PART I

 

Item 1.

Business.

 

General

 

Parkway Acquisition Corp. (“Parkway” or the “Company”) was incorporated as a Virginia corporation on November 2, 2015. Parkway was formed as a business combination shell company for the purpose of completing a business combination transaction between Grayson Bankshares, Inc. (“Grayson”) and Cardinal Bankshares Corporation (“Cardinal”). On November 6, 2015, Grayson, Cardinal and Parkway entered into an agreement pursuant to which Grayson and Cardinal merged with and into Parkway, with Parkway as the surviving corporation (the “Cardinal merger”). The merger agreement established exchange ratios under which each share of Grayson common stock was converted to the right to receive 1.76 shares of common stock of Parkway, while each share of Cardinal common stock was converted to the right to receive 1.30 shares of common stock of Parkway. The exchange ratios resulted in Grayson shareholders receiving approximately 60% of the newly issued Parkway shares and Cardinal shareholders receiving approximately 40% of the newly issued Parkway shares. The Cardinal merger was completed on July 1, 2016. Grayson was considered the acquiror and Cardinal was considered the acquiree in the transaction for accounting purposes. Upon completion of the Cardinal merger, the Bank of Floyd, a wholly-owned subsidiary of Cardinal, was merged with and into Grayson National Bank (the “Bank’), a wholly-owned subsidiary of Grayson. Effective March 13, 2017, the Bank changed its name to Skyline National Bank.

 

On March 1, 2018, Parkway entered into a definitive agreement pursuant to which Parkway acquired Great State Bank (“Great State”), based in Wilkesboro, North Carolina. The agreement provided for the merger of Great State with and into the Bank, with the Bank as the surviving bank (the “Great State merger”). The transaction closed and the merger became effective on July 1, 2018. Each share of Great State common stock was converted into the right to receive 1.21 shares of Parkway common stock. The Company issued 1,191,899 shares and recognized $15.5 million in surplus in the Great State merger. Parkway was considered the acquiror and Great State was considered the acquiree in the transaction for accounting purposes.

 

The Bank was organized under the laws of the United States in 1900 and now serves the Virginia counties of Grayson, Floyd, Carroll, Wythe, Pulaski, Montgomery and Roanoke, and the North Carolina counties of Alleghany, Ashe, Burke, Caldwell, Catawba, Cleveland, Davie, Watauga, Wilkes, and Yadkin, and the surrounding areas through twenty four full-service banking offices and two loan production offices. As a Federal Deposit Insurance Corporation (the “FDIC”) insured national banking association, the Bank is subject to regulation by the Office of the Comptroller of the Currency (the “OCC”) and the FDIC. Parkway is regulated by the Board of Governors of the Federal Reserve System (the “Federal Reserve”).

 

For purposes of this annual report on Form 10-K, all information contained herein as of and for periods prior to July 1, 2016 reflects the operations of Grayson prior to the Cardinal merger. Unless this report otherwise indicates or the context otherwise requires, all references to “Parkway” or the “Company” as of and for periods subsequent to July 1, 2016 refer to the combined company and its subsidiary as a combined entity after the Cardinal merger, and all references to the “Company” as of and for periods prior to July 1, 2016 are references to Grayson and its subsidiary as a combined entity prior to the Cardinal merger. All information contained herein as of and for periods prior to July 1, 2018 reflects the operations of Parkway prior to the Great State merger. Unless this report otherwise indicates or the context otherwise requires, all references to “Parkway” or the “Company” as of and for periods subsequent to July 1, 2018 refer to the combined company and its subsidiary as a combined entity after the Great State merger, and all references to “Parkway” or the “Company” as of and for periods prior to July 1, 2018 are references to Parkway and its subsidiary as a combined entity prior to the merger.

 

 

Lending Activities

 

The Bank’s lending services include real estate, commercial, agricultural, and consumer loans. The loan portfolio constituted 84.78% of the interest earning assets of the Bank at December 31, 2020, and has historically produced the highest interest rate spread above the cost of funds. The Bank’s loan personnel have the authority to extend credit under guidelines established and approved by the Bank’s Board of Directors. The Officers Loan Committee has the authority to approve loans from $1.5 million up to $2.5 million of total indebtedness to a single customer. The Directors’ Loan Committee has the authority to approve loans from $2.5 million up to $4.0 million of total indebtedness to a single customer. All loans in excess $4.0 million must be presented to the full Board of Directors of the Bank for ultimate approval or denial.

 

The Bank has in the past and intends to continue to make most types of real estate loans, including, but not limited to, single and multi-family housing, farm loans, residential and commercial construction loans, and loans for commercial real estate. At December 31, 2020, the Bank had 42.15% of the loan portfolio in single and multi-family housing, 30.70% in non-farm, non-residential real estate loans, 4.89% in farm related real estate loans, and 6.93% in real estate construction and development loans.

 

The Bank’s loan portfolio includes commercial and agricultural production loans totaling 12.77% of the portfolio at December 31, 2020. Consumer and other loans make up approximately 3.56% of the total loan portfolio. Consumer loans include loans for household expenditures, car loans, and other loans to individuals. While this category has historically experienced a greater percentage of charge-offs than the other classifications, the Bank is committed to continue to make this type of loan to fulfill the needs of the Bank’s customer base.

