FIRST NATIONAL CORPORATION The following discussion and analysis of the financial condition and results of operations of the Company for the years endedDecember 31, 2022 and 2021 should be read in conjunction with the consolidated financial statements and related notes to the consolidated financial statements included in Item 8 of this Form 10-K. Executive Overview The Company
•First Bank (the Bank). The Bank owns: •First Bank Financial Services, Inc. •Shen-Valley Land Holdings, LLC •Bank of Fincastle Services, Inc. •ESF, LLC •First National (VA) Statutory Trust II (Trust II)
•
II, the Trusts)
First Bank Financial Services, Inc. owns an interest in an entity that provides
title insurance services. Bank of Fincastle Services, Inc. is no longer an
active operating entity. Shen-Valley Land Holdings, LLC and ESF, LLC
were formed to hold other real estate owned and future office sites. The Trusts
were formed for the purpose of issuing redeemable capital securities, commonly
known as trust preferred securities and are not included in the Company's
consolidated financial statements in accordance with authoritative accounting
guidance because management has determined that the Trusts qualify as variable
interest entities.
Products, Services, Customers and Locations
The Bank offers loan, deposit, and wealth management products and services. Loan products and services include consumer loans, residential mortgages, home equity loans, and commercial loans. Deposit products and services include checking accounts, treasury management solutions, savings accounts, money market accounts, certificates of deposit, and individual retirement accounts. Wealth management services include estate planning, investment management of assets, trustee under an agreement, trustee under a will, individual retirement accounts, and estate settlement. Customers include small and medium-sized businesses, individuals, estates, local governmental entities, and non-profit organizations. The Bank's office locations are well-positioned in attractive markets along theInterstate 81 ,Interstate 66 , andInterstate 64 corridors in theShenandoah Valley ,Roanoke Valley , central regions ofVirginia , and theRichmond market areas. Within these market areas, there are diverse types of industry including regional medical, professional services, manufacturing, retail, warehousing, Federal government, hospitality, and higher education.
The
Bank's products and services are delivered through 20 bank branch offices, mobile banking platform, website, www.fbvirginia.com, a loan production office, and two customer service centers in retirement communities. The Bank's services are also delivered through a network of ATMs located throughout its market area. For the location and general character of each of these offices, see Item 2 of this Form 10-K.
Revenue Sources and Expense Factors
The primary source of revenue is from net interest income earned by the Bank. Net interest income is the difference between interest income and interest expense and typically represents between 70% and 80% of the Company's total revenue. Interest income is determined by the amount of interest-earning assets outstanding during the period and the interest rates earned on those assets. The Bank's interest expense is a function of the amount of interest-bearing liabilities outstanding during the period and the interest rates paid. In addition to net interest income, noninterest income is the other source of revenue for the Company. Noninterest income is derived primarily from service charges on deposits, fee income from wealth management services, ATM and check card fees, and brokered mortgage fees. Primary expense categories are salaries and employee benefits, which comprised 58% of noninterest expenses during 2022, followed by occupancy and equipment expense, which comprised 13% of noninterest expenses. The provision for loan losses is also a primary expense of the Bank. The provision is determined by factors that include net charge-offs, asset quality, economic conditions, and loan growth. Changing economic conditions caused by inflation, recession, unemployment, or other factors beyond the Company's control have a direct correlation with asset quality, net charge-offs, and ultimately the required provision for loan losses.
Overview of Financial Performance and Condition
Net income increased by$6.4 million to$16.8 million , or$2.68 per diluted share, for the year endedDecember 31, 2022 , compared to$10.4 million , or$1.86 per diluted share, for the same period in 2021. Return on average assets was 1.19% and return on average equity was 15.87% for the year endedDecember 31, 2022 , compared to 0.88% and 10.30%, respectively, for the year endedDecember 31, 2021 . The$6.4 million increase in net income for the year endedDecember 31, 2022 resulted primarily from a$10.7 million , or 31%, increase in net interest income, and a$2.5 million , or 24%, increase in noninterest income, compared to the same period of 2021. These favorable variances were partially offset by a$2.5 million increase in provision for loan losses, a$2.9 million , or 9%, increase in noninterest expense and a$1.4 million increase in income tax expense. 26
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Net interest income increased$10.7 million , or 31%, for the year endedDecember 31, 2022 , compared to the same period of 2021 from a$12.3 million increase in total interest income, which was partially offset by a$1.5 million increase in total interest expense. Net interest income increased from a 31-basis point expansion of the net interest margin to 3.44% and a$212.0 million , or 19%, increase in average earning assets. The merger ofThe Bank of Fincastle with and intoFirst Bank onJuly 1, 2021 contributed to the increase in average earning assets.
Accretion of loan discounts, net of premium amortization on acquired loans,
which was included in interest income, increased by
The provision for loan losses increased$2.5 million , which resulted from a provision for loan losses of$1.9 million in 2022 compared to a$650 thousand recovery of loan losses in 2021. The allowance for loan losses totaled$7.4 million , or 0.81% of total loans, atDecember 31, 2022 , compared to$5.7 million , or 0.69% of total loans, atDecember 31, 2021 . The specific reserve increased$833 thousand , and the general reserve increased$903 thousand compared to the prior year. Net charge-offs totaled$114 thousand in 2022 and$1.1 million in 2021. Noninterest income increased$2.4 million , primarily from a gain of$2.9 million recognized from the sale of an interest in a company owned byFirst Bank Financial Services, Inc. Other notable increases include service charges on deposit accounts, ATM and check card fees, wealth management fees, and other operating income totaling$616 thousand ,$370 thousand ,$296 thousand , and$549 thousand , respectively. The increases in these noninterest income categories were partially offset by a$2.0 million net loss on the sale of securities available for sale. Noninterest expense increased$2.9 million , or 9%, and was impacted by the first full year of operations after the merger ofThe Bank of Fincastle with and intoFirst Bank onJuly 1, 2021 , as well as the addition of employees, a loan production office, and customer accounts that resulted from the acquisition of the SmartBank banking office onSeptember 30, 2021 . Several noninterest expense categories increased compared to the prior year, including salaries and employee benefits, occupancy, equipment, bank franchise tax and other operating expenses. The increases were partially offset by decreases in data processing and legal and professional fees. The following is selected financial data for the Company for the years endedDecember 31, 2022 and 2021. This information has been derived from audited financial information included in Item 8 of this Form 10-K (in thousands, except ratios and per share amounts). As of and for the years ended December 31, 2022 2021 Results of Operations Interest and dividend income$ 49,395 $ 37,144 Interest expense 3,820 2,304 Net interest income 45,575 34,840 Provision for (recovery of) loan losses 1,850 (650 ) Net interest income after provision for loan losses 43,725 35,490 Noninterest income 12,621 10,172 Noninterest expense 35,597 32,717 Income before income taxes 20,749 12,945 Income tax expense 3,952 2,586 Net income$ 16,797 $ 10,359 Key Performance Ratios Return on average assets 1.19 % 0.88 % Return on average equity 15.87 % 10.30 % Net interest margin (1) 3.44 % 3.13 % Efficiency ratio (1) 61.75 % 64.44 % Dividend payout 20.85 % 25.69 % Equity to assets 7.91 % 8.42 % Per Common Share Data Net income, basic$ 2.69 $ 1.87 Net income, diluted 2.68 1.86 Cash dividends 0.56 0.48 Book value at period end 16.79 18.28 Financial Condition Assets$ 1,369,383 $ 1,389,437 Loans, net 913,077 819,408 Securities 317,973 324,749 Deposits 1,241,332 1,248,752 Shareholders' equity 108,360 117,039 Average shares outstanding, diluted 6,259
5,559
Capital Ratios (2) Leverage 9.36 % 8.82 % Risk-based capital ratios: Common equity Tier 1 capital 13.82 % 14.09 % Tier 1 capital 13.82 % 14.09 % Total capital 14.60 % 14.76 %
(1) This performance ratio is a non-GAAP financial measure that the Company
believes provides investors with important information regarding operational
performance. Such information is not prepared in accordance with
generally accepted accounting principles (GAAP) and should not be construed
as such. In addition, these non-GAAP financial measures may be calculated
differently and may not be comparable to similar measures provided by other
companies. Management believes such financial information is meaningful to
the reader in understanding operating performance, but cautions that such
information not be viewed as a substitute for GAAP. See "Non-GAAP Financial
Measures" included in Item 7 of this Form 10-K.
(2) All capital ratios reported are for the Bank.
For a more detailed discussion of the Company's annual performance, see "Net Interest Income," "Provision for Loan Losses," "Noninterest Income," "Noninterest Expense" and "Income Taxes" below.
