OLD POINT FINANCIAL CORP - FORM 10-Q

Attached files

file	filename
EX-32.1 - EXHIBIT 32.1 - OLD POINT FINANCIAL CORP	ex32_1.htm
EX-31.2 - EXHIBIT 31.2 - OLD POINT FINANCIAL CORP	ex31_2.htm
EX-31.1 - EXHIBIT 31.1 - OLD POINT FINANCIAL CORP	ex31_1.htm

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

☒	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended March 31, 2020

☐	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from____________ to___________

Commission File Number: 000-12896

OLD POINT FINANCIAL CORPORATION

(Exact name of registrant as specified in its charter)

VIRGINIA		54-1265373
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification No.)

101 East Queen Street, Hampton, Virginia 23669

(Address of principal executive offices) (Zip Code)

(757) 728-1200

(Registrant’s telephone number, including area code)

Not Applicable

(Former name, former address and former fiscal year, if changed since last report)

Securities registered pursuant to Section 12(b) of the Act:

Title of each class	Trading Symbol	Name of each exchange on which registered
Common Stock, $5.00 par value	OPOF	The NASDAQ Stock Market LLC

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. ☒ Yes ☐ No

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). ☒ Yes ☐ No

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

Large accelerated filer	☐	Accelerated filer ☒

Non-accelerated filer	☐	Smaller reporting company ☒

		Emerging growth company ☐

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). ☐ Yes ☒ No

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

5,219,507 shares of common stock ($5.00 par value) outstanding as of May 5, 2020

OLD POINT FINANCIAL CORPORATION

FORM 10-Q

INDEX

PART I - FINANCIAL INFORMATION

		Page

Item 1.	Financial Statements	1

	Consolidated Balance Sheets as of March 31, 2020 (unaudited) and December 31, 2019	1

	Consolidated Statements of Income (unaudited) for the three months ended March 31, 2020 and 2019	2

	Consolidated Statements of Comprehensive Income (unaudited) for the three months ended March 31, 2020 and 2019	3

	Consolidated Statements of Changes in Stockholders’ Equity (unaudited) for the three months ended March 31, 2020 and 2019	3

	Consolidated Statements of Cash Flows (unaudited) for the three months ended March 31, 2020 and 2019	4

	Notes to Consolidated Financial Statements (unaudited)	5

Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	28

Item 3.	Quantitative and Qualitative Disclosures About Market Risk	38

Item 4.	Controls and Procedures	38

	PART II - OTHER INFORMATION

Item 1.	Legal Proceedings	38

Item 1A.	Risk Factors	39

Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	40

Item 3.	Defaults Upon Senior Securities	40

Item 4.	Mine Safety Disclosures	40

Item 5.	Other Information	40

Item 6.	Exhibits	41

	Signatures	41

Index

GLOSSARY OF DEFINED TERMS

2019 Annual Report on Form 10-K	Annual Report on Form 10-K for the year ended December 31, 2019
ALLL	Allowance for Loan and Lease Losses
ASC	Accounting Standards Codification
ASU	Accounting Standards Update
Bank	The Old Point National Bank of Phoebus
CARES	Coronavirus Aid, Relief, and Economic Security Act
CET1	Common Equity Tier 1
Citizens	Citizens National Bank
Company	Old Point Financial Corporation and its subsidiaries
ESPP	Employee Stock Purchase Plan
EVE	Economic Value of Equity
Exchange Act	Securities Exchange Act of 1934, as amended
FASB	Financial Accounting Standards Board
FHLB	Federal Home Loan Bank
Federal Reserve	Board of Governors of the Federal Reserve System
FRB	Federal Reserve Bank
U.S. GAAP	Generally Accepted Accounting Principles
Incentive Stock Plan	Old Point Financial Corporation 2016 Incentive Stock Plan
OAEM	Other Assets Especially Mentioned
OCC	Office of the Comptroller of the Currency
OPM	Old Point Mortgage
OREO	Other Real Estate Owned
PPP	Paycheck Protection Program
SEC	Securities and Exchange Commission
SBA	Small Business Association
TDR	Troubled Debt Restructuring
Trust	Old Point Trust & Financial Services N.A.

Index

PART I – FINANCIAL INFORMATION

Item 1.

Financial Statements.

Old Point Financial Corporation and Subsidiaries

Consolidated Balance Sheets

(dollars in thousands, except share data)	March 31, 2020			December 31, 2019
	(unaudited)
Assets

Cash and due from banks	$	26,896		$	37,280
Interest-bearing due from banks		51,228			48,610
Federal funds sold		6			3,975
Cash and cash equivalents		78,130			89,865
Securities available-for-sale, at fair value		152,608			145,715
Restricted securities, at cost		3,152			2,926
Loans held for sale		2,309			590
Loans, net		750,550			738,205
Premises and equipment, net		35,136			35,312
Premises and equipment, held for sale		907			907
Bank-owned life insurance		27,777			27,547
Other real estate owned, net		236			-
Goodwill		1,650			1,650
Core deposit intangible, net		352			363
Other assets		12,470			11,408
Total assets	$	1,065,277		$	1,054,488

Liabilities & Stockholders’ Equity

Deposits:
Noninterest-bearing deposits	$	258,104		$	262,558
Savings deposits		428,836			399,020
Time deposits		215,596			227,918
Total deposits		902,536			889,496
Overnight repurchase agreements		4,817			11,452
Federal Home Loan Bank advances		42,000			37,000
Other borrowings		1,800			1,950
Accrued expenses and other liabilities		4,080			4,834
Total liabilities		955,233			944,732

Stockholders’ equity:
Common stock, $5 par value, 10,000,000 shares authorized; 5,200,606 and 5,200,038 shares outstanding (includes 12,385 and 19,933 of nonvested restricted stock, respectively)		25,941			25,901
Additional paid-in capital		21,026			20,959
Retained earnings		63,601			62,975
Accumulated other comprehensive loss, net		(524	)		(79	)
Total stockholders’ equity		110,044			109,756
Total liabilities and stockholders’ equity	$	1,065,277		$	1,054,488

See Notes to Consolidated Financial Statements.

Index

Old Point Financial Corporation and Subsidiaries

Consolidated Statements of Income

	Three Months Ended March 31,
(unaudited, dollars in thousands, except per share data)	2020		2019
Interest and Dividend Income:
Loans, including fees	$	8,827	$	8,862
Due from banks		151		57
Federal funds sold		12		7
Securities:
Taxable		864		620
Tax-exempt		86		266
Dividends and interest on all other securities		46		64
Total interest and dividend income		9,986		9,876

Interest Expense:
Checking and savings deposits		340		251
Time deposits		972		870
Federal funds purchased, securities sold under agreements to repurchase and other borrowings		22		37
Federal Home Loan Bank advances		234		359
Total interest expense		1,568		1,517
Net interest income		8,418		8,359
Provision for loan losses		300		226
Net interest income after provision for loan losses		8,118		8,133

Noninterest Income:
Fiduciary and asset management fees		1,017		959
Service charges on deposit accounts		895		1,053
Other service charges, commissions and fees		943		925
Bank-owned life insurance income		231		192
Mortgage banking income		157		216
Gain on sale of available-for-sale securities, net		-		26
Other operating income		35		45
Total noninterest income		3,278		3,416

Noninterest Expense:
Salaries and employee benefits		5,994		5,699
Occupancy and equipment		1,266		1,393
Data processing		819		363
Customer development		114		162
Professional services		475		514
Employee professional development		220		186
Other taxes		150		150
ATM and other losses		98		62
(Gain) loss on other real estate owned		-		(2	)
Other operating expenses		894		764
Total noninterest expense		10,030		9,291
Income before income taxes		1,366		2,258
Income tax expense		116		231
Net income	$	1,250	$	2,027

Basic Earnings per Share:
Weighted average shares outstanding		5,200,250		5,184,586
Net income per share of common stock	$	0.24	$	0.39

Diluted Earnings per Share:
Weighted average shares outstanding		5,200,989		5,184,599
Net income per share of common stock	$	0.24	$	0.39

See Notes to Consolidated Financial Statements.

Index

Old Point Financial Corporation

Consolidated Statements of Comprehensive Income

	Three Months Ended March 31,
(unaudited, dollars in thousands)	2020			2019

Net income	$	1,250		$	2,027
Other comprehensive income (loss), net of tax
Net unrealized gain (loss) on available-for-sale securities		(445	)		1,561
Reclassification for gain included in net income		-			(21	)
Other comprehensive income (loss), net of tax		(445	)		1,540
Comprehensive income	$	805		$	3,567

See Notes to Consolidated Financial Statements.

Old Point Financial Corporation and Subsidiaries

Consolidated Statements of Changes in Stockholders’ Equity

(unaudited, dollars in thousands, except share and per share data)	Shares of Common Stock		Common Stock		Additional Paid-in Capital			Retained Earnings			Accumulated Other Comprehensive Income (Loss)			Total
THREE MONTHS ENDED MARCH 31, 2020

Balance at December 31, 2019		5,180,105	$	25,901	$	20,959		$	62,975		$	(79	)	$	109,756
Net income		-		-		-			1,250			-			1,250
Other comprehensive loss, net of tax		-		-		-			-			(445	)		(445	)
Employee Stock Purchase Plan share issuance		858		4		17			-			-			21
Restricted stock vested		7,258		36		(36	)		-			-			-
Stock-based compensation expense		-		-		86			-			-			86
Cash dividends ($0.12 per share)		-		-		-			(624	)		-			(624	)

Balance at end of period		5,188,221	$	25,941	$	21,026		$	63,601		$	(524	)	$	110,044

THREE MONTHS ENDED MARCH 31, 2019

Balance at December 31, 2018		5,170,600	$	25,853	$	20,698		$	57,611		$	(2,156	)	$	102,006
Net income		-		-		-			2,027			-			2,027
Other comprehensive income, net of tax		-		-		-			-			1,540			1,540
Employee Stock Purchase Plan share issuance		862		4		15			-			-			19
Stock-based compensation expense		-		-		50			-			-			50
Cash dividends ($0.12 per share)		-		-		-			(623	)		-			(623	)

Balance at end of period		5,171,462	$	25,857	$	20,763		$	59,015		$	(616	)	$	105,019

See Notes to Consolidated Financial Statements.

Index

Old Point Financial Corporation and Subsidiaries

Consolidated Statements of Cash Flows

	Three Months Ended March 31,
(dollars in thousands)	2020			2019
CASH FLOWS FROM OPERATING ACTIVITIES
Net income	$	1,250		$	2,027
Adjustments to reconcile net income to net cash (used in) provided by operating activities:
Depreciation and amortization		544			559
Amortization of right of use lease asset		88			-
Accretion related to acquisition, net		(20	)		(81	)
Provision for loan losses		300			226
Gain on sale of securities, net		-			(26	)
Net amortization of securities		154			335
Increase in loans held for sale, net		(1,719	)		(170	)
Net (gain) on sale of other real estate owned		-			(2	)
Income from bank owned life insurance		(231	)		(192	)
Stock compensation expense		86			50
Deferred tax benefit		215			589
Increase in other assets		(573	)		(595	)
Decrease in accrued expenses and other liabilities		(1,426	)		(1,067	)
Net cash (used in) provided by operating activities		(1,332	)		1,653

CASH FLOWS FROM INVESTING ACTIVITIES
Purchases of available-for-sale securities		(13,570	)		(19,141	)
(Purchases of) proceeds from redemption restricted securities, net		(226	)		162
Proceeds from maturities and calls of available-for-sale securities		2,500			2,150
Proceeds from sales of available-for-sale securities		-			6,476
Paydowns on available-for-sale securities		3,459			2,583
Net (increase) decrease in loans held for investment		(12,850	)		10,926
Proceeds from sales of other real estate owned		-			85
Purchases of premises and equipment		(368	)		(498	)
Net cash (used in) provided by investing activities		(21,055	)		2,743

CASH FLOWS FROM FINANCING ACTIVITIES
Decrease in noninterest-bearing deposits		(4,454	)		(13,311	)
Increase in savings deposits		29,816			4,274
(Decrease) increase in time deposits		(12,322	)		2,109
Decrease in federal funds purchased, repurchase agreements and other borrowings, net		(6,785	)		(1,282	)
Increase in Federal Home Loan Bank advances		25,000			5,000
Repayment of Federal Home Loan Bank advances		(20,000	)		(10,000	)
Proceeds from ESPP issuance		21			19
Cash dividends paid on common stock		(624	)		(623	)
Net cash provided by (used in) financing activities		10,652			(13,814	)

Net decrease in cash and cash equivalents		(11,735	)		(9,418	)
Cash and cash equivalents at beginning of period		89,865			42,217
Cash and cash equivalents at end of period	$	78,130		$	32,799

SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION
Cash payments for:
Interest	$	1,639		$	1,486

SUPPLEMENTAL SCHEDULE OF NONCASH TRANSACTIONS
Unrealized gain (loss) on securities available-for-sale	$	(563	)	$	1,949
Loans transferred to other real estate owned	$	236		$	-
Right of use lease asset and liability	$	672		$	751

See Notes to Consolidated Financial Statements.

Index

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

Note 1. Accounting Policies

The accompanying unaudited consolidated financial statements of Old Point Financial Corporation (NASDAQ: OPOF) (the Company) and its subsidiaries have been prepared in accordance with U.S. GAAP for interim financial information. All significant intercompany balances and transactions have been eliminated. In the opinion of management, the accompanying unaudited consolidated financial statements contain all adjustments and reclassifications of a normal and recurring nature considered necessary to present fairly the financial position at March 31, 2020 and December 31, 2019, the statements of income, comprehensive income, changes in stockholders’ equity and the statements of cash flows for the three months ended March 31, 2020 and 2019. The results of operations for the interim periods are not necessarily indicative of the results that may be expected for the full year.

These consolidated financial statements should be read in conjunction with the consolidated financial statements and notes thereto included in the Company’s 2019 Annual Report on Form 10-K. Certain previously reported amounts have been reclassified to conform to current period presentation, none of which were material in nature.

PRINCIPLES OF CONSOLIDATION

The consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries, The Old Point National Bank of Phoebus (the Bank) and Old Point Trust & Financial Services N.A. (Trust). All significant intercompany balances and transactions have been eliminated in consolidation.

NATURE OF OPERATIONS

Old Point Financial Corporation is a holding company that conducts substantially all of its operations through two subsidiaries, the Bank and Trust. The Bank serves individual and commercial customers, the majority of which are in Hampton Roads, Virginia. As of March 31, 2020, the Bank had 19 branch offices. The Bank offers a full range of deposit and loan products to its retail and commercial customers, including mortgage loan products offered through Old Point Mortgage. A full array of insurance products is also offered through Old Point Insurance, LLC in partnership with Morgan Marrow Company. Trust offers a full range of services for individuals and businesses. Products and services include retirement planning, estate planning, financial planning, estate and trust administration, retirement plan administration, tax services and investment management services.

COVID-19

In December 2019, a novel strain of coronavirus (COVID-19) was reported to have surfaced in China, and has since spread to a number of other countries, including the United States. The outbreak of COVID-19 could adversely impact a broad range of industries in which the Company’s customers operate and impair their ability to fulfill their financial obligations to the Company. In March 2020, the World Health Organization declared COVID-19 to be a global pandemic indicating that almost all public commerce and related business activities must be, to varying degrees, curtailed. In response to the COVID-19 pandemic, the Virginia governor has taken preventative or protective actions, such as imposing restrictions on travel and business operations, advising or requiring individuals to limit or forego their time outside of their homes, and ordering temporary closures of businesses that have been deemed to be non-essential. The Bank has been deemed an essential business and our branches remain open for drive-thru services and appointments.

The impact of the COVID-19 pandemic is fluid and continues to evolve. The COVID-19 pandemic and its associated impacts on trade (including supply chains and export levels), travel, employee productivity, unemployment, consumer spending, and other economic activities has resulted in less economic activity, lower equity market valuations and significant volatility and disruption in financial markets, and is reasonably possible to have an adverse effect on the Company’s business, financial condition and results of operations. The ultimate extent of the impact of the COVID-19 pandemic on the Company’s business, financial condition and results of operations is currently not yet estimable and the Company believes that it will depend on various developments and other factors, including, among others, the duration and scope of the pandemic, as well as governmental, regulatory and private sector responses to the pandemic, and the associated impacts on the economy, financial markets and our customers, employees and vendors.

The Company’s business, financial condition and results of operations generally rely upon the ability of its borrowers to repay their loans, the value of collateral underlying secured loans, and the demand for loans and other products and services offered, which are highly dependent on the business environment in the Company’s primary markets. As of April 30, 2020, the Company had payment deferral requests on $125.9 million, or 16.6% of our total loan portfolio. The standard deferral for both principal and interest for mortgage and commercial loans was 90 days and for consumer automobile loans was 60 days.

