NEW PEOPLES BANKSHARES INC 10-K

Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations Caution About Forward Looking Statements We make forward looking statements in this annual report on Form 10-K that are subject to risks and uncertainties. These forward-looking statements include statements regarding expectations, intentions, projections and beliefs concerning our profitability, liquidity, and allowance for loan losses, interest rate sensitivity, market risk, growth strategy, and financial and other goals. 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. The forward-looking information is based on various factors and was derived using numerous assumptions. 17 Important factors that may cause actual results to differ from projections include: the success or failure of our efforts to implement our business plan; any required increase in our regulatory capital ratios; satisfying other regulatory requirements that may arise from examinations, changes in the law and other similar factors; deterioration of asset quality; changes in the level of our nonperforming assets and charge-offs; fluctuations of real estate values in our markets; our ability to attract and retain talent; demographical changes in our markets which negatively impact the local economy; the uncertain outcome of current or future legislation or regulations or policies of state and federal regulators; the successful management of interest rate risk; the successful management of liquidity; changes in general economic and business conditions in our market area and the United States in general; credit risks inherent in making loans such as changes in a borrower’s ability to repay and our management of such risks; competition with other banks and financial institutions, and companies outside of the banking industry, including online lenders and those companies that have substantially greater access to capital and other resources; demand, development and acceptance of new products and services we have offered or may offer; the effects of, and changes in, trade, monetary and fiscal policies and laws, including interest rate policies of the Federal Reserve, inflation, interest rate, market and monetary fluctuations; the occurrence of significant natural disasters, including severe weather conditions, floods, health related issues (including the ongoing novel coronavirus (COVID-19) outbreak and the associated efforts to limit the spread of the disease), and other catastrophic events; geopolitical conditions, including acts or threats of terrorism, international hostilities, or actions taken by the U.S. or other governments in response to acts or threats of terrorism and/or military conflicts, which could impact business and economic conditions in the U.S. and abroad; technology utilized by us; our ability to successfully manage cyber security; our reliance on third-party vendors and correspondent banks; changes in generally accepted accounting principles; changes in governmental regulations, tax rates and similar matters; and, other risks, which may be described, from time to time, in our filings with the SEC. Because of these uncertainties, our actual future results may be materially different from the results indicated by these forward-looking statements. In addition, our past results of operations do not necessarily indicate our future results. We expressly disclaim any obligation to update or revise any forward-looking statements, whether as a result of new information, future events or otherwise, except as required by law. General The following commentary discusses major components of our business and presents an overview of our consolidated financial position at December 31, 2021 and 2020, as well as results of operations for the years ended December 31, 2021 and 2020. This discussion should be reviewed in conjunction with the consolidated financial statements and accompanying notes and other statistical information presented elsewhere in this Form 10-K. New Peoples generates a significant amount of its income from the net interest income earned by the Bank. Net interest income is the difference between interest income and interest expense. Interest income depends on the volume of interest-earning assets outstanding during the period and the interest rates earned thereon. The Bank's interest expense is a function of the average amount of interest-bearing deposits and borrowed money outstanding during the period and the interest rates paid thereon. The quality of the assets further influences the amount of interest income lost on nonaccruing loans and the amount of provision expense added to the allowance for loan losses. The Bank also generates noninterest income from service charges on deposit accounts, debit and credit card interchange income, and commissions on insurance and investment products sold. 18 Critical Accounting Policies Certain critical accounting policies affect the more significant judgments and estimates used in the preparation of our financial statements. Our most critical accounting estimates relate to our provision for loan losses and the calculation of our deferred tax asset and any related valuation allowance. The provision for loan losses reflects the estimated losses resulting from the inability of our customers to make required payments. If the financial condition of our borrowers were to deteriorate, resulting in an impairment of their ability to make payments, our estimates would be updated, and additional provisions could be required. For further discussion of the estimates used in determining the allowance for loan losses, we refer you to the section on “Allowance for Loan Losses” in this discussion. Deferred tax assets or liabilities are computed based upon the difference between financial statement and income tax bases of assets and liabilities using the enacted marginal tax rate. A valuation allowance on net deferred tax assets would be provided if it was deemed more likely than not such assets would not be realized. At December 31, 2021 and 2020, the Company had no valuation allowance on its net deferred tax assets. The Company recognizes the tax benefit from an uncertain tax position only if it is more likely than not the tax position will be sustained on examination by the taxing authorities, based on the technical merits of the position. The tax benefits recognized in the financial statements from such positions are then measured based on the largest benefit that has a greater than 50% likelihood of being realized upon settlement. For further discussion of the deferred tax asset and valuation allowance, we refer you to the section on “Income Taxes and Deferred Tax Assets” in this discussion. For further discussion of our other critical accounting policies, see Note 2, Summary of Significant Accounting Policies, to our Consolidated Financial Statements, found in Item 8 to this annual report on Form 10-K. Cyber Security The Company, primarily through the Bank, depends on its ability to continuously process, record and monitor a large number of customer transactions, and customer, public and regulatory expectations regarding operational and information security have increased over time. Accordingly, the Company’s and its subsidiaries’ operational systems and infrastructure must continue to be safeguarded and monitored for potential failures, disruptions and breakdowns. Although the Company has business continuity plans and other safeguards in place, disruptions or failures in the physical infrastructure or operating systems that support its businesses and customers, or cyber-attacks or security breaches of the networks, systems or devices on which customers’ personal information is stored and that customers use to access the Company’s and its subsidiaries’ products and services could result in customer attrition, regulatory fines, penalties or intervention, reputational damage, reimbursement or other compensation costs, and/or additional compliance costs, any of which could materially adversely affect the Company’s results of operations or financial condition. Although to date the Company has not experienced any material losses relating to cyber-attacks or other information security breaches, there can be no assurance that it or its subsidiaries will not suffer such losses in the future. The Company’s risk and exposure to these matters remains heightened because of, among other things, the evolving nature of these threats, our plans to continue to implement our e-banking and mobile banking channel strategies and develop additional remote connectivity solutions to serve our customers when and how they want to be served. As a result, cyber security and the continued development and enhancement of the Company’s controls, processes and practices, designed to protect its and its subsidiaries’ systems, computers, software, data and networks from attack, damage or unauthorized access, remain a priority for the Company. As cyber threats continue to evolve, the Company may be required to expend significant additional resources to continue to modify or enhance its protective measures or to investigate and remediate any information security vulnerabilities. 