 

All loans in the Bank’s portfolio are subject to risk from the state of the economy in the Bank’s service area and also that of the nation. The Bank has used and continues to use conservative loan-to-value ratios and thorough credit evaluation to lessen the risk on all types of loans. The use of conservative appraisals has also reduced exposure on real estate loans. Thorough credit checks and evaluation of past internal credit history has helped reduce the amount of risk related to consumer loans. Government guarantees of loans are used when appropriate, but apply to a minimal percentage of the portfolio. Commercial loans are evaluated by collateral value and ability to service debt. Businesses seeking loans must have a good product line and sales, responsible management, and demonstrated cash flows sufficient to service the debt.

 

Investments

 

The Bank invests a portion of its assets in U.S. Treasury, U.S. Government agency, and U.S. Government Sponsored Enterprise securities, state, county and local obligations, corporate and equity securities. The Bank’s investments are managed in relation to loan demand and deposit growth, and are generally used to provide for the investment of excess funds at reduced yields and risks relative to increases in loan demand or to offset fluctuations in deposits.

 

Deposit Activities

 

Deposits are the major source of funds for lending and other investment activities. The Bank considers the majority of its regular savings, demand, NOW, money market deposits, individual retirement accounts and small denomination certificates of deposit to be core deposits. These accounts comprised approximately 87.99% of the Bank’s total deposits at December 31, 2020. Certificates of deposit in denominations of $100,000 or more represented the remaining 12.01% of deposits at December 31, 2020.

 

 

Market Area

 

The Bank’s primary market area consists of:

 

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all of Grayson County, Virginia

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all of Floyd County, Virginia

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all of Carroll County, Virginia

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all of Wythe County, Virginia

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all of Pulaski County, Virginia

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all of Montgomery County, Virginia

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portions of Roanoke County, Virginia

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all of Alleghany County, North Carolina

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all of Ashe County, North Carolina

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all of Burke County, North Carolina

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all of Caldwell County, North Carolina

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all of Catawba County, North Carolina

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all of Cleveland County, North Carolina

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all of Davie County, North Carolina

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all of Watauga County, North Carolina

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all of Wilkes County, North Carolina

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all of Yadkin County, North Carolina

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the City of Galax, Virginia

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the City of Salem, Virginia

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the City of Roanoke, Virginia

 

Grayson, Carroll, Alleghany, Ashe, Wilkes, and Yadkin Counties, as well as the City of Galax, are rural in nature and employment in these areas was once dominated by furniture and textile manufacturing. As those industries have declined employment has shifted to healthcare, retail and service, light manufacturing, tourism, and agriculture. Median household income in these markets ranged from a low of $31,938 in the City of Galax, to a high of $43,532 in Yadkin County, based upon 2018 census data. Montgomery, Pulaski, Floyd, Wythe, Burke, Davie, Caldwell, Catawba, Cleveland and Watauga counties, while largely rural, are more economically diverse.  Montgomery County is home to two major universities, Virginia Tech and Radford University, Watauga County is home to Appalachian State University, and community colleges are located in both Wythe County and Pulaski County. The university presence has led to the development of several technology related companies in the region.  Manufacturing, agriculture, tourism, retail, healthcare and service industries are also prevalent in these markets.  The increased economic diversity of these markets is reflected in the median household incomes which range from a low of $40,393 in Cleveland County, to a high of $57,611 in Davie County, according to the 2018 census data.  The Bank has a lesser presence in Roanoke County and the Cities of Roanoke and Salem where median household incomes ranged from a low of $43,028 in Roanoke City, to a high of $65,467 in Roanoke County, based on 2018 census data.     

 

Competition

 

The Bank encounters strong competition both in making loans and attracting deposits. The deregulation of the banking industry and the widespread enactment of state laws that permit multi-bank holding companies as well as an increasing level of interstate banking have created a highly competitive environment for commercial banking. In one or more aspects of its business, the Bank competes with other commercial banks, savings and loan associations, credit unions, finance companies, mutual funds, insurance companies, brokerage and investment banking companies, and other financial intermediaries, as well as marketplace lenders and other financial technology firms. Many of these competitors have substantially greater resources and lending limits and may offer certain services that the Bank does not currently provide. In addition, many of the Bank’s competitors are not subject to the same extensive federal regulations that govern bank holding companies and federally insured banks. Recent federal and state legislation has heightened the competitive environment in which financial institutions must conduct their business, and the potential for competition among financial institutions of all types has increased significantly.

 

 

To compete, the Bank relies upon specialized services, responsive handling of customer needs, and personal contacts by its officers, directors, and staff. Large multi-branch banking competitors tend to compete primarily by rate and the number and location of branches, while smaller, independent financial institutions tend to compete primarily by rate and personal service.

 

Employees

 

At December 31, 2020, the Company had 230 total employees representing 225 full time equivalents, none of whom are represented by a union or covered by a collective bargaining agreement. The Company’s management considers employee relations to be good.

 

Internet Site

 

The Company maintains an internet website at www.skylinenationalbank.bank. Shareholders of the Company and the public may access, free of charge, the Company’s periodic and current reports (including annual reports on Form 10-K, quarterly reports on Form 10-Q and current reports on Form 8-K, and any amendments to those reports) filed with or furnished to the Securities and Exchange Commission (the "SEC"), through the “Investor Relations” section of the Company’s website. The reports are made available on this website as soon as practicable following the filing of the reports with the SEC. The information is free of charge and may be reviewed, downloaded and printed from the website at any time.

