan relationships that meet the Company’s balance threshold of $250 and for which a credit review identified a weakness that indicates principal and interest will not be collected according to the loan terms. All TDRs, regardless of size or past due status, are designated impaired.   TDRs Loan modifications are reviewed 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. Modified loans that meet this criteria are designated TDRs.   Individual evaluation At the reporting date, the fair value of each impaired loan is estimated using either the cash flow method or the collateral method.   33 Table of Contents     Cash flow method The cash flow method is applied to loans that are not collateral dependent and for which cash flows may be estimated. The cash flow method measures fair value using assumptions specific to each loan, including expected amount and timing of cash flows and discount rate. For TDR loans, the discount rate is the rate immediately prior to the modification that resulted in a TDR. If an impaired loan evaluated under the cash flow method becomes 90 days or more past due, it is examined to determine whether the late payment indicates collateral dependency or cash flows below those that were used in the fair value measurement.   Collateral method The collateral method is applied to impaired loans that are collateral-dependent, for which foreclosure is imminent or for which non-collateral repayment sources are determined not to be available or reliable. Collateral may be in the form of real estate or business assets including equipment, inventory, and accounts receivable. Fair value is based upon the “as-is” value of independent appraisals or evaluations. Impaired loans secured by residential 1-4 family properties with outstanding principal balances greater than $250 are valued using an appraisal. Appraisals are also used to value impaired loans secured by commercial real estate with outstanding principal balances greater than $500. Impaired loans secured by residential 1-4 family property with outstanding principal balances of $250 or less, or secured by commercial real estate with outstanding principal balances of $500 or less, are valued using a real estate evaluation prepared by a third party. 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 Company employees 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 pertinent economic conditions. 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 a 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 is reduced by selling costs if recovery is expected solely from the sale of collateral.   Collectively evaluated loans Non-impaired loans are grouped by portfolio segments. Portfolio segments are further divided into smaller loan classes. Loans within a segment or class have similar risk characteristics. 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. Qualitative factors include changes in national and local economic and business conditions, the nature and volume of classes within the portfolio, loan quality, loan officers’ experience, lending policies and the Company’s loan review system. The qualitative factor allocations are determined for pass-rated loans. To reflect the increased risk of criticized assets, qualitative factor allocations are multiplied by 150% for special mention loans, and multiplied by 200% for classified loans.   Loss rates Loss rates are calculated for and applied to individual classes by averaging loss rates over the most recent eight quarters. Two loss rates for each class are calculated: total net charge-offs for the class as a percentage of average class loan balance (“class loss rate”), and total net charge-offs for the class as a percentage of average classified loans in the class (“classified loss rate”). Net charge-offs in both calculations include charge-offs and recoveries for all loans within the class, including classified and non-classified loans, as well as impaired and TDR loans. If the loss rate calculation results in a recovery, the loss rate applied is zero. Class historical loss rates are applied to collectively evaluated pass-rated loan balances and special mention rated loan balances, and classified historical loss rates are applied to collectively evaluated classified loan balances.   Qualitative factor allocations The analysis of certain factors results in standard allocations to all classes. These factors include the risk from changes in lending policies, loan officers’ experience, changes in loan review, and economic factors including local unemployment levels, local bankruptcy rates, interest rate environment, and competition/legal/regulatory environments. Standard allocations for residential vacancy rates and housing inventory are applied to residential construction, investor-owned residential real estate, multifamily loans, other commercial real estate, state and political subdivision loans and all classes within the consumer real estate segment. 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 during 2021 was an economic factor implemented to address COVID-19 uncertainty: national unemployment filings. Local unemployment data lags the reporting date and the Company implemented analysis of national unemployment filings to capture current effects of the COVID-19 pandemic. Historical analysis determined that local unemployment filings were closely correlated to national unemployment filings. National unemployment filings returned to pre-pandemic levels during the fourth quarter of 2021 and no allocation was made during 2022.   34 Table of Contents     Factors analyzed for each class, with resultant allocations based upon the level of risk assessed for each class, include levels of past due loans, levels of nonaccrual loans, current class balance as a percentage of total loans and the percentage of high risk loans within the class. 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.   