On March 27, 2020, the Coronavirus Aid, Relief, and Economic Security Act (CARES Act) was signed into law, which established the Paycheck Protection Program (PPP), establishing $349 billion in funding for loans. Under the program, the Small Business Administration (SBA) will forgive loans made by approved lenders to eligible borrowers for payroll, rent, mortgage interest, and/or utilities. On April 16, 2020, the original funding under the PPP was depleted, and on April 24, 2020, further funding was signed into law, adding another $310 billion to the PPP. As of April 30, 2020, the Company facilitated the approval of $105.0 million in PPP loans for both customers and non-customers. The Company has participated and intends to continue to participate until the PPP funds are depleted.

Index

RECENT ACCOUNTING PRONOUNCEMENTS

In June 2016, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) No. 2016-13, “Financial Instruments – Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments.” The amendments in this ASU, among other things, require the measurement of all expected credit losses for financial assets held at the reporting date based on historical experience, current conditions, and reasonable and supportable forecasts. Financial institutions and other organizations will now use forward-looking information to better inform their credit loss estimates. Many of the loss estimation techniques applied today will still be permitted, although the inputs to those techniques will change to reflect the full amount of expected credit losses. In addition, the ASU amends the accounting for credit losses on available-for-sale debt securities and purchased financial assets with credit deterioration. The FASB has issued multiple updates to ASU No. 2016-13 as codified in Topic 326, including ASU No. 2019-04, ASU No. 2019-05, ASU No. 2019-10, ASU No. 2019-11, ASU No. 2020-02, and ASU No. 2020-03. These ASUs have provided for various minor technical corrections and improvements to the codification as well as other transition matters. Smaller reporting companies who file with the U.S. Securities and Exchange Commission (SEC) and all other entities who do not file with the SEC are required to apply the guidance for fiscal years, and interim periods within those years, beginning after December 15, 2022. The Company has formed a committee to oversee the adoption of the new standard, has engaged a third party to assist with implementation, has performed data fit gap and loss driver analyses, intends to run parallel models beginning with third quarter data, and is continuing to evaluate the impact that ASU No. 2016-13 will have on its consolidated financial statements.

Effective November 25, 2019, the SEC adopted Staff Accounting Bulletin (SAB) 119. SAB 119 updated portions of SEC interpretative guidance to align with FASB ASC 326, “Financial Instruments – Credit Losses.” It covers topics including (1) measuring current expected credit losses; (2) development, governance, and documentation of a systematic methodology; (3) documenting the results of a systematic methodology; and (4) validating a systematic methodology.

In December 2019, the FASB issued ASU No. 2019-12, “Income Taxes (Topic 740) – Simplifying the Accounting for Income Taxes.” The ASU is expected to reduce cost and complexity related to the accounting for income taxes by removing specific exceptions to general principles in Topic 740 (eliminating the need for an organization to analyze whether certain exceptions apply in a given period) and improving financial statement preparers’ application of certain income tax-related guidance. This ASU is part of the FASB’s simplification initiative to make narrow-scope simplifications and improvements to accounting standards through a series of short-term projects. For public business entities, the amendments are effective for fiscal years beginning after December 15, 2020, and interim periods within those fiscal years. Early adoption is permitted. The Company is currently assessing the impact that ASU No. 2019-12 will have on its consolidated financial statements.

In January 2020, the FASB issued ASU No. 2020-01, “Investments – Equity Securities (Topic 321), Investments – Equity Method and Joint Ventures (Topic 323), and Derivatives and Hedging (Topic 815) – Clarifying the Interactions between Topic 321, Topic 323, and Topic 815.” The ASU is based on a consensus of the Emerging Issues Task Force and is expected to increase comparability in accounting for these transactions. ASU No. 2016-01 made targeted improvements to accounting for financial instruments, including providing an entity the ability to measure certain equity securities without a readily determinable fair value at cost, less any impairment, plus or minus changes resulting from observable price changes in orderly transactions for the identical or a similar investment of the same issuer. Among other topics, the amendments clarify that an entity should consider observable transactions that require it to either apply or discontinue the equity method of accounting. For public business entities, the amendments in the ASU are effective for fiscal years beginning after December 15, 2020, and interim periods within those fiscal years. Early adoption is permitted. The Company does not expect the adoption of ASU 2020-01 to have a material impact on its consolidated financial statements.

In March 2020, the FASB issued ASU No. 2020-04 “Reference Rate Reform (Topic 848): Facilitation of the Effects of Reference Rate Reform on Financial Reporting.” These amendments provide temporary optional guidance to ease the potential burden in accounting for reference rate reform. The ASU provides optional expedients and exceptions for applying generally accepted accounting principles to contract modifications and hedging relationships, subject to meeting certain criteria, that reference LIBOR or another reference rate expected to be discontinued. It is intended to help stakeholders during the global market-wide reference rate transition period. The guidance is effective for all entities as of March 12, 2020 through December 31, 2022. The Company is assessing ASU No. 2020-04 and its impact on the Company’s transition away from LIBOR for its loan and other financial instruments.

On March 12, 2020, the SEC finalized amendments to the definitions of its “accelerated filer” and “large accelerated filer” definitions. The amendments increase the threshold criteria for meeting these filer classifications and were effective on April 27, 2020. Any changes in filer status are to be applied beginning with the filer’s first Annual Report on Form 10-K filed with the SEC subsequent to the effective date. Prior to these changes, the Company was required to comply with Section 404(b) of the Sarbanes Oxley Act of 2002 concerning auditor attestation over internal control over financial reporting as an “accelerated filer” as it had more than $75 million in public float but less than $700 million at the end of the Company’s most recent second fiscal quarter. The rule change expands the definition of “non-accelerated filer” to include entities with public float between $75 million and $700 million and less than $100 million in annual revenues. The Company expects to meet this expanded category of non-accelerated filer and will no longer be considered an accelerated filer, as of its Annual Report on Form 10-K for the fiscal year ending December 31, 2020. If the Company’s annual revenues exceed $100 million, its category will change back to “accelerated filer”. The classifications of “accelerated filer” and “large accelerated filer” require a public company to obtain an auditor attestation concerning the effectiveness of internal control over financial reporting (ICFR) and include the opinion on ICFR in its Annual Report on Form 10-K. Non-accelerated filers also have additional time to file quarterly and annual financial statements. All public companies are required to obtain and file annual financial statement audits, as well as provide management’s assertion on effectiveness of internal control over financial reporting, but the external auditor attestation of internal control over financial reporting is not required for non-accelerated filers. As the Bank has total assets exceeding $1.0 billion, it remains subject to the Federal Deposit Insurance Corporation act of 1991, or FDICIA, which requires an auditor attestation concerning internal controls over financial reporting. As such, other than the additional time provided to file quarterly and annual financial statements, this change does not significantly change the Company’s annual reporting and audit requirements.

Index

ACCOUNTING STANDARDS ADOPTED IN 2020

In January 2017, the FASB issued ASU No. 2017-04, “Intangibles - Goodwill and Other (Topic 350) - Simplifying the Test for Goodwill Impairment” (ASU 2017-04). ASU 2017-04 simplifies the accounting for goodwill impairment for all entities by requiring impairment charges to be based on the first step in the previous two-step impairment test. Under the new guidance, if a reporting unit’s carrying amount exceeds its fair value, an entity will record an impairment charge based on that difference. The impairment charge will be limited to the amount of goodwill allocated to that reporting unit. The standard eliminates the prior requirement to calculate a goodwill impairment charge using Step 2, which requires an entity to calculate any impairment charge by comparing the implied fair value of goodwill with its carrying amount. ASU No. 2017-04 was effective for the Company on January 1, 2020 and did not have a material impact on its consolidated financial statements.

In August 2018, the FASB issued ASU No. 2018-13, “Fair Value Measurement (Topic 820) - Changes to the Disclosure Requirements for Fair Value Measurement” (ASU 2018-13). ASU 2018-13 modifies the disclosure requirements on fair value measurements by requiring that Level 3 fair value disclosures include the range and weighted average of significant unobservable inputs used to develop those fair value measurements. For certain unobservable inputs, an entity may disclose other quantitative information in lieu of the weighted average if the entity determines that other quantitative information would be a more reasonable and rational method to reflect the distribution of unobservable inputs used to develop Level 3 fair value measurements. Certain disclosure requirements in Topic 820 were also removed or modified. ASU No. 2018-13 was effective for the Company on January 1, 2020 and did not have a material impact on its consolidated financial statements.

In March 2020, various regulatory agencies, including the Board of Governors of the Federal Reserve System and the Federal Deposit Insurance Corporation, (“the agencies”) issued an interagency statement on loan modifications and reporting for financial institutions working with customers affected by the COVID-19 pandemic, which was revised in April 2020. The interagency statement was effective immediately and impacted accounting for loan modifications. Under ASU No. 310-40, “Receivables – Troubled Debt Restructurings by Creditors,” (ASC 310-40), a restructuring of debt constitutes a troubled debt restructuring (“TDR”) if the creditor, for economic or legal reasons related to the debtor’s financial difficulties, grands a concession to the debtor that it would not otherwise consider. The agencies confirmed with the staff of the FASB that short-term modifications made on a good faith basis in response to COVID-19 to borrowers who were current prior to any relief, are not to be considered TDRs. This includes short-term (e.g., six months) modifications such as payment deferrals, fee waivers, extensions of repayment terms, or other delays in payment that are insignificant. Borrowers considered current are those that are less than 30 days past due on their contractual payments at the time a modification program is implemented. This interagency guidance is expected to have a material impact on the Company’s financial statements; however, this impact cannot be quantified at this time. Refer to Note 3 for further discussion.

Index

Note 2. Securities

Amortized costs and fair values, with gross unrealized gains and losses, of securities available-for-sale as of the dates indicated are as follows:

	March 31, 2020
(Dollars in thousands)	Amortized Cost		Gross Unrealized Gains		Gross Unrealized (Losses)			Fair Value
U.S. Treasury securities	$	6,938	$	187	$	-		$	7,125
Obligations of U.S. Government agencies		35,645		18		(1,963	)		33,700
Obligations of state and policitcal subdivisions		27,914		679		(357	)		28,236
Mortgage-backed securities		74,284		1,433		(828	)		74,889
Money market investments		3,948		-		-			3,948
Corporate bonds and other securities		4,542		168		-			4,710
	$	153,271	$	2,485	$	(3,148	)	$	152,608

	December 31, 2019
(Dollars in thousands)	Amortized Cost		Gross Unrealized Gains		Gross Unrealized (Losses)			Fair Value
U.S. Treasury securities	$	6,925	$	78	$	-		$	7,003
Obligations of U.S. Government agencies		33,998		9		(403	)		33,604
Obligations of state and policitcal subdivisions		24,525		442		(225	)		24,742
Mortbage-backed securities		72,000		460		(552	)		71,908
Money market investments		3,825		-		-			3,825
Corporate bonds and other securities		4,542		94		(3	)		4,633
	$	145,815	$	1,083	$	(1,183	)	$	145,715

The Company has a process in place to identify debt securities that could potentially have a credit or interest-rate related impairment that is other-than-temporary. This process involves monitoring late payments, pricing levels, downgrades by rating agencies, key financial ratios, financial statements, revenue forecasts, and cash flow projections as indicators of credit issues. On a quarterly basis, management reviews all securities to determine whether an other-than-temporary decline in value exists and whether losses should be recognized. Management considers relevant facts and circumstances in evaluating whether a credit or interest-rate related impairment of a security is other-than-temporary. Relevant facts and circumstances considered include: (a) the extent and length of time the fair value has been below cost; (b) the reasons for the decline in value; (c) the financial position and access to capital of the issuer, including the current and future impact of any specific events; and (d) for fixed maturity securities, the Company’s intent to sell a security or whether it is more-likely-than-not the Company will be required to sell the security before the recovery of its amortized cost which, in some cases, may extend to maturity.

The Company has not recorded impairment charges through income on securities for the three months ended March 31, 2020 or 2019.

The following table summarizes net realized gains and losses on the sale of investment securities during the periods indicated:

	Three Months Ended March 31,
(Dollars in thousands)	2020		2019
Securities Available-for-sale
Realized gains on sales of securities	$	-	$	36
Realized losses on sales of securities		-		(10	)
Net realized gain	$	-	$	26

Index

The following tables show the gross unrealized losses and fair value of the Company’s investments with unrealized losses that are not deemed to be other-than-temporarily impaired as of March 31, 2020 and December 31, 2019, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position as of the dates indicated:

	March 31, 2020
	Less than 12 months				12 months or more				Total
(Dollars in thousands)	Gross Unrealized Losses		Fair Value		Gross Unrealized Losses		Fair Value		Gross Unrealized Losses		Fair Value
Obligations of U.S. Government agencies	$	1,903	$	26,400	$	60	$	4,890	$	1,963	$	31,290
Obligations of state and policitcal subdivisions		357		9,601		-		-		357		9,601
Mortgage-backed securities		622		26,806		206		6,319		828		33,125
Corporate bonds and other securities		-		100		-		-		-		100
Total securities available-for-sale	$	2,882	$	62,907	$	266	$	11,209	$	3,148	$	74,116

	December 31, 2019
	Less than 12 months				12 months or more				Total
(Dollars in thousands)	Gross Unrealized Losses		Fair Value		Gross Unrealized Losses		Fair Value		Gross Unrealized Losses		Fair Value
Obligations of U.S. Government agencies		349		29,744		54		2,562		403		32,306
Obligations of state and policitcal subdivisions		225		10,112		-		-		225		10,112
Mortgage-backed securities		405		44,661		147		14,078		552		58,739
Corporate bonds and other securities		-		-		3		197		3		197
Total securities available-for-sale	$	979	$	84,517	$	204	$	16,837	$	1,183	$	101,354

The number of investments at an unrealized loss position as of March 31, 2020 and December 31, 2019 were 38 and 47, respectively. Certain investments within the Company’s portfolio had unrealized losses for more than twelve months at March 31, 2020 and December 31, 2019, as shown in the tables above. The unrealized losses were caused by changes in market interest rates and not a result of credit deterioration. Because the Company does not intend to sell the investments and management believes it is unlikely that the Company will be required to sell the investments before recovery of their amortized cost basis, which may be maturity, the Company does not consider the investments to be other-than-temporarily impaired at March 31, 2020 or December 31, 2019.

Restricted Securities

The restricted security category is comprised of stock in the Federal Home Loan Bank of Atlanta (FHLB), the Federal Reserve Bank (FRB), and Community Bankers’ Bank (CBB). These stocks are classified as restricted securities because their ownership is restricted to certain types of entities and the securities lack a market. Therefore, FHLB, FRB, and CBB stock are carried at cost and evaluated for impairment. When evaluating these stocks for impairment, their value is determined based on the ultimate recoverability of the par value rather than by recognizing temporary declines in value. Restricted stock is viewed as a long-term investment and management believes that the Company has the ability and the intent to hold this stock until its value is recovered.

Note 3. Loans and the Allowance for Loan Losses

The following is a summary of the balances in each class of the Company’s portfolio of loans held for investment as of the dates indicated:

(dollars in thousands)	March 31, 2020		December 31, 2019
Mortgage loans on real estate:
Residential 1-4 family	$	118,026	$	118,561
Commercial - owner occupied		138,414		141,743
Commercial - non-owner occupied		152,859		135,798
Multifamily		24,953		25,865
Construction		40,489		40,716
Second mortgages		13,898		13,941
Equity lines of credit		52,750		52,286
Total mortgage loans on real estate		541,389		528,910
Commercial and industrial loans		69,397		75,383
Consumer automobile loans		92,241		97,294
Other consumer loans		42,702		39,713
Other		14,490		6,565
Total loans, net of deferred fees		760,219		747,865
Less: Allowance for loan losses		9,669		9,660
Loans, net of allowance and deferred fees ⁽¹⁾	$	750,550	$	738,205

(1) Net deferred loan fees totaled $511 thousand and $557 thousand at March 31, 2020 and December 31, 2019, respectively.

Index

Overdrawn deposit accounts are reclassified as loans and included in the Other category in the table above. Overdrawn deposit accounts, excluding internal use accounts, totaled $8.4 million and $449 thousand at March 31, 2020 and December 31, 2019, respectively. The increase at March 31, 2020 was due to one deposit account totaling $8.0 million which entered overdrawn status on March 31, 2020 and returned to a positive balance position on April 1, 2020.

Acquired Loans

The outstanding principal balance and the carrying amount of total acquired loans included in the consolidated balance sheets as of March 31, 2020 and December 31, 2019 are as follows:

(dollars in thousands)	March 31, 2020		December 31, 2019
Outstanding principal balance	$	15,692	$	16,850
Carrying amount		15,434		16,561

The outstanding principal balance and related carrying amount of purchased credit-impaired loans, for which the Company applies FASB ASC 310-30 to account for interest earned, as of March 31, 2020 and December 31, 2019 are as follows:

(dollars in thousands)	March 31, 2020		December 31, 2019
Outstanding principal balance	$	223	$	227
Carrying amount		86		85

The following table presents changes in the accretable yield on purchased credit-impaired loans, for which the Company applies FASB ASC 310-30, at March 31, 2020:

(dollars in thousands)	March 31, 2020			March 31, 2019
Balance at January 1	$	72		$	12
Accretion		(10	)		(1	)
Balance at end of period		62			11

CREDIT QUALITY INFORMATION

The Company uses internally-assigned risk grades to estimate the capability of borrowers to repay the contractual obligations of their loan agreements as scheduled or at all. The Company’s internal risk grade system is based on experiences with similarly graded loans. Credit risk grades are updated at least quarterly as additional information becomes available, at which time management analyzes the resulting scores to track loan performance.