 

Government Supervision and Regulation

 

The Company and the Bank are extensively regulated under federal and state law.  The following information describes certain aspects of that regulation applicable to the Company and the Bank and does not purport to be complete.  Proposals to change the laws and regulations governing the banking industry are frequently raised in U.S. Congress, in state legislatures, and before the various bank regulatory agencies.  The likelihood and timing of any changes and the impact such changes might have on the Company and the Bank are impossible to determine with any certainty.  A change in applicable laws or regulations, or a change in the way such laws or regulations are interpreted by regulatory agencies or courts, may have a material impact on the business, operations, and earnings of the Company and the Bank.

 

Parkway Acquisition Corp.

 

The Company is a bank holding company (“BHC”) within the meaning of the Bank Holding Company Act of 1956, as amended (the “BHC Act”), and is registered as such with the Federal Reserve.  As a bank holding company, the Company is subject to supervision, regulation and examination by the Federal Reserve Bank of Richmond and is required to file various reports and additional information with the Federal Reserve.  The Company is also registered under the bank holding company laws of Virginia and is subject to supervision, regulation and examination by the Virginia State Corporation Commission (the “SCC”).

 

Skyline National Bank

 

The Bank is a federally chartered national bank.  It is subject to federal regulation by the OCC and the FDIC.

 

The OCC conducts regular examinations of the Bank, reviewing such matters as the adequacy of loan loss reserves, quality of loans and investments, management practices, compliance with laws, and other aspects of its operations. In addition to these regular examinations, the Bank must furnish the OCC with periodic reports containing a full and accurate statement of its affairs. Supervision, regulation and examination of banks by these agencies are intended primarily for the protection of depositors rather than shareholders.

 

 

The regulations of the OCC, the FDIC and the Federal Reserve govern most aspects of the Company’s and the Bank’s business, including deposit reserve requirements, investments, loans, certain check clearing activities, issuance of securities, payment of dividends, branching, deposit interest rate ceilings, and numerous other matters. The OCC, the FDIC and the Federal Reserve have adopted guidelines and released interpretative materials that establish operational and managerial standards to promote the safe and sound operation of banks and bank holding companies. These standards relate to the institution’s key operating functions, including but not limited to capital management, internal controls, internal audit system, information systems and data and cybersecurity, loan documentation, credit underwriting, interest rate exposure and risk management, vendor management, executive management and its compensation, asset growth, asset quality, earnings, liquidity and risk management.

 

Dodd-Frank Act

 

On July 21, 2010, President Obama signed into law the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”). The Dodd-Frank Act significantly restructured the financial regulatory regime in the United States and continues to have a broad impact on the financial services industry as a result of the significant regulatory and compliance changes required under the act. While significant rulemaking under the Dodd-Frank Act has occurred, certain of the act’s provisions require additional rulemaking by the federal bank regulatory agencies. The Dodd-Frank Act has increased our operations and compliance costs in the short-term; however, the ultimate impact of the Dodd-Frank Act remains dependent on the regulatory environment and future regulatory rulemaking and interpretations.

 

Recent Legislation

 

In May 2018, the Economic Growth, Regulatory Relief and Consumer Protection Act (the “Economic Growth Act”), was enacted to modify or remove certain regulatory financial reform rules and regulations, including some of those implemented under the Dodd-Frank Act. While the Economic Growth Act maintains most of the regulatory structure established by the Dodd-Frank Act, it amends certain aspects of the regulatory framework for small depository institutions with assets of less than $10 billion, such as the Bank, and for large banks with assets of more than $50 billion.

 

Among other matters, the Economic Growth Act expands the definition of qualified mortgages which may be held by a financial institution with total consolidated assets of less than $10 billion, exempts community banks from the Volcker Rule, and includes additional regulatory relief regarding regulatory examination cycles, call reports, mortgage disclosures and risk weights for certain high-risk commercial real estate loans.

 

In addition, the Economic Growth Act simplifies the regulatory capital rules for financial institutions and their holding companies with total consolidated assets of less than $10 billion by instructing the federal banking regulators to establish a single “Community Bank Leverage Ratio” (“CBLR”) of between 8 and 10 percent. On September 17, 2019, the FDIC finalized a rule that introduced the CBLR framework for community banks with a Tier 1 leverage ratio of greater than 9 percent, less than $10 billion in total assets, and limited amounts of off-balance sheet exposures and trading assets and liabilities. The Economic Growth Act also expands the category of holding companies that may rely on the “Small Bank Holding Company and Savings and Loan Holding Company Policy Statement” (the “HC Policy Statement”) by raising the maximum amount of assets a qualifying holding company may have from $1 billion to $3 billion. This expansion also excludes such holding companies from the minimum capital requirements of the Dodd-Frank Act.

 

Deposit Insurance

 

The deposits of the Bank are insured by the Deposit Insurance Fund (“DIF”) up to applicable limits and are subject to FDIC deposit insurance assessments to maintain the DIF.

 

The Federal Deposit Insurance Act (the “FDIA”), as amended by the Federal Deposit Insurance Reform Act and the Dodd-Frank Act, requires the FDIC to set a ratio of deposit insurance reserves to estimated insured deposits of at least 1.35%. The FDIC uses a risk-based system to calculate assessment rates and revised its methodology in April 2016 to calculate assessment rates for banks with under $10 billion in assets based upon certain financial measures of the bank and its supervisory ratings. Initial base assessment rates currently range from 3 to 30 basis points, subject to a decrease for certain unsecured debt. The reserve ratio reached 1.35% during the third quarter of 2018. Once the reserve ratio reaches 2.0% or greater, initial base assessment rates will range from 2 to 28 basis points and, once the reserve ratio reaches 2.5% or greater, the initial base assessment rates will range from 1 to 25 basis points.