19 As discussed in the Supervision and Regulation section, the federal banking agencies have issued a joint rule that requires banking organizations to notify their primary regulator as soon as possible and no later than 36 hours after any cyber-security incident has occurred. The new rule takes effect on April 1, 2022, with full compliance extended to May 1, 2022. To date, we have not experienced a significant compromise, significant data loss or any material financial losses related to cyber-attacks, but our systems and those of our customers and third-party service providers are under constant threat and it is possible that we could experience a significant event in the future. Recent Events Since March 2020, the COVID-19 pandemic has adversely affected our communities and the way we do business, as well as, economic activity globally, nationally and locally. Among other things, interest rates declined, unemployment increased and economic output slowed dramatically during 2020. Within the last year, as restrictions related to the pandemic eased, employment increased and pent-up demand was released, creating global supply chain issues and shortages of goods, which in turn has triggered price inflation we have not seen in over 30 years. In an effort to address inflation, the Federal Open Market Committee (the “FOMC”) has slowed monetary accommodation and on March 16, 2022 increased the federal funds rate 25 bps, in the first of what is expected to be a series of rate increases during 2022. Adding to economic uncertainty and increased inflationary pressures are military actions taken by Russia against Ukraine commencing in February 2022, which have added stress to existing supply chain concerns and placed upward pressure on oil and natural gas prices. At this time, we cannot reasonably estimate the term or intensity of any possible adverse impact on our financial position, operations or liquidity, resulting from economic disruption and uncertainty related to COVID-19 variants, trade and supply chain disruption, continuing inflationary pressures, ongoing military actions against Ukraine, and the uncertainty of the timing and extent of potential actions that might be taken by the FOMC. Overview The Company made significant progress during 2021 resulting in a record consolidated net income for the year ended December 31, 2021, of $7.0 million, or basic income per share of $0.29, as compared to a net income of $2.9 million, or basic income per share of $0.12, for the year ended December 31, 2020, an improvement of $4.1 million, or 142.6%. Retained earnings stood at $2.0 million at December 31, 2021, the first time it has been positive since 2010. The improvement is due to an increase of $2.1 million in net interest income, a decrease of $1.9 million in provision for loan loss expense, and an increase of $1.8 million in noninterest income, offset by an $870 thousand increase in noninterest expense. The increase of $2.1 million in net interest income was due primarily to a decrease of $2.0 million in interest expense on deposits, plus an increase of $329 thousand in interest income on investments, partially offset by a $315,000 decrease in interest income on loans, including fees. The reduction in both interest income and interest expense was driven mainly by lower market rates, which remained low throughout 2020 and 2021. The decrease of $1.9 million in provision for loan loss expense is due to improving asset quality, as exhibited by reductions in past due loans, classified loans and nonaccrual loans, along with improving employment and non-inflation related economic conditions. The $1.8 million increase in noninterest income was driven by an additional $507 thousand in service charges and fees, a $557 thousand increase in card processing and interchange income, a $313 thousand increase in financial services fees, plus nonrecurring gains on sales of investment securities of $322 thousand. Noninterest expense grew by $870 thousand primarily due to valuation adjustments of $1.1 million on three former branch office locations, which were transferred into other real estate owned, offset by a $566 thousand reduction in salaries and benefit expense. During the year ended December 31, 2021, total assets grew $38.3 million, or 5.1%, to $794.6 million. Loan balances increased $18.2 million, or 3.2%. Excluding the net impact of $25.3 million in PPP loan originations and $53.6 million of PPP loan repayments, the remaining loan portfolio grew $46.6 million, due largely to our new Boone loan production office, which opened during the fourth quarter of 2020. Deposits grew $39.5 million, or 5.9%, due to the impact of stimulus payments and PPP loan funds during the first half of the year, combined with residual liquidity that remains in the financial markets. This deposit growth, combined with a decrease of $30.3 million in interest bearing deposits in other banks, funded a net increase in the investment portfolio of $59.0 million. 20 The Company’s key performance indicators are as follows: Year ended December 31, 2021 2020 Return on average assets 0.88 % 0.39 % Return on average equity 11.52 % 5.18 % Average equity to average assets ratio 7.62 % 7.51 % Highlights from the year 2021 include: · Net income improved 142.6% to a historical Company record of $7.0 million, or $0.29 per share, in 2021 compared to $2.9 million, or $0.12 per share, in 2020; · Total assets increased $38.3 million, or 5.1%, to $794.6 million at December 31, 2021 compared to $756.3 million at December 31, 2020; · Book value per share was $2.66 as of December 31, 2021 and $2.43 as of December 31, 2020; · Net interest income was $27.2 million, an increase of $2.1 million compared to 2020, as described above; · Our net interest margin was 3.64%, a reduction of 1 basis points compared to 3.65% for the year ended December 31, 2020; · Total loans increased $18.2 million, or 3.2%, to $593.7 million during the year ended December 31, 2021; · Securities available for sale increased $59.0 million, or 121.8%, to $107.4 million during the year ended December 31, 2021; · Total deposits increased $39.5 million, or 5.9%, to $707.5 million during the year ended December 31, 2021, primarily due to PPP loan funds and federal stimulus payments; · Noninterest income was $10.0 million, an increase of $1.8 million compared to 2020; · Salaries and employee benefits expense was $12.7 million, a reduction of $566 thousand compared to 2020, which was due mainly to the restructuring announced in May of 2020 and the overall reduction in staff; · During the fourth quarter of 2021, we began implementing a plan to increase our minimum wage to $15.00 per hour.; · Nonperforming assets, which include nonaccrual loans and other real estate owned, totaled $4.3 million at December 31, 2021, a decrease of $4.6 million, or 51.6% during the year ended December 31, 2021; · Nonperforming assets as a percentage of total assets was 0.54% at December 31, 2021, compared to 1.17% at December 31,2020; · Annualized net charge offs as a percentage of average loans were 0.14% during 2021, compared to 0.08% during 2020; and · The allowance for loan losses as a percentage to total loans was 1.13% at December 31, 2021, as compared to 1.25% at December 31, 2020. For detail on the above highlighted items, refer to their related following sections. Net Interest Income and Net Interest Margin The Company’s primary source of income is net interest income, which increased $2.1 million, or 8.2% in 2021 compared to 2020, due primarily to a decrease of $2.0 million in interest expense on deposits, plus an increase of $329,000 in interest income on investments, partially offset by a $315,000 decrease in interest income on loans, including fees. The reduction in interest expense on deposits is due to reduced rates on time deposits and a reduction of $34.7 million in average time deposit balances. The increase in interest income on investments is due to an increase in average balances of $33.6 million, as we redeployed excess funds into investment securities, which generally provide higher yields than federal funds or interest-earning correspondent accounts. The decrease in interest income on loans, including fees, was driven by a decrease of $1.4 million in interest on loans, offset by an increase in fees of $1.1 million, resulting from PPP loan forgiveness. The following table shows the rates paid on earning assets and deposit liabilities for the periods indicated. 