The Company’s internally assigned risk grades are as follows:

•

Pass: Loans are of acceptable risk.

•

Other Assets Especially Mentioned (OAEM): Loans have potential weaknesses that deserve management’s close attention.

•

Substandard: Loans reflect significant deficiencies due to several adverse trends of a financial, economic or managerial nature.

•

Doubtful: Loans have all the weaknesses inherent in a substandard loan with added characteristics that make collection or liquidation in full based on currently existing facts, conditions and values highly questionable or improbable.

•

Loss: Loans have been identified for charge-off because they are considered uncollectible and of such little value that their continuance as bankable assets is not warranted.

Index

The following tables present credit quality exposures by internally assigned risk ratings as of the dates indicated:

Credit Quality Information As of March 31, 2020
(dollars in thousands)	Pass		OAEM		Substandard		Doubtful		Total
Mortgage loans on real estate:
Residential 1-4 family	$	116,167	$	-	$	1,859	$	-	$	118,026
Commercial - owner occupied		132,161		1,534		4,719		-		138,414
Commercial - non-owner occupied		150,824		723		1,312		-		152,859
Multifamily		24,953		-		-		-		24,953
Construction		40,489		-		-		-		40,489
Second mortgages		13,794		-		104		-		13,898
Equity lines of credit		52,750		-		-		-		52,750
Total mortgage loans on real estate	$	531,138	$	2,257	$	7,994	$	-	$	541,389
Commercial and industrial loans		69,088		56		253		-		69,397
Consumer automobile loans		91,859		-		382		-		92,241
Other consumer loans		42,702		-		-		-		42,702
Other		14,490		-		-		-		14,490
Total	$	749,277	$	2,313	$	8,629	$	-	$	760,219

Credit Quality Information As of December 31, 2019
(dollars in thousands)	Pass		OAEM		Substandard		Doubtful		Total
Mortgage loans on real estate:
Residential 1-4 family	$	116,380	$	-	$	2,181	$	-	$	118,561
Commercial - owner occupied		134,570		1,618		5,555		-		141,743
Commercial - non-owner occupied		132,851		1,622		1,325		-		135,798
Multifamily		25,865		-		-		-		25,865
Construction		40,716		-		-		-		40,716
Second mortgages		13,837		-		104		-		13,941
Equity lines of credit		52,286		-		-		-		52,286
Total mortgage loans on real estate	$	516,505	$	3,240	$	9,165	$	-	$	528,910
Commercial and industrial loans		74,963		66		354		-		75,383
Consumer automobile loans		96,907		-		387		-		97,294
Other consumer loans		39,713		-		-		-		39,713
Other		6,565		-		-		-		6,565
Total	$	734,653	$	3,306	$	9,906	$	-	$	747,865

Index

AGE ANALYSIS OF PAST DUE LOANS BY CLASS

All classes of loans are considered past due if the required principal and interest payments have not been received as of the date such payments were due. Interest and fees continue to accrue on past due loans until the date the loan is placed in nonaccrual status, if applicable. The following table includes an aging analysis of the recorded investment in past due loans as of the dates indicated. Also included in the table below are loans that are 90 days or more past due as to interest and principal and still accruing interest, because they are well-secured and in the process of collection.

Age Analysis of Past Due Loans as of March 31, 2020
(dollars in thousands)	30 - 59 Days Past Due		60 - 89 Days Past Due		90 or More Days Past Due and still Accruing		PCI		Nonaccrual		Total Current Loans ⁽¹⁾		Total Loans
Mortgage loans on real estate:
Residential 1-4 family	$	1,056	$	-	$	-	$	-	$	1,165	$	115,805	$	118,026
Commercial - owner occupied		293		-		-		86		2,638		135,397		138,414
Commercial - non-owner occupied		410		-		-		-		1,311		151,138		152,859
Multifamily		-		-		-		-		-		24,953		24,953
Construction		99		-		-		-		-		40,390		40,489
Second mortgages		394		73		13		-		104		13,314		13,898
Equity lines of credit		56		100		40		-		-		52,554		52,750
Total mortgage loans on real estate	$	2,308	$	173	$	53	$	86	$	5,218	$	533,551	$	541,389
Commercial and industrial loans		928		408		9		-		253		67,799		69,397
Consumer automobile loans		1,172		233		265		-		-		90,571		92,241
Other consumer loans		1,377		342		923		-		-		40,060		42,702
Other		149		3		5		-		-		14,333		14,490
Total	$	5,934	$	1,159	$	1,255	$	86	$	5,471	$	746,314	$	760,219

(1) For purposes of this table, Total Current Loans includes loans that are 1 - 29 days past due.

In the table above, the past due totals include student and small business loans with principal and interest amounts that are 97 - 100% guaranteed by the federal government. The past due principal portion of these guaranteed loans totaled $1.8 million at March 31, 2020. The increase in 30-59 days past due loans was primarily related to credits that were 30 days past due as of period end of which the majority subsequently become current.

Age Analysis of Past Due Loans as of December 31, 2019
(dollars in thousands)	30 - 59 Days Past Due		60 - 89 Days Past Due		90 or More Days Past Due and still Accruing		PCI		Nonaccrual		Total Current Loans ⁽¹⁾		Total Loans
Mortgage loans on real estate:
Residential 1-4 family	$	891	$	-	$	-	$	-	$	1,459	$	116,211	$	118,561
Commercial - owner occupied		-		319		-		85		2,795		138,544		141,743
Commercial - non-owner occupied		-		-		-		-		1,422		134,376		135,798
Multifamily		-		-		-		-		-		25,865		25,865
Construction		100		-		-		-		-		40,616		40,716
Second mortgages		49		-		-		-		104		13,788		13,941
Equity lines of credit		25		-		-		-		-		52,261		52,286
Total mortgage loans on real estate	$	1,065	$	319	$	-	$	85	$	5,780	$	521,661	$	528,910
Commercial and industrial loans		211		-		-		-		257		74,915		75,383
Consumer automobile loans		1,115		299		203		-		-		95,677		97,294
Other consumer loans		1,032		891		888		-		-		36,902		39,713
Other		81		9		-		-		-		6,475		6,565
Total	$	3,504	$	1,518	$	1,091	$	85	$	6,037	$	735,630	$	747,865

(1) For purposes of this table, Total Current Loans includes loans that are 1 - 29 days past due.

In the table above, the other consumer loans category includes student and small business loans with principal and interest amounts that are 97 - 100% guaranteed by the federal government. The past due principal portion of these guaranteed loans totaled $1.8 million at December 31, 2019.

Although the portions of the student and small business loan portfolios that are 90 days or more past due would normally be considered impaired, the Company does not include these loans in its impairment analysis. Because the federal government has provided guarantees of repayment of these student loans in an amount ranging from 97% to 98% of the total principal and interest of the loans as of March 31, 2020, management does not expect significant increases in delinquencies of these loans to have a material effect on the Company.

Index

NONACCRUAL LOANS

The Company generally places commercial and industrial loans (including construction loans and commercial loans secured and not secured by real estate) in nonaccrual status when the full and timely collection of interest or principal becomes uncertain, part of the principal balance has been charged off and no restructuring has occurred or the loan reaches 90 days past due, unless the credit is well-secured and in the process of collection.

Under regulatory rules, consumer loans, which are loans to individuals for household, family and other personal expenditures, and consumer loans secured by real estate (including residential 1 - 4 family mortgages, second mortgages, and equity lines of credit) are not required to be placed in nonaccrual status. Although consumer loans and consumer loans secured by real estate are not required to be placed in nonaccrual status, the Company may elect to place these loans in nonaccrual status, if necessary to avoid a material overstatement of interest income. Generally, consumer loans secured by real estate are placed in nonaccrual status only when payments are 120 days past due.

Generally, consumer loans not secured by real estate are placed in nonaccrual status only when part of the principal has been charged off. If a charge-off has not occurred sooner for other reasons, a consumer loan not secured by real estate will generally be placed in nonaccrual status when payments are 120 days past due. These loans are charged off or written down to the net realizable value of the collateral when deemed uncollectible, when classified as a “loss,” when repayment is unreasonably protracted, when bankruptcy has been initiated, or when the loan is 120 days or more past due unless the credit is well-secured and in the process of collection.

When management places a loan in nonaccrual status, the accrued unpaid interest receivable is reversed against interest income and the loan is accounted for by the cost recovery method, until it qualifies for return to accrual status or is charged off. Generally, loans are returned to accrual status when all the principal and interest amounts contractually due are brought current and future payments are reasonably assured, or when the borrower has resumed paying the full amount of the scheduled contractual interest and principal payments for at least six months.

The following table presents loans in nonaccrual status by class of loan as of the dates indicated:

(dollars in thousands)	March 31, 2020		December 31, 2019
Mortgage loans on real estate:
Residential 1-4 family	$	1,165	$	1,459
Commercial - owner occupied		2,638		2,795
Commercial - non-owner occupied		1,311		1,422
Second mortgages		104		104
Total mortgage loans on real estate	$	5,218	$	5,780
Commercial and industrial loans		253		257
Total	$	5,471	$	6,037

No purchased credit-impaired loans were on nonaccrual status at March 31, 2020.

The following table presents the interest income that the Company would have earned under the original terms of its nonaccrual loans and the actual interest recorded by the Company on nonaccrual loans for the periods presented:

	Three Months Ended March 31,
(dollars in thousand)	2020		2019
Interest income that would have been recorded under original loan terms	$	78	$	64
Actual interest income recorded for the period		-		-
Reduction in interest income on nonaccrual loans	$	78	$	64

TROUBLED DEBT RESTRUCTURINGS

The Company’s loan portfolio includes certain loans that have been modified in a troubled debt restructuring (TDR), where economic concessions have been granted to borrowers who are experiencing financial difficulties. These concessions typically result from the Company’s loss mitigation activities and could include reduction in the interest rate below current market rates for borrowers with similar risk profiles, payment extensions, forgiveness of principal, forbearance or other actions intended to maximize collection. The Company defines a TDR as nonperforming if the TDR is in nonaccrual status or is 90 days or more past due and still accruing interest at the report date.

When the Company modifies a loan, management evaluates any possible impairment as stated in the impaired loan section below.

Index

There were no new TDRs in the three months ended March 31, 2020 or 2019.

At March 31, 2020 and 2019, the Company had no outstanding commitments to disburse additional funds on any TDR. The Company had no loans secured by residential 1 - 4 family real estate in the process of foreclosure at March 31, 2020. At December 31, 2019, the Company had $272 thousand in loans secured by 1-4 family residential real estate in process of foreclosure.

In the three months ended March 31, 2020 and 2019, there were no defaulting TDRs where the default occurred within twelve months of restructuring. The Company considers a TDR in default when any of the following occurs: the loan, as restructured, becomes 90 days or more past due; the loan is moved to nonaccrual status following the restructure; the loan is restructured again under terms that would qualify it as a TDR if it were not already so classified; or any portion of the loan is charged off.

All TDRs are factored into the determination of the allowance for loan losses and included in the impaired loan analysis, as discussed below.

Under Section 4013 of the CARES Act, banks may elect not to categorize loan modifications as TDRs if the modifications are related to the COVID-19 pandemic, executed on a loan that was not more than 30 days past due as of December 31, 2019, and executed between March 1, 2020 and the earlier of December 31, 2020 or 60 days after the date of termination of the National Emergency by the President. All short term loan modifications made on a good faith basis in response to the COVID-19 pandemic to borrowers who were current prior to any relief are not considered TDRs. The Company has examined the payment accommodations granted to borrowers in response to COVID-19 and found that all borrowers were current prior to relief and were not experiencing financial difficulty prior to the COVID-19 pandemic.

IMPAIRED LOANS

A loan is considered impaired when, based on current information and events, it is probable that the Company will be unable to collect all amounts when due from the borrower in accordance with the contractual terms of the loan. Impaired loans include nonperforming loans and loans modified in a TDR. When management identifies a loan as impaired, the impairment is measured based on the present value of expected future cash flows, discounted at the loan’s effective interest rate, except when the sole or remaining source of repayment for the loan is the operation or liquidation of the collateral. In these cases, management uses the current fair value of the collateral, less selling costs, when foreclosure is probable, instead of the discounted cash flows. If management determines that the value of the impaired loan is less than the recorded investment in the loan (net of previous charge-offs, deferred loan fees or costs and unamortized premium or discount), impairment is recognized through a specific allocation in the allowance or a charge-off to the allowance.

When the ultimate collectability of the total principal of an impaired loan is in doubt and the loan is in nonaccrual status, all payments are applied to principal under the cost-recovery method. For financial statement purposes, the recorded investment in the loan is the actual principal balance reduced by partial charge-offs and payments that would otherwise have been applied to interest. When reporting information on these loans to the applicable customers, the unpaid principal balance is reported as if these partial charge-offs did not occur and as if payments were applied to principal and interest under the original terms of the loan agreements. Therefore, the unpaid principal balance reported to the customer would be higher than the recorded investment in the loan for financial statement purposes.

The following table includes the recorded investment and unpaid principal balances (a portion of which may have been charged off) for impaired loans, exclusive of purchased credit-impaired loans, with the associated allowance amount, if applicable, as of the dates presented. Also presented are the average recorded investments in the impaired loans and the related amount of interest recognized for the periods presented. The average balances are calculated based on daily average balances.

Impaired Loans by Class
									For the three months ended
	As of March 31, 2020								March 31, 2020
(Dollars in thousands)	Unpaid Principal Balance		Without Valuation Allowance		With Valuation Allowance		Associated Allowance		Average Recorded Investment		Interest Income Recognized
Mortgage loans on real estate:
Residential 1-4 family	$	1,482	$	1,223	$	88	$	39	$	1,325	$	-
Commercial		6,984		4,283		1,679		301		6,038		-
Construction		88		-		86		12		87		1
Second mortgages		245		-		243		104		244		2
Total mortgage loans on real estate		8,799		5,506		2,096		456		7,694		3
Commercial and industrial loans		306		263		-		-		267		-
Other consumer loans		20		19		-		-		20		-
Total	$	9,125	$	5,788	$	2,096	$	456	$	7,981	$	3

Index

Impaired Loans by Class
									For the Year Ended
	As of December 31, 2019								December 31, 2019
(Dollars in thousands)	Unpaid Principal Balance		Without Valuation Allowance		With Valuation Allowance		Associated Allowance		Average Recorded Investment		Interest Income Recognized
Mortgage loans on real estate:
Residential 1-4 family	$	1,542	$	1,519	$	89	$	39	$	1,416	$	11
Commercial		9,333		4,538		1,611		317		6,822		123
Construction		89		-		88		14		88		4
Second mortgages		247		-		245		111		246		6
Total mortgage loans on real estate		11,211		6,057		2,033		481		8,572		144
Commercial and industrial loans		362		354		-		-		273		4
Other consumer loans		22		-		-		-		21		1
Total	$	11,595	$	6,411	$	2,033	$	481	$	8,866	$	149

ALLOWANCE FOR LOAN LOSSES

Management has an established methodology to determine the adequacy of the allowance for loan losses that assesses the risks and probable losses inherent in the loan portfolio. The Company segments the loan portfolio into categories as defined by Schedule RC-C of the Federal Financial Institutions Examination Council Consolidated Reports of Condition and Income Form 041 (Call Report). Loans are segmented into the following pools: commercial, real estate-construction, real estate-mortgage, consumer and other loans. The Company also sub-segments the real estate-mortgage segment into six classes: residential 1-4 family, commercial real estate - owner occupied, commercial real estate - non-owner occupied, multifamily, second mortgages and equity lines of credit.

The Company uses an internally developed risk evaluation model in the estimation of the credit risk process. The model and assumptions used to determine the allowance are independently validated and reviewed to ensure that the theoretical foundation, assumptions, data integrity, computational processes and reporting practices are appropriate and properly documented.

Each portfolio segment has risk characteristics as follows:

•

Commercial and industrial: Commercial and industrial loans carry risks associated with the successful operation of a business or project, in addition to other risks associated with the ownership of a business. The 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 precision.

•

Real estate-construction: Construction loans carry risks that the project will not be finished according to schedule, the project will 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 the loan customer, may be unable to finish the construction project as planned because of financial pressure unrelated to the project.

•

Real estate-mortgage: Residential mortgage loans and equity lines of credit carry risks associated with the continued credit-worthiness of the borrower and changes in the value of the collateral. Commercial real estate loans carry risks associated with the successful operation of a business if owner occupied. If non-owner occupied, the repayment of these loans may be dependent upon the profitability and cash flow from rent receipts.

