Item 7. Management’s Discussion and Analysis
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 credit 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.
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 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 cybersecurity;
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.
17
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, 2023 and
2022, as well as results of operations for the years ended December 31, 2023 and 2022. 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 credit 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.
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 allowance for credit losses.
The allowance for
credit 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 credit
losses, we refer you to the section on “Allowance for Credit 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.
Cybersecurity
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, cybersecurity 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.
18
As discussed under
the heading “Cybersecurity” in Item 1.C 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 cybersecurity incident
has occurred, and the SEC has outlined rules for public disclosure.
Overview
For the year ended
December 31, 2023, net income was $7.2 million, or basic and diluted net income per share of $0.30, compared to a net income of $8.1
million, or basic and diluted net income per share of $0.34, for the year ended December 31, 2022, a decrease of $0.9 million, or 11.1%.
Retained earnings increased to $14.5 million as of December 31, 2023 from $8.9 million as of December 31, 2022, an increase of $5.6 million
or 62.14%.
As discussed in “Net
Interest Income and Net Interest Margin” net interest income for the year ended December 31, 2023 was $28.0 million compared to
$28.3 million for the year ended December 31, 2022. The decrease was primarily due to an increase in the cost of interest-bearing liabilities
of 125 basis points (“bps”; 1 basis point is equal to 1/100 th of 1 percent) to 1.88% during the year ended December
31, 2023 compared to 0.63% during the year ended December 31, 2022.
Noninterest income
increased $709,000 to $9.9 million for the year ended December 31, 2023 from $9.2 million for the comparable period in 2022. The primary
drivers of the increase were the sales of a former operations facility and branch location resulting in a combined gain of $130,000;
an increase in financial services revenue of $168,000; and income resulting from an insurance claim payment in the amount of $257,000.
This was offset by decreases in service charge income and card processing fees totaling a combined $122,000 during the period. Service
charge income decreased due to changes made in 2022 in assessing certain charges that reduced the number of transactions subject to such
fees. Additional changes to our service charge structure took effect during the fourth quarter of 2023, which eliminated charges for
certain representment items, and certain funds transfer fees. Fees from debit card activity declined as customer deposit balances have
reverted to pre-pandemic levels and customer spending habits have also begun to normalize.
Noninterest expense
was $28.0 million for the year ended December 31, 2023 compared to $26.5 million for the year ended December 31, 2022. The $1.5 million
increase was impacted by increases in salaries and employee benefits of $891,000 data processing and telecommunications costs of $112,000,
legal and professional fees of $273,000, cards rewards program expense of $115,000 and deposit insurance of $143,000. These increases
were partially offset by decreases in occupancy expenses of $192,000, and data processing and telecommunication costs of $171,000, in
comparison to the year ended December 31, 2022. During the first quarter of 2024 changes will be made to our branch network, with the
consolidation of our two offices in Bristol, VA along with the opening of a full-service branch office in Boone, NC. It is expected that
personnel and occupancy costs will incur modest increases resulting from these changes.
Total assets as of
December 31, 2023 were $826.3 million, an increase of $51.0 million, or 6.6%, from $775.4 million as of December 31, 2022. Gross loans
increased $53.5 million, or 9.2%, during 2023 due to continuing strong loan demand. Investment securities decreased $6.3 million during
2023 primarily due to principal repayments of amortizing investments and other security maturities of $9.4 million, combined with a decrease
of $2.9 million in the unrealized loss position, partially offset by $500,000 in purchases. All of the Company's investments are designated
as available-for-sale.
Deposits totaled
$716.5 million as of December 31, 2023 compared to $692.7 million as of December 31, 2022. The increase of $23.8 million, or 3.4%, was
due to efforts to attract and retain deposits, specifically time deposits, combined with cyclical funds inflows. As a result of these
efforts, total time deposits increased $64.1 million during the year ended December 31, 2023. The increase in time deposits contributed
to the increase in our cost of funds, as previously discussed, due to the rising interest rate environment experienced over the past
two years.
19
New Peoples Bank
remains well-capitalized. The leverage ratio improved to 11.11% as of December 31, 2023, compared to 10.40% as of December 31, 2022.