21 Net Interest Margin Analysis Average Balances, Income and Expense, and Yields and Rates (Dollars in thousands) For the Year Ended For the Year Ended December 31, 2021 December 31, 2020 Average Income/ Yields/ Average Income/ Yields/ Balance Expense Rates Balance Expense Rates ASSETS Loans (1) (2) $ 586,963 $ 28,323 4.83% $ 578,979 $ 28,638 4.95% Federal funds sold 212 - 0.10% 244 1 0.36% Interest bearing deposits in other banks 78,583 95 0.12% 61,083 208 0.34% Taxable investment securities 81,635 1,494 1.83% 48,072 1,189 2.47% Total earning assets 747,393 29,912 4.00% 688,378 30,036 4.37% Less: Allowance for loans losses (7,034) (6,512) Non-earning assets 58,398 61,411 Total Assets $ 798,757 $ 743,277 LIABILITIES AND SHAREHOLDERS’ EQUITY Interest-bearing demand deposits $ 59,154 $ 59 0.10% $ 45,302 $ 70 0.15% Savings and money market deposits 181,736 148 0.08% 148,320 360 0.24% Time deposits 214,937 2,041 0.95% 252,074 3,854 1.53% Short-term borrowings 2,474 33 1.33% 5,000 68 1.36% Trust preferred securities 16,496 420 2.55% 16,496 541 3.28% Total interest-bearing liabilities 474,797 2,701 0.57% 467,192 4,893 1.05% Non-interest-bearing deposits 254,911 - -% 210,831 - - % Total deposit liabilities and cost of funds 729,708 2,701 0.37% 678,023 4,893 0.72% Other liabilities 8,178 9,431 Total Liabilities 737,886 687,454 Stockholders’ Equity 60,871 55,823 Total Liabilities and Stockholders’ Equity $ 798,757 $ 743,277 Net Interest Income $ 27,211 $ 25,143 Net Interest Margin 3.64% 3.65% Net Interest Spread 3.43% 3.32% (1) Nonaccrual loans have been included in average loan balances. (2) Tax exempt income is not significant and has been treated as fully taxable. Net interest income is affected by changes in both average interest rates and average volumes (balances) of interest-earning assets and interest-bearing liabilities. The following tables set forth the amounts of the total changes in interest income and interest expense which can be attributed to rates, volume and a combination of rates and volume, for the periods indicated. 22 Volume and Rate Analysis Increase (decrease) Year 2021 Compared to 2020 (Dollars in thousands) Volume Effect Rate Effect Rate and Volume Effect Change in Interest Income/ Expense Interest Income: Loans $ 395 $ (700 ) $ (10 ) $ (315 ) Federal funds sold — (1 ) — (1 ) Interest bearing deposits in other banks 59 (134 ) (38 ) (113 ) Taxable investment securities 830 (309 ) (216 ) 305 Total Earning Assets 1,284 (1,144 ) (264 ) (124 ) Interest Expense: Interest-bearing demand deposits 21 (25 ) (7 ) (11 ) Savings and money market deposits 81 (239 ) (54 ) (212 ) Time deposits (568 ) (1,460 ) 215 (1,813 ) Short-term borrowings (34 ) (1 ) — (35 ) Trust preferred securities — (121 ) — (121 ) Total Interest-bearing Liabilities (500 ) (1,846 ) 154 (2192 ) Change in Net Interest Income $ 1,784 $ 702 $ (418 ) $ 2,068 Year 2020 Compared to 2019 (Dollars in thousands) Volume Effect Rate Effect Rate and Volume Effect Change in Interest Income/ Expense Interest Income: Loans $ 1,196 $ (1,113 ) $ (47 ) $ 37 Federal funds sold — (4 ) — (4 ) Interest bearing deposits in other banks 456 (672 ) (381 ) (597 ) Taxable investment securities (280 ) (91 ) 17 (355 ) Total Earning Assets 1,372 (1,880 ) (411 ) (919 ) Interest Expense: Interest-bearing demand deposits 18 (10 ) (3 ) 5 Savings and money market deposits (39 ) (605 ) 24 (620 ) Time deposits (131 ) (78 ) 3 (206 ) Short-term borrowings (12 ) 3 (1 ) (10 ) Trust preferred securities — (255 ) — (255 ) Total Interest-bearing Liabilities (164 ) (945 ) 23 (1,086 ) Change in Net Interest Income $ 1,536 $ (935 ) $ (434 ) $ 167 The reduction in interest income and interest expense during both 2021 and 2020 was driven mainly by lower market rates, which have fallen throughout both years. Overall, our net interest margin decreased 1 basis point to 3.64%in 2021 compared to 3.65% in 2020. While the yield on average assets decreased 37 basis points, to 4.00% from 4.37%, the cost of funds decreased 35 basis points, to 0.37% from 0.72%. The reduction in market rates was a direct result of actions taken by the FMOC, which, in response to the economic impact of the pandemic, reduced the target federal funds rate twice in March 2020, by 150 bps. As a result, the target federal funds rate stood at 0.00% - 0.25% and the prime interest rate stands at 3.25%. In March 2022, the FMOC increased the target federal funds rate 25 bps, resulting in the prime interest rate increasing to 3.50%. It is the general consensus that this increase is the first of a series of increases that the FOMC will effect in 2022. 23 The decrease in interest income is primarily attributed to reduced yield on loans, not including fees, which was mainly driven by lower market rates, as noted above, plus materially lower rates earned on PPP loans. The yield on PPP loans is 1.00%, excluding the impact of deferred fee income. Although loan fees earned and recognized on PPP loans has been material during 2021 and 2020, it does not completely make up for the reduced yield. The increase in loan fee income is a result of recognition of net deferred fees on PPP loans totaling $2.0 million in 2021, and $994 thousand in 2020. Total loan fees recognized as part of the yield calculation on loans was $2.4 million during 2021 and $1.3 million during 2020. Overall, loan interest income, including fees, was lower in 2021 than 2020 by $315 thousand. The PPP ended in June 2021, and remaining PPP loan balances totaled only $6.4 million at December 31, 2021. Therefore, the remaining PPP loans and net unearned fees are not expected to have a material impact on future earnings. Interest income was positively impacted by an additional $305 thousand of interest earned on investment securities, all of which are taxable, due to additional average balances of $33.6 million, as we redeployed excess funds into investment securities, which generally provide higher yields than federal funds sold or interest-bearing deposits in other banks. This improvement in interest income on investments offset the negative effect of reduced interest income from loans. The yield on investment securities decreased to 1.83% in 2021 from 2.47% in 2020, due to lower market rates, as noted above. Interest expense decreased $2.2 million, which more than offset the decrease of $124 thousand in interest income, driving a $2.1 million improvement in net interest income. The primary driver of the improvement in interest expense, and overall cost of funds, was the reduced cost of time deposits, which decreased to 0.95% in 2021 compared to 1.53% in 2020, along with increased average balances in all other types of deposit accounts, which generally have lower rates. This change in the mix of our deposits has supported the reduction in our average cost of funds to 0.37% during 2021, compared to 0.72% during 2020. Average balances of time deposits decreased $37.1 million while average balances of interest-bearing demand deposits grew $13.9 million, average balances of savings and money market deposits grew $34.4 million, and average balances of noninterest-bearing deposits grew $44.1 million. Increases in average balances of both interest-bearing and noninterest-bearing deposits is primarily due to stimulus payments and PPP funds, which are generally deposited into customer deposit accounts. Due to the increased deposit balances, additional borrowings from the FHLB have not been necessary. The Company paid off the last remaining FHLB advance of $5.0 million in June 2021, when it matured. Our future interest rate structure has been impacted by the commencement of the end of the use of LIBOR, which will completely phase-out in 2023. We use LIBOR in pricing some of our interest earning assets and liabilities, including our trust preferred securities. Certain loan and investment products ceased using LIBOR in 2021, for new contracts and commitments. Most of these contracts have been, or will be, replaced with the secured overnight funding rate (SOFR). Loans Our primary source of income is interest earned on loans. Total loan balances increased $18.2 million during 2021, or 3.2%, to $593.7 million at December 31, 2021 as compared to $575.6 million at December 31, 2020. The primary drivers of this increase in total loans were $26.8 million of growth in commercial loans secured by real estate, and $16.5 million of growth in multifamily loans secured by real estate. Commercial loan balances decreased $31.7 million, due mainly to a decrease in PPP loan balances of $28.4 million. PPP loans totaled $6.4 million at December 31, 2021. For more detail on loan balances, refer to Note 6 of the Consolidated Financial Statements and Notes in Item 8 of this Form 10-K. Nonaccrual loan balances decreased $2.6 million during 2021 to $2.9 million at December 31, 2021. Nonaccrual loans negatively affect interest income as these loans are nonearning assets. When doubt about the collectability of a loan exists, it is the Bank’s policy to stop accruing interest on that loan under the following circumstances: (a) whenever we are advised by the borrower that scheduled payment or interest payments cannot be met, (b) when conditions indicate that payment of principal and interest can no longer be expected, or (c) when any such loan becomes delinquent for 90 days and is not both well secured and in the process of collection. All interest accrued but not collected on loans that are placed on nonaccrual is charged off and reversed against interest income in the current period. In the case of a nonaccrual loan that is well secured and in the process of collection, the interest accrued but not collected is not reversed. Interest received on these loans is accounted for on the cash basis or cost-recovery method until qualifying for return to accrual. Generally, loans are returned to accrual status when all the principal and interest amounts contractually due are brought current, six consecutive timely payments are made, and prospects for