Nonaccrual status The Company evaluates loans with certain risk indicators to determine whether the loans should be placed on nonaccrual status, including loans that exceed 89 days past due, loans rated classified, and TDR loans. Impaired loans that are not TDRs and for which fair value measurement indicates an impairment loss are placed into nonaccrual status. Nonaccrual status is applied to TDRs that allow the borrower to discontinue payments of principal or interest for more than 90 days, unless the modification provides reasonable assurance of repayment performance and collateral value supports regular underwriting requirements. Impaired loans with partial charge-offs are maintained as impaired until the remaining balance is satisfied. Loans in nonaccrual are reviewed on an individual loan basis to determine whether they may return to accrual status. To return to accrual status, the Company’s analysis must determine that 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. TDRs that maintain current status for at least a six-month period, including history prior to restructuring, may accrue interest.   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.   Sales, purchases and reclassification of loans The Company finances consumer real estate 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.   Estimation of the allowance for loan losses The estimation of the allowance involves analysis of internal and external variables, methodologies, assumptions and management’s 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, management’s assessment of current economic conditions, and management’s estimate of the impact of qualitative factors. These judgments are inherently subjective and 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. The estimate of the allowance considered market conditions as of the reporting date where possible, and the most recent available information when data was not available as of the reporting date, portfolio conditions and levels of delinquencies at the reporting date, and net charge-offs in the eight quarters prior to the reporting date. For additional discussion of the allowance, see Note 3 to the consolidated financial statements and “Asset Quality,” and “Provision and Allowance for Loan Losses” of Management’s Discussion and Analysis.   Goodwill Goodwill is subject to at least an annual assessment for impairment by applying a fair value based test. The Company engages 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, 2021. As permitted by accounting standards, the Company opted not to perform the preliminary assessment of qualitative factors before performing more substantial testing for impairment. 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.   35 Table of Contents     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.   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 24 office locations and two loan production offices. 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”). Details on non-GAAP measures follow.   Return on Average Assets and Return on Average Equity The return on average assets and return on average equity are measures of profitability, calculated by annualizing net income and dividing by average year-to-date assets or equity, respectively. Larger nonrecurring income or expenses are not annualized, in order to reduce distortion within the ratios. There were no adjustments for the three months ended September 30, 2022. During the three months ended September 30, 2021, the provision recovery, net of tax was removed from annualization. The provision recovery resulted from the Company's normal process of estimating credit risk for the allowance for loan losses.  Because recovery of loan losses occurs less frequently than provision for loan losses, it was removed from annualization. The tables below present the reconciliation of adjusted annualized net income, which is not a measurement under U.S. GAAP, for the three and nine month periods ended September 30, 2022 and 2021.   $ in thousands   Three months ended September 30,       2022     2021   Net Income   $ 6,162     $ 5,752   Items deemed non-recurring by management:                 Provision recovery, net of tax of $82 in 2021     -       (310 ) Adjusted net income     6,162       5,442   Adjusted net income, annualized     24,447       21,591   Items deemed non-recurring by management:                 Add: Provision recovery, net of tax of ($82) in 2021     -       310   Annualized net income for ratio calculation   $ 24,447     $ 21,901     36 Table of Contents         Nine months ended September 30,       2022     2021   Net Income   $ 16,622     $ 15,131   Items deemed non-recurring by management:                 Less: partnership income (1) , net of tax of ($77) in 2022 and ($98) in 2021     (290 )     (369 ) Securities gains, net of tax of ($1) in 2021     -       (4 ) Provision recovery, net of tax of $71 in 2021     -       (267 ) Adjusted net income     16,332       14,491   Adjusted net income, annualized     21,836       19,374   Items deemed non-recurring by management:                 Add: partnership income, net of tax of $77 in 2022 and $98 in 2021     290       369   Add: securities gains, net of tax of $1 in 2021     -       4   Add: provision recovery, net of tax of ($71) in 2021     -       267   Annualized net income for ratio calculation   $ 22,126     $ 20,014       (1) During the first quarter of each year, the Company adjusts its basis in partnership interests. During 2022 and 2021, the adjustment resulted in recognition of a gain. During 2022 and 2021, the Company also received a payout from a partnership interest. The gain and payout are recognized in other 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 fully taxable equivalent (“FTE”) net interest income by total average earning assets. The portion of interest income that is nontaxable is grossed up to the tax equivalent by adding the tax benefit. 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.       Three months ended September 30,       2022     2021   GAAP measures:                 Interest and fees on loans   $ 8,816     $ 9,088   Interest on interest-bearing deposits     506       56   Interest and dividends on securities - taxable     3,425       2,043   Interest on securities - nontaxable     408       469   Total interest income   $ 13,155     $ 11,656                     Interest on deposits   $ 753     $ 719   Net interest income   $ 12,402     $ 10,937                     Non-GAAP measures:                 Tax benefit on nontaxable loan income   $ 84     $ 84   Tax benefit on nontaxable securities income     148       157   Total tax benefit on nontaxable interest income   $ 232     $ 241   Total tax equivalent net interest income   $ 12,634     $ 11,178   Total tax equivalent net interest income, annualized   $ 50,124     $ 44,348       The resulting net interest margin for the three month periods ended September 30, 2022 and 2021 was 2.95% and 2.83%, respectively.  