The Company’s
key performance indicators are as follows:
Year
ended December 31,
2023
2022
Return
on average assets
0.91 %
0.99 %
Return
on average shareholders’ equity
12.00 %
13.89 %
Average
shareholders’ equity to average assets ratio
7.52 %
7.10 %
Net
Interest Income and Net Interest Margin
The Company’s
primary source of income is net interest income, which decreased $0.3 million, or 0.9%, in 2023 compared to 2022 due primarily to
an increase in the cost of interest-bearing liabilities of 125 bps to 1.88% during the year ended December 31, 2023 compared to 0.63%
during the year ended December 31, 2022. Time deposits were the primary contributor to the decline in net interest income, due to an
increase of 176 bps in the cost of time deposits to 2.57% and a $33.3 million increase in the average balance due to a shift in the deposit
mix from lower cost products. Additionally, the cost of borrowed funds increased, as trust preferred securities costs rose 323 bps to
7.65% and other borrowings cost rose 114 bps to 3.60%. The impact of other borrowings cost increase was partially offset by a reduction
of $13.2 million in the average outstanding balance. The increase in cost of funds was offset by an increase of 85 bps in the yield on
earning assets. The yield on loans increased 66 bps to 5.35%, helping to offset the increased cost of funding during the year ended December
31, 2023. These rate and volume activities combined to result in a decrease in net interest income of $266,000, while the net interest
margin rose slightly to 3.67% for the year ended December 31, 2023, from 3.62% for 2022.
20
The following
table shows the rates paid on earning assets and interest-bearing liabilities for the periods indicated.
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, 2023
December
31, 2022
Average
Income/
Yields/
Average
Income/
Yields/
Balance
Expense
Rates
Balance
Expense
Rates
ASSETS
Loans
(1) (2)
$
608,705
$
32,552
5.35%
$
591,179
$
27,739
4.69%
Federal
funds sold
447
22
4.99%
332
8
2.41%
Interest
bearing deposits in other banks
44,864
2,239
4.99%
76,560
1,514
1.98%
Taxable
investment securities
109,303
2,322
2.12%
113,141
2,129
1.88%
Total
earning assets
763,319
37,135
4.87%
781,212
31,390
4.02%
Less: allowance
for credit losses
(6,937)
(6,790)
Non-earning
assets
36,574
44,722
Total
assets
$
792,956
$
819,144
LIABILITIES
AND SHAREHOLDERS’ EQUITY
Interest-bearing
demand deposits
$
74,939
$
459
0.61%
$
74,786
$
98
0.13%
Savings
and money market deposits
164,429
1,442
0.88%
191,136
260
0.13%
Time
deposits
221,275
5,681
2.57%
188,010
1,517
0.81%
Total
interest-bearing deposits
460,643
7,582
1.65%
453,932
1,875
0.41%
Other
borrowings
7,124
260
3.60%
20,370
501
2.46%
Trust
preferred securities
16,426
1,274
7.65%
16,496
729
4.42%
Total
interest-bearing liabilities
484,193
9,116
1.88%
490,798
3,105
0.63%
Noninterest-bearing
deposits
240,121
261,834
Other
liabilities
8,781
8,313
Total
liabilities
733,095
760,945
Shareholders’
equity
59,861
58,199
Total
liabilities and shareholders’ equity
$
792,956
$
819144
Net
interest income
$
28,019
$
28,285
Net
interest margin
3.67%
3.62%
Net
interest spread
2.99%
3.39%
(1) Nonaccrual
loans have been included in average loan balances.
(2)
Tax exempt income is not significant and has been treated as fully taxable.
Note: Yields and rates calculated
based on whole dollars.
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.
21
Volume
and Rate Analysis
Increase
(decrease)
Year
2023 Compared to 2022
(Dollars
in thousands)
Volume
Effect
Rate
Effect
Rate
and Volume Effect
Change
in Interest Income/ Expense
Interest
income:
Loans
$
822
$
3,876
$
115
$
4,813
Federal
funds sold
3
9
2
14
Interest
bearing deposits in other banks
(627)
2,307
(955)
725
Taxable
investment securities
(72)
275
(10)
193
Total
earning assets
126
6,467
(848)
5,745
Interest
expense:
Interest-bearing
demand deposits
-
360
1
361
Savings
and money market deposits
(36)
1,416
(198)
1,182
Time
deposits
268
3,310
586
4,164
Other
borrowings
(326)
242
(157)
(241)
Trust
preferred securities
(3)
550
(2)
545
Total
interest-bearing liabilities
(97)
5878
230
6,011
Change
in net interest income
$
223
$
589
$
(1,078)
$
(266)
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)
Other
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
The increases in
interest income and interest expense during 2023 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 increased five basis points to 3.67%
in 2023 compared to 3.62% in 2022.
The increase in interest
income is primarily attributed to an increase in yields on loans, which was mainly driven by higher market rates, combined with higher
rates on interest bearing deposits in other banks. Overall, loan interest income, including fees, increased $4.8 million during the year
ended December 31, 2023 compared to December 31, 2022.
