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. These forward-looking statements are based on various factors and were derived using numerous assumptions as of the date of this Form 10-K, and are subject to significant risks. 16 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; deposit flows and competition for deposits; 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 lingering impact of the novel coronavirus (COVID-19) outbreak 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 the allowance for loan losses resulting from the adoption and implementation of the CECL methodology; the transition from the use of the LIBOR index; 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 as of December 31, 2022 and 2021, as well as results of operations for the years ended December 31, 2022 and 2021. 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 and fees on deposit accounts, debit and credit card interchange income, and commissions on insurance and investment products sold. 17 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. For further discussion of our other critical accounting policies, see Note 2, Summary of Significant Accounting Policies, to our consolidated financial statements, contained in Item 8 of this 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. On June 15, 2022, we experienced a cybersecurity incident that temporarily interrupted the operability of our computer systems. Limited operations were restored June 17, 2022, and full operations were restored June 21, 2022. Since that date, restoration efforts have been completed and normal operations have resumed. 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 has expended resources and 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. As discussed under the heading “Supervision and Regulation” in Item 1 of this Form 10-K, 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. Overview The Company made significant progress during 2022 resulting in the highest annual consolidated net income in the history of the Company. For the year ended December 31, 2022, net income was $8.1 million, or basic and diluted net income per share of $0.34, compared to a net income of $7.0 million, or basic and diluted net income per share of $0.29, for the year ended December 31, 2021, an improvement of $1.1 million, or 15.3%. Retained earnings increased to $8.9 million as of December 31, 2022 from $2.0 million as of December 31, 2021, an increase of $6.9 million or 339.0%. 18 Net interest income for the year ended December 31, 2022 was $28.3 million compared to $27.2 million for the year ended December 31, 2021. The improvement of $1.1 million in net interest income was primarily attributable to a $33.8 million increase in average earning assets and rising market interest rates during the year, partially offset by a decrease in loan origination fees compared to 2021 as PPP loans were forgiven and an increase in costs of our variable rate trust preferred securities in 2022. Net interest margin was 3.62% compared to 3.64% for the year ended December 31, 2022, and 2021, respectively. Noninterest income was $9.2 million for the year ended December 31, 2022 compared to $10.0 million for the year ended December 31, 2021. The $740,000 decrease was attributable to $322,000 of gains on the sales of investment securities during the year ended December 31, 2021, $190,000 of gains on the sales of three former branch locations during the year December 31, 2021, as well as a write-down of bank owned life insurance (BOLI) of $158,000 during the year ended December 31, 2022, and a decrease in gains and commissions on mortgage loan originations and sales of approximately $162,000 due to the impact of rising interest rates on mortgage demand. Noninterest expense was $26.5 million for the year ended December 31, 2022 compared to $27.9 million for the year ended December 31, 2021. The $1.3 million decrease was primarily due to valuation adjustments of other real estate owned during the year ended December 31, 2021, which consisted of $1.1 million related to former branch locations and approximately $390,000 in net losses and write-downs on the sales of other real estate owned. This was offset by an increase of approximately $703,000 in salaries and benefits during the year ended December 31, 2022, which is attributed to higher bonus accruals based on the Company’s performance, annual wage adjustments, and adjustments to the minimum starting salaries of employees to reflect rising costs to attract and retain talent. During the year ended December 31, 2022, total assets decreased $19.3 million, or 2.4%, to $775.4 million. Loans