future contractual payments are reasonably assured. For more detail on nonaccrual loans, refer to Note 6 of the Consolidated Financial Statements and Notes in Item 8 of this Form 10-K. 24 Impaired loan balances also decreased during 2021, to $2.8 million at December 31, 2021, from $5.1 million at December 31, 2020. I nterest income and cash receipts on impaired loans are handled differently depending on whether or not the loan is on nonaccrual status. If the impaired loan is not on nonaccrual status, the interest income on the loan is computed using the effective interest method. For more detail on impaired loan balances, refer to Note 6 of the Consolidated Financial Statements and Notes in Item 8 of this Form 10-K. The following table presents the dollar composition and percentage of our loan portfolio as of December 31: Loan Composition 2021 2020 (Dollars in thousands) $ % $ % Real estate secured: Commercial $ 206,162 34.7 % $ 179,381 31.2 % Construction and land development 32,325 5.4 % 25,031 4.3 % Residential 1-4 family 224,530 37.8 % 222,980 38.7 % Multifamily 33,048 5.6 % 16,569 2.9 % Farmland 18,735 3.2 % 18,368 3.2 % Total real estate loans 514,800 86.7 % 462,329 80.3 % Commercial 54,325 9.1 % 86,010 14.9 % Agriculture 4,021 0.7 % 4,450 0.8 % Consumer installment loans 18,756 3.2 % 20,632 3.6 % All other loans 1,842 0.3 % 2,145 0.4 % Total loans 593,744 100.0 % 575,566 100.0 % Less: Allowance for loan losses 6,735 7,191 Total $ 587,009 $ 568,375 Our loan maturities, and distribution between fixed and variable rate loans as of December 31, 2021 are shown in the following table: 25 Maturities of Loans (Dollars in thousands) Less than One Year One to Five Years Five to Fifteen Years After Fifteen Years Total Real estate secured: Commercial $ 19,831 $ 54,437 $ 77,974 $ 53,920 $ 206,162 Construction and land development 6,041 6,177 11,942 8,165 32,325 Residential 1-4 family 6,989 20,928 84,520 112,093 224,530 Multifamily 989 4,523 10,749 16,787 33,048 Farmland 4,079 2,491 7,631 4,534 18,735 Total real estate loans 37,929 88,556 192,816 195,499 514,800 Commercial 10,453 34,483 6,624 2,765 54,325 Agriculture 1,373 2,292 56 300 4,021 Consumer installment loans 2,219 13,788 2,713 36 18,756 All other loans 1,444 398 — — 1,842 Total $ 53,418 $ 139,517 $ 202,209 $ 198,600 $ 593,744 The following table presents the dollar amount of fixed rate and variable rate loans with maturities greater than one year as of December 31, 2021: (Dollars in thousands) Fixed Rate Variable Rate Real estate secured: Commercial $ 94,563 $ 91,768 Construction and land development 14,967 11,317 Residential 1-4 family 91,450 126,091 Multifamily 12,127 19,932 Farmland 3,276 11,380 Total real estate loans 216,383 260,488 Commercial 36,088 7,784 Agriculture 2,340 308 Consumer installment loans 13,832 2,705 All other loans 398 — Total $ 269,041 $ 271,285 Contractual maturities of loans do not reflect the actual term of our loan portfolio. The average life of mortgage loans is substantially less than the contractual life due to prepayments and enforcement of due on sale clauses. Scheduled principal amortization also reduces the average life of the loan portfolio. The average life of mortgage loans tends to increase when current market mortgage rates are substantially above rates on existing loans while the average life decreases when rates on existing loans are substantially above current market rates. Some variable rate loans may not reprice, or fully reprice, at their next reset date due to instances where the reset rate may not be above the rate floor, or may be more than the allowable rate increase under the terms of the loan. In these instances, it may take several reset periods before these loans are fully adjusted. 26 Allowance for Loan Losses The methodology we use to calculate the allowance for loan losses is considered a critical accounting policy. The adequacy of the allowance for loan losses is based upon management’s judgment and analysis. The following factors are included in our evaluation of determining the adequacy of the allowance: risk characteristics of the loan portfolio, current and historical loss experience, concentrations, and internal and external factors such as general economic conditions. During 2020, in response to the impact of the pandemic, changes to the allowance model included reviewing our internal scoring related to loan modifications and extensions, and external factors, specifically unemployment and other economic factors. During the fourth quarter of 2021, in response to rising price inflation, this factor has been added to the economic factors considered in the model. We continue to adjust the allowance for loan loss model to best reflect the risks in the portfolio and the improvements made in our internal policies and procedures; however, future provisions may be deemed necessary. The allowance is increased by a provision for loan losses, which is charged to expense and reduced by charge-offs, net of recoveries. Loans are charged against the allowance for loan losses when management believes that collectability of all or part of the principal is unlikely. Subsequent to charging off a loan, management makes best efforts to recover any charged-off balances. The allowance for loan losses decreased to $6.7 million at December 31, 2021 as compared to $7.2 million at December 31, 2020. The allowance for loan losses at the end of 2021 was approximately 1.13% of total loans as compared to 1.25% at the end of 2020. Provisions for loan losses of $372 thousand and $2.3 million were recorded during 2021 and 2020, respectively. Loans charged off, net of recoveries, totaled $828 thousand, or 0.28% of average loans, for the year ended December 31, 2021, compared to $477 thousand, or 0.08% of average loans, in 2020. The low percentage in 2020 is primarily related to the moratorium on foreclosures that existed for most of 2020. The allowance for loan losses is being maintained at a level that management deems appropriate to absorb any potential future losses and known impairments within the loan portfolio whether or not the losses are actually ever realized. Nonaccrual loans present higher risks of default, and we have experienced a decrease in these loans during 2021. At December 31, 2021, there were 65 nonaccrual loans totaling $2.9 million, or 0.50% of total loans. At December 31, 2020, there were 75 nonaccrual loans totaling $5.5 million, or 0.96% of total loans. The amount of interest income that would have been recognized on these loans had they been accruing interest was $223 thousand and $494 thousand in the years 2021 and 2020, respectively. There were no loans past due 90 days or greater and still accruing interest at either December 31, 2021 or 2020. There are no commitments to lend additional funds to non-performing borrowers. A majority of our loans are collateralized by real estate located in our market area. It is our policy to sufficiently collateralize loans to help minimize exposure to losses in cases of default. Increasing real estate values in our area have reduced this exposure somewhat. However, while we consider our market area to be somewhat diverse, certain areas are more reliant upon agriculture, coal mining and natural gas. As a result, increased risk of loan impairments is possible due to the volatile nature of the coal mining and natural gas industries. As a result of the economic impact of the COVID-19 pandemic, a number of industries have been identified as posing increased risk. Specifically, residential and commercial rentals, hotels, restaurants and entertainment, and the coal and gas industries have been adversely impacted by the global and domestic economic slowdown. We are monitoring these industries and consider these segments to be the primary higher risks in the loan portfolio. Commercial and commercial real estate loans are initially risk rated by the originating loan officer. If deterioration in the financial condition of the borrower and/or their capacity to repay the debt occurs, the loan may be downgraded by the loan officer. Guidance for risk rate grading is established by the regulatory authorities who periodically review the Bank’s loan portfolio for compliance. Classifications used by the Bank are Pass, Special Mention, Substandard, Doubtful and Loss. With regard to the Bank’s consumer and consumer real estate loan portfolio, we use the guidance found in the Uniform Retail Credit Classification and Account Management Policy which affects our estimate of the allowance for loan losses. Under this approach, a consumer or consumer real estate loan must initially have a credit risk grade of Pass or better. Subsequently, if the loan becomes contractually 90 days past due or the borrower files for bankruptcy protection, the loan is downgraded to Substandard and placed in nonaccrual status. If the loan is unsecured upon being deemed Substandard, the entire loan amount is charged-off. 27 For non-1-4 family residential loans that are 90 days or more past due or in bankruptcy, the collateral value less estimated liquidation costs is compared to the loan balance to calculate any potential deficiency. If the collateral is sufficient, then no charge-off is