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Acquisition of
OnJuly 1, 2021 , the Company completed the acquisition ofThe Bank of Fincastle for an aggregate purchase price of$33.8 million of cash and stock. The Company paid cash consideration of$6.8 million and issued 1,348,065 shares of its common stock to the shareholders ofFincastle . Upon completion of the transaction,Fincastle was merged with and intoFirst Bank . At the time of closing of the acquisition,The Bank of Fincastle had six bank branch offices operating in theRoanoke Valley region ofVirginia and reported total assets of$267.9 million , total loans of$194.5 million and total deposits of$236.3 million . For the year endedDecember 31, 2021 , the Company recorded merger related expenses of$3.4 million in connection with the acquisition ofFincastle . The Company incurred an additional$69 thousand of merger related expenses in the first and second quarters of 2022. After the merger, the former Fincastle branches continued to operate asThe Bank of Fincastle , a division ofFirst Bank , until the systems were converted onOctober 16, 2021 when the branch offices began operating under theFirst Bank name. Purchased performing loans were recorded at fair value, including a credit discount which is being accreted as an adjustment to yield over the estimated lives of the loans.
Acquisition of SmartBank Loan Portfolio
OnSeptember 30, 2021 , the Bank acquired$82.0 million of loans and certain fixed assets from SmartBank related to itsRichmond area branch, located inGlen Allen, Virginia .First Bank paid cash consideration of$83.7 million for the loans and fixed assets. Additionally, an experienced team of bankers based out of the SmartBank location have transitioned to become employees ofFirst Bank .First Bank did not assume any deposit liabilities from SmartBank in connection with the transaction, and SmartBank closed their branch operation onDecember 31, 2021 .First Bank assumed the facility lease at the branch onDecember 31, 2021 and operates a loan production office in the location of the former SmartBank branch. The Company incurred expenses totaling$101 thousand related to the acquisition of loans and fixed assets of SmartBank in the fourth quarter of 2021 and did not incur any additional acquisition expenses in 2022. Purchased performing loans were recorded at fair value, including a credit discount which is being accreted as an adjustment to yield over the estimated lives of the loans. Non-GAAP Financial Measures This report refers to the efficiency ratio, which is computed by dividing noninterest expense, excluding OREO expense, amortization of intangibles, merger expenses, and gains/(losses) on disposal of premises and equipment, by the sum of net interest income on a tax-equivalent basis and noninterest income, excluding securities gains. This is a non-GAAP financial measure that the Company believes provides investors with important information regarding operational efficiency. Such information is not prepared in accordance with GAAP and should not be construed as such. Management believes, however, such financial information is meaningful to the reader in understanding operating performance, but cautions that such information not be viewed as a substitute for GAAP. The Company, in referring to its net income, is referring to income under GAAP. The components of the efficiency ratio calculation are summarized in the following table (dollars in thousands). Efficiency Ratio 2022 2021 Noninterest expense$ 35,597 $ 32,732
Subtract: other real estate owned income (expense), net 106 (26 ) Subtract: amortization of intangibles
(19 ) (28 )
Subtract: merger related expenses (69 ) (3,514 )
$ 35,615 $
29,164
Tax-equivalent net interest income$ 45,906 $
35,120
Noninterest income 12,621
10,172
Loss (gain) on disposal of premises and equipment 29 (37 ) Gain on sale of other investment (2,885 )
-
Securities losses (gains), net 2,004 -
$ 57,675 $ 45,255
Efficiency ratio 61.75 % 64.44 %
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This report also refers to net interest margin, which is calculated by dividing
tax equivalent net interest income by total average earning assets. Because a
portion of interest income earned by the Company is nontaxable, the tax
equivalent net interest income is considered in the calculation of this ratio.
Tax equivalent net interest income is calculated by adding the tax benefit
realized from interest income that is nontaxable to total interest income then
subtracting total interest expense. The tax rate utilized in calculating the tax
benefit for both 2022 and 2021 is 21%. The reconciliation of tax equivalent net
interest income, which is not a measurement under GAAP, to net interest income,
is reflected in the table below (in thousands).
Reconciliation of Net Interest Income to
Tax-Equivalent Net Interest Income
2022 2021
GAAP measures:
Interest income - loans $ 41,720 $ 32,797
Interest income - investments and other 7,675 4,347
Interest expense - deposits (3,273 ) (1,415 )
Interest expense - subordinated debt (277 ) (619 )
Interest expense - junior subordinated debt (270 ) (270 )
Total net interest income $ 45,575 $ 34,840 Non-GAAP measures: Tax benefit realized on non-taxable interest income - loans
$ 5 $ 32
Tax benefit realized on non-taxable interest income - municipal securities
326 248
Total tax benefit realized on non-taxable interest income
$ 331 $ 280
Total tax-equivalent net interest income $ 45,906 $ 35,120
Critical Accounting Policies
General
The Company's consolidated financial statements and related notes are prepared
in accordance with GAAP. The financial information contained within the
statements is, to a significant extent, financial information that is based on
measures of the financial effects of transactions and events that have already
occurred. A variety of factors could affect the ultimate value that is obtained
either when earning income, recognizing an expense, recovering an asset, or
relieving a liability. The Bank uses historical losses as one factor in
determining the inherent loss that may be present in the loan portfolio. Actual
losses could differ significantly from the historical factors used. In addition,
GAAP itself may change from one previously acceptable method to another.
Although the economics of transactions would be the same, the timing of events
that would impact transactions could change.
Presented below is a discussion of those accounting policies that management
believes are the most important (Critical Accounting Policies) to the portrayal
and understanding of the Company's financial condition and results of
operations. The Critical Accounting Policies require management's most
difficult, subjective, and complex judgments about matters that are inherently
uncertain. In the event that different assumptions or conditions were to
prevail, and depending upon the severity of such changes, the possibility of
materially different financial condition or results of operations is a
reasonable likelihood.
Allowance for Loan Losses
The allowance for loan losses is established as losses are estimated to have
occurred through a provision for loan losses charged to earnings. Loan losses
are charged against the allowance when management determines that the loan
balance is uncollectible. Subsequent recoveries, if any, are credited to the
allowance. For further information about the Company's loans and the allowance
for loan losses, see Notes 1, 3, and 4 to the Consolidated Financial Statements
included in this Form 10-K.
The allowance for loan losses is evaluated on a quarterly basis by management
and is based upon management's periodic review of the collectability of the
loans in light of historical experience, the nature and volume of the loan
portfolio, adverse situations that may affect the borrower's ability to repay,
estimated value of any underlying collateral, and prevailing economic
conditions. This evaluation is inherently subjective as it requires estimates
that are susceptible to significant revision as more information becomes
available.
The Company performs regular credit reviews of the loan portfolio to review
credit quality and adherence to underwriting standards. The credit reviews
consist of reviews by its internal credit administration department and reviews
performed by an independent third party. Upon origination, each loan is assigned
a risk rating ranging from one to nine, with loans closer to one having less
risk. This risk rating scale is the Company's primary credit quality indicator.
The Company has various committees that review and ensure that the allowance for
loans losses methodology is in accordance with GAAP and loss factors used
appropriately reflect the risk characteristics of the loan portfolio.
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The allowance represents an amount that, in management's judgment, will be adequate to absorb any losses on existing loans that may become uncollectible. Management's 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, changes in the nature and volume of the loan portfolio, current economic conditions that may affect a borrower's ability to repay and the value of the collateral, overall portfolio quality, and review of specific potential losses. The evaluation also considers the following risk characteristics of each loan portfolio class:
• 1-4 family residential mortgage loans carry risks associated with the
continued creditworthiness of the borrower and changes in the value of the
collateral.
• Real estate construction and land development loans carry risks that the
project may not be finished according to schedule, the project may not be
finished according to budget, and the value of the collateral may, at any
point in time, be less than the principal amount of the loan. Construction
loans also bear the risk that the general contractor, who may or may not be a
loan customer, may be unable to finish the construction project as planned
because of financial pressure or other factors unrelated to the project.
• Other real estate loans carry risks associated with the successful operation
of a business or a real estate project, in addition to other risks associated
with the ownership of real estate, because repayment of these loans may be
dependent upon the profitability and cash flows of the business or project.
• Commercial and industrial loans carry risks associated with the successful
operation of a business because repayment of these loans may be dependent upon
the profitability and cash flows of the business. In addition, there is risk
associated with the value of collateral other than real estate which may
depreciate over time and cannot be appraised with as much reliability.
• Consumer and other loans carry risk associated with the continuedcreditworthiness of the borrower and the value of the collateral, if any.
Consumer loans are typically either unsecured or secured by rapidly
depreciating assets such as automobiles. These loans are also likely to be
immediately and adversely affected by job loss, divorce, illness, personal
bankruptcy, or other changes in circumstances. Other loans included in this
category include loans to states and political subdivisions.
The allowance for loan losses consists of specific and general components. The
specific component relates to loans that are classified as impaired, and is
established when the discounted cash flows, fair value of collateral less
estimated costs to sell, or observable market price of the impaired loan is
lower than the carrying value of that loan. For collateral dependent loans, an
updated appraisal is ordered if a current one is not on file. Appraisals are
typically performed by independent third-party appraisers with relevant industry
experience. Adjustments to the appraised value may be made based on recent sales
of like properties or general market conditions among other considerations.