Further detail on the net interest margin is provided under the Net Interest Income discussion.   37 Table of Contents         Nine months ended September 30,       2022     2021   GAAP measures:                 Interest and fees on loans   $ 25,240     $ 26,104   Interest on interest-bearing deposits     757       123   Interest and dividends on securities - taxable     8,847       5,736   Interest on securities - nontaxable     1,283       1,472   Total interest income   $ 36,127     $ 33,435                     Interest on deposits   $ 2,055     $ 2,408   Net interest income   $ 34,072     $ 31,027                     Non-GAAP measures:                 Tax benefit on nontaxable loan income   $ 244     $ 237   Tax benefit on nontaxable securities income     445       488   Total tax benefit on nontaxable interest income   $ 689     $ 725   Total tax equivalent net interest income   $ 34,761     $ 31,752   Total tax equivalent net interest income, annualized   $ 46,475     $ 42,452     The resulting net interest margin for the nine month periods ended September 30, 2022 and 2021 was2.79% and 2.81%, respectively.  Further detail on the net interest margin is provided under the Net Interest Income discussion.   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.       Three months ended September 30,       2022     2021   Noninterest expense   $ 6,736     $ 6,367                     Taxable-equivalent net interest income   $ 12,634     $ 11,178   Noninterest income     2,140       1,992   Total income for ratio calculation   $ 14,774     $ 13,170                     Efficiency ratio     45.59 %     48.34 %       Nine months ended September 30,       2022     2021   Noninterest expense   $ 19,660     $ 19,350                     Taxable-equivalent net interest income   $ 34,761     $ 31,752   Noninterest income     6,543       6,267   Less: partnership income     (367 )     (467 ) Less: realized securities gains     -       (5 ) Total income for ratio calculation   $ 40,937     $ 37,547                     Efficiency ratio     48.03 %     51.54 %   38 Table of Contents     Performance Summary   The following table presents the Company’s key performance indicators for the three months ended September 30, 2022 and September 30, 2021. Income and expense items are annualized for the ratios, except for basic and fully diluted earnings per share.       Three Months Ended September 30,       2022     2021   Net Income   $ 6,162     $ 5,752   Return on average assets (1)     1.41 %     1.32 % Return on average equity (1) (2)     17.61 %     11.26 % Basic and fully diluted earnings per share (2)   $ 1.03     $ 0.94   Net interest margin (1)     2.95 %     2.83 % Efficiency ratio (1)     45.59 %     48.34 %   (1)   Ratio is a non-GAAP financial measure that the Company believes provides investors with important information. 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. (2)   During the three months ended September 30, 2022, the Company repurchased 23,500 shares under its publicly announced stock repurchase plan. The repurchase reduced stockholders equity by $795. During the three months ended September 30, 2021, the Company repurchased 73,100 shares, reducing stockholders equity by $2,731.   The following table presents the Company’s key performance indicators for the nine months ended September 30, 2022 and September 30, 2021 and the year ended December 31, 2021. The measures for September 30, 2022 and September 30, 2021 are annualized, except for basic and fully diluted earnings per share.       Nine Months Ended September 30, 2022     Nine Months Ended September 30, 2021     Twelve Months Ended December 31, 2021   Net Income   $ 16,622     $ 15,131     $ 20,382   Return on average assets (1)     1.29 %     1.25 %     1.26 % Return on average equity (1) (2)     14.04 %     10.36 %     10.59 % Basic and fully diluted earnings per share (2)   $ 2.77     $ 2.42     $ 3.28   Net interest margin (1)     2.79 %     2.81 %     2.81 % Efficiency ratio (1)     48.03 %     51.54 %     51.34 %   (1)   Ratio is a non-GAAP financial measure that the Company believes provides investors with important information. 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. (2)   During the nine months ended September 30, 2022, the Company repurchased 106,662 shares under its publicly announced stock repurchase plan. The repurchase reduced stockholders equity by $3,724. During the nine months ended September 30, 2021, the Company repurchased 335,062 shares under its publicly announced stock repurchase plan. The repurchase reduced stockholders equity by $12,085.   When results for the three and nine months ended September 30, 2022 and September 30, 2021 are compared, the increase in net income was primarily generated by growth in net interest income and service charges on deposit accounts, as well as decreased pension expense. This benefitted each of the key performance ratios. The return on average equity also increased due to lower average equity when the three and nine month periods ended September 30, 2022 are compared with the same periods of 2021, and with the year ended December 31, 2021. Average equity decreased due to unrealized losses on securities during 2022 that reduced accumulated other comprehensive loss, a component of stockholders’ equity. The following discussion provides further detail on the Company’s results of operations for the three and nine month periods ended September 30, 2022 and financial position as of September 30, 2022, compared with comparable periods of the prior year.   39 Table of Contents     Key Assets and Liabilities   NBI’s key assets and liabilities and their change from December 31, 2021 are shown in the following table.       