•

Consumer loans: Consumer loans carry risks associated with the continued credit-worthiness of the borrowers and the value of the collateral. Consumer loans are more likely than real estate loans to be immediately adversely affected by job loss, divorce, illness or personal bankruptcy.

•

Other loans: Other loans are loans to mortgage companies, loans for purchasing or carrying securities, and loans to insurance, investment and finance companies. These loans carry risks associated with the successful operation of a business. In addition, there is risk associated with the value of collateral other than real estate which may depreciate over time, depend on interest rates or fluctuate in active trading markets.

Each segment of the portfolio is pooled by risk grade or by days past due. Consumer loans not secured by real estate and made to individuals for household, family and other personal expenditures are segmented into pools based on days past due, while all other loans, including loans to consumers that are secured by real estate, are segmented by risk grades. A historical loss percentage is then calculated by migration analysis and applied to each pool. The migration analysis applied to all pools is able to track the risk grading and historical performance of individual loans throughout a number of periods set by management, which provides management with information regarding trends (or migrations) in a particular loan segment. At March 31, 2020 and December 31, 2019 management used eight twelve-quarter migration periods.

Management also provides an allocated component of the allowance for loans that are specifically identified as impaired, and are individually analyzed for impairment. An allocated allowance is established when the present value of expected future cash flows from the impaired loan (or the collateral value or observable market price of the impaired loan) is lower than the carrying value of that loan.

Index

Based on credit risk assessments and management’s analysis of qualitative factors, additional loss factors are applied to loan balances. These additional qualitative factors include: economic conditions, trends in growth, loan concentrations, changes in certain loans, changes in underwriting, changes in management and changes in the legal and regulatory environment.

Given the timing of the outbreak in the United States of the COVID-19 pandemic, management does not believe that the Company’s first quarter performance was significantly impacted. The COVID-19 pandemic represents an unprecedented challenge to the global economy in general and the financial services sector in particular. However, there is still significant uncertainty regarding the overall length of the pandemic and the aggregate impact that it will have on global and regional economies, including uncertainties regarding the potential positive effects of governmental actions taken in response to the pandemic during the latter portion of the first quarter of 2020 and into April. With so much uncertainty, it is impossible for the Company to accurately predict the impact that the pandemic will have on the Company’s primary market and the overall extent to which it will affect the Company’s financial condition and results of operations during the remainder of the current fiscal year. At a minimum, the actions taken by the Company to assist its customers experiencing challenges from the pandemic will likely have a material impact on the Company’s second quarter performance. The Company’s credit administration is closely monitoring and analyzing the higher risk segments within the loan portfolio, tracking loan payment deferrals, customer liquidity and providing timely reports to senior management and the board of directors. Based on capital levels, stress testing indications, prudent underwriting policies, watch credit processes, and loan concentration diversification, the Company currently expects to be able to manage the economic risks and uncertainties associated with the pandemic which may include additional increases in the provision for loan losses.

Acquired loans are recorded at their fair value at acquisition date without carryover of the acquiree’s previously established ALL, as credit discounts are included in the determination of fair value. The fair value of the loans is determined using market participant assumptions in estimating the amount and timing of both principal and interest cash flows expected to be collected on the loans and then applying a market-based discount rate to those cash flows. During evaluation upon acquisition, acquired loans are also classified as either purchased credit-impaired or purchased performing.

Purchased credit-impaired loans reflect credit quality deterioration since origination, as it is probable at acquisition that the Company will not be able to collect all contractually required payments. These purchased credit-impaired loans are accounted for under ASC 310-30, Receivables – Loans and Debt Securities Acquired with Deteriorated Credit Quality. The purchased credit-impaired loans are segregated into pools based on loan type and credit risk. Loan type is determined based on collateral type, purpose, and lien position. Credit risk characteristics include risk rating groups, nonaccrual status, and past due status. For valuation purposes, these pools are further disaggregated by maturity, pricing characteristics, and re-payment structure. Purchased credit-impaired loans are written down at acquisition to fair value using an estimate of cash flows deemed to be collectible. Accordingly, such loans are no longer classified as nonaccrual even though they may be contractually past due because the Company expects to fully collect the new carrying values of such loans, which is the new cost basis arising from purchase accounting.

ALLOWANCE FOR LOAN LOSSES BY SEGMENT

The total allowance reflects management’s estimate of losses inherent in the loan portfolio at the balance sheet date. The Company considers the allowance for loan losses of $9.7 million adequate to cover probable loan losses inherent in the loan portfolio at March 31, 2020.

Index

The following tables present, by portfolio segment, the changes in the allowance for loan losses and the recorded investment in loans for the periods presented. Allocation of a portion of the allowance to one category of loans does not preclude its availability to absorb losses in other categories.

ALLOWANCE FOR LOAN LOSSES AND RECORDED INVESTMENT IN LOANS

For the three months ended March 31, 2020
(Dollars in thousands)	Commercial and Industrial			Real Estate Construction		Real Estate - Mortgage ⁽¹⁾			Consumer ⁽²⁾			Other			Unallocated			Total
Allowance for loan losses:
Balance, beginning	$	1,244		$	258	$	6,168		$	1,694		$	296		$	-		$	9,660
Charge-offs		-			-		(46	)		(270	)		(124	)		-			(440	)
Recoveries		2			-		9			125			13			-			149
Provision for loan losses		(244	)		27		109			124			236			48			300
Ending Balance	$	1,002		$	285	$	6,240		$	1,673		$	421		$	48		$	9,669

Individually evaluated for impairment	$	-		$	12	$	444		$	-		$	-		$	-		$	456
Collectively evaluated for impairment		1,002			273		5,796			1,673			421			48			9,213
Purchased credit-impaired loans		-			-		-			-			-						-

Ending Balance	$	1,002		$	285	$	6,240		$	1,673		$	421		$	48		$	9,669

Loans Balances:																0.50	%
Individually evaluated for impairment		263			86		7,516			19			-			-			7,884
Collectively evaluated for impairment		69,048			40,403		493,384			134,924			14,490			-			752,249
Purchased credit-impaired loans		86			-		-			-			-						86
Ending Balance	$	69,397		$	40,489	$	500,900		$	134,943		$	14,490		$	-		$	760,219

⁽¹⁾	The real estate-mortgage segment includes residential 1 – 4 family, commercial real estate, second mortgages and equity lines of credit.

⁽²⁾	The consumer segment includes consumer automobile loans.

For the Year ended December 31, 2019
(Dollars in thousands)	Commercial and Industrial			Real Estate Construction		Real Estate - Mortgage ⁽¹⁾			Consumer ⁽²⁾			Other			Unallocated		Total
Allowance for loan losses:
Balance, beginning	$	2,340		$	156	$	5,956		$	1,354		$	305		$	-	$	10,111
Charge-offs		-			-		(197	)		(776	)		(425	)		-		(1,398	)
Recoveries		10			-		200			351			68			-		629
Provision for loan losses		(1,106	)		102		209			765			348			-		318
Ending Balance	$	1,244		$	258	$	6,168		$	1,694		$	296		$	-	$	9,660

Individually evaluated for impairment	$	-		$	14	$	467		$	-		$	-		$	-	$	481
Collectively evaluated for impairment		1,244			244		5,701			1,694			296			-		9,179
Purchased credit-impaired loans		-			-		-			-			-					-

Ending Balance	$	1,244		$	258	$	6,168		$	1,694		$	296		$	-	$	9,660

Loans Balances:
Individually evaluated for impairment		354			88		8,002			-			-			-		8,444
Collectively evaluated for impairment		74,944			40,628		480,192			137,007			6,565			-		739,336
Purchased credit-impaired loans		85			-		-			-			-					85
Ending Balance	$	75,383		$	40,716	$	488,194		$	137,007		$	6,565		$	-	$	747,865

⁽¹⁾	The real estate-mortgage segment includes residential 1 – 4 family, commercial real estate, second mortgages and equity lines of credit.

⁽²⁾	The consumer segment includes consumer automobile loans.

Note 4. Leases

On January 1, 2019, the Company adopted ASU No. 2016-02 “Leases (Topic 842)” and all subsequent ASUs that modified Topic 842. The Company elected the optional transition method provided by ASU No. 2018-11 and did not adjust prior periods for ASC 842. The Company also elected certain practical expedients within the standard and consistent with such elections did not reassess whether any expired or existing contracts are or contain leases, did not reassess the lease classification for any expired or existing leases, and did not reassess any initial direct costs for existing leases. As stated in the Company’s 2019 Form 10-K, the implementation of the new standard resulted in recognition of a right-of-use asset and lease liability of $751 thousand at the date of adoption, which is related to the Company’s lease of premises used in operations. The right-of-use asset and lease liability are included in other assets and other liabilities, respectively, in the consolidated balance sheets.

Index

Lease liabilities represent the Company’s obligation to make lease payments and are presented at each reporting date as the net present value of the remaining contractual cash flows. Cash flows are discounted at the Company’s incremental borrowing rate in effect at the commencement date of the lease. Right-of-use assets represent the Company’s right to use the underlying asset for the lease term and are calculated as the sum of the lease liability and if applicable, prepaid rent, initial direct costs and any incentives received from the lessor.

The Company’s long-term lease agreements are classified as operating leases. Certain of these leases offer the option to extend the lease term and the Company has included such extensions in its calculation of the lease liabilities to the extent the options are reasonably assured of being exercised. The lease agreements do not provide for residual value guarantees and have no restrictions or covenants that would impact dividends or require incurring additional financial obligations.

The following tables present information about the Company’s leases:

(Dollars in thousands)	March 31, 2020
Lease liabilities	$	1,023
Right-of-use assets	$	1,016
Weighted average remaining lease term	4.7 years
Weighted average discount rate		2.60	%

	Three Months Ended March 31,
Lease cost (in thousands)	2020		2019
Operating lease cost	$	88	$	85
Total lease cost	$	88	$	85

Cash paid for amounts included in the measurement of lease liabilities	$	84	$	84

A maturity analysis of operating lease liabilities and reconciliation of the undiscounted cash flows to the total of operating lease liabilities is as follows:

Lease payments due (in thousands)	As of March 31, 2020
Nine months ending December 31, 2020	$	268
Twelve months ending December 31, 2021		220
Twelve months ending December 31, 2022		202
Twelve months ending December 31, 2023		117
Thereafter		328
Total undiscounted cash flows	$	1,135
Discount		(112	)
Lease liabilities	$	1,023

Note 5. Low-Income Housing Tax Credits

The Company was invested in four separate housing equity funds at both March 31, 2020 and December 31, 2019. The general purpose of these funds is to encourage and assist participants in investing in low-income residential rental properties located in the Commonwealth of Virginia; develop and implement strategies to maintain projects as low-income housing; deliver Federal Low Income Housing Credits to investors; allocate tax losses and other possible tax benefits to investors; and preserve and protect project assets.

The investments in these funds were recorded as other assets on the consolidated balance sheets and were $2.9 million and $3.0 million at March 31, 2020 and 2019, respectively. The expected terms of these investments and the related tax benefits run through 2033. Total projected tax credits to be received for 2019 are $413 thousand, which is based on the most recent quarterly estimates received from the funds. Additional capital calls expected for the funds totaled $32 thousand at March 31, 2020 and $50 thousand at December 31, 2019, respectively, and are recorded in accrued expenses and other liabilities on the corresponding consolidated balance sheet.

	Three Months Ended March 31				Affected Line Item on
	2020		2019		Consolidated Income Statement
Tax credits and other benefits
Amortization of operating losses	$	45	$	80	ATM and other losses
Tax benefit of operating losses*		9		17	Income tax expense (benefit)
Tax credits		103		124	Income tax expense (benefit)
Total tax benefits	$	112	$	141

* Computed using a 21% tax rate.

Index

Note 6. Borrowings

The Company classifies all borrowings that will mature within a year from the date on which the Company enters into them as short-term borrowings. Short-term borrowings sources consist of federal funds purchased, overnight repurchase agreements (which are secured transactions with customers that generally mature within one to four days), and advances from the FHLB.

The Company maintains federal funds lines with several correspondent banks to address short-term borrowing needs. At March 31, 2020 and December 31, 2019, the remaining credit available from these lines totaled $55.0 million. The Company has a collateral dependent line of credit with the FHLB with remaining credit availability of $272.4 million and $276.3 as of March 31, 2020 and December 31, 2019, respectively.

SHORT-TERM BORROWINGS

The following table presents total short-term borrowings as of the dates indicated:

(dollar in thousands)	March 31, 2020			December 31, 2019
Overnight repurchase agreements	$	4,817		$	11,452
Federal Home Loan Bank advances		-			-
Total short-term borrowings	$	4,817		$	11,452

Maximum month-end outstanding balance	$	7,090		$	38,138
Average outstanding balance during the period	$	6,427		$	27,382
Average interest rate (year-to-date)		0.00	%		0.71	%
Average interest rate at end of period		0.09	%		0.10	%

LONG-TERM BORROWINGS

The Company had long-term FHLB advances totaling $42.0 million outstanding at March 31, 2020 and $37.0 million outstanding at December 31, 2019. Scheduled maturity dates of the advances at March 31, 2020 range from August 29, 2020 to March 5, 2025, and the interest rates range from 0.88% to 2.89%.

The Company also obtained a loan maturing on April 1, 2023 from a correspondent bank during the second quarter of 2018 to provide partial funding for the Citizens acquisition. The terms of the loan include a LIBOR based interest rate that adjusts monthly and quarterly principal curtailments. At March 31, 2020 the outstanding balance was $1.8 million as compared to $2.0 million at December 31, 2019, and the then-current interest rate was 4.02%.

The loan agreement with the lender contains financial covenants including minimum return on average asset ratio and Bank capital leverage ratio, maintenance of a well-capitalized position as defined by regulatory guidance and a maximum level of non-performing assets as a percentage of capital plus the allowance for loan losses. The Company was in compliance with each covenant at March 31, 2020.

Note 7. Commitments and Contingencies

CREDIT-RELATED FINANCIAL INSTRUMENTS

The Company is a party to credit-related financial instruments with off-balance-sheet risk in the normal course of business in order 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 Company’s exposure to credit loss is represented by the contractual amount of these commitments. The Company follows the same credit policies in making such commitments as it does for on-balance-sheet instruments.

Index

The following financial instruments whose contract amounts represent credit risk were outstanding at March 31, 2020 and December 31, 2019:

(dollars in thousands)	March 31, 2020		December 31, 2019
Commitments to extend credit:
Home equity lines of credit	$	62,904	$	62,267
Commercial real estate, construction and development loans committed but not funded		17,619		15,637
Other lines of credit (principally commercial)		48,435		62,321
Total	$	128,958	$	140,225

Letters of credit	$	8,451	$	7,724

Note 8. Share-Based Compensation

The Company has adopted an employee stock purchase plan and offers share-based compensation through its equity compensation plan. Share-based compensation arrangements may include stock options, restricted and unrestricted stock awards, restricted stock units, performance units and stock appreciation rights. Accounting standards require all share-based payments to employees to be valued using a fair value method on the date of grant and to be expensed based on that fair value over the applicable vesting period. The Company accounts for forfeitures during the vesting period as they occur.

The 2016 Incentive Stock Plan (the Incentive Stock Plan) permits the issuance of up to 300,000 shares of common stock for awards to key employees and non-employee directors of the Company and its subsidiaries in the form of stock options, restricted stock, restricted stock units, stock appreciation rights, stock awards and performance units. As of March 31, 2020 only restricted stock has been granted under the Incentive Stock Plan.

Restricted stock activity for the three months ended March 31, 2020 is summarized below:

	Shares			Weighted Average Grant Date Fair Value
Nonvested, January 1, 2020		19,933		$	22.70
Issued		-			-
Vested		(7,258	)		22.17
Forfeited		(290	)		21.68
Nonvested, March 31, 2020		12,385		$	23.03

The weighted average period over which nonvested awards are expected to be recognized is 1.34 years.

There was no restricted stock granted during the three months ended March 31, 2020. The fair value of restricted stock granted during the three months ended March 31, 2019 was $361 thousand.

The remaining unrecognized compensation expense for nonvested restricted stock shares totaled $134 thousand as of March 31, 2020.

Stock-based compensation expense was $86 thousand and $50 thousand for the three months ended March 31, 2020 and 2019, respectively.

Under the Company’s Employee Stock Purchase Plan (ESPP), substantially all employees of the Company and its subsidiaries can authorize a specific payroll deduction from their base compensation for the periodic purchase of the Company’s common stock. Shares of stock are issued quarterly at a discount to the market price of the Company’s stock on the day of purchase, which can range from 0-15% and was set at 5% for 2019 and for the first three months of 2020.

858 shares were purchased under the ESPP during the three months ended March 31, 2020. At March 31, 2020, the Company had 237,412 remaining shares reserved for issuance under the ESPP.