necessary. If a deficiency exists, then upon the loan becoming contractually 120 days past due, the deficiency is charged-off against the allowance for loan loss. In the case of 1-4 family residential or home equity loans, upon the loan becoming 120 days past due, a current value is obtained and after application of an estimated liquidation discount, a comparison is made to the loan balance to calculate any deficiency. Subsequently, any noted deficiency is then charged-off against the allowance for loan loss when the loan becomes contractually 180 days past due. If the customer has filed bankruptcy, then within 60 days of the bankruptcy notice, any calculated deficiency is charged-off against the allowance for loan loss. Collection efforts continue by means of repossessions or foreclosures, and upon bank ownership, liquidation ensues. All loans classified as substandard, doubtful or loss are individually reviewed for impairment in accordance with Accounting Standards Codification (ASC) 310-10-35. In evaluating impairment, a current appraisal is generally used to determine if the collateral is sufficient. Appraisals are typically less than a year old and must be independently reviewed to be relied upon. If the appraisal is not current, we perform a useful life review of the appraisal to determine if it is reasonable. If this review determines that the appraisal is not reasonable, then a new appraisal is ordered. Loans considered impaired decreased to $2.8 million with $880 thousand requiring a valuation allowance of $166 thousand at December 31, 2021, as compared to $5.1 million with $2.5 million requiring a valuation allowance of $1.1 million at December 31, 2020. Management is aggressively working to reduce the impaired credits at minimal loss. In determining the component of our allowance in accordance with the Contingencies topic of the Accounting Standards Codification (ASC 450), we do not directly consider the potential for outdated appraisals since that portion of our allowance is based on the analysis of the performance of loans with similar characteristics, external and internal risk factors. We consider the overall quality of our underwriting process in our internal risk factors, but the need to update appraisals is associated with loans identified as impaired under the Receivables topic of the Accounting Standards Codification (ASC 310). If an appraisal is older than one year, a new external certified appraisal may be obtained and used to determine impairment. If an exposure exists, a specific allowance is directly made in the amount of the potential loss, in addition to estimated liquidation and disposal costs. The evaluation is inherently subjective as it requires estimates that are susceptible to significant revision as more information becomes available. In addition to impaired loans, the remaining loan portfolio is evaluated based on net charge-off history, economic conditions, and internal processes. To calculate the net charge-off history factor, we perform a 12-quarter look-back and use the average net charge offs as a percentage of the loan balances. To calculate the economic conditions factor, we use current economic data which includes national and local regional unemployment information, local housing price changes, gross domestic product growth, and interest rates. Lastly, we evaluate our internal processes of underwriting and consider the inherent risks present in the portfolio due to past and present lending practices. As economic conditions, performance of our loans, and internal processes change, it is possible that future increases or decreases may be needed to the allowance for loan losses. Selected Credit Ratios December 31, (Dollars in thousands) 2021 2020 Allowance for loan losses $ 6,735 $ 7,191 Total loans 593,744 575,566 Allowance for loan losses to total loans 1.13 % 1.25 % Nonaccrual loans $ 2,941 $ 5,548 Nonaccrual loans to total loans 0.50 % 0.96 % Ratio of allowance for loan losses to nonaccrual loans 2.29 X 1.30 X Charge-offs net of recoveries $ 828 $ 477 Average loans $ 586,963 $ 578,979 Net charge-offs to average loans 0.14 % 0.08 % The above table includes $1.1 million and $2.5 million in nonaccrual loans as of December 31, 2021 and 2020, respectively, which have been classified as troubled debt restructurings. No troubled debt restructurings were past due 90 days or more and still accruing interest at December 31, 2021 and 2020. There were $2.5 million in loans classified as troubled debt restructurings as of December 31, 2021, as compared to $4.0 million in loans classified as troubled debt restructurings as of December 31, 2020. For more detail on nonaccrual, impaired, past due and restructured loans, refer to Note 6 and Note 8 to the Consolidated Financial Statements and Notes in Item 8 of this Form 10-K. 28 The following table shows the average balance, net charge-offs or recoveries and percentage of net charge-offs or recoveries by each major category of loans for the years ended December 31, 2021 and 2020: December 31, 2021 December 31, 2020 (Dollars in thousands) Average Balance Net Charge-offs (Recoveries) Net Charge-offs (Recoveries) as % of Average Loan Type Average Balance Net Charge-offs (Recoveries) Net Charge-offs (Recoveries) as % of Average Loan Type Real estate secured: Commercial $ 194,517 $ 913 0.47 % $ 175,281 $ 8 0.00 % Construction and land development 28,820 (6 ) -0.02 % 27,536 — 0.00 % Residential 1-4 family 220,524 (37 ) -0.02 % 235,289 127 0.05 % Multifamily 23,840 — 0.00 % 14,851 — 0.00 % Farmland 19,144 (29 ) -0.15 % 19,749 9 0.05 % Total real estate loans 486,845 841 0.17 % 472,706 144 0.03 % Commercial 74,711 (45 ) -0.06 % 77,874 289 0.37 % Agriculture 4,095 (1 ) -0.02 % 4,781 14 0.29 % Consumer and all other loans 19,441 33 0.17 % 21,819 30 0.14 % Unallocated 1,871 — 0.00 % 1,799 — 0.00 % Total loans $ 586,963 $ 828 0.14 % $ 578,979 $ 477 0.08 % The following table shows the balance and percentage of our allowance for loan losses allocated to each major category of loans. Allocation of the Allowance for Loan Losses December 31, 2021 December 31, 2020 (Dollars in thousands) Amount % of ALLL % of Loans Amount % of ALLL % of Loans Real estate secured: Commercial 2,134 31.7 % 34.7 % 2,281 31.8 % 31.3 % Construction and land development 189 2.8 % 5.4 % 233 3.2 % 4.4 % Residential 1-4 family 2,237 33.2 % 37.8 % 1,951 27.1 % 38.9 % Multifamily 254 3.8 % 5.6 % 151 2.1 % 2.9 % Farmland 149 2.2 % 3.2 % 97 1.3 % 3.2 % Total real estate loans 4,963 73.7 % 86.7 % 4,713 65.5 % 80.6 % Commercial $ 1,099 16.3 % 9.1 % $ 2,275 31.6 % 15.0 % Agriculture 28 0.4 % 0.7 % 40 0.6 % 0.8 % Consumer and all other loans 108 1.6 % 3.5 % 163 2.3 % 3.6 % Unallocated 537 8.0 % — — — — Total $ 6,735 100.0 % 100.0 % $ 7,191 100 % 100.0 % We have allocated the allowance according to the amount deemed to be reasonably necessary to provide for the possibility of losses being incurred within each of the categories of loans. The allocation of the allowance as shown in the table above should not be interpreted as an indication that loan losses in future years will occur in the same proportions or that the allocation indicates future loan loss trends. Furthermore, the portion allocated to each loan category is not the total amount available for future losses that might occur within such categories since the total allowance is a general allowance applicable to the entire portfolio. The allocation of the allowance for loan losses is based on our judgment of the relative risk associated with each type of loan. We have allocated 31.7% of the allowance to commercial real estate loans, which constituted 34.7% of our loan portfolio at December 31, 2021. This allocation is similar to the 31.8% in 2020 due primarily to reduction in problem credits in this category over the past several years. We have allocated 16.3% of the allowance to commercial loans, which constituted 9.1% of our loan portfolio at December 31, 2021. This allocation percentage increased compared to December 31, 2020 due to the significant reduction in PPP loans, which are included in commercial loans, which have guarantees provided by the SBA, which resulted in their being excluded from the allowance assessment of commercial loans. 