September 30, 2022     December 31, 2021     Percent Change   Interest-bearing deposits   $ 79,466     $ 130,021       (38.88 ) % Securities available for sale and restricted stock     658,351       686,925       (4.16 ) % Loans, net     844,656       795,574       6.17 % Total assets     1,698,946       1,702,175       (0.19 ) % Deposits     1,570,649       1,494,587       5.09 %   Asset Quality   Key indicators of the Company’s asset quality are presented in the following table.       September 30, 2022     September 30, 2021     December 31, 2021   Nonperforming loans   $ 2,888     $ 3,114     $ 2,873   Loans past due 90 days or more, and still accruing     48       62       90   Other real estate owned     907       957       957   Allowance for loan losses to loans net of unearned income and deferred fees and costs     0.96 %     0.97 %     0.96 % Net charge-off ratio     0.03 %     0.08 %     0.05 % Ratio of nonperforming assets to loans, net of unearned income and deferred fees and costs, plus other real estate owned     0.44 %     0.51 %     0.48 % Ratio of allowance for loan losses to nonperforming loans     284.18 %     247.21 %     267.11 %   The Company’s risk analysis at September 30, 2022 determined an allowance for loan losses of $8,207 or 0.96% of loans net of unearned income and deferred fees and costs. The allowance at September 30, 2021 was $7,698 or 0.97% of loans net of unearned income and deferred fees and costs. The allowance at December 31, 2021 was $7,674 or 0.96% of loans net of unearned income and deferred fees and costs. The determination of the appropriate level for the allowance for loan losses resulted in a provision of $696 for the nine months ended September 30, 2022, compared with a recovery of $338 for the nine month period ended September 30, 2021, and a recovery of $398 for the 12 months ended December 31, 2021. 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 decreased from December 31, 2021 to September 30, 2022, due to the payoff of one relationship. At September 30, 2022 individually evaluated loans were $3,049 on both a gross basis and net of unearned income and deferred fees and costs. There were no specific allocations to the allowance for loan losses at September 30, 2022. Individually evaluated impaired loans at December 31, 2021 were $5,878 gross and $5,880 net of unearned income and deferred fees and costs. There were no specific allocations to the allowance for loan losses as of December 31, 2021. The specific allocation is determined based on criteria particular to each impaired loan.   Collectively Evaluated Loans Collectively evaluated loans totaled $850,223 gross and $849,814 net of unearned income and deferred fees and costs, with an allowance of $8,207 or 0.97% of collectively-evaluated loans net of unearned income and deferred fees and costs at September 30, 2022. At December 31, 2021, collectively evaluated loans totaled $797,851 gross and $797,368 net of unearned income and deferred fees and costs, with an allowance of $7,674 or 0.96% of collectively-evaluated loans net of unearned income and deferred fees and costs. 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 management.   40 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. On a portfolio level, net charge-offs were $163 for the nine months ended September 30, 2022, or 0.03% of average loans. For the nine months ended September 30, 2021, net charge-offs were $445, or 0.08% of average loans. For the 12 months ended December 31, 2021, net charge-offs were $409 or 0.05% of average loans. The 8-quarter average historical loss rate was 0.03% for the nine months ended September 30, 2022 and 0.06% for the nine months ended September 30, 2021, and 0.05% for the 12 months ended December 31, 2021.   Economic Factors Economic factors influence credit risk and impact the allowance for loan loss. The Company sources economic data pertinent to its market from the most recently available publications, including: unemployment, business and personal bankruptcy filings, the residential vacancy rate and the inventory of new and existing homes. As of September 30, 2022, the unemployment rate for the Company’s market area was measured as of August 31, 2022 and increased from the measurement available at December 31, 2021, increasing the allocation to the allowance for loan losses. Business and personal bankruptcy filing data was available as of June 2022. 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, 2021, business bankruptcy filings and personal bankruptcy filings slightly decreased. The Company estimates that bankruptcy filings are artificially low due to a backlog in the court system and prolonged government aid. When the pandemic began, precautions for COVID-19 slowed the work of the court system. The federal government also implemented a foreclosure moratorium, provided direct payments to qualifying recipients and PPP loans to small businesses, and encouraged banks to work with borrowers who were impacted by the pandemic, all of which had a minimizing effect on bankruptcy filings. All of these measures expired by the end of 2021. Management believes bankruptcy filings will normalize and currently available data does not reflect credit risk. The allocation was based on current data and an average of pre-pandemic filings from 2017 through 2020, which was higher than the current level and the level incorporated to the allowance at December 31, 2021. 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 September 30, 2022 was measured as of the second quarter of 2022 and worsened from the data incorporated into the December 31, 2021 calculation, resulting in a higher allocation. Housing inventory data was available as of September 30, 2022. The level is slightly higher than at December 31, 2021, resulting in a higher allocation. Economic factors in 2021 included an allocation for national unemployment filings. This factor was added early in the pandemic to capture risk that may not have been reflected by the Company’s standard economic indicators. By the beginning of 2022, national unemployment filings had returned to pre-pandemic levels for a sustained period and the Company removed the allocation provided in 2021.   