 

 

Capital Requirements

 

The Federal Reserve, the OCC and the FDIC have issued substantially similar risk-based and leverage capital guidelines applicable to banks and bank holding companies.  In addition, those regulatory agencies may from time to time require that a banking organization maintain capital above the minimum levels because of its financial condition or actual or anticipated growth. Pursuant to the HC Policy Statement, qualifying bank holding companies with total consolidated assets of less than $3 billion, such as the Company, are not subject to consolidated regulatory capital requirements.

 

Effective January 1, 2015, the federal banking regulators adopted rules to implement the Basel III regulatory capital reforms from the Basel Committee on Banking Supervision and certain provisions of the Dodd-Frank Act. The final rules required the Bank to comply with the following new minimum capital ratios: (i) a common equity Tier 1 capital ratio of 4.5% of risk-weighted assets; (ii) a Tier 1 capital ratio of 6% of risk-weighted assets; (iii) a total capital ratio of 8% of risk-weighted assets; and (iv) a leverage ratio of 4% of total assets.  As fully phased in effective January 1, 2019, the rules require the Bank to maintain (i) a minimum ratio of common equity Tier 1 to risk-weighted assets of at least 4.5%, plus a 2.5% “capital conservation buffer” (which is added to the 4.5% common equity Tier 1 ratio, effectively resulting in a minimum ratio of common equity Tier 1 to risk-weighted assets of at least 7%), (ii) a minimum ratio of Tier 1 capital to risk-weighted assets of at least 6.0%, plus the 2.5% capital conservation buffer (which is added to the 6.0% Tier 1 capital ratio, effectively resulting in a minimum Tier 1 capital ratio of 8.5%), (iii) a minimum ratio of total capital to risk-weighted assets of at least 8.0%, plus the 2.5% capital conservation buffer (which is added to the 8.0% total capital ratio, effectively resulting in a minimum total capital ratio of 10.5%), and (iv) a minimum leverage ratio of 4%, calculated as the ratio of Tier 1 capital to average assets.

 

The capital conservation buffer requirement has been phased in beginning January 1, 2016, at 0.625% of risk-weighted assets, increasing by the same amount each year until fully implemented at 2.5% on January 1, 2019. The capital conservation buffer is designed to absorb losses during periods of economic stress.  Banking institutions with a ratio of common equity Tier 1 to risk-weighted assets above the minimum but below the conservation buffer will face constraints on dividends, equity repurchases, and compensation based on the amount of the shortfall.

 

The rules also revised the prompt corrective action framework, which is designed to place restrictions on insured depository institutions if their capital levels begin to show signs of weakness. Under the prompt corrective action requirements, which are designed to complement the capital conservation buffer, insured depository institutions are required to meet the following capital level requirements in order to qualify as “well capitalized:” a common equity Tier 1 capital ratio of 6.5%; a Tier 1 capital ratio of 8%; a total capital ratio of 10%; and a Tier 1 leverage ratio of 5%.

 

Based on management’s understanding and interpretation of the new capital rules, it believes that, as of December 31, 2020, the Bank meets all capital adequacy requirements under such rules on a fully phased-in basis as if such requirements were in effect as of such date.

 

In December 2017, the Basel Committee published standards that it described as the finalization of the Basel III post-crisis regulatory reforms (the standards are commonly referred to as “Basel IV”). Among other things, these standards revise the Basel Committee’s standardized approach for credit risk (including by recalibrating risk weights and introducing new capital requirements for certain “unconditionally cancellable commitments,” such as unused credit card lines of credit) and provide a new standardized approach for operational risk capital. Under the proposed framework, these standards will generally be effective on January 1, 2022, with an aggregate output floor phasing-in through January 1, 2027. Under the current capital rules, operational risk capital requirements and a capital floor apply only to advanced approaches institutions, and not to the Company. The impact of Basel IV on the Company and the Bank will depend on the manner in which it is implemented by the federal bank regulatory agencies.

 

As directed by the Economic Growth Act, on September 17, 2019, the FDIC finalized a rule that introduces an optional simplified measure of capital adequacy for qualifying community banking organizations (i.e., the community bank leverage ratio (“CBLR”) framework). 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 9.00%, less than $10.0 billion in total consolidated assets, and limited amounts of off-balance sheet exposures and trading assets and liabilities.  The CBLR rules were temporarily modified in response to COVID-19.  See “CARES Act” below.  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 calculated risk-based capital.

 

The CBLR framework was available for banks to use in their December 31, 2020, Call Report. At this time the Company has elected not to opt into the CLBR framework for the Bank, but may opt into the CBLR framework in the future.