receivable decreased $9.1 million, or 1.5%, during 2022, which is partly attributable to several large borrowers selling their businesses or collateral and paying off the related loans. Additionally, loan pricing remains very competitive in the Company’s market and has impacted loan originations. Investment securities decreased $11.0 million in 2022, which is primarily due to the decline in the market value of the investment portfolio due to rising interest rates. Total deposits declined $14.8 million, or 2.1%, during 2022, with most of the decline occurring during the fourth quarter as competition for funding intensified. New Peoples Bank remains well-capitalized. Leverage ratio improved to 10.40%. The Company’s key performance indicators are as follows: Year ended December 31, 2022 2021 Return on average assets 0.99 % 0.88 % Return on average shareholders’ equity 13.89 % 11.52 % Average shareholders’ equity to average assets ratio 7.10 % 7.62 % Net Interest Income and Net Interest Margin The Company’s primary source of income is net interest income, which increased $1.1 million, or 3.95%, in 2022 compared to 2021 due primarily to a $33.8 million increase in average earning assets and rising market interest rates during the year. This was offset by an increase in interest expense on borrowed funds of approximately $777,000, or 171.5%, related to the increase in variable rates on trust preferred securities as well as an increase in borrowings from the Federal Home Loan Bank (FHLB) during the year. The decrease in interest income on loans, including fees, was driven by a decrease in fees of $1.8 million resulting from PPP loan forgiveness in 2021 that did not reoccur during 2022. The following table shows the rates paid on earning assets and deposit liabilities for the periods indicated. 19 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, 2022 December 31, 2021 Average Income/ Yields/ Average Income/ Yields/ Balance Expense Rates Balance Expense Rates ASSETS Loans (1) (2) $ 591,179 $ 27,739 4.69% $ 586,963 $ 28,323 4.83% Federal funds sold 332 8 2.41% 212 - 0.10% Interest bearing deposits in other banks 76,560 1,514 1.98% 78,583 95 0.12% Taxable investment securities 113,141 2,129 1.88% 81,635 1,494 1.83% Total earning assets 781,212 31,390 4.02% 747,393 29,912 4.00% Less: allowance for loans losses (6,790) (7,034) Non-earning assets 40,657 58,398 Total assets $ 815,079 $ 798,757 LIABILITIES AND SHAREHOLDERS’ EQUITY Interest-bearing demand deposits $ 74,786 $ 98 0.13% $ 59,154 $ 59 0.10% Savings and money market deposits 191,136 260 0.13% 181,736 148 0.08% Time deposits 188,010 1,517 0.81% 214,937 2,041 0.95% Short-term borrowings 20,370 501 2.46% 2,474 33 1.33% Trust preferred securities 16,496 729 4.42% 16,496 420 2.55% Total interest-bearing liabilities 490,798 3,105 0.63% 474,797 2,701 0.57% Non-interest-bearing deposits 261,834 - -% 254,911 - - % Total deposit liabilities and cost of funds 752,632 3,105 0.41% 729,708 2,701 0.37% Other liabilities 4,248 8,178 Total liabilities 756,880 737,886 Shareholders’ equity 58,199 60,871 Total liabilities and shareholders’ equity $ 815,079 $ 798,757 Net interest income $ 28,285 $ 27,211 Net interest margin 3.62% 3.64% Net interest spread 3.39% 3.43% (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. 20 Volume and Rate Analysis Increase (decrease) Year 2022 Compared to 2021 (Dollars in thousands) Volume Effect Rate Effect Rate and Volume Effect Change in Interest Income/ Expense Interest Income: Loans $ 206 $ (784) $ (6) $ (584) Federal funds sold - 5 3 8 Interest bearing deposits in other banks (2) 1,459 (38) 1,419 Taxable investment securities 577 42 16 635 Total Earning Assets 781 722 (25) 1,478 Interest Expense: Interest-bearing demand deposits 16 19 4 39 Savings and money market deposits 8 99 5 112 Time deposits (282) (281) 39 (524) Short-term borrowings 239 28 201 468 Trust preferred securities - 309 - 309 Total Interest-bearing Liabilities (19) 174 249 404 Change in Net Interest Income $ 800 $ 548 $ (274) $ 1,074 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 (2,192) Change in Net Interest Income $ 1,784 $ 702 $ (418) $ 2.068 21 The increases in interest income and interest expense during 2022 were driven mainly by increased interest rates, as short-term assets and liabilities tied to short-term rates adjusted to market rate increases throughout the year, new production at higher rates, and asset yields outpacing increases in funding costs in the rising interest rate environment. Overall, our net interest margin decreased 2 basis points to 3.62% in 2022 compared to 3.64% in 2021. The increase in interest income is