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 0.17% of total loans net of unearned income and deferred fees and costs at September 30, 2022, an increase from 0.12% at December 31, 2021. Accruing loans past due 90 days or more were 0.01% of total loans, net of unearned income and deferred fees and costs at September 30, 2022 and at December 31, 2021. Nonaccrual loans as a percentage of total loans net of unearned income and deferred fees and costs were 0.34% at September 30, 2022 and 0.36% at December 31, 2021. 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 at September 30, 2022 were $311, compared with $3,728 at December 31, 2021, due to improvement in credit quality of a large relationship. Collectively evaluated loans rated classified were $1,041 at September 30, 2022 and $1,064 at December 31, 2021.   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. The interest rate environment impacts variable rate loans. When interest rates increase, the payment on variable rate loans increases, which may increase credit risk. The Federal Reserve increased the target Fed Funds rate in March, May, June, July, and September 2022, resulting in an increased allocation for September 30, 2022, compared with the allocation for December 31, 2021. 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, 2021. The legal and regulatory environments remain in a similar posture to that at December 31, 2021.   41 Table of Contents     Lending policies, loan review procedures and management’s experience influence credit risk. During the second quarter of 2022, appraisal requirements on residential real estate changed, resulting in an increased allocation from December 31, 2021. Loan review procedures remained similar to those at December 31, 2021 and no allocation was taken. During the first quarter of 2022, the Company hired a seasoned Chief Credit Officer to replace the employee who left at the end of 2021. The allocation taken at December 31, 2021 was removed. During the second and third quarters of 2022, the Company opened a new loan production office and hired an experienced commercial lender, resulting in a small allocation to reflect potential risk. 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 increased 5.99% from the level at December 31, 2021, resulting in an increased allocation.   Unallocated Surplus The unallocated surplus at September 30, 2022 is $141 or 1.75% in excess of the calculated requirement. The unallocated surplus at December 31, 2021 was $361 or 4.94% in excess of the calculated requirement. The surplus provides some mitigation of current economic uncertainty that may impact credit risk.   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 Company augmented the calculated requirement with an unallocated surplus. 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 September 30, 2022.   Provision and Allowance for Loan Losses   The calculation of the allowance for loan losses resulted in a provision for loan losses of $252 for the three month period ended September 30, 2022, compared with a recovery of $392 for the three month period ended September 30, 2021. The provision for the nine month period ended September 30, 2022 was $696, compared with a recovery of $338 for the nine months ended September 30, 2021. The recovery in 2021 reflected a decrease in risk provided for during 2020 and early 2021. The provision for 2022 reflects loan growth and changes in factors detailed in “Asset Quality” above.   Loan Modifications and TDRs   Modifications In the ordinary course of business the Company modifies loan terms on a case-by-case basis 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. Please refer to the Company’s 2021 Form 10-K, Note 1: Summary of Significant Accounting Policies for information on TDR designation. 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. Modifications to consumer loans generally involve short-term payment extensions to accommodate specific, temporary circumstances. Payment extensions provide short-term payment relief 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 commercial loans may include, but are not limited to, changes in interest rate, maturity, amortization and financial covenants. The Company codes modifications to assist in identifying TDRs.   Modifications That Are Not TDR During the three months ended September 30, 2022, the Company provided 187 modifications for competitive reasons to loans totaling $27,389. During the nine months ended September 30, 2022, the Company provided 652 modifications to loans totaling $101,347. The modifications were not TDRs and were not related to COVID-19. The Company provided non-TDR modifications for competitive reasons to 205 loans totaling $24,754 during the three months ended September 30, 2021, and to 659 loans totaling $72,327 during the nine months ended September 30, 2021. During nine months ended September 30, 2021, the Company also provided 45 modifications to loans totaling $38,561 related to COVID-19 difficulty. The modifications met the criteria under the CARES Act, the CAA and regulatory guidance and were not designated as TDRs.   42 Table of Contents     TDRs The Company’s TDRs, by delinquency status, are presented below:         TDR Status as of September 30, 2022               Accruing               Total TDR Loans     Current     30-89 Days Past Due     90+ Days Past Due     Nonaccrual   Consumer real estate   $ 187     $ 187     $ -     $ -     $ -   Commercial real estate     2,599       92       -       -       2,507   Commercial non real estate     263       -       -       -       263   Total TDR Loans   $ 3,049     $ 279     $ -     $ -     $ 2,770         TDR Status as of December 31, 2021               Accruing               Total TDR Loans     Current     30-89 Days Past Due     90+ Days Past Due     Nonaccrual   Consumer real estate   $ 191     $ 191     $ -     $ -     $ -   Commercial real estate     5,386       2,814       -       -       2,572   Commercial non real estate     301       -       -       -       301   Total TDR Loans   $ 5,878     $ 3,005     $ -     $ -     $ 2,873       Please refer to Note 3: Allowance for Loan Losses, Nonperforming Assets and Impaired Loans for information on TDRs.            