 

Dividends

 

The Company’s ability to distribute cash dividends depends primarily on the ability of the Bank to pay dividends to it. The Company is a legal entity, separate and distinct from its subsidiaries. A significant portion of the Company’s revenues result from dividends paid to it by the Bank. There are various legal limitations applicable to the payment of dividends by the Bank to the Company and to the payment of dividends by the Company to its shareholders. As a national bank, the Bank is subject to certain restrictions on its reserves and capital imposed by federal banking statutes and regulations. Under OCC regulations, a national bank may not declare a dividend in excess of its undivided profits. Additionally, a national bank may not declare a dividend if the total amount of all dividends, including the proposed dividend, declared by the national bank in any calendar year exceeds the total of the national bank’s retained net income of that year to date, combined with its retained net income of the two preceding years, unless the dividend is approved by the OCC. A national bank may not declare or pay any dividend if, after making the dividend, the national bank would be “undercapitalized,” as defined in regulations of the OCC.

 

In addition, under the current supervisory practices of the Federal Reserve, the Company should inform and consult with its regulators reasonably in advance of declaring or paying a dividend that exceeds earnings for the period (e.g., quarter) for which the dividend is being paid or that could result in a material adverse change to the Company’s capital structure.

 

Permitted Activities

 

As a bank holding company, the Company is limited to managing or controlling banks, furnishing services to or performing services for its subsidiaries, and engaging in other activities that the Federal Reserve determines by regulation or order to be so closely related to banking or managing or controlling banks as to be a proper incident thereto. In determining whether a particular activity is permissible, the Federal Reserve must consider whether the performance of such an activity reasonably can be expected to produce benefits to the public that outweigh possible adverse effects. Possible benefits include greater convenience, increased competition, and gains in efficiency. Possible adverse effects include undue concentration of resources, decreased or unfair competition, conflicts of interest, and unsound banking practices. Despite prior approval, the Federal Reserve may order a bank holding company or its subsidiaries to terminate any activity or to terminate ownership or control of any subsidiary when the Federal Reserve has reasonable cause to believe that a serious risk to the financial safety, soundness or stability of any bank subsidiary of that bank holding company may result from such an activity.

 

Banking Acquisitions; Changes in Control

 

The BHC Act requires, among other things, the prior approval of the Federal Reserve in any case where a bank holding company proposes to (i) acquire direct or indirect ownership or control of more than 5% of the outstanding voting stock of any bank or bank holding company (unless it already owns a majority of such voting shares), (ii) acquire all or substantially all of the assets of another bank or bank holding company, or (iii) merge or consolidate with any other bank holding company. In determining whether to approve a proposed bank acquisition, the Federal Reserve will consider, among other factors, the effect of the acquisition on competition, the public benefits expected to be received from the acquisition, the projected capital ratios and levels on a post-acquisition basis, and the acquiring institution’s performance under the Community Reinvestment Act of 1977 (the “CRA”) and its compliance with fair housing and other consumer protection laws.

 

 

Subject to certain exceptions, the BHC Act and the Change in Bank Control Act, together with the applicable regulations, require Federal Reserve approval (or, depending on the circumstances, no notice of disapproval) prior to any person or company acquiring “control” of a bank or bank holding company. A conclusive presumption of control exists if an individual or company acquires the power, directly or indirectly, to direct the management or policies of an insured depository institution or to vote 25% or more of any class of voting securities of any insured depository institution. A rebuttable presumption of control exists if a person or company acquires 10% or more but less than 25% of any class of voting securities of an insured depository institution and either the institution has registered its securities with the Securities and Exchange Commission under Section 12 of the Securities Exchange Act of 1934 (the “Exchange Act”) or no other person will own a greater percentage of that class of voting securities immediately after the acquisition. The Company’s common stock currently is not registered under Section 12 of the Exchange Act.

 

In addition, Virginia law requires the prior approval of the SCC for (i) the acquisition of more than 5% of the voting shares of a Virginia bank or any holding company that controls a Virginia bank, or (ii) the acquisition by a Virginia bank holding company of a bank or its holding company domiciled outside Virginia.

 

Source of Strength

 

Federal Reserve policy has historically required bank holding companies to act as a source of financial and managerial strength to their subsidiary banks. The Dodd-Frank Act codified this policy as a statutory requirement. Under this requirement, the Company is expected to commit resources to support the Bank, including at times when the Company may not be in a financial position to provide such resources. Any capital loans by a bank holding company to any of its subsidiary banks are subordinate in right of payment to depositors and to certain other indebtedness of such subsidiary banks. In the event of a bank holding company’s bankruptcy, any commitment by the bank holding company to a federal bank regulatory agency to maintain the capital of a subsidiary bank will be assumed by the bankruptcy trustee and entitled to priority of payment.

 

Safety and Soundness

 

There are a number of obligations and restrictions imposed on bank holding companies and their subsidiary banks by law and regulatory policy that are designed to minimize potential loss to the depositors of such depository institutions and the FDIC insurance fund in the event of a depository institution default. For example, under the Federal Deposit Insurance Corporation Improvement Act of 1991, to avoid receivership of an insured depository institution subsidiary, a bank holding company is required to guarantee the compliance of any subsidiary bank that may become “undercapitalized” with the terms of any capital restoration plan filed by such subsidiary with its appropriate federal bank regulatory agency up to the lesser of (i) an amount equal to 5% of the institution’s total assets at the time the institution became undercapitalized or (ii) the amount that is necessary (or would have been necessary) to bring the institution into compliance with all applicable capital standards as of the time the institution fails to comply with such capital restoration plan.

 

Under the FDIA, the federal bank regulatory agencies have adopted guidelines prescribing safety and soundness standards. These guidelines establish general standards relating to internal controls and information systems, internal audit systems, loan documentation, credit underwriting, interest rate exposure, asset growth and compensation, fees and benefits. In general, the guidelines require, among other things, appropriate systems and practices to identify and manage the risk and exposures specified in the guidelines.