Interest expense
increased $6.0 million, due primarily to an increase in the average balance and yield on time deposits, as noted above, combined with
increased market rates on interest-bearing demand deposits, savings and money market deposits, and trust preferred securities. This was
offset by a decrease in interest expense on other borrowings due to a reduction in volume.
22
Our interest rate
structure was impacted by the end of the use of LIBOR, which phased-out in 2023. We used LIBOR in pricing a limited number of our interest
earning assets and liabilities, including our trust preferred securities. Most of these contracts were replaced with the secured overnight
funding rate (“SOFR”).
Loans
Our primary source
of income is interest earned on loans. Total gross loans increased $53.5 million during 2023, or 9.15%, to $638.1 million as of December
31, 2023 as compared to $584.6 million as of December 31, 2022. The primary driver of this increase in total loans was an increase of
$43.1 million in commercial real estate loans to $240.2 million as of December 31, 2023 compared to $197.1 million as of December 31,
2022. Additionally, residential 1-4 family, multifamily, commercial, and consumer installment loans increased $11.0 million, $4.9 million,
$6.5 million, and $3.3 million, respectively. This was offset by decreases of $13.6 million in construction and land development loans;
$1.3 million in farmland loans; $248,000 in agricultural loans; and $114,000 in all other 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 $0.1 million during 2023 from $3.4 million as of December 31, 2022 to $3.5 million as of December 31, 2023. 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.
Individually evaluated
loans, previously known as impaired loans under the incurred loss methodology, decreased during 2023, to $1.1 million as of December
31, 2023, from $2.7 million as of December 31, 2022. I nterest income and cash receipts on individually
evaluated loans are handled differently depending on whether or not the loan is on nonaccrual status. If the individually evaluated loan
is not on nonaccrual status, the interest income on the loan is computed using the effective interest method. For more detail
on individually evaluated loan balances, refer to Note 6 of the consolidated financial statements
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
2023
2022
(Dollars
in thousands)
$
%
$
%
Real
estate secured:
Commercial
$
240,187
37.6%
$
197,069
33.7%
Construction
and land development
28,830
4.5%
42,470
7.3%
Residential
1-4 family
238,233
37.3%
227,232
38.9%
Multifamily
34,571
5.4%
29,710
5.1%
Farmland
16,401
2.6%
17,744
3.0%
Total
real estate loans
558,222
87.4%
514,225
88.0%
Commercial
53,230
8.3%
46,697
8.0%
Agriculture
3,508
0.5%
3,756
0.6%
Consumer
installment loans
22,639
3.6%
19,309
3.3%
All
other loans
512
0.1%
626
0.1%
Total
loans
638,111
100.0%
584,613
100.0%
Less:
allowance for credit losses 1
7,256
6,727
Total
$
630,855
$
577,886
1 The
Company adopted ASU 2016-13 on January 1, 2023 using the modified retrospective approach. Therefore, amounts as of December 31, 2022
are shown using the incurred loss methodology.
23
Our loan maturities,
and distribution between fixed and variable rate loans as of December 31, 2023 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
$
17,173
$
44,897
$
87,241
$
90,876
$
240,187
Construction
and land development
5,897
3,656
9,880
9,397
28,830
Residential
1-4 family
10,013
20,113
82,642
125,465
238,233
Multifamily
1,346
4,526
11,825
16,874
34,571
Farmland
971
3,712
8,780
2,938
16,401
Total
real estate loans
35,400
76,904
200,368
245,550
558,222
Commercial
10,311
30,550
7,660
4,709
53,230
Agriculture
1,243
1,956
-
309
3,508
Consumer
installment loans
2,727
17,797
2,067
48
22,639
All
other loans
276
236
-
-
512
Total
$
49,957
$
127,443
$
210,095
$
250,616
$
638,111
The following table
presents the dollar amount of fixed rate and variable rate loans with maturities greater than one year as of December 31, 2023:
(Dollars
in thousands)
Fixed
Rate
Variable
Rate
Real
estate secured:
Commercial
$
83,656
$
139,397
Construction
and land development
6,869
15,620
Residential
1-4 family
86,809
141,932
Multifamily
11,851
21,200
Farmland
3,815
11,648
Total
real estate loans
193,000
329,797
Commercial
33,760
6,459
Agriculture
1,951
263
Consumer
installment loans
19,131
1,439
All
other loans
455
-
Total
$
248,297
$
337,958
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.