Other Real Estate Owned   The following table discloses the OREO in physical possession and in process at each reporting date:   Other Real Estate Owned, net of valuation allowance   September 30, 2022     December 31, 2021   Real estate construction   $ 907     $ 957   Consumer real estate     -       -   Total other real estate owned   $ 907     $ 957     As of September 30, 2022, loans in various stages of foreclosure totaled $224, all of which are secured by residential real estate. Loans currently in the process of foreclosure may increase 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. If the Company’s market experiences an economic downturn, real estate values could decline and foreclosure activity could increase. A decline in value may result in loss recognition for OREO, while an increase in foreclosures may increase the number of OREO properties.   43 Table of Contents     Net Interest Income   The following table shows interest‑earning assets and interest‑bearing liabilities, the interest earned or paid, the average yield or rate on the daily average balance outstanding, net interest income and net yield on average interest‑earning assets for the periods indicated.       Three Months Ended September 30,       2022     2021       Average Balance     Interest     Average Yield/Rate     Average Balance     Interest     Average Yield/Rate   Interest-earning assets:                                                 Loans (1)(2)(4)(5)   $ 849,929     $ 8,900       4.15 %   $ 798,807     $ 9,172       4.56 % Taxable securities (6)(7)     683,490       3,425       1.99 %     540,854       2,043       1.50 % Nontaxable securities (1)(6)     74,670       556       2.95 %     79,097       626       3.14 % Interest-bearing deposits     89,165       506       2.25 %     145,759       56       0.15 % Total interest-earning assets   $ 1,697,254     $ 13,387       3.13 %   $ 1,564,517     $ 11,897       3.02 % Interest-bearing liabilities:                                                 Interest-bearing demand deposits   $ 936,368     $ 686       0.29 %   $ 839,477     $ 617       0.29 % Savings deposits     217,637       36       0.07 %     195,767       41       0.08 % Time deposits     78,198       31       0.16 %     86,379       61       0.28 % Total interest-bearing liabilities   $ 1,232,203     $ 753       0.24 %   $ 1,121,623     $ 719       0.25 % Net interest income and interest rate spread           $ 12,634       2.89 %           $ 11,178       2.77 % Net yield on average interest‑earning assets                     2.95 %                     2.83 %       Nine Months Ended September 30,       2022     2021       Average Balance     Interest     Average Yield/Rate     Average Balance     Interest     Average Yield/Rate   Interest-earning assets:                                                 Loans (1)(3)(4)(5)   $ 829,133     $ 25,484       4.11 %   $ 786,613     $ 26,341       4.48 % Taxable securities (6)(7)     662,824       8,847       1.78 %     505,134       5,736       1.52 % Nontaxable securities (1)(6)     75,806       1,728       3.05 %     80,596       1,960       3.25 % Interest-bearing deposits     97,917       757       1.03 %     136,391       123       0.12 % Total interest-earning assets   $ 1,665,680     $ 36,816       2.96 %   $ 1,508,734     $ 34,160       3.03 % Interest-bearing liabilities:                                                 Interest-bearing demand deposits   $ 911,926     $ 1,839       0.27 %   $ 799,593     $ 2,053       0.34 % Savings deposits     216,691       111       0.07 %     186,720       132       0.09 % Time deposits     79,981       105       0.18 %     88,009       223       0.34 % Total interest-bearing liabilities   $ 1,208,598     $ 2,055       0.23 %   $ 1,074,322     $ 2,408       0.30 % Net interest income and interest rate spread           $ 34,761       2.73 %           $ 31,752       2.73 % Net yield on average interest‑earning assets                     2.79 %                     2.81 %   (1) Interest on nontaxable loans and securities is computed on a fully taxable equivalent basis using a Federal income tax rate of 21%. (2) Included in interest income are loan fees of $82 for the three months ended September 30, 2022. For the three months ended September 30, 2021, interest income included loan fees $911, of which $882 was related to PPP loans. (3) Included in interest income are loan fees of $195 for the nine months ended September 30, 2022. For the nine months ended September 30, 2021, interest income included loan fees of $1,855, of which $1,776 was related to PPP loans. (4) Nonaccrual loans are included in average balances for yield computations. (5) Includes loans held for sale. (6) Daily averages are shown at amortized cost. (7) Includes restricted stock.   44 Table of Contents     When results from the nine month period ended September 30, 2022 are compared with the same period of 2021, net interest income benefitted from both lower interest expense and higher interest income. Interest expense for the nine months ended September 30, 2022 improved $353 compared with the same period of 2021.  The cost of interest-bearing liabilities improved from an annualized 0.30% for the nine months ended September 30, 2021 to 0.23% for the nine months ended September 30, 2022.  Elevated levels of deposits and liquidity within the Company, similar to the general banking industry, supported favorable deposit pricing during 2022. The increase in interest income stemmed from Federal Reserve interest rate increases in 2022 as well as growth in earning assets.  The FTE yield on earning assets for the nine months ended September 30, 2022 was 2.96%, compared with 3.03% for the nine months ended September 30, 2021.  Results for 2021 were impacted by Paycheck Protection Program (PPP) loans.  If PPP loans are excluded, the yield on earning assets for the nine months ended September 30, 2021 would have been 2.85%.   