primarily attributed to an increase in yields on overnight deposits with banks, which was mainly driven by higher market rates, as noted above, combined with a reinvesting of funds in investment securities at higher rates. This increased income offset a decrease in loan interest Overall, loan interest income, including fees, decreased $584,000 during the year ended December 31, 2022 compared to December 31, 2021, due to the impact of PPP loan fees recognized in 2021, that was not repeated in 2022. Interest expense increased $404,000, due primarily to an increase in the average balance of FHLB advances of $20.4 million during the year, combined with increased market rates on trust preferred securities. This was offset by a decrease in interest expense on time deposits due to a reduction in volume and rate. While rates on time deposits reset at lower rates during 2022, this trend is not expected to continue into 2023, due to the continuing increase in interest rates, combined with the competitive pressures to acquire and retain deposits. 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 a limited number 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 gross loans decreased $9.1 million during 2022, or 1.54%, to $584.6 million as of December 31, 2022 as compared to $593.7 million at December 31, 2021. The primary drivers of this decrease in total loans were a reduction in commercial real estate loans, multifamily, and commercial loans of $9.1 million, $3.3 million, and $7.6 million, respectively. This was offset by an increase in construction and land development loans of $10.1 million in comparison to December 31, 2021. The decrease in commercial real estate and commercial loans was partly attributable to several large borrowers selling their businesses or collateral and paying off the related loans. For more detail on loan balances, refer to Note 6 of the consolidated financial statements contained in Item 8 of this Form 10-K. Nonaccrual loans increased approximately $472,000 during 2022 from $2.9 million as of December 31, 2021 to $3.4 million as of December 31, 2022. 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 in Item 8 of this Form 10-K. Impaired loan balances decreased during 2022, to $2.7 million as of December 31, 2022, from $2.8 million as of December 31, 2021. 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 in Item 8 of this Form 10-K. 22 The following table presents the dollar composition and percentage of our loan portfolio as of December 31: Loan Composition 2022 2021 (Dollars in thousands) $ % $ % Real estate secured: Commercial $ 197,069 33.7 % $ 206,162 34.7 % Construction and land development 42,470 7.3 % 32,325 5.4 % Residential 1-4 family 227,232 38.9 % 224,530 37.8 % Multifamily 29,710 5.1 % 33,048 5.6 % Farmland 17,744 3.0 % 18,735 3.2 % Total real estate loans 514,225 88.0 % 514,800 86.7 % Commercial 46,697 8.0 % 54,325 9.1 % Agriculture 3,756 0.6 % 4,021 0.7 % Consumer installment loans 19,309 3.3 % 18,756 3.2 % All other loans 626 0.1 % 1,842 0.3 % Total loans 584,613 100.0 % 593,744 100.0 % Less: allowance for loan losses 6,727 6,735 Total $ 577,886 $ 587,009 Our loan maturities, and distribution between fixed and variable rate loans as of December 31, 2022 are shown in the following tables : 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 $ 11,285 $ 39,525 $ 73,958 $ 72,301 $ 197,069 Construction and land development 7,511 10,491 10,664 13,804 42,470 Residential 1-4 family 7,255 22,850 85,214 111,913 227,232 Multifamily 1,152 5,342 11,178 12,038 29,710 Farmland 1,995 2,843 8,400 4,506 17,744 Total real estate loans 29,198 81,051 189,414 214,562 514,225 Commercial 15,853 22,929 5,487 2,428 46,697 Agriculture 1,276 2,324 — 156 3,756 Consumer installment loans 3,192 14,804 1,293 20 19,309 All other loans 295 331 — — 626 Total $ 49,814 $ 121,439 $ 196,194 $ 217,166 $ 584,613 23 The following table presents the dollar amount of fixed rate and variable rate loans with maturities greater than one year as of December 31, 2022: (Dollars in thousands) Fixed Rate Variable Rate Real estate secured: Commercial $ 75,192 $ 110,592 Construction and land development 17,756 17,203 Residential 1-4 family 90,416 129,561 Multifamily 12,651 15,907 Farmland 3,069 12,680 Total real estate loans 199,084 285,943 Commercial 23,975 6,869 Agriculture 2,287 193 Consumer installment loans 15,032 1,085 All other loans 331 — Total $ 240,709 $ 294,090 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. 