29 Both residential and commercial real estate loans are secured by real estate whose value tends to be easily ascertainable. These loans are made consistent with appraisal policies and real estate lending policies, which detail maximum loan-to-value ratios and maturities. We have allocated 2.8% of the allowance to real estate construction loans, which constituted 5.4% of our loan portfolio at December 31, 2021. Construction loans are secured by real estate with values that are dependent upon market and economic conditions. Additionally, these credits are generally shorter-term projects, of eighteen months or less. These loans are made consistent with appraisal policies and real estate lending policies which detail maximum loan-to-value ratios and maturities. We have allocated 33.2% of the allowance to residential real estate loans, which constituted 37.8% of our loan portfolio at December 31, 2021. Our allocation increased as a percentage of the allowance for loan losses due to the $1.6 million increase in residential real estate loans during 2021. We have allocated 1.6% of the allowance to consumer and all other loans, which constituted 3.5% of our loan portfolio at December 31, 2021. Our allocation decreased as a percentage of the allowance for loan losses due to these credits principally being loans to municipal and other government entities, compared to the 2.3% allocation we had in 2020. At December 31, 2021, we had an unallocated portion of the allowance for loan losses totaling $537 thousand. While our legacy loan loss model calculation did not fully allocate the entire allowance, we believe that the lingering impact of the pandemic, combined with the recent impact of inflation warrant the maintenance of the allowance for loan losses. We have commenced the process of implementing the Current Expected Credit Loss (CECL) model to replace our legacy loan loss model. We expect to be testing and running concurrent quarterly calculations of both our legacy and CECL models by the second quarter of 2022. Other Real Estate Owned Other real estate owned decreased $2.0 million, or 59.2%, to $1.4 million at December 31, 2021 from $3.3 million at December 31, 2020. All properties are available for sale, primarily, by commercial and residential realtors under the direction of our Special Assets division. Our aim is to reduce the level of OREO in order to reduce the level of nonperforming assets at the Bank, while keeping in mind the impact to earnings and capital. In 2021 and 2020, pricing adjustments were made to make certain properties more marketable, which, in some cases, reduced the price below the fair value of the property (which is based on an appraisal less estimated disposition costs). During 2021, we recorded OREO write-downs of $466 thousand as compared to $132 thousand during 2020. During 2021, we added $566 thousand in OREO properties as a result of settlement of foreclosed loans, offset by sales of $2.6 million with net gains of $76 thousand. During 2020, we added $1.1 million in OREO properties as a result of settlement of foreclosed loans, which was offset by sales of $687 thousand with net gains totaling $60 thousand. As noted previously, a moratorium on foreclosures was initiated in Virginia during the first quarter of 2020 and remained in effect into the third quarter of 2020. Additionally, during 2021, three closed branch office facilities were transferred from bank premises to OREO at a value of $950 thousand. As previously discussed, we continue to take an aggressive approach toward liquidating properties to reduce our level of OREO properties by making pricing adjustments and holding auctions on some of our older properties. We expect to continue these efforts in 2022, which could result in additional losses, while reducing future carrying costs. Although the properties remain for sale and are actively marketed, we did have lease agreements on certain other real estate owned properties which generated rental income at market rates. Rental income on OREO properties was $24 thousand and $54 thousand in 2021 and 2020, respectively. Investment Securities Total investment securities increased $59.0 million, or 121.8%, to $107.4 million at December 31, 2021, Prior to their sale in 2021, from $48.4 million at December 31, 2020. All securities are classified as available-for-sale for liquidity purposes. Sales of securities during 2021 totaled $7.7 million, with $322 thousand in gains realized, while sales of securities in 2020 totaled $1.1 million, with $4 thousand in gains realized. During 2021, maturities, calls and paydowns totaled $16.3 million, and purchases of securities totaled $85.1 million. Investment securities with a carrying value of $12.1 million and $6.8 million at December 31, 2021 and 2020, respectively, were pledged to secure public deposits and for other purposes required by law. 30 Our strategy is to invest excess funds in investment securities, which typically yield more interest income than other short-term investment options, such as federal funds sold and overnight deposits with the Federal Reserve Bank of Richmond, but which still provide liquidity. The fair value of our investment portfolio is substantially affected by changes in interest rates, which could result in realized losses if we need to sell the securities and recognize the loss in a rising interest rate environment due to Federal Reserve actions, U.S. fiscal policies or other factors affecting market interest rates. At December 31, 2021, we had a net unrealized loss in our investment portfolio totaling $1.0 million as compared to a $938 thousand gain at December 31, 2020. As interest rates increase the level of unrealized losses could change substantially. However, these changes would have no impact on earnings or regulatory capital, unless the underlying securities were sold at a loss. We have reviewed our investment portfolio and no investment security is deemed to have other than temporary impairment. We monitor our portfolio regularly and use it to maintain liquidity, manage interest rate risk and enhance earnings. The fair value and weighted average yield of investment securities at December 31, 2021 are shown in the following schedule by contractual maturity and do not reflect principal paydowns for amortizing securities. Expected maturities will differ from contractual maturities because issuers may have the right to call or prepay obligations with or without call or prepayment penalties. Weighted average yields are calculated by dividing the contractual interest for each time period by the average amortized contractual cost. Less than One Year One to Five Years Five to ten years After ten years Total (Dollars in thousands) Fair Value Average Yield Fair Value Average Yield Fair Value Average Yield Fair Value Average Yield Fair Value Average Yield U.S Treasuries $ — -% $ 6,003 0.79 % $ 1,668 1.04 % $ — -% $ 7,671 0.84 % U.S. Government Agencies 502 1.82 % 441 2.26 % 1,902 2.57 % 6,244 1.67 % 9,089 1.79 % Taxable municipals 558 3.23 % — -% 1,900 1.74 % 20,522 2.33 % 22,980 2.30 % Corporate bonds — -% 1,037 4.80 % 982 2.00 % — -% 2,019 3.41 % Mortgage backed securities — -% 323 1.29 % 6,295 1.22 % 58,981 1.36 % 65,599 1.34 % $ 1,060 2.56 % $ 7,804 1.41 % $ 12,747 1.54 % $ 85,747 1.61 % $ 107,358 1.59 % Bank Owned Life Insurance At both December 31, 2021 and 2020, we had an aggregate total cash surrender value of $4.7 million on life insurance policies covering former key officers. Total income for the policies during 2021 and 2020 was $32 thousand and $77 thousand, respectively. Deposits Total deposits were $707.5 million at December 31, 2021, an increase of $39.5 million, or 5.9%, from $668.0 million at December 31, 2020. Most of the increase was driven by savings and money market deposits, which grew $34.6 million, or 21.9%, to $192.0 million during 2021. Noninterest-bearing demand deposits grew by $27.5 million, or 12.3%, to $251.3 million. Interest-bearing demand deposits also grew, by $15.6 million, or 31.3%, to $65.2 million. Generally, PPP loan disbursements and federal stimulus payments received by customers are deposited into noninterest-bearing or interest-bearing demand deposit accounts, which primarily explains the increases in those types of accounts. Due to the large influx of non-interest-bearing balances, we allowed attrition of time deposit balances, which decreased by $38.1 million and allowed us to reduce our average cost of funds. Information detailing average deposit balances and average rates paid on deposits is presented in the Net Interest Margin Analysis table contained in the Net Interest Income and Net Interest Margin section. Core deposits are considered to include demand deposits and other types of transaction accounts, such as commercial relationships and savings products, all of which saw growth in 2021. Overall, we continue to maintain core deposits through attractive consumer and commercial deposit products and strong ties with our customer base and communities. 