 

The Federal Deposit Insurance Corporation Improvement Act

 

Under the Federal Deposit Insurance Corporation Improvement Act of 1991 (“FDICIA”), the federal bank regulatory agencies possess broad powers to take prompt corrective action to resolve problems of insured depository institutions.  The extent of these powers depends upon whether the institution is “well capitalized,” “adequately capitalized,” “undercapitalized,” “significantly undercapitalized,” or “critically undercapitalized,” as defined by the law.

 

 

Reflecting changes under the new Basel III capital requirements, the relevant capital measures that became effective on January 1, 2015 for prompt corrective action are the total capital ratio, the common equity Tier 1 capital ratio, the Tier 1 capital ratio and the leverage ratio.  A bank will be (i) “well capitalized” if the institution has a total risk-based capital ratio of 10.0% or greater, a common equity Tier 1 capital ratio of 6.5% or greater, a Tier 1 risk-based capital ratio of 8.0% or greater, and a leverage ratio of 5.0% or greater, and is not subject to any capital directive order; (ii) “adequately capitalized” if the institution has a total risk-based capital ratio of 8.0% or greater, a common equity Tier 1 capital ratio of 4.5% or greater, a Tier 1 risk-based capital ratio of 6.0% or greater, and a leverage ratio of 4.0% or greater and is not “well capitalized”; (iii) “undercapitalized” if the institution has a total risk-based capital ratio that is less than 8.0%, a common equity Tier 1 capital ratio less than 4.5%, a Tier 1 risk-based capital ratio of less than 6.0% or a leverage ratio of less than 4.0%; (iv) “significantly undercapitalized” if the institution has a total risk-based capital ratio of less than 6.0%, a common equity Tier 1 capital ratio less than 3.0%, a Tier 1 risk-based capital ratio of less than 4.0% or a leverage ratio of less than 3.0%; and (v) “critically undercapitalized” if the institution’s tangible equity is equal to or less than 2.0% of average quarterly tangible assets. An institution may be downgraded to, or deemed to be in, a capital category that is lower than indicated by its capital ratios if it is determined to be in an unsafe or unsound condition or if it receives an unsatisfactory examination rating with respect to certain matters. A bank’s capital category is determined solely for the purpose of applying prompt corrective action regulations, and the capital category may not constitute an accurate representation of the bank’s overall financial condition or prospects for other purposes.  Management believes, as of December 31, 2020 and 2019, the Company met the requirements for being classified as “well capitalized.”

 

As discussed under “Capital Requirements” above, federal banking regulators have issued a final rule that permits qualifying banks that have less than $10 billion in total consolidated assets to elect to be subject to a 9% “community bank leverage ratio,” in which case a bank that has chosen such proposed framework would be considered to have met the capital ratio requirements to be “well capitalized” under prompt corrective action rules, provided it has a community bank leverage ratio greater than 9%.

 

As required by FDICIA, the federal bank regulatory agencies also have adopted guidelines prescribing safety and soundness standards relating to, among other things, internal controls and information systems, internal audit systems, loan documentation, credit underwriting, and interest rate exposure.  In general, the guidelines require appropriate systems and practices to identify and manage the risks and exposures specified in the guidelines.  In addition, the agencies adopted regulations that authorize, but do not require, an institution which has been notified that it is not in compliance with safety and soundness standard to submit a compliance plan.  If, after being so notified, an institution fails to submit an acceptable compliance plan, the agency must issue an order directing action to correct the deficiency and may issue an order directing other actions of the types to which an undercapitalized institution is subject under the prompt corrective action provisions described above.

 

Branching

 

The Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994, as amended (the “Interstate Banking Act”), generally permits well capitalized bank holding companies to acquire banks in any state, and preempts all state laws restricting the ownership by a bank holding company of banks in more than one state. The Interstate Banking Act also permits a bank to merge with an out-of-state bank and convert any offices into branches of the resulting bank if both states have not opted out of interstate branching; and permits a bank to acquire branches from an out-of-state bank if the law of the state where the branches are located permits the interstate branch acquisition. Under the Dodd-Frank Act, a bank holding company or bank must be well capitalized and well managed to engage in an interstate acquisition. Bank holding companies and banks are required to obtain prior Federal Reserve approval to acquire more than 5% of a class of voting securities, or substantially all of the assets, of a bank holding company, bank or savings association. The Interstate Banking Act and the Dodd-Frank Act permit banks to establish and operate de novo interstate branches to the same extent a bank chartered by the host state may establish branches.

 

Transactions with Affiliates

 

Pursuant to Sections 23A and 23B of the Federal Reserve Act and Regulation W, the authority of the Bank to engage in transactions with related parties or “affiliates” or to make loans to insiders is limited. Loan transactions with an affiliate generally must be collateralized and certain transactions between the Bank and its affiliates, including the sale of assets, the payment of money or the provision of services, must be on terms and conditions that are substantially the same, or at least as favorable to the Bank, as those prevailing for comparable nonaffiliated transactions. In addition, the Bank generally may not purchase securities issued or underwritten by affiliates.