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 the fourth quarter of 2021, in response to rising price inflation, we added inflation to the economic factors considered in the model. Throughout 2022, we continued to adjust external factors impacting the allowance for loan loss model to best reflect changes in the general and local economies, the increasing interest rate environment, and the risks in the portfolio. 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 remained at $6.7 million as of December 31, 2022. The allowance for loan losses at the end of 2022 was approximately 1.15% of total loans as compared to 1.13% at the end of 2021. Provisions for loan losses of approximately $625,000 and $372,000 were recorded during the years ended December 31, 2022 and 2021, respectively. Loans charged off, net of recoveries, totaled approximately $633,000, or 0.11% of average loans, for the year ended December 31, 2022, compared to approximately $828,000, or 0.14% of average loans, in 2021. 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 an increase in the volume of these loans during 2022, while the number of nonaccrual loans decreased. As of December 31, 2022, there were 41 nonaccrual loans totaling $3.4 million, or 0.58% of total loans. As of December 31, 2021, there were 65 nonaccrual loans totaling $2.9 million, or 0.50% of total loans. The amount of interest income that would have been recognized on these loans had they been accruing interest was approximately $10,000 and $223,000 in the years ended December 31, 2022 and 2021, respectively. There were no loans past due 90 days or greater and still accruing interest at either December 31, 2022 or 2021. There are no commitments to lend additional funds to non-performing borrowers. 24 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 lingering 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 coupled with rising inflation. 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 or our watch list committee. 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. 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 are 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 of $250,000 or more, along with selected other credits, classified as substandard, doubtful or loss are individually reviewed for impairment in accordance with Accounting Standards Codification (ASC) 310-10-35. The increase in the threshold to $250,000 during 2022, did not significantly impact level of loans assessment for impairment. 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. Impaired loan balances decreased during 2022, to $2.7 million, with a related allowance of approximately $86,000, as of December 31, 2022, from $2.8 million, with a related allowance of approximately $166,000, as of December 31, 2021. 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, and 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. 25 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 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) 2022 2021 Allowance for loan losses $ 6,727 $ 6,735 Total loans 584,613 593,744 Allowance for loan losses to total loans 1.15 % 1.13 % Nonaccrual loans $ 3,413 $ 2,941 Nonaccrual loans to total loans 0.58 % 0.50 % Ratio of allowance for loan losses to nonaccrual loans 1.97 X 2.29 X Charge-offs net of recoveries $ 633 $ 828 Average loans $ 591,179 $ 586,963 Net charge-offs to average loans 0.11 % 0.14 % The above table includes $823,000 and $1.1 million in nonaccrual loans as of December 31, 2022 and 2021, respectively, which have been classified as troubled debt restructurings. No troubled debt restructurings were past due 90 days or more and still accruing interest as of December 31, 2022 or 2021. There were $2.0 million in loans classified as troubled debt restructurings as of December 31, 2022, as compared to $2.5 million in loans classified as troubled debt restructurings as of December 31, 2021. For more detail on nonaccrual, impaired, past due and restructured loans, refer to Note 6 and Note 8 to the consolidated financial statements in Item 8 of this Form 10-K. 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, 2022 and 2021: December 31, 2022 December 31, 2021 (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 $ 202,435 $ (28 ) -0.01 % $ 194,517 $ 913 0.47 % Construction and land development 39,986 143 0.36 % 28,820 (6 ) -0.02 % Residential 1-4 family 225,334 (36 ) -0.02 % 220,524 (37 ) -0.02 % Multifamily 32,768 109 0.33 % 23,840 — 0.00 % Farmland 18,022 (13 ) -0.07 % 19,144 (29 ) -0.15 % Total real estate loans 518,545 175 0.03 % 486,845 841 0.17 % Commercial 48,093 14 0.03 % 74,711 (45 ) -0.06 % Agriculture 3,823 — 0.00 % 4,095 (1 ) -0.02 % Consumer and all other loans 19,235 444 2.31 % 19,441 33 0.17 % Unallocated 1,483 — 0.00 % 1,871 — 0.00 % Total loans $ 