31 Time deposits of $250,000 or more equaled approximately 4.0% of deposits at the end of 2021 and 5.2% of deposits at the end of 2020. At December 31, 2021 and 2020, uninsured deposits are estimated to be $93.8 million and $79.4 million, respectively. Included in estimated uninsured deposits are $13.6 million and $15.8 million of public funds, for such respective periods, considered secured via pledged securities or letters of credit we have with the FHLB. The following table shows maturities of all time deposits considered uninsured by the FDIC or otherwise. Maturities of Uninsured Time Deposits (Dollars in thousands) December 31, 2021 Three months or less $ 2,507 Over three months through six months 3,517 Over six months through twelve months 3,945 Over one year 6,788 Total $ 16,757 At December 31, 2021 and 2020, $12.1 million and $6.8 million of securities, respectively, were pledged to collateralize public deposits, including time deposits, held in our Tennessee offices, and as collateral for credit facilities available through FRB. Additionally, we held letters of credit from the FHLB for $12.0 million at both December 31, 2021 and 2020, to secure public deposits, including time deposits, held in our Virginia offices. We held no brokered deposits at December 31, 2021 and 2020. Internet accounts are limited to customers located in our primary market area and the surrounding geographical area. The average balance of and the average rate paid on deposits is shown in the net interest margin analysis table in the “Net Interest Income and Net Interest Margin” section above. Total Certificate of Deposit Registry Service (CDARS) time deposits were $5.8 million and $9.6 million at December 31, 2021 and 2020, respectively. Noninterest Income For the year ended December 31, 2021, noninterest income improved $1.8 million, or 22.5%, to $10.0 million, or 1.25% of average assets, from $8.1 million, or 1.10% of average assets, for the same period in 2020. The improvement was driven by an increase of $507 thousand in service charges and fees, a $557 thousand increase in card processing and interchange income, a $313 thousand increase in insurance and investment fees, plus non-recurring gains on sales of investment securities of $322 thousand. The improvement in service charges and fees resulted from the fee schedule changes we made in August 2020. The new fee schedule was implemented as part of the overall assessment of products and processes undertaken in 2020. The adjustment of the fee schedule was designed to allow customers to avoid or minimize certain fees by taking advantage of certain services such as combined and online account statements. The improvement in card processing and interchange income resulted from increased volume and the related increase in interchange fees received. Efforts to increase noninterest income revenues from financial services drove the improvement in insurance and investment fees, as we believe this segment continues to show potential for continued growth. Other non-interest income also increased, by $138 thousand, but after considering the non-recurring net gains on sales of fixed assets of $190 thousand in 2021 and the $220 thousand bonus payment received in 2020 from our card service provider, the increase in this component would have been $168 thousand. This increase can be explained primarily by an increase of $128 thousand from commissions and gains on originations and sales of mortgage loans into the secondary market, partially driven by the loan production office we opened in Boone, North Carolina in the fourth quarter of 2020 and the deployment of additional loan originators during 2021. 32 Noninterest Expense Noninterest expenses increased $870 thousand, or 3.2%, to $27.9 million at December 31, 2021, compared to $27.0 million at December 31, 2020. Although higher, noninterest expense as a percent of total average assets improved to 3.49% in 2021 from 3.63% in 2020. The increase in noninterest expense was primarily due to an increase of $1.2 million in occupancy and equipment expense, offset by a $566 thousand reduction in salaries and benefit expense. The increase in occupancy and equipment expense was driven nearly entirely by $1.1 million in non-recurring losses on three former branch office locations, which were transferred into other real estate owned during the third quarter of 2021. Excluding this loss, occupancy and equipment expense would have increased $182 thousand, due largely to costs associated with the Kingsport office, which was opened in the third quarter of 2020. The $566 thousand reduction in salaries and benefits expense is due to the restructuring implemented in May 2020, which included a combination of eliminated positions, retirements or resignations representing 12% of the workforce. Excluding the $358 thousand of severance costs incurred in 2020, this reduction would have been $924 thousand. Other operating expenses were up $240 thousand due to higher loan and other real estate expenses of $246 thousand and $199 thousand, respectively. These increases offset decreases in FDIC insurance and consulting, which decreased $127 thousand and $235 thousand, respectively. FDIC premiums decreased due to improvements in our risk assessment. Consulting decreased due to costs incurred in 2020, which were not repeated in 2021. In addition, 2021 includes a $76 thousand increase in bank franchise taxes due to the increased tax base and added taxes for other states. Our efficiency ratio, a non-GAAP measure, which is defined as noninterest expense divided by the sum of net interest income plus noninterest income, improved to 75.56% in 2021 compared to 81.10% in 2020. The decrease in this ratio is a result of improvements in both net interest income and noninterest income, as discussed above and in the Net Interest Income and Net Interest Margin section earlier in this Item 7. We continue to seek opportunities to operate more efficiently through the use of technology, improving processes, reducing nonperforming assets and increasing productivity. Income Taxes and Deferred Tax Assets Income taxes were $1.9 million in 2021, compared to $1.1 million in 2020. The effective tax rates were 21.7%, and 27.6% for 2021 and 2020, respectively. The effective tax rate for the periods differed from the federal statutory rate of 21.0% principally due the impact of the recapture of operating loss carryforwards and applicable credits. The higher effective tax rate in 2020 is the result of an increase in pre-tax earnings in relation to the various tax preference items. Deferred tax assets represent the future tax benefit of future deductible differences. If it is more likely than not that a tax asset will not be realized, a valuation allowance is required to reduce the recorded deferred tax assets to net realizable value. The Company has evaluated positive and negative evidence to assess the realizability of its deferred taxes. Based on the evidence, including taxable income projections, the Company believes it is more likely than not that its deferred tax assets will be realizable. Accordingly, the Company did not include a valuation allowance against its deferred tax assets as of December 31, 2021 or 2020. Tax positions are evaluated in a two-step process. The Company first determines whether it is more likely than not that a position will be sustained upon examination. If a tax position meets the more likely than not recognition threshold, it is then measured to determine the amount of benefit to recognize in the financial statements. The tax position is measured as the largest amount of benefit that is greater than 50% likely of being recognized. The Company classifies interest and penalties as a component of income tax expense. As of December 31, 2021, the Company had Federal net operating loss carry forward amounts of approximately $2.2 million. These amounts are not limited pursuant to Internal Revenue Code (IRC) Section 382. The Company is subject to examination in the United States and multiple state jurisdictions. Open tax years for examination are 2018 – 2021. Capital Resources Our total stockholders’ equity at the end of 2021 was $63.6 million compared to $58.2 million at the end of 2020. The increase was $5.4 million, or 9.4%. Book value per common share was $2.66 at December 31, 2021 compared to $2.43 at December 31, 2020. 33 The Company meets the eligibility criteria to be considered a small bank holding company in accordance with the Federal Reserve’s Small Bank Holding Company Policy Statement issued in February 2015 and does not report consolidated regulatory capital. The Bank continues to be subject to various capital requirements administered by banking agencies. The Bank is characterized as "well capitalized" under the “prompt corrective action” regulations pursuant to Section 38 of the FDIA. The capital adequacy ratios for the Bank, including the minimum ratios to be considered “well capitalized,” are set forth in Note 21, Capital, to the consolidated financial statements in Item 8 of this Form 10-K. The Bank is also subject to the rules implementing the Basel III capital framework and certain related provisions of the Dodd-Frank Act. The final rules require the Bank to comply with the following minimum capital ratios: (i) a Common Equity Tier 1 (CET1) ratio of at least 4.5%, plus a 2.5% “capital conservation buffer” (effectively resulting in a minimum CET1 ratio of 7%), (ii) a ratio of Tier 1 capital to risk-weighted assets of at least 6.0%, plus the 2.5% capital conservation buffer (effectively resulting in a minimum Tier 1 capital ratio of 8.5%), (iii) a ratio of total capital to risk-weighted assets of at least 8.0%, plus the 2.5% capital conservation buffer (effectively resulting in a minimum total capital ratio of 10.5%), and (iv) a leverage ratio of 4%, calculated as the ratio of Tier 1 capital to average assets. The capital conservation buffer is designed to absorb losses during periods of economic stress. Banking institutions with a CET1 ratio above the minimum but below the conservation buffer face constraints on dividends, equity repurchases, and compensation based on the amount of the shortfall. As of December 31, 2021, the Bank meets all capital adequacy requirements to which it is subject. Total assets increased in 2021 and we anticipate asset levels to increase in the future