 

 

Loans to executive officers, directors or to any person who directly or indirectly, or acting through or in concert with one or more persons, owns, controls or has the power to vote more than 10% of any class of voting securities of a bank (a “10% Shareholders”), are subject to Sections 22(g) and 22(h) of the Federal Reserve Act and their corresponding regulations (Regulation O) and Section 13(k) of the Exchange Act relating to the prohibition on personal loans to executives (which exempts financial institutions in compliance with the insider lending restrictions of Section 22(h) of the Federal Reserve Act). Among other things, these loans must be made on terms substantially the same as those prevailing on transactions made to unaffiliated individuals and certain extensions of credit to those persons must first be approved in advance by a disinterested majority of the entire board of directors. Section 22(h) of the Federal Reserve Act prohibits loans to any of those individuals where the aggregate amount exceeds an amount equal to 15% of an institution’s unimpaired capital and surplus plus an additional 10% of unimpaired capital and surplus in the case of loans that are fully secured by readily marketable collateral, or when the aggregate amount on all of the extensions of credit outstanding to all of these persons would exceed the Bank’s unimpaired capital and unimpaired surplus. Section 22(g) of the Federal Reserve Act identifies limited circumstances in which the Bank is permitted to extend credit to executive officers.

 

Consumer Financial Protection

 

The Company is subject to a number of federal and state consumer protection laws that extensively govern its relationship with its customers. These laws include the Equal Credit Opportunity Act, the Fair Credit Reporting Act, the Truth in Lending Act, the Truth in Savings Act, the Electronic Fund Transfer Act, the Expedited Funds Availability Act, the Home Mortgage Disclosure Act, the Fair Housing Act, the Real Estate Settlement Procedures Act, the Fair Debt Collection Practices Act, the Service Members Civil Relief Act, laws governing flood insurance, federal and state laws prohibiting unfair and deceptive business practices, foreclosure laws, and various regulations that implement some or all of the foregoing. These laws and regulations mandate certain disclosure requirements and regulate the manner in which financial institutions must deal with customers when taking deposits, making loans, collecting loans and providing other services. If the Company fails to comply with these laws and regulations, it may be subject to various penalties. Failure to comply with consumer protection requirements may also result in failure to obtain any required bank regulatory approval for merger or acquisition transactions the Company may wish to pursue or being prohibited from engaging in such transactions even if approval is not required.

 

The Dodd-Frank Act centralized responsibility for consumer financial protection by creating a new agency, the Consumer Financial Protection Bureau (“CFPB”), and giving it responsibility for implementing, examining, and enforcing compliance with federal consumer protection laws. The CFPB focuses on (i) risks to consumers and compliance with the federal consumer financial laws, (ii) the markets in which firms operate and risks to consumers posed by activities in those markets, (iii) depository institutions that offer a wide variety of consumer financial products and services, and (iv) non-depository companies that offer one or more consumer financial products or services. The CFPB has broad rule making authority for a wide range of consumer financial laws that apply to all banks, including, among other things, the authority to prohibit “unfair, deceptive or abusive” acts and practices. Abusive acts or practices are defined as those that materially interfere with a consumer’s ability to understand a term or condition of a consumer financial product or service or take unreasonable advantage of a consumer’s (i) lack of financial savvy, (ii) inability to protect himself in the selection or use of consumer financial products or services, or (iii) reasonable reliance on a covered entity to act in the consumer’s interests. The CFPB can issue cease-and-desist orders against banks and other entities that violate consumer financial laws. The CFPB may also institute a civil action against an entity in violation of federal consumer financial law in order to impose a civil penalty or injunction.

 

Community Reinvestment Act

 

The CRA requires the appropriate federal banking agency, in connection with its examination of a bank, to assess the bank’s record in meeting the credit needs of the communities served by the bank, including low and moderate income neighborhoods.  Furthermore, such assessment is also required of banks that have applied, among other things, to merge or consolidate with or acquire the assets or assume the liabilities of an insured depository institution, or to open or relocate a branch.  In the case of a BHC applying for approval to acquire a bank or BHC, the record of each subsidiary bank of the applicant BHC is subject to assessment in considering the application.  Under the CRA, institutions are assigned a rating of “outstanding,” “satisfactory,” “needs to improve,” or “substantial non-compliance.”  The Company was rated “outstanding” in its most recent CRA evaluation.

 

 

On June 5, 2020, the OCC published a final rule, effective October 1, 2020, to modernize the agency’s regulations under the CRA. The rule (i) clarifies which activities qualify for CRA credit and (ii) requires banks to identify an additional assessment area based on where they receive a significant portion of their domestic retail products, thus creating two assessment areas: a deposit-based assessment area and a facility-based assessment area. Further, on November 24, 2020, the OCC issued a proposed rule to establish the agency's proposed approach to determine the CRA evaluation measure benchmarks, retail lending distribution test thresholds, and community development minimums under the general performance standards set forth in the June 2020 final rule. The Company is evaluating what impact this new rule will have on its operations.

 

Anti-Money Laundering Laws and Regulations

 

The Bank is subject to several federal laws that are designed to combat money laundering, terrorist financing, and transactions with persons, companies or foreign governments designated by U.S. authorities (“AML laws”). This category of laws includes the Bank Secrecy Act of 1970, the Money Laundering Control Act of 1986, the USA PATRIOT Act of 2001, and the Anti-Money Laundering Act of 2020. The Anti-Money Laundering Act of 2020, the most sweeping anti-money laundering legislation in 20 years, requires various federal agencies to promulgate regulations implementing a number of its provisions.