591,179 $ 633 0.11 % $ 586,963 $ 828 0.14 % 26 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, 2022 December 31, 2021 (Dollars in thousands) Amount % of ALLL % of Loans Amount % of ALLL % of Loans Real estate secured: Commercial $ 2,364 35.1 33.7 $ 2,134 31.7 34.7 Construction and land development 345 5.2 7.3 189 2.8 5.4 Residential 1-4 family 2,364 35.1 38.9 2,237 33.2 37.8 Multifamily 262 3.9 5.1 254 3.8 5.6 Farmland 153 2.3 3.0 149 2.2 3.2 Total real estate loans 5,488 81.6 88.00 4,963 73.7 86.7 Commercial 381 5.7 8.0 1,099 16.3 9.1 Agriculture 32 0.5 0.6 28 0.4 0.7 Consumer and all other loans 386 5.7 3.4 108 1.6 3.5 Unallocated 440 6.5 — 537 8.0 — Total $ 6,727 100.0 100.0 $ 6,735 100.0 100.0 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 35.1% of the allowance to commercial real estate loans, which constituted 33.7% of our loan portfolio at December 31, 2022. This allocation increased slightly compared to the 31.7% in 2021, due primarily to the impact of the external factors considered as part of the determination of the overall allowance for loan losses. We have allocated 5.7% of the allowance to commercial loans, which constituted 8.0% of our loan portfolio at December 31, 2022. This allocation percentage decreased compared to December 31, 2021, due to a lower loss rate on commercial loans for the historical period assessed in the loan loss model for 2022. 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 allocated 5.2% of the allowance to real estate construction loans, which constituted 7.3% of our loan portfolio as of December 31, 2022. 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 allocated 35.1% of the allowance to residential real estate loans, which constituted 38.9% of our loan portfolio as of December 31, 2022. We allocated 5.74% of the allowance to consumer and all other loans, which constituted 3.41% of our loan portfolio as of December 31, 2022. Our allocation increased as a percentage of the allowance for loan losses due to the impact of overdrawn deposit account losses resulting from the cybersecurity incident, combined with a change in the treatment of deposit account charge-offs during 2022. As of December 31, 2022, we had an unallocated portion of the allowance for loan losses totaling approximately $440,000. 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 implemented the Current Expected Credit Loss (CECL) model to replace our legacy loan loss model for the first quarter of 2023. The cumulative effects of this implementation were immaterial. 27 Other Real Estate Owned Other real estate owned decreased $1.1 million, or 80.82%, to approximately $261,000 as of December 31, 2022 from $1.4 million as of December 31, 2021. 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. During 2022, three former branch locations transferred to OREO in 2021 were sold, which decreased OREO approximately $912,000. While the levels of problem credits and foreclosed properties have been reduced significantly over the past several years, we remain mindful of the impact on earnings and capital as we work to achieve our goal to reduce nonperforming assets. However, we may recognize some losses and reductions in the allowance for loan losses as we expedite the resolution of these problem assets. Investment Securities Total investment securities decreased $11.3 million, or 10.51%, to $96.1 million as of December 31, 2022 from $107.4 million as of December 31, 2021. All securities are classified as available-for-sale for liquidity purposes. There were no sales of securities during the year ended December 31, 2022. Sales of securities during 2021 totaled $7.7 million, with gains of approximately $322,000 realized. During the year ended December 31, 2022 and 2021, there were maturities, calls and paydowns of $14.0 million and $16.3 million, respectively. The Company purchased $19.8 million and $85.1 million in investment securities during the year ended December 31, 2022 and 2021, respectively. Investment securities with a carrying value of $27.3 and $12.1 million as of December 31, 2022 and 2021, respectively, were pledged to secure public deposits and for other purposes required, or permitted, by law. 