The general component covers loans that are not considered impaired and is based
on historical loss experience adjusted for qualitative factors. The historical
loss experience is calculated by loan type and uses an average loss rate during
the preceding twelve quarters. The qualitative factors are assigned by
management based on delinquencies and asset quality, national and local economic
trends, effects of the changes in the value of underlying collateral, trends in
volume and nature of loans, effects of changes in the lending policy, the
experience and depth of management, concentrations of credit, quality of the
loan review system, and the effect of external factors such as competition and
regulatory requirements. The factors assigned differ by loan type. The general
allowance estimates losses whose impact on the portfolio has yet to be
recognized by a specific allowance. Allowance factors and the overall size of
the allowance may change from period to period based on management's assessment
of the above described factors and the relative weights given to each factor.
For further information regarding the allowance for loan losses, see Notes 1 and
4 to the Consolidated Financial Statements included in this Form 10-K.
Loans Acquired in a Business Combination
Acquired loans are classified as either (i) purchased credit-impaired (PCI) loans or (ii) purchased performing loans and are recorded at fair value on the date of acquisition. PCI loans are those for which there is evidence of credit deterioration since origination and for which it is probable at the date of acquisition that the Corporation will not collect all contractually required principal and interest payments. When determining fair value, PCI loans may be evaluated individually or may be aggregated into pools of loans based on common risk characteristics as of the date of acquisition such as loan type, date of origination, and evidence of credit quality deterioration such as internal risk grades and past due and nonaccrual status. The difference between contractually required payments at acquisition and the cash flows expected to be collected at acquisition is referred to as the "nonaccretable difference." Any excess of cash flows expected at acquisition over the estimated fair value is referred to as the "accretable yield" and is recognized as interest income over the remaining life of the loan when there is a reasonable expectation about the amount and timing of such cash flows. There were no acquired loans classified as PCI in the acquisition ofFincastle and the SmartBank loan portfolio acquisition during the third quarter of 2021. Purchased performing loans are those for which there is no evidence of credit deterioration. When determining fair value for purchased performing loans acquired from theBank of Fincastle and SmartBank during 2021,First Bank evaluated the loans individually and they were initially recorded at fair value on the date of the acquisitions. Overall, there were net discounts recorded for the acquired loans, which are being accreted into income over the life of the loans through interest and fees on loans. The Bank calculated a required allowance for loan loss for each purchased performing loan on a quarterly basis. Provision for loan losses were recorded for purchased performing loans for the amount of the required allowance for loan losses that exceeded the unaccreted discount.Goodwill The Company's goodwill was recognized in connection with business combinations that occurred in the third quarter of 2021. The Company reviews the carrying value of goodwill at least annually or more frequently if certain impairment indicators exist. In testing goodwill for impairment, the Company first considers qualitative factors to determine whether the existence of events or circumstances lead to a determination that it is more likely than not that the fair value of a reporting unit is less than its carrying amount. If, after assessing the totality of events and circumstances, the Company concludes that it is not more likely than not that the fair value of a reporting unit is less than its carrying amount, then no further testing would be required and the goodwill of the reporting unit would not be impaired. If the Company elects to bypass the qualitative assessment or if we conclude that it is more likely than not that the fair value of a reporting unit is less than its carrying amount, then the fair value of the reporting unit will be compared with its carrying value to determine whether an impairment exists. The Company evaluated goodwill as ofJune 30, 2022 and determined there was no impairment. 30
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Table of Contents Lending Policies General In an effort to manage risk, the Bank's loan policy gives loan amount approval limits to individual loan officers based on their position within the Bank and level of experience. The Management Loan Committee can approve new loans up to the Bank's legal lending limit. The Board Loan Committee reviews all loans greater than$1.0 million . The Board Loan Committee currently consists of five directors, four of which are non-management directors. The Board Loan Committee approves the Bank's Loan Policy and reviews risk management reports, including watch list reports, concentrations of credit, policy exceptions, and risk grade migration. The Board Loan Committee meets at least two times per quarter and the Chairman of the Committee then reports to the Board of Directors. Residential loan originations are primarily generated by mortgage loan officer solicitations and referrals by employees, real estate professionals, and customers. Commercial real estate loan originations and commercial and industrial loan originations are primarily obtained through direct solicitation and additional business from existing customers. All completed loan applications are reviewed by the Bank's loan officers. As part of the application process, information is obtained concerning the income, financial condition, employment, and credit history of the applicant. The Bank also participates in commercial real estate loans and commercial and industrial loans originated by other financial institutions that are typically outside its market area. In addition, the Bank has purchased consumer loans originated by other financial institutions that are typically outside its market area. Loan quality is analyzed based on the Bank's experience and credit underwriting guidelines depending on the type of loan involved. Except for loan participations with other financial institutions, real estate collateral is valued by independent appraisers who have been pre-approved by the Board Loan Committee. As part of the ongoing monitoring of the credit quality of the Company's loan portfolio, certain appraisals are analyzed by management or by an outsourced appraisal review specialist throughout the year in order to ensure standards of quality are met. The Company also obtains an independent review of loans within the portfolio on an annual basis to analyze loan risk ratings and validate specific reserves on impaired loans. In the normal course of business, the Bank makes various commitments and incurs certain contingent liabilities which are disclosed but not reflected in its financial statements, including commitments to extend credit. AtDecember 31, 2022 , commitments to extend credit, stand-by letters of credit, and rate lock commitments totaled$177.2 million .
Construction and Land Development Lending
The Bank makes local construction loans, including residential and land
acquisition and development loans. These loans are secured by the property under
construction and the underlying land for which the loan was obtained. The
majority of these loans mature in one year. Construction lending entails
significant additional risks, compared with residential mortgage lending.
Construction and land development loans sometimes involve larger loan balances
concentrated with single borrowers or groups of related borrowers. Another risk
involved in construction and land development lending is the fact that loan
funds are advanced upon the security of the land or property under construction,
which value is estimated based on the completion of construction. Thus, there is
risk associated with failure to complete construction and potential cost
overruns. To mitigate the risks associated with this type of lending, the Bank
generally limits loan amounts relative to the appraised value and/or cost of the
collateral, analyzes the cost of the project and the creditworthiness of its
borrowers, and monitors construction progress. The Bank typically obtains a
first lien on the property as security for its construction loans, typically
requires personal guarantees from the borrower's principal owners, and typically
monitors the progress of the construction project during the draw period.
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1-4 Family Residential Real Estate Lending
1-4 family residential lending activity may be generated by Bank loan officer solicitations and referrals by real estate professionals and existing or new bank customers. Loan applications are taken by a Bank loan officer. As part of the application process, information is gathered concerning income, employment, and credit history of the applicant. Residential mortgage loans generally are made on the basis of the borrower's ability to make payments from employment and other income and are secured by real estate whose value tends to be readily ascertainable. In addition to the Bank's underwriting standards, loan quality may be analyzed based on guidelines issued by a secondary market investor. The valuation of residential collateral is generally provided by independent fee appraisers who have been approved by the Board Loan Committee. In addition to originating mortgage loans with the intent to sell to correspondent lenders or broker to wholesale lenders, the Bank also originates and retains certain mortgage loans in its loan portfolio.
Commercial Real Estate Lending
Commercial real estate loans are secured by various types of commercial real estate typically in the Bank's market area, including multi-family residential buildings, office and retail buildings, hotels, industrial buildings, and religious facilities. Commercial real estate loan originations are primarily obtained through direct solicitation of customers and potential customers. The valuation of commercial real estate collateral is provided by independent appraisers who have been approved by the Board Loan Committee. Commercial real estate lending entails significant additional risk, compared with residential mortgage lending. Commercial real estate loans typically involve larger loan balances concentrated with single borrowers or groups of related borrowers. Additionally, the payment experience on loans secured by income producing properties is typically dependent on the successful operation of a business or a real estate project and thus may be subject, to a greater extent, to adverse conditions in the real estate market or in the economy in general. The Bank's commercial real estate loan underwriting criteria require an examination of debt service coverage ratios, the borrower's creditworthiness, prior credit history, and reputation. The Bank typically requires personal guarantees of the borrowers' principal owners and considers the valuation of the real estate collateral.
Commercial and Industrial Lending
Commercial and industrial loans generally have a higher degree of risk than
loans secured by real estate, but typically have higher yields. Commercial and
industrial loans typically are made on the basis of the borrower's ability to
make repayment from cash flow from its business. The loans may be unsecured or
secured by business assets, such as accounts receivable, equipment, and
inventory. As a result, the availability of funds for the repayment of
commercial business loans is substantially dependent on the success of the
business itself. Furthermore, any collateral for commercial business loans may
depreciate over time and generally cannot be appraised with as much reliability
as real estate.