Index

Note 9. Stockholders’ Equity and Earnings per Share

STOCKHOLDERS’ EQUITY – Accumulated Other Comprehensive Income (Loss)

The following table presents information on amounts reclassified out of accumulated other comprehensive income (loss), by category, during the periods indicated:

	Three Months Ended March 31,				Affected Line Item on
(dollars in thousands)	2020		2019		Consolidated Statement of Income
Available-for-sale securities
Realized gains on sales of securities	$	-	$	26	Gain on sale of available-for-sale securities, net
Tax effect		-		5	Income tax expense
	$	-	$	21

The following tables present the changes in accumulated other comprehensive income (loss), by category, net of tax, for the periods indicated:

(dollars in thousands)	Unrealized Gains (Losses) on Available-for-Sale Securities			Accumulated Other Comprehensive Loss

Three Months Ended March 31, 2020
Balance at beginning of period	$	(79	)	$	(79	)
Net other comprehensive loss		(445	)		(445	)
Balance at end of period	$	(524	)	$	(524	)

Three Months Ended March 31, 2019
Balance at beginning of period	$	(2,156	)	$	(2,156	)
Net other comprehensive income		1,540			1,540
Balance at end of period	$	(616	)	$	(616	)

The following tables present the change in each component of accumulated other comprehensive income (loss) on a pre-tax and after-tax basis for the periods indicated.

	Three Months Ended March 31, 2020
(dollars in thousands)	Pretax			Tax			Net-of-Tax
Unrealized losses on available-for-sale securities:
Unrealized holding losses arising during the period	$	(563	)	$	(118	)	$	(445	)

Total change in accumulated other comprehensive income, net	$	(563	)	$	(118	)	$	(445	)

	Three Months Ended March 31, 2019
(dollars in thousands)	Pretax			Tax			Net-of-Tax
Unrealized gains on available-for-sale securities:
Unrealized holding gains arising during the period	$	1,976		$	415		$	1,561
Reclassification adjustment for gains recognized in income		(26	)		(5	)		(21	)

Total change in accumulated other comprehensive loss, net	$	1,950		$	410		$	1,540

EARNINGS PER COMMON SHARE

Basic earnings per share is computed by dividing net income by the weighted average number of common shares outstanding during the period. Diluted earnings per share is computed using the weighted average number of common shares outstanding during the period, including the effect of dilutive potential common shares attributable to the employee stock purchase plan.

The following is a reconciliation of the denominators of the basic and diluted EPS computations for the three months ended March 31, 2020 and 2019:

(dollars in thousands except per share data)	Net Income Available to Common Shareholders (Numerator)		Weighted Average Common Shares (Denominator)		Per Share Amount
Three Months Ended March 31, 2020
Net income, basic	$	1,250		5,200	$	0.24
Potentially dilutive common shares - employee stock purchase program		-		1		-
Diluted	$	1,250		5,201	$	0.24

Three Months Ended March 31, 2019
Net income, basic	$	2,027		5,187	$	0.39
Potentially dilutive common shares - employee stock purchase program		-		-		-
Diluted	$	2,027		5,187	$	0.39

Index

The Company had no antidilutive shares outstanding in the three months ended March 31, 2020 and 2019, respectively. Nonvested restricted common shares, which carry all rights and privileges of a common share with respect to the stock, including the right to vote, were included in the basic and diluted per common share calculations.

Note 10. Fair Value Measurements

The Company uses fair value measurements to record fair value adjustments to certain assets and liabilities and to determine fair value disclosures. In accordance with the “Fair Value Measurements and Disclosures” topics of FASB ASU 2010-06, FASB ASU 2011-04, and FASB ASU No. 2016-01, the fair value of a financial instrument is the price that would be received in the sale of an asset or transfer of a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants at the measurement date. Fair value is best determined based upon quoted market prices. However, in many instances, there are no quoted market prices for the Company’s various financial instruments. In cases where quoted market prices are not available, fair values are based on estimates using present value or other valuation techniques. Those techniques are significantly affected by the assumptions used, including the discount rate and estimate of future cash flows. Accordingly, the fair value estimates may not be realized in an immediate settlement of the instrument.

The fair value guidance provides a consistent definition of fair value, which focuses on exit price in the principal or most advantageous market for the asset or liability in an orderly transaction (that is, not a forced liquidation or distressed sale) between market participants at the measurement date under current market conditions. If there has been a significant decrease in the volume and level of activity for the asset or liability, a change in valuation technique or the use of multiple valuation techniques may be appropriate. In such instances, determining the price at which willing market participants would transact at the measurement date under current market conditions depends on the facts and circumstances and requires the use of significant judgment. The fair value can be a reasonable point within a range that is most representative of fair value under current market conditions.

In estimating the fair value of assets and liabilities, the Company relies mainly on two sources. The first source is the Company’s bond accounting service provider, which uses a model to determine the fair value of securities. Securities are priced based on an evaluation of observable market data, including benchmark yield curves, reported trades, broker/dealer quotes, and issuer spreads. Pricing is also impacted by credit information about the issuer, perceived market movements, and current news events impacting the individual sectors. The second source is a third party vendor the Company utilizes to provide fair value exit pricing for loans and interest bearing deposits in accordance with guidance.

In accordance with ASC 820, “Fair Value Measurements and Disclosures,” the Company groups its financial assets and financial liabilities generally measured at fair value into three levels, based on the markets in which the assets and liabilities are traded and the reliability of the assumptions used to determine fair value.

•

Level 1: Valuation is based on quoted prices in active markets for identical assets or liabilities that the reporting entity has the ability to access at the measurement date. Level 1 assets and liabilities generally include debt and equity securities that are traded in an active exchange market. Valuations are obtained from readily available pricing sources for market transactions involving identical assets or liabilities.

•

Level 2: Valuation is based on inputs other than quoted prices included within Level 1 that are observable for the asset or liability, either directly or indirectly. The valuation may be based on quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the asset or liability.

•

Level 3: Valuation is based on unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities. Level 3 assets and liabilities include financial instruments whose value is determined using pricing models, discounted cash flow methodologies, or similar techniques, as well as instruments for which determination of fair value requires significant management judgment or estimation.

An instrument’s categorization within the valuation hierarchy is based upon the lowest level of input that is significant to the fair value measurement.

ASSETS MEASURED AT FAIR VALUE ON A RECURRING BASIS

Debt securities with readily determinable fair values that are classified as “available-for-sale” are recorded at fair value, with unrealized gains and losses excluded from earnings and reported in other comprehensive income. Securities available-for-sale are recorded at fair value on a recurring basis. Fair value measurement is based upon quoted market prices, when available (Level 1). If quoted market prices are not available, fair values are measured utilizing independent valuation techniques of identical or similar securities for which significant assumptions are derived primarily from or corroborated by observable market data. Third party vendors compile prices from various sources and may determine the fair value of identical or similar securities by using pricing models that consider observable market data (Level 2). In certain cases where there is limited activity or less transparency around inputs to the valuation, securities are classified within Level 3 of the valuation hierarchy. Currently, all of the Company’s available-for-sale securities are considered to be Level 2 securities.

Index

The following tables present the balances of certain assets measured at fair value on a recurring basis as of the dates indicated:

			Fair Value Measurements at March 31, 2020 Using
(dollars in thousands)	Balance		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Available-for-sale securities
U.S. Treasury securities	$	7,125	$	-	$	7,125	$	-
Obligations of U.S. Government agencies		33,700		-		33,700		-
Obligations of state and political subdivisions		28,236		-		28,236		-
Mortgage-backed securities		74,889		-		74,889		-
Money market investments		3,948		-		3,948		-
Corporate bonds and other securities		4,710		-		4,710		-
Total available-for-sale securities	$	152,608	$	-	$	152,608	$	-

			Fair Value Measurements at December 31, 2019 Using
(dollars in thousands)	Balance		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Available-for-sale securities
U.S. Treasury securities	$	7,003	$	-	$	7,003	$	-
Obligations of U.S. Government agencies		33,604		-		33,604		-
Obligations of state and political subdivisions		24,742		-		24,742		-
Mortgage-backed securities		71,908		-		71,908		-
Money market investments		3,825		-		3,825		-
Corporate bonds and other securities		4,633		-		4,633		-
Total available-for-sale securities	$	145,715	$	-	$	145,715	$	-

ASSETS MEASURED AT FAIR VALUE ON A NONRECURRING BASIS

Under certain circumstances, adjustments are made to the fair value for assets and liabilities although they are not measured at fair value on an ongoing basis.

Impaired loans

A loan is considered impaired when, based on current information and events, it is probable that the Company will be unable to collect all amounts when due from the borrower in accordance with the contractual terms of the loan agreement. The measurement of fair value and loss associated with impaired loans can be based on the observable market price of the loan, the fair value of the collateral securing the loan, or the present value of the loan’s expected future cash flows, discounted at the loan’s effective interest rate. Collateral may be in the form of real estate or business assets including equipment, inventory, and accounts receivable, with the vast majority of the collateral in real estate.

The value of real estate collateral is determined utilizing an income, market, or cost valuation approach based on an appraisal conducted by an independent, licensed appraiser outside of the Company. In the case of loans with lower balances, the Company may obtain a real estate evaluation instead of an appraisal. Evaluations utilize many of the same techniques as appraisals, and are typically performed by independent appraisers. Once received, appraisals and evaluations are reviewed by trained staff independent of the lending function to verify consistency and reasonability. Appraisals and evaluations are based on significant unobservable inputs, including but not limited to: adjustments made to comparable properties, judgments about the condition of the subject property, the availability and suitability of comparable properties, capitalization rates, projected income of the subject or comparable properties, vacancy rates, projected depreciation rates, and the state of the local and regional economy. The Company may also elect to make additional reductions in the collateral value based on management’s best judgment, which represents another source of unobservable inputs. Because of the subjective nature of collateral valuation, impaired loans are considered Level 3.

Index

Impaired loans may be secured by collateral other than real estate. The value of business equipment is based upon an outside appraisal if deemed significant, or the net book value on the applicable business’ financial statements if not considered significant using observable market data. Likewise, values for inventory and accounts receivable collateral are based on financial statement balances or aging reports (Level 3). If a loan is not collateral-dependent, its impairment may be measured based on the present value of expected future cash flows, discounted at the loan’s effective interest rate. Because the loan is discounted at its effective rate of interest, rather than at a market rate, the loan is not considered to be held at fair value and is not included in the tables below. Collateral-dependent impaired loans allocated to the allowance for loan losses are measured at fair value on a nonrecurring basis. Any fair value adjustments are recorded in the period incurred as part of the provision for loan losses on the Consolidated Statements of Income.

Other Real Estate Owned (OREO)

Loans are transferred to OREO when the collateral securing them is foreclosed on. The measurement of gain or loss associated with OREO is based on the fair value of the collateral compared to the unpaid loan balance and anticipated costs to sell the property. If there is a contract for the sale of a property, and management reasonably believes the transaction will be consummated in accordance with the terms of the contract, fair value is based on the sale price in that contract (Level 1). If management has recent information about the sale of identical properties, such as when selling multiple condominium units on the same property, the remaining units would be valued based on the observed market data (Level 2). Lacking either a contract or such recent data, management would obtain an appraisal or evaluation of the value of the collateral as discussed above under Impaired Loans (Level 3). After the asset has been booked, a new appraisal or evaluation is obtained when management has reason to believe the fair value of the property may have changed and no later than two years after the last appraisal or evaluation was received. Any fair value adjustments to OREO below the original book value are recorded in the period incurred and expensed against current earnings.

Loans Held For Sale

Loans held for sale are carried at the lower of cost or fair value. These loans currently consist of residential loans originated for sale in the secondary market. Fair value is based on the price secondary markets are currently offering for similar loans using observable market data which is not materially different than cost due to the short duration between origination and sale (Level 2). Gains and losses on the sale of loans are reported on a separate line item on the Company’s Consolidated Statements of Income.

The following table presents the assets carried in the consolidated balance sheets for which a nonrecurring change in fair value has been recorded. Assets are shown by class of loan and by level in the fair value hierarchy, as of the dates indicated. Certain impaired loans are valued by the present value of the loan’s expected future cash flows, discounted at the loan’s effective interest rate rather than at a market rate. These loans are not carried in the consolidated balance sheets at fair value and, as such, are not included in the tables below.

			Carrying Value at March 31, 2020
(dollars in thousands)	Fair Value		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Impaired loans
Mortgage loans on real estate:
Residential 1-4 family	$	83	$	-	$	-	$	83
Commercial		1,247		-		-		1,247
Construction		74		-		-		74
Total mortgage loans on real estate	$	1,404	$	-	$	-	$	1,404
Commercial loans		-		-		-		-
Total	$	1,404	$	-	$	-	$	1,404

Loans
Loans held for sale	$	2,309	$	-	$	2,309	$	-

Other real estate owned
Residential 1-4 family	$	236	$	-	$	-	$	236
Total	$	236	$	-	$	-	$	236

Index

			Carrying Value at December 31, 2019
(dollars in thousands)	Fair Value		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Impaired loans
Mortgage loans on real estate:
Residential 1-4 family	$	74	$	-	$	-	$	74
Commercial		1,294		-		-		1,294
Construction		74		-		-		74
Total mortgage loans on real estate		1,442		-		-		1,442
Commercial loans		-		-		-		-
Total	$	1,442	$	-	$	-	$	1,442

Loans
Loans held for sale	$	590	$	-	$	590	$	-

The following tables display quantitative information about Level 3 Fair Value Measurements as of the dates indicated:

			Quantitative Information About Level 3 Fair Value Measurements
(dollars in thousands)	Fair Value at March 31, 2020		Valuation Techniques	Unobservable Input	Range (Weighted Average)
Impaired loans
Residential 1-4 family real estate	$	83	Market comparables	Selling costs		7.25	%
				Liquidation discount		4.00	%
Commercial real estate	$	1,247	Market comparables	Selling costs		6.00	%
				Liquidation discount		35.00	%
Construction	$	74	Market comparables	Selling costs		7.25	%
				Liquidation discount		4.00	%
Other real estate owned
Residential 1-4 family	$	236	Market comparables	Selling costs		7.25	%
				Liquidation discount		4.00	%

			Quantitative Information About Level 3 Fair Value Measurements
(dollars in thousands)	Fair Value at December 31, 2019		Valuation Techniques	Unobservable Input	Range (Weighted Average)
Impaired loans
Residential 1-4 family real estate	$	74	Market comparables	Selling costs		7.25	%
				Liquidation discount		4.00	%
Commercial real estate	$	1,294	Market comparables	Selling costs		6.00	%
				Liquidation discount		35.00	%
Construction	$	74	Market comparables	Selling costs		7.25	%
				Liquidation discount		4.00	%

Index

The estimated fair values, and related carrying or notional amounts, of the Company’s financial instruments as of the dates indicated are as follows:

			Fair Value Measurements at March 31, 2020 Using
(dollars in thousands)	Carrying Value		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Assets
Cash and cash equivalents	$	78,130	$	78,130	$	-	$	-
Securities available-for-sale		152,608		-		152,608		-
Restricted securities		3,152		-		3,152		-
Loans held for sale		2,309		-		2,309		-
Loans, net of allowances for loan losses		750,550		-		-		739,303
Bank owned life insurance		27,777		-		27,777		-
Accrued interest receivable		2,756		-		2,756		-

Liabilities
Deposits	$	902,536	$	-	$	905,120	$	-
Overnight repurchase agreements		4,817		-		4,817		-
Federal Home Loan Bank advances		42,000		-		41,353		-
Other borrowings		1,800		-		1,800		-
Accrued interest payable		549		-		549		-

			Fair Value Measurements at December 31, 2019 Using
(dollars in thousands)	Carrying Value		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Assets
Cash and cash equivalents	$	89,865	$	89,865	$	-	$	-
Securities available-for-sale		145,715		-		145,715		-
Restricted securities		2,926		-		2,926		-
Loans held for sale		590		-		590		-
Loans, net of allowances for loan losses		738,205		-		-		734,932
Bank owned life insurance		27,547		-		27,547		-
Accrued interest receivable		2,762		-		2,762		-

Liabilities
Deposits	$	889,496	$	-	$	893,584	$	-
Overnight repurchase agreements		11,452		-		11,452		-
Federal Home Loan Bank advances		37,000		-		36,747		-
Other borrowings		1,950		-		1,950		-
Accrued interest payable		620		-		620		-

Note 11. Segment Reporting

The Company operates in a decentralized fashion in three principal business segments: The Old Point National Bank of Phoebus (the Bank), Old Point Trust & Financial Services, N. A. (Trust), and the Company as a separate segment (for purposes of this Note, the Parent). Revenues from the Bank’s operations consist primarily of interest earned on loans and investment securities and service charges on deposit accounts. Trust’s operating revenues consist principally of income from fiduciary activities. The Parent’s revenues are mainly fees and dividends received from the Bank and Trust companies. The Company has no other segments.

The Company’s reportable segments are strategic business units that offer different products and services. They are managed separately because each segment appeals to different markets and, accordingly, requires different technologies and marketing strategies.