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. Losses could be realized if liquidity and/or business strategy necessitate the sale of securities in a loss position, due to Federal Reserve actions, U.S. fiscal policies or other factors affecting market interest rates. As of December 31, 2022, we had a net unrealized loss in our investment portfolio totaling $17.6 million as compared to a $1.0 million loss as of December 31, 2021. As market 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 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 as of December 31, 2022 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 $ 971 3.87 % $ 9,281 1.39 % $ 1,433 1.04 % $ — — % $ 11,685 1.54 % U.S. Government Agencies 1 4.56 % 2,992 3.76 % 2,091 3.12 % 4,315 2.60 % 9,399 3.08 % Taxable municipals — — % 504 2.95 % 3,476 2.30 % 12,835 2.33 % 16,815 2.33 % Corporate bonds 503 5.48 % 1,427 3.49 % 1,206 2.58 % — — % 3,136 3.43 % Mortgage backed securities — — % 1,470 1.92 % 5,203 1.77 % 48,368 1.66 % 55,041 1.68 % $ 1,475 4.51 % $ 15,674 2.12 % $ 13,409 2.11 % $ 65,518 1.86 % $ 96,076 1.97 % 28 Bank Owned Life Insurance As of December 31, 2022 and 2021, the Bank had an aggregate total cash surrender value of $4.5 million and $4.7 million, respectively, on life insurance policies covering former key officers. The Company recorded a loss of $136,000 due to a write-down of approximately $158,000, partially offset by earnings of $22,000, during the year ended December 31, 2022. The write-down was due to the impact of rising interest rates on the value of the underlying assets supporting the policies. The Company recognized income of approximately $32,000 during the year ended December 31, 2021. Deposits Total deposits were $692.7 million as of December 31, 2022, a decrease of $14.8 million, or 2.1%, from $707.5 million as of December 31, 2021. Most of the decrease was driven by savings and money market deposits, which decreased $20.6 million, or 10.7%, to $171.5 million as of December 31, 2022. The majority of the decline occurred during the fourth quarter of 2022 as competition for funds for lending and other needs intensified among banks and non-banks in the Company’s markets. 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 decreased in 2022. Overall, we continue to maintain core deposits through attractive consumer and commercial deposit products and strong ties with our customer base and communities. Time deposits of $250,000 or more equaled approximately 3.87% of deposits at the end of 2022 and 4.00% of deposits at the end of 2021. As of December 31, 2022 and 2021, uninsured deposits are estimated to be $87.5 million and $93.8 million, respectively. Included in estimated uninsured deposits are $14.4 million and $13.6 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, 2022 Three months or less $ 2,339 Over three months through six months 3,078 Over six months through twelve months 10,374 Over one year 5,252 Total $ 21,043 As of December 31, 2022 and 2021, $27.3 million and $12.1 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 $7.0 million and $12.0 million at December 31, 2022 and 2021, respectively, to secure public deposits, including time deposits, held in our Virginia offices. We held no brokered deposits at December 31, 2022 or 2021. 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. Total Certificate of Deposit Registry Service (CDARS) time deposits were $1.4 million and $5.8 million at December 31, 2022 and 2021, respectively. 29 Noninterest Income For the year ended December 31, 2022, noninterest income decreased approximately $740,000, or 7.4%, to $9.2 million, or 1.1% of average assets, from $10.0 million, or 1.3% of average assets, for the same period in 2021. The decrease was primarily attributable to non-recurring net gains on sales of investment securities of $322,000 in 2021 and net gains on sales of fixed assets of $190,000 in 2021. During the period immediately after the cybersecurity incident, in June 2022, we temporarily stopped assessing overdraft and certain other service charges. we estimate that additional normalized charges of approximately $125,000 would have been realized during this period. Additionally, the Company recognized a write-down on BOLI of $158,000 during the year ended December 31, 2022 due to declines in the market value of the underlying investments supporting the policy related to increased interest rates. Gains and commissions on mortgage loan originations decreased approximately $162,000 due to rising interest rates on mortgage loans. Noninterest Expense Noninterest expenses decreased $1.3 million, or 4.8%, to $26.5 million for the year ended December 31, 2022, compared to $27.9 million for the year ended December 31, 2021. Noninterest expense as a percent of total average assets decreased to 3.2% in 2022 from 3.5% in 2021. The decrease in noninterest expense was primarily due to a decrease of $1.7 million in occupancy and equipment expense. The decrease 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. The decrease in occupancy and equipment was partially offset by a $703,000 increase in salaries and benefits expense attributable to higher bonus accruals based on Company performance, annual performance raises, and adjustments to minimum starting salaries to reflect rising costs to attract and retain talent. 