due to an emphasis on growing the loan portfolio and the core deposit base of the Bank. Based upon projections, we believe our earnings will be sufficient to support the Bank’s planned asset growth. No cash dividends have been paid historically due to our past retained deficit. Earnings have accumulated over the last several years and we attained retained earnings in 2021. Subsequent to December 31, 2021, the Board of Directors declared a $0.05 cash dividend per share payable on March 31, 2022 to stockholders of record on March 15, 2022. This is the first cash dividend paid in the history of the Company. Future payments of cash dividends, if any, will depend on a number of factors including but not limited to maintaining positive retained earnings, compliance with regulatory rules governing the payment of dividends, strategic plans, and sufficient capital at the Bank to allow payment of dividends to the parent company. Liquidity We closely monitor our liquidity and our liquid assets in the form of cash, due from banks, federal funds sold and unpledged available-for-sale investments. Collectively, those balances were $159.3 million at December 31, 2021, down from $134.0 million at December 31, 2020. As discussed previously in this Form 10-K, this change is a direct result of redeployment of excess cash into investment securities, which generally return higher yields, while still providing liquidity, as discussed below. A surplus of short-term assets is maintained at levels management deems adequate to meet potential liquidity needs. At December 31, 2021, all of our investments are classified as available-for-sale, providing an additional source of liquidity in the amount of $98.3 million, which is net of the $12.1 million of securities pledged as collateral. This will serve as a source of liquidity while yielding a higher return when compared to other short-term investment options, such as federal funds sold and overnight deposits with the Federal Reserve Bank of Richmond. Total investment securities increased $59.0 million, or 121.8%, during 2021 from $48.4 million at December 31, 2020. Our loan to deposit ratio was 83.92% at December 31, 2021 and 86.16% at December 31, 2020. Available third-party sources of liquidity remain intact at December 31, 2021 which includes the following: our line of credit with the FHLB totaling $199.9 million, the brokered certificates of deposit markets, internet certificates of deposit, and the discount window at the Federal Reserve Bank of Richmond. We also have $30.0 million in unsecured federal funds lines of credit available from three correspondent banks as of December 31, 2021. We have used our line of credit with FHLB to issue letters of credit totaling $12.0 million to the Treasury Board of Virginia for collateral on public funds. No draws on the letters of credit have been issued. The letters of credit are considered draws on our FHLB line of credit. An additional $187.9 million was available on December 31, 2021 on the $199.9 million line of credit, of which $123.6 million is secured by a blanket lien on our residential real estate loans. 34 While we have access to the brokered deposits market, we held no brokered deposits at December 31, 2021 or 2020. As of December 31, 2021, we had $5.8 million in reciprocal CDARS time deposits, compared to $9.6 million at December 31, 2020. The Bank has access to additional liquidity through the Federal Reserve Bank of Richmond’s Discount Window for overnight funding needs. We may collateralize this line with investment securities and loans at our discretion; however, we do not anticipate using this funding source except as a last resort. With the on-balance sheet liquidity and other external sources of funding, we believe the Bank has adequate liquidity and capital resources to meet our requirements and needs for the foreseeable future. However, liquidity can be further affected by a number of factors such as, counterparty willingness or ability to extend credit, regulatory actions and customer preferences, some of which are beyond our control. With the current economic uncertainty resulting from the COVID-19 pandemic, inflation and the war in Ukraine, we continue monitoring of our liquidity position, specifically cash on hand in order to meet customer demands. Additionally, our contingency funding plan is reviewed quarterly with our Asset Liability Committee. Financial Instruments with Off-Balance-Sheet Risk The Bank is a party to financial instruments with off-balance-sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments to extend credit and standby letters of credit. Those instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the balance sheet. The contract or notional amounts of those instruments reflect the extent of involvement the Bank has in particular classes of financial instruments. The Bank’s exposure to credit loss in the event of nonperformance by the other party to the financial instrument for commitments to extend credit and standby letters of credit is represented by the contractual amount of those instruments. The Bank uses the same credit policies in making commitments and conditional obligations as it does for on-balance-sheet instruments. A summary of the contract amount of the Bank’s exposure to off-balance-sheet risk as of December 31, 2021 and 2020 is as follows: (Dollars in thousands) 2021 2020 Financial instruments whose contract amounts represent credit risk: Commitments to extend credit $ 69,015 $ 57,334 Standby letters of credit 3,684 2,031 Commitments to extend credit are agreements to lend to a customer provided there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The Bank evaluates each customer’s credit worthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary by the Bank upon extension of credit, is based on management’s credit evaluation of the counterparty. Collateral held varies but may include accounts receivable, inventory, property and equipment, and income-producing commercial properties. Unfunded commitments under lines of credit are commitments for possible future extensions of credit to existing customers. Those lines of credit may not actually be drawn upon to the total extent to which the Bank is committed. Standby letters of credit are conditional commitments issued by the Bank to guarantee the performance of a customer to a third party. Those guarantees are primarily issued to support public and private borrowing arrangements, including commercial paper, bond financing, and similar transactions. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers. The Bank holds certificates of deposit, deposit accounts, and real estate as collateral supporting those commitments for which collateral is deemed necessary. Interest Sensitivity At December 31, 2021, we had a negative cumulative gap rate sensitivity ratio of 12.97% for the one-year re-pricing period, compared to 21.46% at December 31, 2020. A negative cumulative gap generally indicates that net interest income would decline in a rising interest rate environment as liabilities re-price more quickly than assets. Conversely, net interest income would likely increase in periods during which interest rates are increasing. The below table is based on contractual maturities and does not take into consideration prepayment speeds of investment securities and loans, nor does it consider decay rates for non-maturity deposits. When considering these prepayment speed and decay rate assumptions, along with our ability to control the repricing of a significant portion of the deposit portfolio, we are in a position to increase interest income in a rising interest rate environment. With the FOMC initiating a series of expected rate increases, we believe our current interest risk profile remains acceptable. Furthermore, we are implementing strategies to moderate any potential adverse impact to our current interest rate risk profile, from what could be a sustained medium- to long-term environment of rising interest rates. 35 Interest Sensitivity Analysis December 31, 2021 (In thousands of dollars) 1 - 90 Days 91-365 Days 1 - 3 Years 4-5 Years 6-10 Years Over 10 years Total Uses of funds: Loans $ 117,732 $ 108,871 $ 196,232 $ 117,809 $ 45,156 $ 7,944 $ 593,744 Federal funds sold 228 — — — — — 228 Deposits with banks 45,516 — 250 — — 45,766 Investments 7,525 10,891 21,277 18,367 31,564 18,764 108,388 Bank owned life insurance 4,685 — — — — — 4,685 Total earning assets $ 175,686 $ 119,762 $ 217,759 $ 136,176 $ 76,720 $ 26,708 $ 752,811 Sources of funds: Int Bearing DDA 65,212 — — — — — 65,212 Savings & MMDA 194,702 — — — — — 194,702 Time Deposits 34,727 81,983 51,120 28,512 — — 196,342 Trust Preferred Securities 16,496 — — — — — 16,496 Federal funds purchased — — Other Borrowings — — — — — — — Total interest bearing liabilities $ 311,137 $ 81,983 $ 51,120 $ 28,512 $ — $ — $ 472,752 Discrete Gap $ (135,451 ) $ 37,779 $ 166,639 $ 107,664 $ 76,720 $ 26,708 $ 280,059 Cumulative Gap $ (135,451 ) $ (97,672 ) $ 68,967 $ 176,631 $ 253,351 $ 280,059 Cumulative Gap as % of Total Earning Assets -17.99 % -12.97 % 9.16 % 23.46 % 33.65 % 37.20 % Item 7A. Quantitative and Qualitative Disclosures About Market Risk Not required. 36