Index

Information about reportable segments, and reconciliation of such information to the consolidated financial statements as of and for the three months ended March 31, 2020 and 2019 follows:

	Three Months Ended March 31, 2020
(dollars in thousands)	Bank		Trust		Parent			Eliminations			Consolidated
Revenues
Interest and dividend income	$	9,963	$	23	$	1,439		$	(1,439	)	$	9,986
Income from fiduciary activities		-		1,017		-			-			1,017
Other income		1,990		286		50			(65	)		2,261
Total operating income		11,953		1,326		1,489			(1,504	)		13,264

Expenses
Interest expense		1,548		-		20			-			1,568
Provision for loan losses		300		-		-			-			300
Salaries and employee benefits		4,988		814		192			-			5,994
Other expenses		3,682		342		77			(65	)		4,036
Total operating expenses		10,518		1,156		289			(65	)		11,898

Income before taxes		1,435		170		1,200			(1,439	)		1,366

Income tax expense (benefit)		129		37		(50	)		-			116

Net income	$	1,306	$	133	$	1,250		$	(1,439	)	$	1,250

Capital expenditures	$	368	$	-	$	-		$	-		$	368

Total assets	$	1,058,955	$	6,774	$	111,861		$	(112,313	)	$	1,065,277

	Three Months Ended March 31, 2019
(dollars in thousands)	Bank		Trust		Parent			Eliminations			Consolidated
Revenues
Interest and dividend income	$	9,847	$	29	$	725		$	(725	)	$	9,876
Income from fiduciary activities		-		959		-			-			959
Other income		2,188		284		50			(65	)		2,457
Total operating income		12,035		1,272		775			(790	)		13,292

Expenses
Interest expense		1,486		-		31			-			1,517
Provision for loan losses		226		-		-			-			226
Salaries and employee benefits		4,818		767		114			-			5,699
Other expenses		3,348		249		60			(65	)		3,592
Total operating expenses		9,878		1,016		205			(65	)		11,034

Income before taxes		2,157		256		570			(725	)		2,258

Income tax expense (benefit)		209		55		(33	)		-			231

Net income	$	1,948	$	201	$	603		$	(725	)	$	2,027

Capital expenditures	$	498	$	-	$	-		$	-		$	498

Total assets	$	1,021,007	$	6,310	$	107,427		$	(107,864	)	$	1,026,880

The accounting policies of the segments are the same as those described in the summary of significant accounting policies reported in the Company’s 2019 Annual Report on Form 10-K. The Company evaluates performance based on profit or loss from operations before income taxes, not including nonrecurring gains or losses.

Index

Item 2.

Management’s Discussion and Analysis of Financial Condition and Results of Operations.

Management’s discussion and analysis is presented to aid the reader in understanding and evaluating the financial condition and results of operations of Old Point Financial Corporation and its subsidiaries (collectively, the Company). This discussion and analysis should be read with the consolidated financial statements, the notes to the financial statements, and the other financial data included in this report, as well as the Company’s 2019 Annual Report on Form 10-K and management’s discussion and analysis for the year ended December 31, 2019. Highlighted in the discussion are material changes from prior reporting periods and certain identifiable trends affecting the Company. Results of operations for the three months ended March 31, 2020 and 2019 are not necessarily indicative of results that may be attained for any other period. Amounts are rounded for presentation purposes while some of the percentages presented are computed based on unrounded amounts.

Caution About Forward-Looking Statements

In addition to historical information, certain statements in this report which use language such as “believes,” “expects,” “plans,” “may,” “will,” “should,” “projects,” “contemplates,” “anticipates,” “forecasts,” “intends” and similar expressions, may identify forward-looking statements. For this purpose, any statement that is not a statement of historical fact may be deemed to be a forward-looking statement. These forward-looking statements are based on the beliefs of the Company’s management, as well as estimates and assumptions made by, and information currently available to, management. These statements are inherently uncertain, and there can be no assurance that the underlying estimates, assumptions or beliefs will prove to be accurate. Actual results could differ materially from historical results or those anticipated by such statements. Forward-looking statements in this report may include, without limitation: statements regarding future financial performance and profitability; the acquisition of Citizens and the performance of the purchased loan portfolio; performance of the investment and loan portfolios, including performance of the purchased student loan portfolio and expected trends in the quality of the loan portfolio; the ability of the Company to manage the impact of the COVID-19 pandemic; the effects of diversifying the loan portfolio; strategic business and growth initiatives; management’s efforts to reposition the balance sheet; deposit growth; levels and sources of liquidity; the securities portfolio; use of proceeds from the sale of securities; future levels of charge-offs or net recoveries; the impact of changes in NPAs on future earnings; write-downs and expected sales of other real estate owned; income taxes; monetary policy actions of the Federal Open Market Committee; and changes in interest rates.

Factors that could have a material adverse effect on the operations and future prospects of the Company include, but are not limited to, changes in: interest rates and yields; general economic and business conditions, including unemployment levels and slowdowns in economic growth, especially related to further and sustained economic impacts of the COVID-19 pandemic; the effects of the COVID-19 pandemic on, among other things, the Company’s business, financial condtion, results of operations, liquidity, and credit quality and potential claims, damages and fines related to litigation or government actions, including litigation or actions arising from the Company’s participation in the administration of programs related to the COVID-19 pandemic (including, among other things, the CARES Act); demand for loan products; future levels of government defense spending particularly in the Company’s service area; uncertainty over future federal spending or budget priorities of the current administration, particularly in connection with the Department of Defense, on the Company’s service area; the performance of the Company’s dealer lending program; the legislative/regulatory climate; monetary and fiscal policies of the U.S. government, including policies of the U.S. Treasury and the Federal Reserve Board and any changes associated with the current administration; the quality or composition of the loan or securities portfolios; changes in the volume and mix of interest-earning assets and interest-bearing liabilities; the effects of management’s investment strategy and strategy to manage the net interest margin; the U.S. government’s guarantee of repayment of student or small business loans purchased by the Company; the level of net charge-offs on loans; deposit flows; competition; demand for financial services in the Company’s market area; implementation of new technologies; the Company’s ability to develop and maintain secure and reliable electronic systems; any interruption or breach of security in the Company’s information systems or those of the Company’s third party vendors or other service providers; reliance on third parties for key services; the use of inaccurate assumptions in management’s modeling systems; technological risks and developments and cyber-attacks, threats and events; the real estate market; accounting principles, policies and guidelines; and other factors detailed in the Company’s publicly filed documents, including the Company’s 2019 Annual Report on Form 10-K. These risks and uncertainties should be considered in evaluating the forward-looking statements contained herein, and readers are cautioned not to place undue reliance on such statements, which speak only as of date of the report.

These risks and uncertainties, in addition to the risks and uncertainties identified in the Company’s 2019 Annual Report on Form 10-K, should be considered in evaluating the forward-looking statements contained herein, and readers are cautioned not to place undue reliance on such statements. Any forward-looking statement speaks only as of the date on which it is made, and the Company undertakes no obligation to update any forward-looking statement to reflect events or circumstances after the date on which it is made. In addition, past results of operations are not necessarily indicative of future results. We undertake no obligation to update or revise any forward-looking statement to reflect events or circumstances arising after the date on which the statement was made, except as otherwise required by law.

Index

Available Information

The Company maintains a website on the Internet at www.oldpoint.com. The Company makes available free of charge, on or through its website, its proxy statements, annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and any amendments to those reports as soon as reasonably practicable after such material is electronically filed with the Securities and Exchange Commission (SEC). This reference to the Company’s Internet address shall not, under any circumstances, be deemed to incorporate the information available at such Internet address into this Form 10-Q or other SEC filings. The information available on the Company’s Internet website is not part of this Form 10-Q or any other report filed by the Company with the SEC. The Company’s SEC filings can also be obtained on the SEC’s website on the Internet at www.sec.gov.

About Old Point Financial Corporation

The Company is the parent company of The Old Point National Bank of Phoebus (the Bank) and Old Point Trust & Financial Services, N. A. (Trust). The Bank is a locally managed community bank serving the Hampton Roads localities of Chesapeake, Hampton, Isle of Wight County, Newport News, Norfolk, Virginia Beach, Williamsburg/James City County and York County. The Bank currently has 19 branch offices. Trust is a wealth management services provider.

On April 1, 2018, the Company acquired Citizens National Bank (Citizens). Under the terms of the merger agreement, Citizens stockholders received 0.1041 shares of Company stock and $2.19 in cash for each share of Citizens stock. Systems integration was completed in May 2018.

On March 11, 2020, the World Health Organization declared COVID-19 a pandemic. The effects of COVID-19 did not have a material impact on the financial results of the Company as of March 31, 2020. Due to orders issued by the Governor of Virginia and in an abundance of caution for the health of our customers and employees, the Company closed lobbies of all branches but remained fully operational through appointments. The Company is actively assisting both customers and non-customers in obtaining loans through the PPP administered by the SBA. Additionally, the Company is working with customers affected by COVID-19 through payment deferrals and is tracking all payment accommodations to customers to identify and quantify any impact they might have on the Company. As of April 30, 2020, payment deferrals of principal and interest have been granted on $125.9 million, or 16.6% of the total loan portfolio. Effects of COVID-19 may negatively impact management assumptions and estimates, such as the allowance for loan losses. Management considered the COVID-19 pandemic a triggering event for an interim impairment evaluation of goodwill and determined no impairment should be recorded as of March 31, 2020. The Company currently expects to be able to manage the economic risks and uncertainties associated with the COVID-19 pandemic with sufficient liquidity and capital levels. However, the ultimate extent of the impact of the COVID-19 pandemic on the Company’s business, financial condition, results of operations, liquidity position and resources, credit quality, and capital levels is currently not yet estimable and will depend on various developments and other factors, including, among others, the duration and scope of the pandemic, as well as governmental, regulatory and private sector responses to the pandemic, and the associated impacts on the economy, financial markets and our customers, employees and vendors.

Critical Accounting Policies and Estimates

The accounting and reporting policies of the Company are in accordance with U.S. GAAP and conform to general practices within the banking industry. The Company’s financial position and results of operations are affected by management’s application of accounting policies, including estimates, assumptions, and judgments made to arrive at the carrying value of assets and liabilities and amounts reported for revenues, expenses, and related disclosures. Different assumptions in the application of these policies could result in material changes in the Company’s consolidated financial position and/or results of operations. The Company evaluates its critical accounting estimates and assumptions on an ongoing basis and updates them, as needed. Management has discussed the Company’s critical accounting policies and estimates with the Audit Committee of the Board of Directors.

The critical accounting and reporting policies include the Company’s accounting for the allowance for loan losses. Accordingly, the Company’s significant accounting policies are discussed in Note 3 of the Notes to the Consolidated Financial Statements included in this quarterly report on Form 10-Q, and are discussed in further detail in the Company’s 2019 Annual Report on Form 10-K.

Executive Overview

For the three months ended March 31, 2020 net income was $1.3 million, or $0.24 per diluted share. This compares to net income of $2.0 million, or $0.39 per diluted share, for the first three months of 2019. This decrease was principally attributable to decreased noninterest income and increased noninterest expense

Highlights for the quarter are as follows:

•

Non-performing assets totaled $7.0 million as of March 31, 2020, down from $12.9 million at March 31, 2019. Non-performing assets as a percentage of total assets improved to 0.65% at March 31, 2020 which compared to 0.72% at December 31, 2019.

•

Net interest income remained essentially steady at $8.4 million for the first quarter of 2020 compared to the first and fourth quarters of 2019.

Index

•

The net interest margin (on a fully tax-equivalent basis) for the first quarter of 2020 compressed to 3.53% from 3.67% for the same period of 2019 but improved slightly from 3.51% for the fourth quarter of 2019.

•

Net loans grew $12.3 million, or 6.7% annualized, from December 31, 2019 to March 31, 2020.

•

Deposits grew $13.0 million to $902.5 million at March 31, 2020 from December 31, 2019.

Net Interest Income

The principal source of earnings for the Company is net interest income. Net interest income is the difference between interest and fees generated by earning assets and interest expense paid to fund them. Changes in the volume and mix of interest-earning assets and interest-bearing liabilities, as well as their respective yields and rates, have a significant impact on the level of net interest income. The net interest margin is calculated by dividing tax-equivalent net interest income by average earning assets.

For the first quarter of 2020, net interest income was $8.4 million, an increase of $59 thousand or 0.7% from the first quarter of 2019. Net interest income, on a fully tax-equivalent basis, for the first quarters of 2020 and 2019 was $8.5 million and $8.4 million, respectively. The impact of higher average earning asset balances was offset by lower yields on earning assets due to the falling rate environment as the Federal Reserve dropped the federal funds target rate by 75 basis points from July, 2019 to October, 2019. During March, 2020, the Federal Reserve further reduced the federal funds target rate 150 basis points to range of 0.00% to 0.25% in response to the COVID-19 pandemic.

Average earning assets increased year-over-year $30.2 million, or 3.2%. The average tax-equivalent yield on earning assets for the first quarter of 2020 decreased by 14 basis points compared to the same period of 2019. The average rate on interest-bearing liabilities for the quarter ended March 31, 2020 was 0.92%, up from 0.90% for the same period of 2019. Higher deposit and repurchase agreement borrowing rates were responsible for this increase.

Index

The following tables show analyses of average earning assets, interest-bearing liabilities and rates and yields for the periods indicated. Nonaccrual loans are included in loans outstanding.

AVERAGE BALANCE SHEETS, NET INTEREST INCOME AND RATES

	For the quarter ended March 31,
	2020								2019
(dollars in thousands)	Average Balance			Interest Income/ Expense		Yield/ Rate**			Average Balance			Interest Income/ Expense		Yield/ Rate**
ASSETS
Loans*	$	754,710		$	8,839		4.71	%	$	771,143		$	8,876		4.67	%
Investment securities:
Taxable		142,853			863		2.43	%		103,264			620		2.43	%
Tax-exempt*		11,223			110		3.93	%		43,648			337		3.13	%
Total investment securities		154,076			973		2.54	%		146,912			957		2.64	%
Interest-bearing due from banks		47,931			151		1.27	%		9,933			57		2.31	%
Federal funds sold		3,367			12		1.45	%		1,124			7		2.38	%
Other investments		2,991			46		6.15	%		3,783			64		6.91	%
Total earning assets		963,075		$	10,021		4.19	%		932,895		$	9,961		4.33	%
Allowance for loan losses		(9,636	)							(10,462	)
Other non-earning assets		103,101								102,043
Total assets	$	1,056,540							$	1,024,476

LIABILITIES AND STOCKHOLDERS’ EQUITY
Time and savings deposits:
Interest-bearing transaction accounts	$	49,222		$	3		0.02	%	$	28,145		$	3		0.04	%
Money market deposit accounts		280,955			317		0.45	%		251,086			227		0.37	%
Savings accounts		86,607			20		0.09	%		87,949			22		0.10	%
Time deposits		223,126			972		1.75	%		230,091			870		1.53	%
Total time and savings deposits		639,910			1,312		0.82	%		597,271			1,122		0.76	%
Federal funds purchased, repurchase agreements and other borrowings		8,595			22		1.03	%		25,220			37		0.60	%
Federal Home Loan Bank advances		38,484			234		2.45	%		58,222			359		2.50	%
Total interest-bearing liabilities		686,989			1,568		0.92	%		680,713			1,518		0.90	%
Demand deposits		253,429								235,381
Other liabilities		4,093								4,896
Stockholders’ equity		112,029								103,486
Total liabilities and stockholders’ equity	$	1,056,540							$	1,024,476
Net interest margin				$	8,453		3.53	%				$	8,443		3.67	%

*Computed on a fully tax-equivalent basis using a 21% rate, adjusting interest income by $35 thousand and $84 thousand, respectively.

**Annualized

Provision for Loan Losses

The provision for loan losses is a charge against earnings necessary to maintain the allowance for loan losses at a level consistent with management’s evaluation of the portfolio. This expense is based on management’s estimate of probable credit losses inherent to the loan portfolio. Management’s evaluation included credit quality trends, collateral values, discounted cash flow analysis, loan volumes, geographic, borrower and industry concentrations, the findings of internal credit quality assessments and results from external regulatory examinations. These factors, as well as identified impaired loans, historical losses and current economic and business conditions, were used in developing estimated loss factors for determining the loan loss provision. Based on its analysis of the adequacy of the allowance for loan losses, management concluded that the provision was appropriate.

For the three months ended March 31, 2020, the Company recorded $300 thousand for the provision for loan losses compared to $226 thousand for the comparative 2019 period. The allowance for loan and lease losses was $9.7 million at March 31, 2020 and December 31, 2019. The ALLL as a percentage of loans held for investment was 1.27% at March 31, 2020 compared to 1.29% at December 31, 2019. Historical annualized net charge offs as a percentage of average loans outstanding increased 2 basis points to 0.15% for the first quarter of 2020 compared 0.13% in the first quarter of 2019. Overall improving asset quality combined with continued improvement in non-performing assets resulted in a 7 basis point reduction in the historical loss rate as a percentage of loans evaluated collectively for impairment overall. The overall qualitative factor components for loans evaluated collectively for impairment increased 6 basis points during the first quarter of 2020 based primarily on adjustments for economic condtions. The Company continues to have higher levels of reserve in relation to peer. As the economic impact of the COVID-19 pandemic and the related federal relief efforts materialize, elevated levels of risk within the loan portfolio may require additional increases in the allowance for loan losses.