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 70.6% in 2022 compared to 75.6% in 2021. The decrease in this ratio is a result of improvements in net interest income and noninterest expense, 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 $2.3 million for the year ended December 31, 2022, compared to $1.9 million for the same period in 2021. The effective tax rates were 22.2%, and 21.7% for 2022 and 2021, respectively. The effective tax rate for the periods differed from the federal statutory rate of 21.0% principally due to the impact of the recapture of operating loss carryforwards and applicable credits, along with the effect of certain state income taxes. The higher effective tax rate in 2022 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, 2022 or 2021. 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. 30 Capital Resources Our total shareholders’ equity at the end of 2022 was $57.2 million compared to $63.6 million at the end of 2021. The decrease was $6.4 million, or 10.1%. Book value per common share was $2.40 at December 31, 2022 compared to $2.66 at December 31, 2021. As previously discussed, the year-over-year decline was primarily driven by the $13.1 million net increase in the accumulated other comprehensive loss related to the unrealized loss on investment securities available-for-sale. Excluding the impact of the unrealized loss, equity increased $6.7 million. During 2022, the board of directors authorized the repurchase of up to 500,000 shares of common stock through March 31, 2023. Through December 31, 2022, 73,595 shares have been repurchased at an average price of $2.33 per share. On February 27, 2023, the board of directors approved an extension of the repurchase program through March 31, 2024. 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, 2022, the Bank meets all capital adequacy requirements to which it is subject. Based upon projections, we believe our earnings will be sufficient to support the Bank’s planned asset growth. The Company paid its first cash dividend of $0.05 per share in 2022. On February 27, 2023, the board of directors declared a dividend of $0.06 per share, to be paid on March 31, 2023. Future payments of cash dividends 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 $130.5 million as of December 31, 2022, down from $159.3 million as of December 31, 2021. 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, and the decrease in deposits. A surplus of short-term assets is maintained at levels management deems adequate to meet potential liquidity needs. The Bank’s primary funding source is deposits from customers in the markets in which it provides banking services. As discussed previously, deposits declined during the fourth quarter of 2022 as competition for deposits intensified from both bank and non-bank institutions. The Company expects that pressure on the rates paid on deposits will continue and that it may be required to increase the rates paid on its deposit products, possibly faster and to a higher degree not currently projected, to retain existing customers and attract new deposit relationships to fund loans and other activities. As discussed below, the Company has other liquidity sources to manage its liquidity needs as they arise. At December 31, 2022, all of our investments are classified as available-for-sale, providing an additional source of liquidity in the amount of $68.8 million, which is net of the $27.3 million of securities pledged as collateral. Generally, the investment portfolio serves as a source of liquidity while yielding a higher return at the purchase date 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 decreased $11.3 million, or 10.51%, during 2022 from $107.4 million as of December 31, 2021 to $96.1 million as of December 31, 2022. 