24
Allowance
for Credit Losses
On
January 1, 2023, the Company adopted ASU 2016-13 Financial Instruments – Credit Losses (Topic 326): Measurement of Credit Losses
on Financial Instruments (ASC 326). This standard replaced the incurred loss methodology with an expected loss methodology that is referred
to as the current expected credit loss (“CECL”) methodology. CECL requires an estimate of credit losses for the remaining
estimated life of the financial asset using historical experience, current conditions, and reasonable and supportable forecasts and generally
applies to financial assets measured at amortized cost, including loan receivables and held-to-maturity debt securities, and some off-balance
sheet credit exposures such as unfunded commitments to extend credit. Financial assets measured at amortized cost will be presented at
the net amount expected to be collected by using an allowance for credit losses.
The
Company adopted ASC 326 and all related subsequent amendments thereto effective January 1, 2023 using the modified retrospective approach
for all financial assets measured at amortized cost and off-balance sheet credit exposures. The transition adjustment for the adoption
of CECL included a decrease in the allowance for credit losses on loans of $80,000, which is presented as a reduction to net loans outstanding,
and an increase in the allowance for credit losses on unfunded loan commitments of $348,000, which is recorded within other liabilities.
The Company recorded a net decrease to retained earnings of $212,000 as of January 1, 2023 for the cumulative effect of adopting CECL,
which reflects the transition adjustments noted above, net of the applicable deferred tax assets recorded. Results for reporting periods
beginning after January 1, 2023 are presented under CECL while prior period amounts continue to be reported in accordance with previously
applicable accounting standards (“Incurred Loss”).
The allowance for
credit losses is a valuation account that is deducted from the loans' amortized cost basis to present the net amount expected to be collected
on the loans. Loans are charged off against the allowance when management believes the uncollectibility of a loan balance is confirmed.
Expected recoveries do not exceed the aggregate of amounts previously charged-off and expected to be charged-off. Accrued interest receivable
is excluded from the estimate of credit losses.
The allowance for
credit losses represents management’s estimate of lifetime credit losses inherent in loans as of the balance sheet date. The allowance
for credit losses is estimated by management using relevant available information, from both internal and external sources, relating
to past events, current conditions, and reasonable and supportable forecasts.
The Company primarily
utilizes the cohort and the probability of default/loss given default methodologies for its reasonable and supportable forecasting of
current expected credit losses. To further adjust the allowance for credit losses for expected losses not already included within the
quantitative component of the calculation, the Company may consider the following qualitative adjustment factors: changes to: lending
policies and procedures, national and local economic conditions, the experience and ability of management and staff, the volume and severity
of past due, rated and nonaccrual assets, loan review system, collateral value, concentrations of credit, and legal or regulatory requirements
and competition.
The Company measures
expected credit losses for loans on a pooled basis when similar risk characteristics exist. Loans that do not share risk characteristics
are evaluated on an individual basis. The Company designates loan relationships of $250,000 or more that have been determined to meet
the regulatory definitions of “special mention” or “classified” (together known as “criticized”)
as individually evaluated. The fair value of individually evaluated loans is measured using the fair value of collateral (“collateral
method”) or the discounted cash flow (“DCF”) method.
The allowance for
credit losses increased to $7.3 million as of December 31, 2023 from $6.7 million as of December 31, 2022. The allowance for credit losses
at the end of 2023 was approximately 1.14% of total loans as compared to 1.15% at the end of 2022. Provisions for credit losses for loans
receivable of approximately $712,000 and $625,000 were recorded during the years ended December 31, 2023 and 2022, respectively. Loans
charged off, net of recoveries, totaled approximately $103,000, or 0.02% of average loans, for the year ended December 31, 2023, compared
to approximately $633,000, or 0.11% of average loans, in 2022. The allowance for credit losses represents an amount that, in the Company's
judgment, will be adequate to absorb expected and estimable losses inherent in the loan portfolio. The judgment in determining the level
of the allowance is based on evaluations of the collectability of loans while taking into consideration such factors as trends in delinquencies
and charge-offs for relevant periods of time, changes in the nature and volume of the loan portfolio, current reasonable and supportable
forecasts of economic conditions that may affect a borrower's ability to repay and the value of collateral, overall portfolio quality
and review of specific potential losses. This evaluation is inherently subjective because it requires estimates that are susceptible
to significant revision as more information becomes available.
25
Nonaccrual loans
increased approximately $0.1 million during 2023 from $3.4 million as of December 31, 2022 to $3.5 million as of December 31, 2023. The
amount of interest income that would have been recognized on these loans had they been accruing interest was approximately $61,000 and
$10,000 in the years ended December 31, 2023 and 2022, respectively. There were no loans past due 90 days or greater and still accruing
interest at either December 31, 2023 or 2022. 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 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 credit 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 credit losses.