Index

Noninterest Income

Noninterest income was $3.3 million in the three months ended March 31, 2020, an decrease of $138 thousand or 4.0% from the first quarter of 2019. The decrease for the first quarter of 2020 was primarily driven by decreased service charges on deposit accounts and mortgage banking income, partially offset by higher fiduciary and asset management fees and bank owned life insurance.

Service charges on deposit accounts declined $158 thousand, or 15.0%, when comparing the first quarters of 2020 and 2019. The year over year decrease is primarily attributable to personal checking service charges and nonsufficient fund and overdraft charges. Mortgage banking income decreased $59 thousand, or 27.3%, when comparing the first quarters of 2020 and 2019, primarily due to a first quarter 2020 vendor conversion. Net gains on sales of securities in the first quarter of 2019 were $26 thousand and there were no gains or losses on sales of securities in the first quarter of 2020.

Noninterest Expense

Noninterest expense increased $739 thousand or 8.0% when comparing the first quarters of 2020 and 2019. Year-over-year first quarter increases were primarily related to salaries and employee benefits, data processing, and other operating expenses, partially offset by decreases in occupancy and equipment.

Total salaries and benefits costs increased $295 thousand, or 5.2%, when comparing the first quarters of 2020 and 2019. The year over year increase was primarily impacted by the addition of quality staff in lending, credit management, and executive management in the later part of 2019. Occupancy and equipment expenses decreased $127 thousand, or 9.1%, in the first quarter of 2020 relative to the first quarter of 2019. Bank-wide technology and efficiency initiatives were the drivers of the year-over-year increase in data processing. These included outsourcing of the Bank’s core application, upgrades to critical infrastructure software related to imaging, digital platform migration to a new vendor, and final stages of implementing a new loan origination system. Additionally, occupancy and equipment costs associated with operating an in-house core environment during the first quarter of 2019 have migrated to data processing costs in the first quarter of 2020 as the operational structure was outsourced. Other operating expense increased $130 thousand, or 17.0%, over the first quarter of 2019 and was primarily related to directors fees and a single loss event of $85 thousand in the first quarer of 2020.

The Company’s income tax expense for the first quarter 2020 decreased $115 thousand when compared to the same period in 2019. The Company’s effective tax rate remains low due to its investments in tax-exempt securities and bank-owned life insurance and its receipt of federal income tax credits for its investment in certain housing projects. The effective federal income tax rates for the three months ended March 31, 2020 and 2019 were 8.5% and 10.2%, respectively.

Balance Sheet Review

Unless otherwise noted, all comparisons in this section are between balances at December 31, 2019 and March 31, 2020.

Total assets as of March 31, 2020 and December 31, 2019 were $1.1 billion. Net loans held for investment increased $12.3 million, or 1.7%, from December 31, 2019 to $750.6 million. Net loan growth in real estate secured portfolio segments were partially offset by pay-downs in the indirect automobile and commercial and industrial segments. Cash and cash equivalents decreased $11.7 million, or 13.1%, and securities available-for-sale increased $6.9 million, or 4.7%.

Total deposits increased $13.0 million, or 1.5%, to $902.5 million at March 31, 2020. Noninterest-bearing deposits decreased $4.5 million, or 1.7%, savings deposits increased $29.8 million, or 7.5%, and time deposits decreased $12.3 million, or 5.4%. The Company focused on repricing strategies for expanding lower cost deposits and shortening time deposit maturities. Total borrowings decreased $1.6 million, or 3.4% due primarily to a reduction of overnight repurchase agreements offset by an increase in FHLB borrowings.

Average assets for the first three months of 2020 increased $32.1 million, or 3.1%, compared to the first three months of 2019. Comparing the first three months of 2020 to the first three months of 2019, average loans decreased $16.4 million, and average investment securities increased $7.2 million. Total average deposits increased $60.7 million with year-over-year average balance increases of 7.7% in non-interest bearing deposits and 13.5% in savings deposits, including interest-bearing transaction and money market accounts. Average borrowings decreased $36.7 million.

Liquidity

Liquidity is the ability of the Company to meet present and future financial obligations through either the sale or maturity of existing assets or the acquisition of additional funds through liability management. Liquid assets include cash, interest-bearing deposits with banks, federal funds sold, investments in securities and loans maturing within one year. The Company’s internal sources of such liquidity are deposits, loan and investment repayments and securities available-for-sale. As of March 31, 2020, the Bank’s unpledged, available-for-sale securities totaled $91.0 million. The Company’s primary external source of liquidity is advances from the FHLB.

Index

A major source of the Company’s liquidity is its large, stable deposit base. In addition, secondary liquidity sources are available through the use of borrowed funds if the need should arise, including secured advances from the FHLB. As of the end of the first quarter of 2020, the Company had $272.5 million in additional FHLB borrowing availability based on loans and securities currently available for pledging, less advances currently outstanding. The Company believes that the availability at the FHLB is sufficient to meet future cash-flow needs. The Company also has available short-term, unsecured borrowed funds in the form of federal funds lines of credit with correspondent banks. As of the end of the first quarter of 2020, the Company had $55.0 million available in federal funds lines to address any short-term borrowing needs.

As disclosed in the Company’s consolidated statements of cash flows, net cash used in operating activities was $1.3 million, net cash used in investing activities was $21.1 million, and net cash provided by financing activities was $10.7 million for the three months ended March 31, 2020. Combined, this contributed to an $11.7 million decrease in cash and cash equivalents for the three months ended March 31, 2020.

Management is not aware of any market or institutional trends, events or uncertainties, other than potential impacts from COVID-19, that are expected to have a material effect on the liquidity, capital resources or operations of the Company. Nor is management aware of any current recommendations by regulatory authorities that would have a material effect on liquidity, capital resources or operations.

Based on the Company’s management of liquid assets, the availability of borrowed funds, and the Company’s ability to generate liquidity through liability funding, management believes that the Company maintains overall liquidity sufficient to satisfy its depositors’ requirements and to meet its customers’ future borrowing needs.

Notwithstanding the foregoing, the Company’s ability to maintain sufficient liquidity may be affected by numerous factors, including economic conditions nationally and in the Company’s markets. Depending on its liquidity levels, its capital position, conditions in the capital markets and other factors, the Company may from time to time consider the issuance of debt, equity, other securities or other possible capital markets transactions, the proceeds of which could provide additional liquidity for the Company’s operations.

Nonperforming Assets

Nonperforming assets consist of nonaccrual loans, loans past due 90 days or more and accruing interest, restructured loans that are accruing interest and not performing according to their modified terms, and OREO. OREO consists of real estate from a foreclosure on loan collateral. The Company had no OREO as of December 31, 2019.

The majority of the loans past due 90 days or more and accruing interest at March 31, 2020 are student loans with principal and interest amounts that are 97 - 98% guaranteed by the federal government. When a loan changes from “past due 90 days or more and accruing interest” status to “nonaccrual” status, the loan is reviewed for impairment. In most cases, if the loan is considered impaired, then the difference between the value of the collateral and the principal amount outstanding on the loan is charged off. If the Company is waiting on an appraisal to determine the collateral’s value or is in negotiations with the borrower or other parties that may affect the value of the collateral, management allocates funds to the allowance for loan losses to cover the anticipated deficiency, based on information available to management at that time.

In the case of TDRs, the restructuring may be to modify to an unsecured loan (e.g., a short sale) that the borrower can afford to repay. In these circumstances, the entire balance of the loan would be specifically allocated for, unless the present value of expected future cash flows was more than the current balance on the loan. It would not be charged off if the loan documentation supports the borrower’s ability to repay the modified loan.

Index

The following table presents information on nonperforming assets, as of the dates indicated:

NONPERFORMING ASSETS
(dollars in thousands)	March 31, 2020		December 31, 2019		Increase (Decrease)
Nonaccrual loans
Commercial and industrial	$	253	$	257	$	(4	)
Real estate-mortgage (1)		5,218		5,780		(562	)
Total nonaccrual loans	$	5,471	$	6,037	$	(566	)

Loans past due 90 days or more and accruing interest
Commercial and industrial	$	9	$	-	$	9
Real estate-mortgage (1)		53		-		53
Consumer loans (2)		1,188		1,091		97
Other		5		-		5
Total loans past due 90 days or more and accruing interest	$	1,255	$	1,091	$	164

Restructured loans
Commercial and industrial	$	253	$	257	$	(4	)
Real estate-construction		86		88		(2	)
Real estate-mortgage (1)		6,613		6,754		(141	)
Total restructured loans	$	6,952	$	7,099	$	(147	)
Less nonaccrual restructured loans (included above)		4,568		4,693		(125	)
Less restructured loans currently in compliance (3)		2,384		2,406		(22	)
Net nonperforming, accruing restructured loans	$	-	$	-	$	-
Nonperforming loans	$	6,726	$	7,128	$	(402	)

Other real estate owned
1-4 family residential properties	$	236		-		236
Total other real estate owned	$	236	$	-	$	236

Total nonperforming assets	$	6,962	$	7,128	$	(166	)

(1) The real estate-mortgage segment includes residential 1 – 4 family, commercial real estate, second mortgages and equity lines of credit.

(2) Amounts listed include student loans with principal and interest amounts that are 97 - 98% guaranteed by the federal government. The portion of these guaranteed loans that is past due 90 days or more totaled $923 thousand at March 31, 2020 and $885 thousand at December 31, 2019.

(3) As of March 31, 2020 and December 31, 2019, all of the Company’s restructured accruing loans were performing in compliance with their modified terms.

Nonperforming assets as of March 31, 2020 were $7.0 million, $166 thousand lower than nonperforming assets as of December 31, 2019. Nonaccrual loans decreased $566 thousand when comparing the balances as of March 31, 2020 to December 31, 2019. See Note 3 of the Notes to the Consolidated Financial Statements included in this quarterly report on Form 10-Q for additional information about the change in nonaccrual loans. Management has set aside specific allocations on those loans where it is deemed appropriate based on the information available to management at this time regarding the cash flow, anticipated financial performance, and collateral securing these loans. Management believes that the collateral and/or discounted cash flow on these loans will be sufficient to cover balances for which it has no specific allocation.

The majority of the balance of nonaccrual loans at March 31, 2020 was related to a few large credit relationships. Of the $5.5 million of nonaccrual loans at March 31, 2020, $4.1 million, or approximately 75.3%, was comprised of three credit relationships. All loans in these relationships have been analyzed to determine whether the cash flow of the borrower and the collateral pledged to secure the loans is sufficient to cover outstanding principal balances. The Company has set aside specific allocations for those loans without sufficient cash flow or collateral and charged off any balance that management does not expect to collect.

Index

Loans past due 90 days or more and accruing interest increased $164 thousand. As of March 31, 2020, $923 thousand of the $1.3 million of loans past due 90 days or more and accruing interest were government-guaranteed student loans on which the Company expects to experience minimal losses. Because the federal government has provided guarantees of repayment of these loans in an amount ranging from 97% to 98% of the total principal and interest of the loans, management does not expect even significant increases in past due student loans to have a material effect on the Company.

Total restructured loans decreased by $147 thousand from December 31, 2019 to March 31, 2020 primarily due to paydowns and pay-offs. All accruing TDRs are performing in accordance with their modified terms and have been evaluated for impairment, with any necessary reserves recorded as needed.

Management believes the Company has excellent credit quality review processes in place to identify problem loans quickly. This allows management to work with problem loan relationships to identify any payment shortfall and assist these borrowers to improve performance or correct the problems.

Allowance for Loan Losses

The allowance for loan losses is based on several components. The first component of the allowance for loan losses is determined based on specifically identified loans that may become impaired. These loans are individually analyzed for impairment and include nonperforming loans and both performing and nonperforming TDRs. This component may also include loans considered impaired for other reasons, such as outdated financial information on the borrower or guarantors or financial problems of the borrower, including operating losses, marginal working capital, inadequate cash flow, or business interruptions. Changes in TDRs and nonperforming loans affect the dollar amount of the allowance. Increases in the impairment allowance for TDRs and nonperforming loans are reflected as an increase in the allowance for loan losses except in situations where the TDR or nonperforming loan does not require a specific allocation (i.e. the discounted present value of expected future cash flows or the collateral value is considered sufficient).

The majority of the Company’s TDRs and nonperforming loans are collateralized by real estate. When reviewing loans for impairment, the Company obtains current appraisals when applicable. If the Company is waiting on an appraisal to determine the collateral’s value or is in negotiations with the borrower or other parties that may affect the value of the collateral, any loan balance that is in excess of the estimated appraised value is allocated in the allowance. As of March 31, 2020 and December 31, 2019, the impaired loan component of the allowance for loan losses was $456 thousand and $481 thousand, respectively.

The second component of the allowance consists of qualitative factors and includes items such as economic conditions, growth trends, loan concentrations, changes in certain loans, changes in underwriting, changes in management and legal and regulatory changes.

Historical loss is the final component of the allowance for loan losses and is calculated based on the migration of loans from performing to charge-off over a period of time that management deems appropriate to provide a reasonable estimate of losses inherent in the loan portfolio. Historical loss is based on eight migration periods of twelve quarters each.

Both the historical loss and qualitative factor components of the allowance are applied to loans evaluated collectively for impairment. The portfolio is segmented based on the loan classifications set by the Federal Financial Institutions Examination Council in the instructions for the call report applicable to the Bank. Consumer loans not secured by real estate and made to individuals for household, family and other personal expenditures are segmented into pools based on whether the loan’s payments are current (including loans 1 – 29 days past due), or are 30 – 59 days past due, 60 – 89 days past due, or 90 days or more past due. All other loans, including loans to consumers that are secured by real estate, are segmented by the Company’s internally assigned risk grades: substandard, other assets especially mentioned (OAEM, rated just above substandard), and pass (all other loans). The Company may also assign loans to the risk grades of Doubtful or Loss, but as of March 31, 2020 and December 31, 2019 the Company had no loans in these categories.

The overall historical loss rate from December 31, 2019 to March 31, 2020, improved 7 basis points as a percentage of loans evaluated collectively for impairment. For the same period, the qualitative factor components increased 6 basis points as a percentage of loans evaluated collectively for impairment overall. This increase was primarily due to adjustments for economic conditions and uncertainty related to the COVID-19 pandemic.

On a combined basis, the historical loss and qualitative factor components amounted to $9.2 million as of March 31, 2020 and December 31, 2019. The allowance for loan losses at March 31, 2020 included $48 thousand, or 0.5%, of unallocated reserve, which is within Company policy. Management felt the unallocated reserve was prudent as of March 31, 2020 in light of current economic uncertainty related to the COVID-19 pandemic. Management is monitoring portfolio activity, such as levels of deferral and/or modification requests, as well as industry concentration levels to identify areas within the loan portfolio which may create elevated levels of risk should the economic environment created by COVID-19 or limited positive impact from federal government relief programs present indications of economic instability that is other than temporary in nature.

The allowance for loan losses was 1.27% of total loans on March 31, 2020 and 1.29% on December 31, 2019. As of March 31, 2020, the allowance for loan losses was 143.8% of nonperforming loans and 138.9% of nonperforming assets; this compares to 127.9% of both nonperforming loans and nonperforming assets as of December 31, 2019. Management believes it has provided an adequate reserve for nonperforming loans at March 31, 2020.

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Acquired loans are recorded at their fair value at acquisition date without carryover of the acquiree’s previously established ALLL, as credit discounts are included in the determination of fair value. The fair value of the loans is determined using market participant assumptions in estimating the amount and timing of both principal and interest cash flows expected to be collected on the loans and then applying a market-based discount rate to those cash flows. During evaluation upon acquisition, acquired loans are also classified as either purchased credit-impaired (or PCI) or purchased performing.

A PCI loan will be removed from a pool (at its carrying value) only if the loan is sold, foreclosed, or assets are received in full satisfaction of the loan. For purposes of removing the loan from the pool, the carrying value is deemed to equal the amount of principal cash flows received in lieu of the loan balance. This treatment ensures that the percentage yield calculation used to recognize accretable yield on the pool of loans is not affected.

Quarterly, management will evaluate purchased credit-impaired loans based on updated future expected cash flows. The excess of the cash flows expected to be collected over a pool’s carrying value is considered to be the accretable yield and is recognized as interest income over the estimated life of the loan or pool using the effective yield method. The accretable yield may change due to changes in the timing and amounts of expected cash flows; these changes are disclosed in Note 3 “Loans and Allowance for Loan Losses.”

The excess of the undiscounted contractual balances due over the cash flows expected to be collected is considered to be the nonaccretable difference, which represents the estimate of credit losses expected to occur and was considered in determining the fair value of loan at the acquisition date. Any subsequent increases in expected cash flows over those expected at the acquisition date in excess of fair value are adjusted through an increase in the accretable yield on a prospective basis; any decreases in expected cash flows attributable to credit deterioration are recognized by recording a provision for loan losses.