31 Our loan to deposit ratio was 84.4% as of December 31, 2022 and 83.9% as of December 31, 2021. Available third-party sources of liquidity remain intact at December 31, 2022 which includes the following: our line of credit with the FHLB totaling $200.1 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, 2022. We have used our line of credit with FHLB to issue a letter of credit totaling $7.0 million to the Treasury Board of Virginia for collateral on public funds. No draws on the letter of credit have been issued. This letter of credit is considered to be a draw on our FHLB line of credit. An additional $200.1 million was available on December 31, 2022 on the $207.1 million line of credit, of which $113.7 million is secured by a blanket lien on our residential real estate loans. While we have access to the brokered deposits market, we held no brokered deposits as of December 31, 2022 or 2021. As of December 31, 2022, we had $1.4 million in reciprocal CDARS time deposits, compared to $5.8 million as of December 31, 2021. The Bank has access to additional liquidity through the Federal Reserve Bank of Richmond’s Discount Window for overnight funding needs. We have collateralized this line with investment securities; 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 recovering from the lingering effects of the COVID-19 pandemic, inflation and the war in Ukraine, we continue monitoring 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. On March 10, 2023, Silicon Valley Bank (SVB) a regional banking company headquartered in Santa Clara, California, with total assets in excess of $200 billion, was taken into receivership through FDIC, after the bank experienced a significant outflow of deposit funds fueled by concerns of large commercial and retail deposit customers holding funds far in excess of the FDIC insured limits at SVB. These concerns related to unrealized losses in SVB’s investment portfolio combined with the long-term maturities of the investments and other earning assets held by SVB. While we, or any other financial institution, can be impacted by sudden changes in market conditions or customer sentiment, we believe that our funding and liquidity management strategies and procedures are sound. In addition, our deposit customer base is diverse without significant exposure to uninsured deposit relationships. Prior to receivership of SVB our deposit fluctuations were largely tied to cyclical events and inflows and outflows related to customers seeking higher interest rates. Since the date of the receivership, we have not experienced any significant or unusual deposit outflows and we have taken steps to successfully test certain liquidity facilities in the event of any future deposit outflows. 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. 32 A summary of the contract amount of the Bank’s exposure to off-balance-sheet risk as of December 31, 2022 and 2021 is as follows: 2022 2021 (Dollars in thousands) Commitments to extend credit $ 84,149 $ 69,015 Standby letters of credit 3,751 3,684 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. In response to two bank failures in March, 2023, and liquidity concerns for other super-regional banks, we have not experienced any significant unusual activity by borrowers drawing against their lines of credit, nor do we anticipate experiencing such demand that might cause us to limit customer access to these lines of credit. 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 As of December 31, 2022, we had a negative cumulative gap rate sensitivity ratio of 17.89% for the one-year re-pricing period, compared to 12.97% as of December 31, 2021. 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 next repricing date 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; however, the ability to control the repricing of the deposit portfolio can be significantly impacted by competitive pressures, liquidity needs and access to and availability of other funding sources. With the FOMC initiating a series of rate increases, which are expected to continue into 2023, 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. 33 Interest Sensitivity Analysis December 31, 2022 (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 $ 104,724 $ 92,065 $ 170,703 $ 135,643 $ 60,156 $ 21,322 $ 584,613 Federal funds sold 960 — — — — — 960 Deposits with banks 46,497 — 250 — — 46,747 Investments 3,614 7,636 23,440 18,406 28,082 32,546 113,724 Bank owned life insurance 4,549 — — — — — 4,549 Total earning assets $ 160,344 $ 99,701 $ 194,393 $ 154,049 $ 88,238 $ 53,868 $ 750,593 Sources of funds: Int Bearing DDA 80,299 — — — — — 80,299 Savings & MMDA 174,251 — — — — — 174,251 Time Deposits 28,982 94,288 50,670 14,293 — — 188,233 Trust Preferred Securities 16,496 — — — — — 16,496 Federal funds purchased — — Other Borrowings — — — — — — — Total interest bearing liabilities $ 300,028 $ 94,288 $ 50,670 $ 14,293 $ — $ — $ 459,279 Discrete Gap $ (139,684 ) $ 5,413 $ 143,723 $ 139,756 $ 88,238 $ 53,868 $ 291,314 Cumulative Gap $ (139,684 ) $ (134,271 ) $ 9,452 $ 149,208 $ 237,446 $ 291,314 Cumulative Gap as % of Total Earning Assets -18.61 % -17.89 % 1.26 % 19.88 % 31.63 % 38.81 % Item 7A. Quantitative and Qualitative Disclosures About Market Risk Not required. 34