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 credit losses 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 credit losses. Collection efforts continue by means of repossessions or foreclosures, and upon bank ownership, liquidation
ensues.
Prior to the adoption
of ASU 2016-13, loans were considered impaired when, based on current information and events, it was probable the Company would be unable
to collect all amounts due in accordance with the original contractual terms of the loan agreements. Impaired loans included loans on
nonaccrual status and accruing troubled debt restructurings. When determining if the Company would be unable to collect all principal
and interest payments due in accordance with the contractual terms of the loan agreement, the Company considered the borrower’s
capacity to pay, which included such factors as the borrower’s current financial statements, an analysis of global cash flow sufficient
to pay all debt obligations and an evaluation of secondary sources of repayment, such as guarantor support and collateral value. The
Company individually assessed for impairment all nonaccrual loans greater than $250,000 and all troubled debt restructurings, whether
or not currently classified as such. The tables below include all loans deemed impaired, whether or not individually assessed for impairment.
If a loan was deemed impaired, a specific valuation allowance was allocated, if necessary, so that the loan was reported net, at the
present value of estimated future cash flows using the loan’s existing rate or at the fair value of collateral if repayment was
expected solely from the collateral. Interest payments on impaired loans were typically applied to principal unless collectability of
the principal amount was reasonably assured, in which case interest was recognized on a cash basis.
Annualized net charge-offs,
as a percentage of average loans, was 0.02% during the year ended December 31, 2023, compared to 0.11% for the same period of 2022. The
allowance for credit losses is maintained at a level that management deems appropriate to absorb any potential future losses and known
credit losses within the loan portfolio, whether or not the losses are actually ever realized. Through our quarterly assessment, we continue
to adjust the CECL model to best reflect the risks in the portfolio. However, future provisions may be deemed necessary. During the year
ended December 31, 2023, we made modest adjustments to our qualitative factors to consider risk factors associated with commercial real
estate and residential mortgage loans. Those changes, along with the assessment of the historical and specific risks associated with
the loan portfolio, resulted in a net provision for credit losses of $649,000, of which $712,000 was provided for the loan portfolio;
offset by a reduction of the allowance for unfunded commitments of $63,000. The following table summarizes components of the allowance
for credit losses and related loans as of December 31, 2023 and 2022:
26
Selected
Credit Ratios
December
31,
(Dollars
in thousands)
2023
2022
Allowance
for credit losses 1
$ 7,256
$ 6,727
Total
loans
638,111
584,613
Allowance
for credit losses to total loans 1
1.14 %
1.15 %
Nonaccrual
loans
$ 3,534
$ 3,413
Nonaccrual
loans to total loans
0.55 %
0.58 %
Ratio
of allowance for credit losses 1 to nonaccrual loans
2.05 X
1.97 X
Charge-offs
net of recoveries
$ 103
$ 633
Average
loans
$ 608,705
$ 591,179
Net charge-offs
to average loans
0.02 %
0.11 %
1 The Company
adopted ASU 2016-13 on January 1, 2023 using the modified retrospective approach. Therefore, amounts as of December 31, 2022 are shown
using the incurred loss methodology.
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, 2023 and 2022:
December
31, 2023
December
31, 2022
(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
$
212,409
$
-
0.00%
$
202,435
$
(28)
-0.01%
Construction and land development
39,920
(35)
-0.09%
39,986
143
0.36%
Residential 1-4 family
232,280
14
0.01%
225,334
(36)
-0.02%
Multifamily
33,332
(111)
-0.33%
32,768
109
0.33%
Farmland
17,253
-
0.00%
18,022
(13)
-0.07%
Total real estate loans
535,194
(132)
-0.02%
518,545
175
0.03%
Commercial
48,586
26
0.05%
48,093
14
0.03%
Agriculture
3,596
54
1.50%
3,823
-
0.00%
Consumer and all other loans
20,748
155
0.75%
19,235
444
2.31%
Unallocated
581
-
0.00%
1,483
-
0.00%
Total loans
$
608,705
$
103
0.02%
$
591,179
$
633
0.11%
27
The following table
shows the balance and percentage of our allowance for credit losses allocated to each major category of loans.