Also included in this category are loans originated under the SBA's PPP. PPP
loans are fully guaranteed by the SBA, and in some cases borrowers may be
eligible to obtain forgiveness of the loans, in which case loans would be repaid
by the SBA.
Consumer Lending
Loans to individual borrowers may be secured or unsecured, and include unsecured
consumer loans and lines of credit, automobile loans, deposit account loans, and
installment and demand loans. These consumer loans may entail greater risk than
residential mortgage loans, particularly in the case of consumer loans which are
unsecured or secured by rapidly depreciating assets such as automobiles. In such
cases, any repossessed collateral for a defaulted consumer loan may not provide
an adequate source of repayment of the outstanding loan balance as a result of
the greater likelihood of damage, loss, or depreciation. Consumer loan
collections are dependent on the borrower's continuing financial stability, and
thus are more likely to be adversely affected by job loss, divorce, illness, or
personal bankruptcy. Furthermore, the application of various federal and state
laws, including federal and state bankruptcy and insolvency laws, may limit the
amount which can be recovered on such loans.
The underwriting standards employed by the Bank for consumer loans include a
determination of the applicant's payment history on other debts and an
assessment of ability to meet existing obligations and payments on a proposed
loan. The stability of the applicant's monthly income may be determined by
verification of gross monthly income from primary employment, and additionally
from any verifiable secondary income.
Also included in this category are loans purchased through a third-party lending
program. These portfolios include consumer loans and carry risks associated with
the borrower, changes in the economic environment, and the vendor itself. The
Company manages these risks through policies that require minimum credit scores
and other underwriting requirements, robust analysis of actual performance
versus expected performance, as well as ensuring compliance with the Company's
vendor management program.
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Table of Contents Results of Operations General Net interest income represents the primary source of earnings for the Company. Net interest income equals the amount by which interest income on interest-earning assets, predominantly loans and securities, exceeds interest expense on interest-bearing liabilities, including deposits, other borrowings, subordinated debt, and junior subordinated debt. Changes in the volume and mix of interest-earning assets and interest-bearing liabilities, as well as their respective yields and rates, are the components that impact the level of net interest income. The net interest margin is calculated by dividing tax-equivalent net interest income by average earning assets. The provision for loan losses, noninterest income, noninterest expense and income tax expense are the other components that determine net income. Noninterest income and expense primarily consists of income from service charges on deposit accounts, ATM and check card income, wealth management income, income from other customer services, income from bank owned life insurance, general and administrative expenses, and amortization expense. Net Interest Income Net interest income increased$10.7 million , or 31%, for the year endedDecember 31, 2022 , compared to the same period of 2021 from a$12.3 million increase in total interest income, which was partially offset by a$1.5 million increase in total interest expense. The net interest margin expanded by 31-basis points to 3.44% and average earnings assets increased by$212.0 million , or 19%, which both contributed to the increase in net interest income. The merger ofFincastle with and into the Bank onJuly 1, 2021 , contributed to the increase in average earning assets. Accretion of loan discounts, net of premium amortization on acquired loans, increased by$722 thousand compared to the prior year and totaled$1.1 million in 2022. While accretion on loan discounts increased, accretion of deferred PPP loan income, net of origination costs, which was also included in interest income, decreased by$1.6 million compared to the prior year and totaled$359 thousand in 2022. Total interest income increased$12.3 million , or 33%, and was attributable to a$212.0 million , or 19%, increase in average earning assets and a 39-basis point increase in the yield on total earning assets. Total interest expense increased by$1.5 million , or 66%, from a$141.8 million , or 19%, increase in average interest-bearing liabilities and a 12-basis point increase in the cost of total interest-bearing liabilities. The merger ofFincastle with and into the Bank onJuly 1, 2021 , contributed to the increases in average earning assets and average interest-bearing liabilities. The increases in the yield on total earning assets and cost of interest-bearing liabilities were impacted by the increases in market interest rates, including the Federal funds rate, which increased from 0.25% to 4.50%, at the high end of the Federal funds rate range, during the year endedDecember 31, 2022 . The increase in total interest income over the prior year was a result of an$8.9 million increase in interest and fees on loans, a$2.3 million increase in interest and dividends on securities, and a$1.0 million increase in interest on deposits in banks. Interest and fees on loans increased from a$160.3 million increase in average loans and a 17-basis point increase in the yield on loans. Interest and dividends on securities increased from a$129.2 million increase in average total securities, which was partially offset by a 3-basis point decrease in the yield on total securities. Interest on deposits in banks increased from a 101-basis point increase in yield and was partially offset by a$56.6 million decrease in the average balance of deposits in banks. The increase in total interest expense over the prior year was a result of a$1.9 million increase in interest expense on deposits, which was partially offset by a$342 thousand decrease in interest expense on subordinated debt. Interest expense on deposits increased from a$146.4 million increase in average interest-bearing deposits and an 18-basis point increase in the cost of interest-bearing deposits. Interest expense on subordinated debt decreased from a decrease in the average balance of subordinated debt and a 105 basis points decrease in the cost of subordinated debt as the Company repaid$5.0 million of subordinated debt onJanuary 1, 2022 . 33
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The following table provides information on average interest-earning assets and interest-bearing liabilities for the years endedDecember 31, 2022 and 2021 as well as amounts and rates of tax equivalent interest earned and interest paid (dollars in thousands). The volume and rate analysis table analyzes the changes in net interest income for the periods broken down by their rate and volume components (in thousands). Average Balances, Income and Expense,
Yields and Rates (Taxable Equivalent Basis)
Years Ending December 31,
2022 2021
Interest Interest
Average Balance Income/Expense Yield/Rate Average Balance Income/Expense Yield/Rate
Assets
Interest-bearing deposits in
other banks $ 107,530 $ 1,223 1.14 % $ 164,118 $ 213 0.13 %
Securities:
Taxable 284,380 5,131 1.80 % 173,363 3,100 1.79 %
Tax-exempt (1) 65,836 1,555 2.36 % 47,570 1,184 2.49 %
Restricted 1,887 92 4.87 % 1,926 88 4.56 %
Total securities 352,103 6,778 1.93 % 222,859 4,372 1.96 %
Loans: (2)
Taxable 872,440 41,700 4.78 % 709,347 32,677 4.61 %
Tax-exempt (1) 548 25 4.49 % 3,389 152 4.49 %
Total loans 872,988 41,725 4.78 % 712,736 32,829 4.61 %
Federal funds sold 1 - 2.25 % 20,934 10 0.05 %
Total earning assets 1,332,622 49,726 3.73 % 1,120,647 37,424 3.34 %
Less: allowance for loan losses (6,013 ) (6,316 )
Total nonearning assets 82,101 68,105
Total assets $ 1,408,710 $ 1,182,436
Liabilities and Shareholders'
Equity
Interest-bearing deposits:
Checking $ 295,530 $ 1,394 0.47 % $ 254,077 $ 424 0.17 %
Money market accounts 218,783 930 0.43 % 168,932 187 0.11 %
Savings accounts 205,532 173 0.08 % 164,768 107 0.07 %
Certificates of deposit:
Less than $100 74,616 345 0.46 % 69,904 310 0.44 %
Greater than $100 62,036 428 0.69 % 52,304 385 0.74 %
Brokered deposits 556 3 0.57 % 650 2 0.34 %
Total interest-bearing deposits 857,053 3,273 0.38 % 710,635 1,415 0.20 %
Federal funds purchased 1 - 2.27 % 1 - 0.47 %
Subordinated debt 5,379 277 5.15 % 9,992 619 6.20 %
Junior subordinated debt 9,279 270 2.91 % 9,279 270 2.91 %
Other borrowings - - - % 0 - 0.00 %
Total interest-bearing
liabilities 871,712 3,820 0.44 % 729,907 2,304 0.32 %
Noninterest-bearing liabilities
Demand deposits 426,823 348,829
Other liabilities 4,306 3,104
Total liabilities 1,302,841 1,081,840
Shareholders' equity 105,869 100,596
Total liabilities and
shareholders' equity $ 1,408,710 $ 1,182,436
Net interest income $ 45,906 $ 35,120
Interest rate spread 3.29 % 3.02 %
Cost of funds 0.29 % 0.21 %
Interest expense as a percent of
average earning assets 0.29 % 0.21 %
Net interest margin 3.44 % 3.13 %
(1) Income and yields are reported on a taxable-equivalent basis assuming a
federal tax rate of 21%. The tax-equivalent adjustment was
2022, and
(2) Loans placed on a non-accrual status are reflected in the balances.