The Company’s policy is to remove an individual loan from a pool based on comparing the amount received from its resolution with its contractual amount. Any difference between these amounts is absorbed by the nonaccretable difference for the entire pool. This removal method assumes that the amount received from resolution approximates pool performance expectations. The remaining accretable yield balance is unaffected and any material change in remaining effective yield caused by this removal method is addressed by the quarterly cash flow evaluation process for each pool. For loans that are resolved by payment in full, there is no release of the nonaccretable difference for the pool because there is no difference between the amount received at resolution and the contractual amount of the loan.

The purchased credit-impaired loans are and will continue to be subject to the Company’s internal and external credit review and monitoring. If further credit deterioration is experienced, such deterioration will be measured and the provision for loan losses will be increased.

Purchased performing loans are accounted for under ASC 310-20, Receivables – Nonrefundable Fees and Other Costs. The difference between the fair value and unpaid principal balance of the loan at acquisition date (premium or discount) is amortized or accreted into interest income over the life of the loans. If the purchased performing loan has revolving privileges, it is accounted for using the straight-line method; otherwise, the effective interest method is used. The adequacy of the remaining discount as compared to the reserve that would be required under the Company’s allowance for loan loss methodology is evaluated quarterly. Should the methodology reserve exceed the remaining discount, additional provision would be recognized.

Capital Resources

Total stockholders’ equity as of March 31, 2020 was $110.0 million, an increase of $288 thousand or 0.3% from $110.0 million at December 31, 2019. The increase was the result of increased retained earnings offset by an increase in net unrealized loss on available-for-sale securities, a component of accumulated other comprehensive income (loss) on the consolidated balance sheets. The change in the unrealized gain/loss position was driven by changes in market rates.

Index

The maintenance of appropriate levels of capital is a management priority and is monitored on a regular basis. The Company’s principal goals related to the maintenance of capital are to provide adequate capital to support the Company’s risk profile consistent with the board approved risk appetite, provide financial flexibility to support future growth and client needs, comply with relevant laws, regulations, and supervisory guidance, and provide a competitive return to stockholders. Risk-based capital ratios, which include CET1 capital, Tier 1 capital and Total for the Bank capital are calculated based on regulatory guidance related to the measurement of capital and risk-weighted assets.

The Economic Growth, Regulatory Relief and Consumer Protection Act of 2018 (EGRRCPA), enacted in May 2018, contains a variety of provisions that will affect regulations applicable to the Company and the Bank. Certain provisions of the EGRRCPA were effective immediately, while others depend upon future rulemaking by federal banking regulatory agencies. The EGRRCPA required action by the Federal Reserve Board to expand the applicability of its small bank holding company policy statement, which, among other things, exempts certain bank holding companies from reporting consolidated regulatory capital ratios and from minimum regulatory capital requirements that apply to other bank holding companies. In August 2018, the Federal Reserve Board issued an interim final rule provisionally expanding the applicability of the small bank holding company policy statement to bank holding companies with consolidated total assets of less than $3 billion. The statement previously applied only to bank holding companies with consolidated total assets of less than $1 billion. As a result of the interim final rule, which was effective upon its issuance, the Company expects that it will be treated as a small bank holding company and will no longer be subject to regulatory capital requirements. At March 31, 2020, the Company’s capital ratios exceed all minimum capital requirements that would apply to the Company if it were not a small bank holding company.

On September 17, 2019 the Federal Deposit Insurance Corporation 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 EGRRCPA. 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 of greater than 9 percent, less than $10 billion in total consolidated assets, and limited amounts of off-balance-sheet exposures and trading assets and liabilities. 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 will not be required to report or calculate risk-based capital.

The CBLR framework will be available for banks to use in their March 31, 2020, Call Report. The Company did not opt into the CBLR framework.

The following is a summary of the Bank’s capital ratios at March 31, 2020. As shown below, these ratios were all well above the recommended regulatory minimum levels.

	2020 Regulatory Minimums			March 31, 2020
Common Equity Tier 1 Capital to Risk-Weighted Assets		4.500	%		11.67	%
Tier 1 Capital to Risk-Weighted Assets		6.000	%		11.67	%
Tier 1 Leverage to Average Assets		4.000	%		9.73	%
Total Capital to Risk-Weighted Assets		8.000	%		12.79	%
Capital Conservation Buffer		2.500	%		4.79	%
Risk-Weighted Assets (in thousands)				$	871,624

Book value per share was $21.21 at March 31, 2020 as compared to $20.31 at March 31, 2019. Cash dividends were $624 thousand or $0.12 per share in the first three months of 2020 and $623 thousand or $0.12 per share in the first three months of 2019.

Contractual Obligations

In the normal course of business there are various outstanding contractual obligations of the Company that will require future cash outflows. In addition, there are commitments and contingent liabilities, such as commitments to extend credit that may or may not require cash outflows.

The Company obtained a loan maturing on April 1, 2023 from a correspondent bank during the second quarter of 2018 to provide partial funding for the Citizens acquisition. The terms of the loan include a LIBOR based interest rate that adjusts monthly and quarterly principal curtailments. At March 31, 2020 the outstanding balance was $1.8 million, and the then-current interest rate was 4.02%.

Index

As of March 31, 2020, there have been no material changes outside the ordinary course of business in the Company’s contractual obligations disclosed in the Company’s 2019 Annual Report on Form 10-K.

Off-Balance Sheet Arrangements

As of March 31, 2020, there were no material changes in the Company’s off-balance sheet arrangements disclosed in the Company’s 2019 Annual Report on Form 10-K.

Item 3.

Quantitative and Qualitative Disclosures About Market Risk.

Not required.

Item 4.

Controls and Procedures.

Disclosure Controls and Procedures. Management evaluated, with the participation of the Company’s Chief Executive Officer and Chief Financial Officer, the effectiveness of the Company’s disclosure controls and procedures (as defined in Rule 13a-15(e) under the Securities Exchange Act of 1934, as amended (the Exchange Act)) as of the end of the period covered by this report. Based on that evaluation, the Company’s Chief Executive Officer and Chief Financial Officer concluded that the Company did not maintain effective disclosure controls and procedures as of March 31, 2020 due to a material weakness in internal controls over financial reporting that was identified and reported in the Company’s Annual Report on Form 10-K for the year ended December 31, 2019. The material weakness was related to controls surrounding the Company’s primary correspondent bank account reconciliation that did not allow for the timely idenfication of stale-dated and other reconciling items that began with the Company’s conversion to an outsourced core provider platform on December 9, 2019. This material weakness did not result in any material misstatements and adjustments to the Consolidated Statemenst of Income fo the three months ended March 31, 2020 or for the twelve months ended December 31, 2019. In designing and evaluating its disclosure controls and procedures, management recognized that disclosure controls and procedures, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the disclosure controls and procedures are met. The design of any disclosure controls and procedures also is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions.

Remediation Plan for Material Weakness in Internal Control Over Financial Reporting. As a result of our conversion to an outsourced core provider platform, certain transactions were processed inconsistently with the manner in which they were previously processed. This change created reconciliation issues in our correspondent bank account. Management has determined the root cause and is working with the outsourced vendor to convert processing of these transactions to a consistent and efficient manner. In addition, Management has engaged an independent third party to assist with tracing outstanding reconciling items and with subsequent reconciliations in order to develop a streamlined process. Remediation is expected to be completed as of June 30, 2020.

Internal Control over Financial Reporting. Management is responsible for establishing and maintaining adequate internal control over financial reporting (as defined in Rule 13a-15(f) under the Exchange Act). Other than the remediation discussed above, no changes in the Company’s internal control over financial reporting occurred during the fiscal quarter ended March 31, 2020 that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting. Management assessed the impact of the remote work practices related to the COVID-19 pandemic and determined they did not materially affect the Company’s internal control environment at March 31, 2020. Because of its inherent limitations, a system of internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

PART II - OTHER INFORMATION

Item 1.

Legal Proceedings.

There are no pending legal proceedings to which the Company, or any of its subsidiaries, is a party or to which the property of the Company or any of its subsidiaries is subject that, in the opinion of management, may materially impact the financial condition of the Company.

Index

Item 1A.

Risk Factors.

The Company is providing these additional risk factors to supplement the risk factors disclosed in the Company’s 2019 Annual Report on Form 10-K.

The COVID-19 pandemic has adversely affected (and may mateirally adversly affect) our business, financial condition and results of operations, and the ultimate impacts of the pandemic on our business, financial condition and results of operations will depend on future developments and other factors that are highly uncertain and will be impacted by the scope and duration of the pandemic and actions taken by governmental authorities in response to the pandemic.

The ongoing COVID-19 global and national health emergency has caused significant disruption in the international and United States economies and financial markets and has had an adverse effect on our business, financial condition and results of operations and will continue to have a significant impact on our business, finacial condition and results of operations. The spread of COVID-19 has caused illness, quarantines, cancellation of events and travel, business and school shutdowns, reduction in business activity and financial transactions, supply chain interruptions and overall economic and financial market instability. In response to the COVID-19 pandemic, the State of Virginia has taken preventative or protective actions, such as imposing restrictions on travel and business operations, advising or requiring individuals to limit or forego their time outside of their homes, and ordering temporary closures of businesses that have been deemed to be non-essential. These restrictions and other consequences of the pandemic have resulted in significant adverse effects for many different types of businesses, including, among others, those in the travel, hospitality and food and beverage industries, and have resulted in a significant number of layoffs and furloughs of employees nationwide and in the region in which we operate.

The ultimate effects of the COVID-19 pandemic on the broader economy and the markets we serve are not known nor is the ultimate length of the restrictions described above and any accompanying effects. Moreover, the Federal Reserve has taken action to lower the Federal Funds rate, which may negatively affect our interest income and, therefore, earnings, financial condition and results of operation. Additional impacts of the COVID-19 pandemic on our business could be widespread and material, and may include, or exacerbate, among other consequences, the following:

●

employees contracting COVID-19;

●

reductions in our operating effectiveness as our employees work from home;

cybersecurity risks increasing as a result of an increased number of employees working from home;

●

a work stoppage, forced stay-at-home and shelter-in-place orders, or other interruption of our business;

●

unavailability of key personnel necessary to conduct our business activities;

●

effects on key employees, including operational management personnel and those charged with preparing, monitoring and evaluating our financial reporting and internal controls;

●

sustained closures of our branch lobbies or the offices of our customers;

●

declines in demand for loans and other banking services and products;

●

reduced consumer spending due to both job losses and other effects attributable to the COVID-19 pandemic;

●

unprecedented volatility in United States financial markets;

●

volatile performance of our investment securities portfolio;

●

decline in the credit quality of our loan portfolio, owing to the effects of the COVID-19 pandemic in the markets we serve, leading to a need to increase our allowance for credit losses;

●

declines in value of collateral for loans, including real estate collateral;

the potential unavailability of services from third party vendors;

●

declines in the net worth and liquidity of borrowers and loan guarantors, impairing their ability to honor commitments to us; and

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declines in demand resulting from businesses being deemed to be “non-essential” by governments in the markets we serve, and from “non-essential” and “essential” businesses suffering adverse effects from reduced levels of economic activity in our markets.

These factors, together or in combination with other events or occurrences that may not yet be known or anticipated, may materially and adversely affect our business, financial condition and results of operations.

The ongoing COVID-19 pandemic has resulted in meaningfully lower stock prices for many companies, as well as the trading prices for many other securities. Additionally, mitigating the pandemic’s effects have included and may include further market volatility, including lower interest rates, disrupted trade and supply chains, increased unemployment and reduced economic activity, inlcuding an economic recession, The further spread of the COVID-19 outbreak, as well as ongoing or new governmental, regulatory and private sector responses to the pandemic, may materially disrupt banking and other economic activity generally and in the areas in which we operate. This could result in further decline in demand for our banking products and services, and could negatively impact, among other things, our liquidity, regulatory capital and our growth strategy. Any one or more of these developments could have a material adverse effect on our business, financial condition and results of operations.

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We are taking precautions to protect the safety and well-being of our employees and customers. However, no assurance can be given that the steps being taken will be adequate or deemed to be appropriate, nor can we predict the level of disruption which will occur to our employee’s ability to provide customer support and service. If we are unable to recover from a business disruption on a timely basis, our business, financial condition and results of operations could be materially and adversely affected. We may also incur additional costs to remedy damages caused by such disruptions, which could further adversely affect our business, financial condition and results of operations.

As a participating lender in the SBA Paycheck Protection Program (PPP), the Company and the Bank are subject to additional risks regarding the Bank’s processing of PPP loans and risks that the SBA may not fund some or all PPP loan guaranties.

The Bank is a participating lender in the PPP. Since the opening of the PPP, several other larger banks have been subject to litigation regarding the process and procedures that such banks followed in accepting and processing applications for the PPP. We may be exposed to the risk of similar litigation, from both customers and non-customers that contacted the Bank regarding obtaining PPP loans with respect to the processes and procedures we used in processing applications for the PPP. If any such litigation is filed against us and is not resolved in a manner favorable to us, it may result in significant financial liability to us or adversely affect our reputation. In addition, litigation can be costly, regardless of outcome. Any financial liability, litigation costs or reputational damage caused by PPP-related litigation could have a material adverse impact on our reputation, business, financial condition and results of operations.

The Company may have credit risk on PPP loans if a determination is made by the SBA that there is a deficiency in the manner in which the loan was originated, funded, or serviced by the Company, such as an issue with the eligibility of a borrower to receive a PPP loan, which may or may not be related to the ambiguity in the laws, rules and guidance regarding the operation of the PPP. In the event of a loss resulting from a default on a PPP loan and a determination by the SBA that there was a deficiency in the manner in which the PPP loan was originated, funded, or serviced by the Company, the SBA may deny its liability under the guaranty, reduce the amount of the guaranty, or, if it has already paid under the guaranty, seek recovery of any loss related to the deficiency from the Company.

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds.

Pursuant to the Company’s equity compensation plans, participants may pay the exercise price of certain awards or satisfy tax withholding requirements associated with awards by surrendering shares of the Company’s common stock that the participants already own. Shares surrendered by participants of these plans are repurchased at current market value pursuant to the terms of the applicable awards. During the three months ended March 31, 2020, the Company did not repurchase any shares related to the exercise of awards.

During the three months ended March 31, 2020, the Company did not repurchase any shares pursuant to the Company’s stock repurchase program. The Company is authorized to repurchase, during any given calendar year, up to an aggregate of 5 percent of the shares of the Company’s common stock outstanding as of January 1 of that calendar year.

Item 3.

Defaults Upon Senior Securities.

None.

Item 4.

Mine Safety Disclosures.

None.

Item 5.

Other Information.

The Company has made no changes to the process by which security holders may recommend nominees to its board of directors, which is discussed in the Company’s Proxy Statement for the Company’s 2020 Annual Meeting of Stockholders.

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Item 6.

Exhibits.

Exhibit No.	Description
2.1	Agreement and Plan of Reorganization, dated as of October 27, 2017, by and among Old Point Financial Corporation, The Old Point National Bank of Phoebus, and Citizens National Bank (incorporated by reference to Exhibit 2.1 to Form 8-K filed November 2, 2017)

3.1	Articles of Incorporation of Old Point Financial Corporation, as amended effective June 22, 2000 (incorporated by reference to Exhibit 3.1 to Form 10-K filed March 12, 2009)

3.1.1	Articles of Amendment to Articles of Incorporation of Old Point Financial Corporation, effective May 26, 2016 (incorporated by reference to Exhibit 3.1.1 to Form 8-K filed May 31, 2016)

3.2	Bylaws of Old Point Financial Corporation, as amended and restated August 9, 2016 (incorporated by reference to Exhibit 3.2 to Form 10-Q filed August 10, 2016)

31.1	Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

31.2	Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

32.1	Certification of Chief Executive Officer and Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

101	The following materials from Old Point Financial Corporation’s quarterly report on Form 10-Q for the quarter ended March 31, 2020, formatted in XBRL (Extensible Business Reporting Language), filed herewith: (i) Consolidated Balance Sheets (unaudited for March 31, 2020), (ii) Consolidated Statements of Income (unaudited), (iii) Consolidated Statements of Comprehensive Income (unaudited), (iv) Consolidated Statements of Changes in Stockholders’ Equity (unaudited), (v) Consolidated Statements of Cash Flows (unaudited), and (vi) Notes to Consolidated Financial Statements (unaudited)

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

	OLD POINT FINANCIAL CORPORATION

May 11, 2020	/s/ Robert F. Shuford, Jr.
	Robert F. Shuford, Jr.
	Chairman, President & Chief Executive Officer
	(Principal Executive Officer)

May 11, 2020	/s/ Elizabeth T. Beale
	Elizabeth T. Beale
	Chief Financial Officer & Senior Vice President
	(Principal Financial & Accounting Officer)

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