Allocation of the
Allowance for Credit Losses 1
December
31, 2023
December
31, 2022
(Dollars
in thousands)
Amount
%
of ACL
%
of Loans
Amount
%
of ALLL 1
%
of Loans
Real
estate secured:
Commercial
$
2,518
34.7
37.6
$
2,364
35.1
33.7
Construction
and land development
300
4.1
4.5
345
5.2
7.3
Residential
1-4 family
2,666
36.7
37.3
2,364
35.1
38.9
Multifamily
509
7.0
5.4
262
3.9
5.1
Farmland
163
2.2
2.6
153
2.3
3.0
Total
real estate loans
6,156
84.7
87.4
5,488
81.6
88.00
Commercial
673
9.3
8.3
381
5.7
8.0
Agriculture
33
0.5
0.5
32
0.5
0.6
Consumer
and all other loans
394
5.5
3.8
386
5.7
3.4
Unallocated
-
-
-
440
6.5
-
Total
$
7,256
100.0
100.0
$
6,727
100.0
100.0
1 The Company
adopted ASU 2016-13 on January 1, 2023 using the modified retrospective approach. Therefore, amounts as of December 31, 2022 are shown
using the incurred loss methodology.
We have allocated
the allowance according to the amount deemed to be reasonably necessary to provide for the expected credit losses 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 credit
losses in future years will occur in the same proportions or that the allocation indicates future credit 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 credit losses is based on our judgment of the relative risk associated with each type of loan. We have allocated 34.7%
of the allowance to commercial real estate loans, which constituted 37.6% of our loan portfolio at December 31, 2023. This allocation
decreased slightly compared to 35.1% in 2022, due primarily to the impact of the CECL methodology. We have allocated 9.3% of the allowance
to commercial loans, which constituted 8.3% of our loan portfolio at December 31, 2023. This allocation percentage increased compared
to December 31, 2022, due to the impact of the CECL methodology.
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 4.1%
of the allowance to real estate construction loans, which constituted 4.5% of our loan portfolio as of December 31, 2023. 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 36.7%
of the allowance to residential real estate loans, which constituted 37.3% of our loan portfolio as of December 31, 2023.
We allocated 5.5%
of the allowance to consumer and all other loans, which constituted 3.8% of our loan portfolio as of December 31, 2023. Our allocation
generally remained consistent with the allocation as of December 31, 2022.
Other Real Estate
Owned
Other real estate
owned decreased $104,000, or 39.9%, to approximately $157,000 as of December 31, 2023 from $261,000 as of December 31, 2022. All properties
are available for sale, primarily, by commercial and residential realtors under the direction of our Special Assets division. During
2023, four properties were sold in the amount of $132,000 and three properties were acquired in the amount of $124,000.
28
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 credit losses as we expedite the resolution of these problem assets.
Investment
Securities
Total investment
securities decreased $6.3 million, or 6.5%, to $89.8 million as of December 31, 2023 from $96.1 million as of December 31, 2022. All
securities are classified as available-for-sale for liquidity purposes. There were no sales of securities during 2023 and 2022. During
2023 and 2022, there were maturities, calls and paydowns of $9.4 million and $14.0 million, respectively. The Company purchased $0.5
million and $19.8 million in investment securities during 2023 and 2022, respectively. Investment securities with a carrying value of
$36.8 million and $27.3 million as of December 31, 2023 and 2022, 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, 2023, we had a net unrealized loss in our investment portfolio totaling $14.8 million
as compared to a $17.6 million loss as of December 31, 2022. 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 believe that all unrealized losses resulted from temporary changes in interest rates and current market conditions and
are not a result of credit deterioration. No allowance for credit losses on available-for-sale securities was recorded as of December
31, 2023. 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, 2023 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
$
4,159
1.58%
$
6,826
1.22%
$
-
0.00%
$
-
-%
$
10,985
1.35%
U.S. Government Agencies
494
3.51%
2,440
3.94%
3,056
3.23%
2,821
3.24%
8,811
3.44%
Taxable municipals
-
-%
510
2.95%
6,175
2.12%
11,174
2.40%
17,859
2.33%
Corporate bonds
496
2.76%
964
3.87%
1,228
2.58%
-
-%
2,688
3.04%
Mortgage backed securities
-
-%
1,465
1.95%
4,390
1.98%
43,607
1.68%
49,462
1.71%
$
5,149
1.87%
$
12,205
2.10%
$
14,849
2.34%
$
57,602
1.90%
$
89,805
2.00%
Bank Owned Life
Insurance
As of December 31,
2023 and 2022, the Bank had an aggregate total cash surrender value of $4.6 million and $4.5 million, respectively, on life insurance
policies covering former key officers.
The Company recognized
income of approximately $40,000 during the year ended December 31, 2023. 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.
Deposits
Total deposits were
$716.5 million as of December 31, 2023, an increase of $23.8 million, or 3.4%, from $692.7 million as of December 31, 2022, due to efforts
to attract and retain deposits, specifically time deposits, combined with cyclical fund inflows. Most of the increase was driven by time
deposits, which increased $64.1 million, or 34.0%, to $252.3 million as of December 31, 2023.