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Volume and Rate
Years Ending December 31,
2022
Change in
Volume Effect Rate Effect Income/Expense
Interest-bearing deposits in other banks $ (96 ) $ 1,106 $ 1,010
Loans, taxable 7,777 1,247 9,024
Loans, tax-exempt (127 ) (1 ) (128 )
Securities, taxable 1,202 829 2,031
Securities, tax-exempt 292 79 371
Securities, restricted (2 ) 6 4
Federal funds sold - (10 ) (10 )
Total earning assets $ 9,046 $ 3,256 $ 12,302
Checking $ 82 $ 888 $ 970
Money market accounts 68 675 743
Savings accounts 42 24 66
Certificates of deposits:
Less than $100 21 14 35
Greater than $100 67 (24 ) 43
Brokered deposits - 1 1
Federal funds purchased - - -
Subordinated debt (250 ) (92 ) (342 )
Junior subordinated debt - - -
Other borrowings - - -
Total interest-bearing liabilities $ 30 $ 1,486 $ 1,516
Change in net interest income $ 9,016 $ 1,770 $ 10,786
Provision for Loan Losses
Provision for loan losses totaled $1.9 million for the year ended December 31,
2022 , and resulted in an allowance for loan losses that totaled $7.4 million , or
0.81% of total loans. This compared to a recovery of loan losses of $650
thousand for the year ended December 31, 2021 , and an allowance for loan losses
of $5.7 million , or 0.69% of total loans at December 31, 2021 . The increase in
the allowance for loan losses resulted from an increase in both the general and
specific reserve components.
For the year ended December 31, 2022 , provision for loan losses of $1.9 million
and net charge offs of $114 thousand resulted in a $1.7 million increase in the
allowance for loan losses. The general reserve component of the allowance for
loan losses increased $903 thousand and the specific reserve component of the
allowance for loan losses increased $833 thousand . The increase in the general
reserve was attributable to loan growth and reserves on purchased loans, which
were partially offset by improvements to the asset quality and economic
conditions qualitative factors. The increase in the specific reserve was
attributable to two new impaired loans.
For the prior year ended December 31, 2021 , recovery of loan losses of $650
thousand and net charge offs of $1.1 million resulted in a $1.8 million decrease
in the allowance for loan losses. The specific reserve component of the
allowance for loan losses decreased $2.2 million , while the general reserve
component of the allowance for loan losses increased $392 thousand . The
decrease in the specific reserve was primarily attributable to the resolution of
a previously impaired loan. The increase in the general reserve was attributable
to loan growth, an increase in historical losses, and reserves on purchased
loans. These increases were partially offset by improvements to the asset
quality and economic qualitative factors.
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Table of Contents Noninterest Income Noninterest income increased$2.4 million , or 24%, to$12.6 million for the year endingDecember 31, 2022 , compared to the prior year. The increase was primarily attributable to a$616 thousand , or 30%, increase in service charges on deposit accounts, a$370 thousand , or 13%, increase in ATM and check card fees, a$296 thousand , or 11%, increase in wealth management fees, a$549 thousand , or 99%, increase in other operating income, and a$2.9 million gain on sale of an interest in a company owned byFirst Bank Financial Services, Inc. The increases in service charges on deposit accounts and ATM and check card fees were attributable to the addition of new customer deposit accounts through the merger withFincastle during 2021 and an increase in customer check card transactions. Wealth management revenue increased from a higher amount of assets under management. Other operating income increased primarily from a recovery on a purchased loan. These increases were partially offset by a$2.0 million net loss on sale of securities available for sale and a$294 thousand decrease in brokered mortgage fee income. Noninterest Expense Noninterest expense increased$2.9 million , or 9%, to$35.6 million for the year endingDecember 31, 2022 , compared to the prior year. Several expense categories increased and were impacted by the addition of employees, customers, branch locations, and a loan production office as a result of the acquisitions ofFincastle and the SmartBank office during the third quarter of 2021. Expense categories that were impacted by the acquisitions included salaries and employee benefits, occupancy, equipment, marketing, ATM and check card expense,FDIC assessment, and other operating expense. The acquisitions impacted the full year of 2022 compared to only a partial year of 2021. While several expense categories increased, legal and professional fees decreased by$1.1 million and data processing expense decreased by$1.2 million when compared to the prior year. The decreases were attributable to merger and acquisition expenses that were incurred during the prior year endingDecember 31, 2021 . Merger and acquisitions expenses totaled$69 thousand in 2022 compared to$3.5 million in 2021. Income Taxes Income tax expense increased$1.4 million during the year endedDecember 31, 2022 compared to the prior year. The Company's income tax expense differed from the amount of income tax determined by applying theU.S. federal income tax rate to pretax income for the year endedDecember 31, 2022 and 2021. The difference was a result of net permanent tax deductions, primarily comprised of tax-exempt interest income and income from bank owned life insurance. A more detailed discussion of the Company's tax calculation is contained in Note 11 to the Consolidated Financial Statements included in this Form 10-K. 36
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Table of Contents Financial Condition General Total assets decreased$20.1 million during the year and totaled$1.4 billion atDecember 31, 2022 . The decrease was primarily attributable to a$111.2 million decrease in interest-bearing deposits in banks, which was partially offset by offset by a$93.7 million increase in net loans. Securities available for sale decreased$126.6 million and was mostly offset by securities held to maturity that increased$119.7 million during the year endedDecember 31, 2022 . During 2022, the Bank transferred$74.4 million of market value of securities from the available for sale to the held to maturity category, which contributed to the changes in the securities balances.
Total liabilities decreased
Total shareholders' equity decreased$8.6 million to$108.4 million atDecember 31, 2022 , compared to$117.0 million atDecember 31, 2021 . The decrease was primarily attributable to a$22.8 million decrease in accumulated other comprehensive income due to unrealized losses in the available-for-sale securities portfolio, which was partially offset by a$13.3 million increase in retained earnings. The unrealized loss resulted from market interest rate increases during 2022. Loans The Bank is an active lender with a loan portfolio that includes commercial and residential real estate loans, commercial loans, consumer loans, construction and land development loans, and home equity loans. The Bank's lending activity is concentrated on individuals, small and medium-sized businesses, and local governmental entities primarily in its market areas. As a provider of community-oriented financial services, the Bank does not attempt to further geographically diversify its loan portfolio by undertaking significant lending activity outside its market areas. The Bank actively participated as a lender in theU.S. Small Business Administration's (SBA) Paycheck Protection Program (PPP) to support local small businesses and non-profit organizations by providing forgivable loans. Loan fees received from the SBA are accreted by the Bank into income evenly over the life of the loans, net of loan origination costs, through interest and fees on loans. PPP loans totaled$350 thousand and$12.4 million atDecember 31, 2022 and 2021, respectively; with$350 thousand scheduled to mature in the first and second quarters of 2026. The Company believes these loans will ultimately be forgiven and repaid by the SBA in accordance with the terms of the program. It is the Company's understanding that loans funded through the PPP program are fully guaranteed by theU.S. government. Should those circumstances change, the Company could be required to establish additional allowance for loan losses through additional provision for loan losses charged to earnings. The Bank recognized$359 thousand and$2.0 million of accretion on deferred PPP income, net of origination costs, through interest and fees on loans for year endedDecember 31, 2022 and 2021, respectively. The total amount of deferred PPP income, net of origination costs, not yet recognized through interest and fees on loans totaled$8 thousand atDecember 31, 2022 . Loans increased$95.4 million to$920.5 million atDecember 31, 2022 , compared to$825.1 million atDecember 31, 2021 . Residential real estate loans increased by$39.4 million , other real estate loans increased by$53.5 million , and commercial and industrial loans increased by$11.4 million . These increases were partially offset by decreases in construction and land development loans and consumer loans that decreased by$3.9 million and$5.1 million , respectively. 37
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The following table sets forth the maturities of the loan portfolio atDecember 31, 2022 (in thousands): Maturity/Repricing Schedule of Loans Held for Investment December 31, 2022 Construction Secured by 1-4 and Land Family Other Real Commercial and Consumer and Development Residential Estate Industrial Other Loans Total Variable Rate: Within 1 year$ 15,168 $ 12,036$ 12,611 $ 12,868 $ 77$ 52,760 1 to 5 years 2,378 13,488 5,195 2,576 152 23,789 5 to 15 years 6,761 113,485 134,740 6,922 3,361 265,269 After 15 years 1,091 46,748 68,853 882 - 117,574 Fixed Rate: Within 1 year 16,120 2,440 12,619 5,776 266 37,221 1 to 5 years 6,696 23,385 72,476 39,706 3,538 145,801 5 to 15 years 3,626 75,023 100,016 39,820 187 218,672 After 15 years - 44,816 11,946 2,675 - 59,437$ 51,840 $ 331,421 $ 418,456 $ 111,225 $ 7,581 $ 920,523 Asset Quality Management classifies non-performing assets as non-accrual loans and OREO. OREO represents real property taken by the Bank when its customers do not meet the contractual obligation of their loans, either through foreclosure or through a deed in lieu thereof from the borrower and properties originally acquired for branch operations or expansion but no longer intended to be used for that purpose. OREO is recorded at the lower of cost or fair value, less estimated selling costs, and is marketed by the Bank through brokerage channels. The Bank had$184 thousand and$1.8 million in assets classified as OREO atDecember 31, 2022 and 2021, respectively. Non-performing assets totaled$2.9 million and$4.2 million atDecember 31, 2022 and 2021, representing approximately 0.21% and 0.30% of total assets, respectively. Non-performing assets consisted of$184 thousand of OREO and$2.7 million of non-accrual loans atDecember 31, 2022 . Non-performing assets consisted of$1.8 million of OREO and$2.3 million of non-accrual loans and atDecember 31, 2021 . AtDecember 31, 2022 , 42.8% of non-performing assets were commercial and industrial loans, 18.6% were residential real estate loans, 38.1% construction loans, and 0.5% were other real estate loans. Non-performing assets could increase due to the deterioration of other loans identified by management as potential problem loans. Other potential problem loans are defined as performing loans that possess certain risks, including the borrower's ability to pay and the collateral value securing the loan, that management has identified that may result in the loans not being repaid in accordance with their terms. Other potential problem loans totaled$2.3 million and$1.1 million atDecember 31, 2022 andDecember 31, 2021 , respectively. The amount of other potential problem loans in future periods may be dependent on economic conditions and other factors influencing a customers' ability to meet their debt requirements. 38