Noninterest Income       Three Months Ended September 30,               2022     2021     Percent Change   Service charges on deposits   $ 661     $ 548       20.62 % Other service charges and fees     51       50       2.00 % Credit and debit card fees, net     448       460       (2.61 )% Trust fees     492       433       13.63 % BOLI income     239       248       (3.63 )% Gain on sale of mortgage loans     40       76       (47.37 )% Other income     209       177       18.08 % Total noninterest income   $ 2,140     $ 1,992       7.43 %       Nine Months Ended September 30,               2022     2021     Percent Change   Service charges on deposits   $ 1,826     $ 1,488       22.72 % Other service charges and fees     157       134       17.16 % Credit and debit card fees, net     1,423       1,373       3.64 % Trust fees     1,374       1,282       7.18 % BOLI income     718       664       8.13 % Gain on sale of mortgage loans     136       287       (52.61 )% Other income     909       1,034       (12.09 )% Realized securities gain, net     -       5       (100.00 )% Total noninterest income   $ 6,543     $ 6,267       4.40 %   The increase from 2021 in service charges on deposits stemmed from higher fee income for non-sufficient funds and overdrafts, as depositor activity recovered from lower levels earlier in the COVID-19 pandemic. The Company offers depositors various overdraft solutions and provides disclosures on its fees. Other service charges and fees increased when the three and nine month periods ended September 30, 2022 are compared with the same periods of 2021, due to higher service charges on letters of credit and safe deposit box fee income. Credit and debit card fees are presented net of interchange expense. Credit and debit card fees are driven by volume. Trust income increased for the three and nine month periods ended September 30, 2022, when compared with the same periods of 2021. 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 slightly when the three month periods ended September 30, 2022 and September 30, 2021 are compared and increased when the nine month periods ended September 30, 2022 and September 30, 2021 are compared. The Company purchased an additional $5 million in BOLI investments during June, 2021. Gain on sale of mortgage loans decreased when 2022 is compared with 2021. The Federal Reserve interest rate increases in 2022 have dampened real estate refinance and purchase financing activity.   45 Table of Contents     Other income includes revenue from investment and insurance sales, adjustments to partnership basis and other miscellaneous components. These areas fluctuate with market conditions and competitive factors. Other income increased for the three month period ended September 30, 2022 compared to the same period in 2021 due to higher commissions on securities sales. When the nine month periods ended September 30, 2022 and September 30, 2021 are compared, other income decreased due to lower commissions on securities sales and decreased dividends on a partnership investment.   Noninterest Expense       Three Months Ended September 30,               2022     2021     Percent Change   Salaries and employee benefits   $ 4,144     $ 3,909       6.01 % Occupancy, furniture and fixtures     476       447       6.49 % Data processing and ATM     774       728       6.32 % FDIC assessment     114       120       (5.00 )% Net costs of other real estate owned     68       11       518.18 % Franchise taxes     375       367       2.18 % Other operating expenses     785       785       0.00 % Total noninterest expense   $ 6,736     $ 6,367       5.80 %       Nine Months Ended September 30,               2022     2021     Percent Change   Salaries and employee benefits   $ 12,133     $ 11,767       3.11 % Occupancy, furniture and fixtures     1,432       1,378       3.92 % Data processing and ATM     2,354       2,292       2.71 % FDIC assessment     336       296       13.51 % Net costs of other real estate owned     78       49       59.18 % Franchise taxes     1,108       1,059       4.63 % Other operating expenses     2,219       2,509       (11.56 )% Total noninterest expense   $ 19,660     $ 19,350       1.60 %   Salaries and employee benefits 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 expense increased when the three and nine month periods ended September 30, 2022 are compared with the same periods ended September 30, 2021. Lower pension expense was offset by normal increases in salary expense, insurance and salary continuation expense. Expense for occupancy, furniture and fixtures and data processing and ATM increased due to normal business activity. Federal Deposit Insurance (“FDIC”) assessment expense decreased when the three month period ended September 30, 2022 is compared to the same period in 2021 and increased when the nine month period ended September 30, 2022 is compared with the same period of 2021. 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. Net costs of other real estate owned increased when 2022 is compared with 2021, primarily due to a write-down of $50, taken during the third quarter of 2022. The Company received an updated appraisal and modified its marketing strategy for the property, resulting in the write-down. Franchise tax expense increased when the three and nine month periods ended September 30, 2022 and September 30, 2021 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 remained the same when the three month period ended September 30, 2022 is compared to the same period in 2021 and decreased when the nine month period ended September 30, 2022 is compared with the same period ended September 30, 2021, due to lower non-service pension cost and cost control measures.   46 Table of Contents     Income Tax   Income tax expense was $1,392 for the three months ended September 30, 2022 and $1,202 for the same period of 2021. For the nine months ended September 30, 2022 and 2021, income tax expense was $3,637 and $3,151 respectively. The Company’s federal statutory tax rate is 21%. The Company’s effective tax rate was 18.43% and 17.95% for the three and nine month periods ended September 30, 2022, compared with 17.29% and 17.24% for the three and nine month periods ended September 30, 2021.   