29
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 2023. 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 7.36% of deposits at the end of 2023 and 3.87% of deposits at the end of 2022.
As of December 31,
2023 and 2022, uninsured deposits are estimated to be $93.8 million and $87.5 million, respectively. Estimated uninsured deposits represented
13.1% and 12.6% of total deposits as of December 31, 2023 and 2022, respectively. Included in estimated uninsured deposits are $27.9
million and $14.4 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,
2023
Three
months or less
$ 4,780
Over
three months through six months
14,503
Over
six months through twelve months
16,344
Over
one year
12,635
Total
$ 48,262
As of December 31,
2023 and 2022, $36.8 million and $27.3 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 and $7.0 million at December 31, 2023 and 2022, respectively, to secure public deposits, including
time deposits, held in our Virginia offices.
We held no brokered
deposits at December 31, 2023 or 2022. 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 $6.3 million and $1.4 million at December 31, 2023 and 2022, respectively.
Noninterest Income
Noninterest income
increased $709,000 to $9.9 million for the year ended December 31, 2023 from $9.2 million for the comparable period in 2022. The primary
drivers of the increase were the sales of a former operations facility and branch location resulting in a combined gain of $130,0000;
an increase in financial services revenue of $168,000; and income resulting from an insurance claim payment from the cybersecurity incident
in the amount of $257,000. This was offset by decreases in service charge income and card processing fees totaling a combined $122,000
during the period. Service charge income decreased due to changes made in 2022 in assessing certain charges that reduced the number of
transactions subject to such fees. Additional changes to our service charge structure took effect during the fourth quarter of 2023,
which eliminated charges for certain representment items, and certain funds transfer fees. Fees from debit card activity declined as
customer deposit balances have reverted to pre-pandemic levels and customer spending habits have also begun to normalize.
Noninterest
Expense
Noninterest expense
was $28.0 million for the year ended December 31, 2023 compared to $26.5 million for the year ended December 31, 2022. The $1.5 million
increase was impacted by increases in salaries and employee benefits of $891,000, data processing and telecommunications costs of $112,000,
legal and professional fees of $273,000, cards rewards program expense of $115,000 and deposit insurance of $143,000. These increases
were partially offset by decreases in occupancy expenses of $192,0000, and data processing and telecommunication costs of $171,000, in
comparison to the year ended December 31, 2022.
30
Our efficiency ratio,
a non-GAAP measure, which is defined as noninterest expense divided by the sum of net interest income plus noninterest income, was 73.7%
in 2023 compared to 70.6% in 2022. The modest performance decline in this ratio is a result of the decline in net interest income and
increased noninterest expenses, 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
$2.1 million for the year ended December 31, 2023, compared to $2.3 million for the same period in 2022. The effective tax rates were
23.0%, and 22.2% for 2023 and 2022, respectively. The effective tax rate for the periods differed from the federal statutory rate of
21.0% principally due to the lessened impact of tax preference items, along with the effect of certain state income taxes. The higher
effective tax rate in 2023 is the result of an increase in pre-tax earnings in relation to the various tax preference items, and increased
income in states that maintain a tax structure based on allocated income.
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, 2023 or 2022.
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.
Capital
Resources
During the year ended
December 31, 2023, total shareholders’ equity increased $7.6 million to $64.8 million due to the earnings of $7.2 million and the
$2.3 million decrease in the net unrealized loss on available-for-sale investment securities, which was partially offset by a cash dividend
payment of $1.4 million and the repurchase of common stock totaling $237,000. Additionally, the implementation of the current expected
credit loss (“CECL”) methodology resulted in a one-time net of tax, direct charge to retained earnings of $212,000. Consequently,
book value per share increased to $2.73 as of December 31, 2023 compared to $2.40 as of December 31, 2022. The Bank remains well capitalized
per regulatory guidance.
As previously reported,
the Board extended the repurchase of up to 500,000 shares of the Company’s common stock through March 31, 2024. During 2023, the
Company repurchased 100,875 shares at an average price of $2.31 per share. Since commencement of the repurchase plan, 174,470 shares
have been repurchased at an average rate of $2.32.
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 22,
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, 2023, 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.
31
The Company paid
a cash dividend of $0.06 per share in 2023. On February 28, 2024, the Board of Directors declared a dividend of $0.07 per share, to be
paid on March 29, 2024. 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 $118.0 million as of December 31, 2023, down from $130.5 million as of December 31, 2022. The decrease
is primarily due to loan growth exceeding funding growth through deposits and other borrowings. 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
increased during 2023 but competition for deposits remains intense 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.