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There were no loans greater than 90 days past due and still accruing at
In response to the unknown impact of the pandemic on the economy and its customers, the Bank created and implemented a loan payment deferral program for individual and business customers beginning in the first quarter of 2020, which provided them the opportunity to defer monthly payments for 90 days. ByJune 30, 2020 , loans participating in the program reached$182.6 million . The majority of these loans resumed regular payments during the second half of 2020 after their deferral periods ended. There were no loans remaining in the program atDecember 31, 2021 . These loans were not considered troubled debt restructurings (TDRs) because they were modified in accordance with relief provisions of the CARES Act and interagency regulatory guidance. During the fourth quarter of 2020 and the first half of 2021, the Bank modified terms of certain loans for customers that continued to be negatively impacted by the pandemic by lowering borrower's loan payments with interest only payments for periods ranging between 6 and 24 months. Modified loans totaled$9.1 million atDecember 31, 2022 , which were all in the Bank's commercial real estate loan portfolio. All modified loans were either performing under their modified terms or resumed regular loan payments as ofDecember 31, 2022 . The allowance for loan losses represents management's analysis of the existing loan portfolio and related credit risks. The provision for loan losses is based upon management's current estimate of the amount required to maintain an adequate allowance for loan losses reflective of the risks in the loan portfolio. The allowance for loan losses totaled$7.4 million atDecember 31, 2022 and$5.7 million atDecember 31, 2021 , representing 0.81% and 0.69% of total loans, respectively. After analyzing the composition of the loan portfolio, related credit risks, and changes in asset quality during recent years, the Company determined that the three year loss period and the qualitative adjustment factors that established the general reserve component of the allowance for loan losses were appropriate atDecember 31, 2022 . The allowance for loan losses as a percentage of total loans increased to 0.81% atDecember 31, 2022 compared to 0.69% atDecember 31, 2021 primarily as a result of an$833 thousand increase in the specific reserve component of the allowance for loan losses.
For further discussion regarding the allowance for loan losses, see "Provision for Loan Losses" above.
A recovery of loan losses of$66 thousand was recorded in the consumer and other loan class during the year endedDecember 31, 2022 . The recovery of loan losses in the consumer and other loan class resulted primarily from a decrease in the general reserve. This recovery was offset by provision for loan losses totaling$1.9 million in the construction and land development, 1-4 family residential, other real estate loan and commercial and industrial loan classes. For more detailed information regarding the provision for loan losses, see Note 4 to the Consolidated Financial Statements included in this Form 10-K. Impaired loans totaled$2.7 million and$2.3 million atDecember 31, 2022 and 2021, respectively. The related allowance for loan losses required for these loans totaled$888 thousand and$55 thousand atDecember 31, 2022 andDecember 31, 2021 , respectively. The average recorded investment in impaired loans during 2022 and 2021 was$1.3 million and$4.5 million , respectively. Included in the impaired loans total are loans classified as TDRs totaling$101 thousand and$1.6 million atDecember 31, 2022 and 2021, respectively. Loans classified as TDRs represent situations in which a modification to the contractual interest rate or repayment structure has been granted to address a financial hardship. As ofDecember 31, 2022 , none of these TDRs were performing under the restructured terms and all were considered non-performing assets. 39
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Management believes, based upon its review and analysis, that the Bank has
sufficient reserves to cover losses inherent within the loan portfolio. For each
period presented, the provision for loan losses charged to expense was based on
management's judgment after taking into consideration all factors connected with
the collectability of the existing portfolio. Management considers economic
conditions, historical loss factors, past due percentages, internally generated
loan quality reports, and other relevant factors when evaluating the loan
portfolio. There can be no assurance, however, that an additional provision for
loan losses will not be required in the future, including as a result of changes
in the qualitative factors underlying management's estimates and judgments,
changes in accounting standards, adverse developments in the economy, on a
national basis or in the Company's market area, loan growth, or changes in the
circumstances of particular borrowers. For further discussion regarding the
allowance for loan losses, see "Critical Accounting Policies" above. The
following table shows a detail of loans charged-off, recovered, and the changes
in the allowance for loan losses (dollars in thousands).
Allowance for loan losses
Secured by 1-4
Construction and Family OtherReal Commercial and Consumer and
Land Development Residential Estate Industrial Other Loans Total
For the year ended
December 31, 2021:
Balance at beginning of
year $ 306 $ 1,022 $ 4,956 $ 784 $ 417 $ 7,485
Charge-offs - (15 ) (992 ) (6 ) (434 ) (1,447 )
Recoveries 6 65 3 7 241 322
Provision for (recovery
of) loan losses 33 5 (737 ) (67 ) 116 (650 )
Balance at end of year $ 345 $ 1,077 $ 3,230 $ 718 $ 340 $ 5,710
Average loans $ 32,233 $ 265,900 $ 296,381 $ 107,964 $ 10,258 $ 712,736
Ratio of net
(recoveries)
charge-offs to average
loans -0.02 % -0.02 % 0.33 % 0.00 % 1.88 % 0.16 %
For the year ended
December 31, 2022:
Balance at beginning of
year 345 1,077 3,230 718 340 5,710
Charge-offs - - - (398 ) (131 ) (529 )
Recoveries - 10 15 277 113 415
Provision for (recovery
of) loan losses 4 192 350 1,370 (66 ) 1,850
Balance at end of year $ 349 $ 1,279 $ 3,595 $ 1,967 $ 256 $ 7,446
Average loans $ 49,671 $ 308,276 $ 399,395 $ 107,561 $ 8,085 $ 872,988
Ratio of net
(recoveries)
charge-offs to average
loans 0.00 % 0.00 % 0.00 % 0.11 % 0.22 % 0.01 %
The following table shows the balance of the Bank's allowance for loan losses
allocated to each major category of loans and the ratio of related outstanding
loan balances to total loans (dollars in thousands).
Allocation of Allowance for Loan Losses
At December 31,
2022 2021
Allocation of Allowance for Loan Losses:
Real estate loans:
Construction and land development $ 546 $ 345
Secured by 1-4 family 1,108 1,077
Other real estate loans 3,609 3,230
Commercial and industrial 1,874 718
Consumer and other loans 309 340
Total allowance for loan losses $ 7,446 $ 5,710
Ratios of loans to total period-end loans:
Real estate loans:
Construction and land development 5.6 % 6.8 %
Secured by 1-4 family 36.0 % 35.4 %
Other real estate loans 45.5 % 44.2 %
Commercial and industrial 12.1 % 12.1 %
Consumer and other loans 0.8 % 1.5 %
100.0 % 100.0 %
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The following table provides information on the Bank's non-performing assets at the dates indicated (dollars in thousands).
Non-performing Assets
At December 31,
2022 2021
Non-accrual loans $ 2,673 $ 2,304
Other real estate owned 184 1,848
Total non-performing assets $ 2,857 $ 4,152
Loans past due 90 days accruing interest - -
Total non-performing assets and past due loans
$ 101 $ 1,638 Non-performing assets to period end loans 0.31 % 0.50 %
The following table summarizes the Company's credit ratios on a consolidated
basis as of
Consolidated Credit Ratios
December 31, 2022
2022 2021
Total Loans $ 920,523 $ 825,118
Nonaccrual loans $ 2,673 $ 2,304
Allowance for loan losses (ALL)
0.29 % 0.28 %
ALL to total loans 0.81 % 0.69 %
ALL to nonaccrual loans 278.56 % 247.83 %
Securities
Securities totaled $318.0 million at December 31, 2022 , a decrease of
$6.8 million , or 2.1%, from $324.8 million at the end of 2021. Investment
securities are comprised of U.S. agency and mortgage-backed securities,
obligations of state and political subdivisions, corporate debt securities, and
restricted securities. As of December 31, 2022 , neither the Company nor the Bank
held any derivative financial instruments in their respective investment
security portfolios. Gross unrealized gains in the available for sale portfolio
totaled $99 thousand and $2.0 million at December 31, 2022 and 2021,
respectively. Gross unrealized losses in the available for sale portfolio
totaled $24.0 million and $2.6 million at December 31, 2022 and 2021,
respectively. There were no gross unrealized gains in the held to maturity
portfolio at December 31, 2022 . Gross unrealized gains in the held to maturity
portfolio totaled $242 thousand at December 31, 2022 Gross unrealized losses in
the held to maturity portfolio totaled $11.4 million and $66
thousand at December 31, 2022 and 2021, respectively. Investments in an
unrealized loss position were considered temporarily impaired at December 31,
2022 and 2021. The change in the unrealized gains and losses of investment
securities from December 31, 2021 to December 31, 2022 was related to changes in
market interest rates and was not related to credit concerns of the issuers.