Balance Sheet   Year-to-date daily averages for the major balance sheet categories are as follows:   Assets   September 30, 2022     December 31, 2021     Percent Change   Interest-bearing deposits   $ 97,917     $ 133,020       (26.39 )% Securities available for sale, net, and restricted stock     694,216       612,636       13.32 % Loans, net of unearned income and deferred fees and costs and the allowance for loan losses     821,082       778,920       5.41 % Total assets     1,716,907       1,618,642       6.07 %                           Liabilities and stockholders ’ equity                         Noninterest-bearing demand deposits   $ 334,727     $ 316,976       5.60 % Interest-bearing demand deposits     911,926       811,661       12.35 % Savings deposits     216,691       190,997       13.45 % Time deposits     79,981       86,089       (7.09 )% Stockholders’ equity     157,540       192,545       (18.18 )%   The decline in interest-bearing deposits resulted as the Company invested in securities and loans to increase yields. The decline in stockholders’ equity resulted from contraction in accumulated other comprehensive income (loss). Changes in securities, loans and deposits are discussed below.   Securities       September 30, 2022     December 31, 2021     Percent Change   Amortized cost   $ 765,371     $ 682,467       12.15  % Unrealized gain (loss)     (107,961 )     3,613       (3088.13 )% Securities available for sale   $ 657,410     $ 686,080       (4.18 )%   Securities available for sale are measured at fair value as of each reporting date. During the nine months ended September 30, 2022, the amortized cost of securities available for sale increased from December 31, 2021 by $82,904, while unrealized losses decreased the fair value from December 31, 2021 by $111,574. Change in the fair value of bonds is inversely related to interest rate movement. During the nine months ended September 30, 2022, the Federal Reserve increased its target rate 300 basis points. These increases, as well as market expectations decreased the fair value of the securities portfolio. The Company’s Asset Liability Management Committee is closely monitoring interest rate risk on all of the Company’s financial assets and liabilities. At this time, the Company has high liquidity and a relatively low loan-to-deposit ratio. No securities sales are anticipated.  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.   47 Table of Contents     Loans       September 30, 2022     December 31, 2021     Percent Change   Real estate construction loans   $ 62,821     $ 48,841       28.62 % Consumer real estate loans     219,617       208,977       5.09 % Commercial real estate loans     435,185       405,722       7.26 % Commercial non real estate loans     52,409       60,264       (13.03 )% Public sector and IDA     48,912       47,899       2.11 % Consumer non real estate     34,328       32,026       7.19 % Less: unearned income and deferred fees and costs     (409 )     (481 )     14.97 % Loans, net of unearned income and deferred fees and costs   $ 852,863     $ 803,248       6.18 %   Loan demand continues to provide growth. Most of the increase in construction loans is due to investment in participations with other banks.   Deposits       September 30, 2022     December 31, 2021     Percent Change   Noninterest-bearing demand deposits   $ 358,772     $ 317,430       13.02 % Interest-bearing demand deposits     917,449       890,124       3.07 % Saving deposits     217,405       208,065       4.49 % Time deposits     77,023       78,968       (2.46 )% Total deposits   $ 1,570,649     $ 1,494,587       5.09 %   Total deposits increased from December 31, 2021 to September 30, 2022. 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 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 September 30, 2022, the Bank did not have any borrowings.  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 September 30, 2022, 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. The Company’s liquidity position has benefitted over the past two years from increased customer deposits fueled by federal stimulus payments for COVID-19 pandemic relief. At September 30, 2022, 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 September 30, 2022, 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 internally-set target range. At September 30, 2022, the loan to deposit ratio was 54.30%. 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.   48 Table of Contents     Capital Resources   Total stockholders’ equity at September 30, 2022 was $112,187, a decrease of $79,564 or 41.49%, from the $191,751 at December 31, 2021. Book value declined from $31.62 at December 31, 2021 to $18.83 at September 30, 2022. The decline in stockholders equity and book value is due to worsening of accumulated other comprehensive loss associated with the unrealized loss in fair value of securities. Accumulated other comprehensive loss is excluded from regulatory capital calculations and does not impact regulatory capital requirements or ratios. The Company qualifies as a small bank holding company under the Federal Reserve’s Small Bank Holding Company Policy Statement, which exempts bank holding companies with less than $3 billion in assets from reporting consolidated regulatory capital ratios and from minimum regulatory capital requirements. NBB is subject to various capital requirements administered by banking agencies, including an additional capital conservation buffer in order to make capital distributions or discretionary bonus payments. Risk-based capital ratios are calculated in compliance with OCC rules based on the Basel III Capital Rules. The Bank’s ratios are well above the required minimums. 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     17.52 %     4.50 %     7.00 % Tier I Capital Ratio     17.52 %     6.00 %     8.50 % Total Capital Ratio     18.26 %     8.00 %     10.50 % Leverage Ratio     10.88 %     4.00 %     4.00 %   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 September 30, 2022. 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 three or nine months ended September 30, 2022.   Contractual Obligations   The Company had no finance lease or purchase obligations and no long-term debt at September 30, 2022.   Item 3.   Quantitative and Qualitative Disclosures About Market Risk   Not applicable.   49 Table of Contents