As of December 31,
2023, all of our investments are classified as available-for-sale, providing an additional source of liquidity in the amount of $53.0
million, which is net of the $36.8 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 $6.3 million, or 6.5%,
during 2023 from $96.1 million as of December 31, 2022 to $89.8 million as of December 31, 2023. The Bank also has additional borrowing
capacity on lines for which investments are currently pledged.
Our loan to deposit
ratio was 89.1% as of December 31, 2023 and 84.4% as of December 31, 2022.
Available third-party
sources of liquidity remain intact as of December 31, 2023 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, 2023.
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 letter of credit have been issued. This letter of credit is considered to be a draw on our FHLB line of credit.
An additional $178.1 million was available on December 31, 2023 on the $200.1 million line of credit, of which $118.9 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, 2023 or 2022. As of December 31, 2023, we had $6.3 million
in reciprocal CDARS time deposits, compared to $1.4 million as of December 31, 2022.
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. As part of the discount window capacity the FRB, starting in March 2023, offered borrowings through
the Bank Term Funding Program which was created to support businesses and consumers by making additional funds available to eligible
depository institutions. This program, which expired in March 2024, provided loans of up to one year in length, at a fixed rate, with
no prepayment penalties. Collateral guidelines for this program valued eligible collateral at par value with the margin of 100% of par
value. We participated in this program in December 2023, through a $10 million borrowing for one year at a rate of 4.83%. This borrowing
supplemented loan fundings during the month.
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During the fourth
quarter of 2023 we made a voluntary principal payment of $310,000 on one of the outstanding trust preferred securities, originally issued
in 2004. We may consider making future principal payments based on our available liquidity and considering other funding opportunities
that may be available.
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 wars in Ukraine and Gaza,
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.
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 and discussion
of the contract amount of the Bank’s exposure to off-balance-sheet risk as of December 31, 2023 and 2022 is presented at “Consolidated
Financial Statements and Notes” “Note 20 Financial Instruments with Off-Balance Sheet Risk”. With the implementation
of CECL in 2023, we established an allowance for credit losses on unfunded commitments, which totaled $285,000 at December 31, 2023.
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 resulting liquidity
concerns for other super-regional banks, we drew a short-term advance from FHLB as precaution against any significant unusual activity
by borrowers drawing against their lines of credit. We did not experience any significant draws by borrowers during that period nor do
we anticipate experiencing such demand that might cause us to limit customer access to these lines of credit.
Interest Sensitivity
As of December 31,
2023, we had a negative cumulative gap rate sensitivity ratio of 21.59% for the one-year re-pricing period, compared to 17.89% as of
December 31, 2022. 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 decreasing. 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 indications that the period of rate increases has tapered and consensus is that at least some modest rate
decreases can be anticipated in the near- to mid-term, we are implementing strategies to moderate any potential adverse impact to our
current interest rate risk profile, from what could be a period of flat to decreasing interest rates.
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Interest
Sensitivity Analysis
December
31, 2023
(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
$
111,139
$
86,463
$
192,119
$
170,535
$
60,042
$
17,813
$
638,111
Federal funds sold
18
-
-
-
-
-
18
Deposits with banks
50,113
250
-
-
-
-
50,363
Investments
4,452
10,378
22,121
16,112
26,910
24,583
104,556
Bank owned life insurance
4,589
-
-
-
-
-
4,589
Total earning assets
$
170,311
$
97,091
$
214,240
$
186,647
$
86,952
$
42,396
$
797,637
Sources of funds:
Int Bearing DDA
69,528
-
-
-
-
-
69,528
Savings & MMDA
160,745
-
-
-
-
-
160,745
Time Deposits
45,258
137,876
60,944
8,238
-
-
252,316
Trust Preferred Securities
16,186
-
-
-
-
-
16,186
Other Borrowings
-
10,000
-
10,000
-
-
20,000
Total interest bearing
liabilities
$
291,717
$
147,876
$
60,944
$
18,238
$
-
$
-
$
518,775
Discrete Gap
$
(121,406)
$
(50,785)
$
153,296
$
168,409
$
86,952
$
42,396
$
278,862
Cumulative Gap
$
(121,406)
$
(172,191)
$
(18,895)
$
149,514
$
236,466
$
278,862
Cumulative Gap as % of Total Earning Assets
-15.22%
-21.59%
-2.37%
18.74%
29.65%
34.96%
Item 7A. Quantitative
and Qualitative Disclosures About Market Risk
Not required.
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