On September 1, 2022 , the Bank transferred 24 securities designated as available
for sale with a combined book value of $82.2 million , market value of $74.4
million , and unrealized loss of $7.8 million , to securities designated held to
maturity. The unrealized loss is being amortized monthly over the life of the
securities with an increase to the carrying value of securities and a decrease
to the related accumulated other comprehensive loss, which is included in the
shareholders' equity section of the Company's balance sheet. The amortization of
the unrealized loss on the transferred securities totaled $593 thousand , or $468
thousand net of tax, for the year ended December 31, 2022 . The securities
selected for transfer had larger potential decreases in their fair market values
in higher interest rate environments than most of the other securities in the
available for sale portfolio and included U.S. Treasury , agency, municipal and
commercial mortgage-backed securities. The securities were transferred to
mitigate the potential unfavorable impact that higher market interest rates may
have on the carrying value of the securities and on the related accumulated
other comprehensive loss. Securities designated as held to maturity are carried
on the balance sheet at amortized cost, while securities designated as available
for sale are carried at fair market value.
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The following table shows the maturities of debt and restricted securities at amortized cost and market value atDecember 31, 2022 and approximate weighted average yields of such securities (dollars in thousands). Yields on state and political subdivision securities are shown on a tax equivalent basis, assuming a 21% federal income tax rate. The Company attempts to maintain diversity in its portfolio and maintain credit quality and re-pricing terms that are consistent with its asset/liability management and investment practices and policies. For further information on securities, see Note 2 to the Consolidated Financial Statements included in this Form 10-K. Securities Portfolio
Maturity Distribution/Yield Analysis
At
Greater than Ten
Less than One One to Five Five to Ten Years and Equity
Year Years Years Securities Total
U.S. Treasury securities
Amortized cost $ - $ 48,184 $ 2,496 $ - $ 50,680
Market value $ - $ 46,684 $ 2,188 $ - $ 48,872
Weighted average yield - % 3.01 % 1.28 % - % 2.92 %
U.S. agency and
mortgage-backed securities
Amortized cost $ - $ 9,566 $ 38,978 $ 160,802 $ 209,346
Market value $ - $ 8,845 $ 36,023 $ 142,235 $ 187,103
Weighted average yield - % 2.22 % 2.60 % 2.32 % 2.37 %
Obligations of state and
political subdivisions
Amortized cost $ 905 $ 6,493 $ 22,516 $ 47,044 $ 76,958
Market value $ 902 $ 6,409 $ 20,185 $ 38,585 $ 66,081
Weighted average yield 2.67 % 3.39 % 2.33 % 2.49 % 2.52 %
Corporate debt securities
Amortized cost $ - $ - $ 3,000 $ - $ 3,000
Market value $ - $ - $ 2,648 $ - $ 2,648
Weighted average yield - % - % 4.50 - % 4.50 %
Restricted securities
Amortized cost $ - $ - $ - $ 1,908 $ 1,908
Market value $ - $ - $ - $ 1,908 $ 1,908
Weighted average yield - % - % - % 4.87 % 4.87 %
Total portfolio
Amortized cost $ 905 $ 64,243 $ 66,990 $ 209,754 $ 341,892
Market value $ 902 $ 61,938 $ 61,044 $ 182,728 $ 306,612
Weighted average yield (1) 2.67 % 2.93 % 2.54 % 2.38 % 2.52 %
(1) Yields on tax-exempt securities have been calculated on a tax-equivalent
basis using the federal corporate income tax rate of 21 percent. The weighted
average yield is calculated based on the relative amortized costs of the
securities.
The above table was prepared using the contractual maturities for all securities
with the exception of mortgage-backed securities (MBS) and collateralized
mortgage obligations (CMO). Both MBS and CMO securities were recorded using the
yield book prepayment model that incorporates four causes of prepayments
including home sales, refinancing, defaults, and curtailments/full payoffs.
As of December 31, 2022 , the Company did not own securities of any issuer for
which the aggregate book value of the securities of such issuer exceeded ten
percent of shareholders' equity.
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Table of Contents Deposits AtDecember 31, 2022 , deposits totaled$1.2 billion , decreasing slightly by$7.4 million , from$1.2 billion atDecember 31, 2021 . There was a slight change in the deposit mix when comparing the periods. AtDecember 31, 2022 , noninterest-bearing demand deposits, savings and interest-bearing demand deposits, and time deposits composed 34%, 55%, and 11% of total deposits, respectively, compared to 33%, 55%, and 12% atDecember 31, 2021 .
The following tables include a summary of average deposits and average rates paid (dollars in thousands).
Average Deposits and Rates Paid
Year Ended December 31,
2022 2021
Amount Rate Amount Rate
Noninterest-bearing deposits
- % Interest-bearing deposits: Interest checking$ 295,530 0.47 %$ 254,077 0.17 % Money market 218,783 0.43 % 168,932 0.11 % Savings 205,532 0.08 % 164,768 0.07 % Time deposits: Less than$100 74,616 0.46 % 69,904 0.44 % Greater than$100 62,036 0.69 % 52,304 0.74 % Brokered deposits 556 0.57 % 650 0.34 % Total interest-bearing deposits$ 857,053 0.38 %$ 710,635 0.20 % Total deposits$ 1,283,876 $ 1,059,464
The table above includes brokered deposits greater than
As ofDecember 31, 2022 the estimated amount of total uninsured deposits was$256.5 million . Maturities of the estimated amount of uninsured time deposits atDecember 31, 2022 are presented in the table below. The estimate of uninsured deposits generally represents the portion of deposit accounts that exceed theFDIC insurance limit of$250,000 and is calculated based on the same methodologies and assumptions used for purposes of the Bank's regulatory reporting requirements.
Maturities of Uninsured Time Deposits
December 31, 2022
3 months or less $ 1,730
3-6 months 331
6-12 months 4,207
Over 12 months 4,192
$ 10,460
Liquidity
Liquidity represents the ability to meet present and future financial
obligations through either the sale or maturity of existing assets or with
borrowings from correspondent banks or other deposit markets. The Company
classifies cash, interest-bearing and noninterest-bearing deposits with banks,
federal funds sold, investment securities, and loans maturing within one year as
liquid assets. As part of the Bank's liquidity risk management, stress tests and
cash flow modeling are performed quarterly.
As a result of the Bank's management of liquid assets and the ability to
generate liquidity through liability funding, management believes that the Bank
maintains overall liquidity sufficient to satisfy its depositors' requirements
and to meet its customers' borrowing needs.
At December 31, 2022 , cash, interest-bearing and noninterest-bearing deposits
with banks, securities, and loans maturing within one year totaled
$157.9 million . At December 31, 2022 , 10% or $90.0 million of the loan portfolio
is scheduled to mature within one year. Non-deposit sources of available funds
totaled $287.3 million at December 31, 2022 , which included $188.8 million of
secured funds available from Federal Home Loan Bank of Atlanta (FHLB), $51.0
million of unsecured federal funds lines of credit with other correspondent
banks, and $47.5 million available through the Federal Reserve Discount Window.
Subordinated Debt
See Note 9 to the Consolidated Financial Statements included in this Form 10-K, for discussion of subordinated debt.
Junior Subordinated Debt
See Note 10 to the Consolidated Financial Statements included in this Form 10-K, for discussion of junior subordinated debt.
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Off-Balance Sheet Arrangements
The Company, through the Bank, is a party to credit related financial instruments with risk not reflected in the consolidated financial statements in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments to extend credit, standby letters of credit, and commercial letters of credit. Such commitments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the consolidated balance sheets. The Bank's exposure to credit loss is represented by the contractual amount of these commitments. The Bank follows the same credit policies in making commitments as it does for on-balance sheet instruments.
At
2022 2021
Commitments to extend credit and unfunded commitments under lines of credit$ 158,297 $ 161,428 Stand-by letters of credit 17,950 18,904 Commitments to extend credit are agreements to lend to a customer as long as 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. The commitments for lines of credit may expire without being drawn upon. Therefore, the total commitment amounts do not necessarily represent future cash requirements. The amount of collateral obtained, if it is deemed necessary by the Bank, is based on management's credit evaluation of the customer. Unfunded commitments under commercial lines of credit, revolving credit lines, and overdraft protection agreements are commitments for possible future extensions of credit to existing customers. These lines of credit are collateralized as deemed necessary and may or may not be drawn upon to the total extent to which the Bank is committed. Commercial and standby letters of credit are conditional commitments issued by the Bank to guarantee the performance of a customer to a third party. Those letters of credit are primarily issued to support public and private borrowing arrangements. Essentially all letters of credit issued have expiration dates within one year. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers. The Bank generally holds collateral supporting those commitments if deemed necessary. AtDecember 31, 2022 , the Bank had$998 thousand in locked-rate commitments to originate mortgage loans. Risks arise from the possible inability of counterparties to meet the terms of their contracts. The Bank does not expect any counterparty to fail to meet its obligations. OnApril 21, 2020 , the Company entered into interest rate swap agreements related to its outstanding junior subordinated debt. The Company uses derivatives to manage exposure to interest rate risk through the use of interest rate swaps. Interest rate swaps involve the exchange of fixed and variable rate interest payments between two parties, based on a common notional principal amount and maturity date with no exchange of underlying principal amounts. The interest rate swaps qualified and are designated as cash flow hedges. The Company's cash flow hedges effectively modify the Company's exposure to interest rate risk by converting variable rates of interest on$9.0 million of the Company's junior subordinated debt to fixed rates of interest for periods that end betweenJune 2034 andOctober 2036 . The cash flow hedges' total notional amount is$9.0 million . AtDecember 31, 2022 , the cash flow hedges had a fair value of$2,679 thousand , which is recorded in other assets. The net gain/loss on the cash flow hedges is recognized as a component of other comprehensive income and reclassified into earnings in the same period(s) during which the hedged transactions affect earnings. The Company's derivative financial instruments are described more fully in Note 24 to the Consolidated Financial Statements included in this Form 10-K. Capital Resources The adequacy of the Company's capital is reviewed by management on an ongoing basis with reference to the size, composition, and quality of the Company's asset and liability levels and consistent with regulatory requirements and industry standards. Management seeks to maintain a capital structure that will assure an adequate level of capital to support anticipated asset growth and absorb potential losses. The Company meets eligibility criteria of a small bank holding company in accordance with theFederal Reserve Board's Small Bank Holding Company Policy Statement issued inFebruary 2015 and is no longer obligated to report consolidated regulatory capital. EffectiveJanuary 1, 2015 , the Bank became subject to capital rules adopted by federal bank regulators implementing the Basel III regulatory capital reforms adopted by theBasel Committee on Banking Supervision (the Basel Committee), and certain changes required by the Dodd-Frank Act. The minimum capital level requirements applicable to the Bank under the final rules are as follows: a new common equity Tier 1 capital ratio of 4.5%; a Tier 1 capital ratio of 6%; a total capital ratio of 8%; and a Tier 1 leverage ratio of 4% for all institutions. The final rules also established a "capital conservation buffer" above the new regulatory minimum capital requirements. The capital conservation buffer was phased-in over four years and, as fully implemented effectiveJanuary 1, 2019 , requires a buffer of 2.5% of risk-weighted assets. This results in the following minimum capital ratios beginning in 2019: a common equity Tier 1 capital ratio of 7.0%, a Tier 1 capital ratio of 8.5%, and a total capital ratio of 10.5%. Under the final rules, institutions are subject to limitations on paying dividends, engaging in share repurchases, and paying discretionary bonuses if its capital level falls below the buffer amount. These limitations establish a maximum percentage of eligible retained income that could be utilized for such actions. Management believes, as ofDecember 31, 2022 andDecember 31, 2021 , that the Bank met all capital adequacy requirements to which it is subject, including the capital conservation buffer. 44
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The following table summarizes the Bank's regulatory capital and related ratios
at
Analysis of Capital
At December 31,
2022 2021
Common equity Tier 1 capital $ 132,103 $ 120,224
Tier 1 capital 132,103 120,224
Tier 2 capital 7,446 5,710
Total risk-based capital 139,549 125,934
Risk-weighted assets 955,779 852,959
Capital ratios:
Common equity Tier 1 capital ratio 13.82 % 14.09 %
Tier 1 capital ratio 13.82 % 14.09 %
Total capital ratio 14.60 % 14.76 %
Leverage ratio (Tier 1 capital to average assets) 9.36 % 8.82 %
Capital conservation buffer ratio(1) 6.60 % 6.76 %
(1) Calculated by subtracting the regulatory minimum capital ratio requirements
from the Company's actual ratio for Common equity Tier 1, Tier 1, and Total
risk based capital. The lowest of the three measures represents the Bank's
capital conservation buffer ratio.
The prompt corrective action framework is designed to place restrictions on
insured depository institutions if their capital levels begin to show signs of
weakness. Under the prompt corrective action requirements, which are designed to
complement the capital conservation buffer, insured depository institutions are
required to meet the following capital level requirements in order to qualify as
"well capitalized:" a common equity Tier 1 capital ratio of 6.5%; a Tier 1
capital ratio of 8%; a total capital ratio of 10%; and a Tier 1 leverage ratio
of 5%. The Bank met the requirements to qualify as "well capitalized" as of
December 31, 2022 and 2021.
On September 17, 2019 the FDIC finalized a rule that introduces an optional
simplified measure of capital adequacy for qualifying community banking
organizations (i.e., the community bank leverage ratio (CBLR) framework), as
required by the Economic Growth Act. The CBLR framework is designed to reduce
burden by removing the requirements for calculating and reporting risk-based
capital ratios for qualifying community banking organizations that opt into the
framework.
In order to qualify for the CBLR framework, a community banking organization
must have a tier 1 leverage ratio greater than 9%, less than $10 billion in
total consolidated assets, and limited amounts of off-balance sheet exposures
and trading assets and liabilities. The CARES Act temporarily lowered the tier 1
leverage ratio requirement to 8% until December 31, 2020 . A qualifying community
banking organization that opts into the CBLR framework and meets all
requirements under the framework will be considered to have met the
"well-capitalized" ratio requirements under the prompt corrective action
regulations and would not be required to report or calculate risk-based capital.
Although the Bank did not opt into the CBLR framework at December 31, 2021 , it
may opt into the CBLR framework in a future quarterly period. For further
discussion regarding the CARES Act, see "Supervision and Regulation" included in
Item 1 of this Form 10-K.
During the fourth quarter of 2022, the Board of Directors of the Company
authorized a stock repurchase plan pursuant to which the Company could
repurchase up to
The Company continues to update its enterprise risk assessment and capital plan as the operating environment develops. As a result of its risk assessments and capital planning, the Company issued$5.0 million of subordinated debt inJune 2020 . The purpose of the issuance was primarily to further strengthen holding company liquidity and to remain a source of strength for the Bank in the event of a severe economic downturn. The Company was able to use the proceeds of the issuance for general corporate purposes. The subordinated debt issued consisted of a 5.50% fixed-to-floating rate subordinated note due 2030 issued to an institutional investor and was structured to qualify as Tier 2 capital under bank regulatory guidelines. After considering several factors, including the overall risk profile and capital adequacy of the Company and the Bank, onJanuary 1, 2022 , the Company repaid$5.0 million of subordinated debt with a fixed interest rate of 6.75% that was issued in 2015. The capital planning process also included consideration of whether to continue the Company's cash dividend payments to common shareholders. The Company continued to pay quarterly cash dividends on its common stock during the years endedDecember 31, 2022 and 2021. The Company acquiredFincastle onJuly 1, 2021 and their shareholders received aggregate merger consideration of$6.8 million in cash and 1,348,065 shares of the Company's common stock. The acquisition ofFincastle resulted in goodwill and other intangible assets that were excluded from the regulatory capital ofFirst Bank . For the twelve-month period endedDecember 31, 2021 , the Company recorded merger and acquisition related expenses of$3.4 million in connection with the acquisition ofFincastle . The Company incurred aggregateFincastle merger related costs of$3.4 million , which includes$69 thousand of merger related costs incurred during the first and second quarters of 2022. The Bank acquiredSmartBank's Richmond, Virginia office and hired a team of their employees onSeptember 30, 2021 , which included the office's loan portfolio and certain fixed assets. The Bank also assumedSmartBank's office lease during the fourth quarter of 2021. The acquisition of the SmartBank loans resulted in goodwill that was excluded from the regulatory capital of the Bank. For the twelve-month period endedDecember 31, 2021 , the Company recorded merger and acquisition related expenses of$101 thousand in connection with the acquisition of the SmartBank loans. The Company did not incur any additional SmartBank acquisition related costs during the year endedDecember 31, 2022 .
Recent Accounting Pronouncements
See Note 1 to the Consolidated Financial Statements included in this Form 10-K, for discussion of recent accounting pronouncements.
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