 

The AML laws and their implementing regulations require insured depository institutions, broker-dealers, and certain other financial institutions to have policies, procedures, and controls to detect, prevent, and report money laundering and terrorist financing. The AML laws and their regulations also provide for information sharing, subject to conditions, between federal law enforcement agencies and financial institutions, as well as among financial institutions, for counter-terrorism purposes. Federal banking regulators are required, when reviewing bank holding company acquisition and bank merger applications, to take into account the effectiveness of the anti-money laundering activities of the applicants. To comply with these obligations, the Company has implemented appropriate internal practices, procedures, and controls.

 

Privacy Legislation

 

Several recent laws, including the Right to Financial Privacy Act, and related regulations issued by the federal bank regulatory agencies, also provide new protections against the transfer and use of customer information by financial institutions. A financial institution must provide to its customers information regarding its policies and procedures with respect to the handling of customers’ personal information. Each institution must conduct an internal risk assessment of its ability to protect customer information. These privacy provisions generally prohibit a financial institution from providing a customer’s personal financial information to unaffiliated parties without prior notice and approval from the customer.

 

Incentive Compensation

 

In June 2010, the federal bank regulatory agencies issued comprehensive final guidance on incentive compensation policies intended to ensure that the incentive compensation policies of financial institutions do not undermine the safety and soundness of such institutions by encouraging excessive risk-taking. The Interagency Guidance on Sound Incentive Compensation Policies, which covers all employees that have the ability to materially affect the risk profile of a financial institutions, either individually or as part of a group, is based upon the key principles that a financial institution’s incentive compensation arrangements should (i) provide incentives that do not encourage risk-taking beyond the institution’s ability to effectively identify and manage risks, (ii) be compatible with effective internal controls and risk management, and (iii) be supported by strong corporate governance, including active and effective oversight by the financial institution’s board of directors.

 

 

The OCC will review, as part of the regular, risk-focused examination process, the incentive compensation arrangements of financial institutions, such as the Bank, that are not “large, complex banking organizations.” These reviews will be tailored to each financial institution based on the scope and complexity of the institution’s activities and the prevalence of incentive compensation arrangements. The findings of the supervisory initiatives will be included in reports of examination. Deficiencies will be incorporated into the institution’s supervisory ratings, which can affect the institution’s ability to make acquisitions and take other actions. Enforcement actions may be taken against a financial institution if its incentive compensation arrangements, or related risk-management control or governance processes, pose a risk to the institution’s safety and soundness and the financial institution is not taking prompt and effective measures to correct the deficiencies. At December 31, 2020, the Company had not been made aware of any instances of non-compliance with the final guidance.

 

Cybersecurity

 

The federal banking agencies have adopted guidelines for establishing information security standards and cybersecurity programs for implementing safeguards under the supervision of a financial institution’s board of directors. These guidelines, along with related regulatory materials, increasingly focus on risk management and processes related to information technology and the use of third parties in the provision of financial products and services. The federal banking agencies expect financial institutions to establish lines of defense and ensure that their risk management processes also address the risk posed by compromised customer credentials, and also expect financial institutions to maintain sufficient business continuity planning processes to ensure rapid recovery, resumption and maintenance of the institution’s operations after a cyber-attack. If the Bank fails to meet the expectations set forth in this regulatory guidance, it could be subject to various regulatory actions and any remediation efforts may require significant resources of the Bank. In addition, all federal and state bank regulatory agencies continue to increase focus on cybersecurity programs and risks as part of regular supervisory exams.

 

In December 2020, the federal banking agencies issued a notice of proposed rulemaking that would require banking organizations to notify their primary regulator within 36 hours of becoming aware of a “computer-security incident” or a “notification incident.” The proposed rule also would require specific and immediate notifications by bank service providers that become aware of similar incidents.

 

Effect of Governmental Monetary Policies

 

The Company’s operations are affected not only by general economic conditions, but also by the policies of various regulatory authorities.  In particular, the Federal Reserve regulates money and credit conditions and interest rates to influence general economic conditions.  These policies have a significant impact on overall growth and distribution of loans, investments and deposits; they affect interest rates charged on loans or paid for time and savings deposits.  Federal Reserve monetary policies have had a significant effect on the operating results of commercial banks, including the Company, in the past and are expected to do so in the future.  As a result, it is difficult for the Company to predict the potential effects of possible changes in monetary policies upon its future operating results.

 

CARES Act

 

On March 27, 2020, President Trump signed the Coronavirus Aid Relief and Economic Security (“CARES”) Act into law.  The CARES Act established several new temporary U.S. Small Business Administration (“SBA”) loan programs to assist U.S. small businesses through the COVID-19 pandemic.  One of the new loan programs is the Small Business Paycheck Protection Program (“SBA-PPP”), an expansion of the SBA’s 7(a) loan program and the Economic Injury Disaster Loan Program.  Many of the provisions of the CARES Act, including the availability of PPP loans, were renewed or extended by the Coronavirus Response and Relief Supplemental Appropriations Act on December 21, 2020.

 

The SBA-PPP provides loans to small businesses who were affected by economic conditions as a result of COVID-19 to provide cash-flow assistance to employers who maintain their payroll (including healthcare and certain related expenses), mortgage interest, rent, leases, utilities and interest on existing debt during this emergency.  Eligible borrowers need to make a good faith certification that the uncertainty of current economic conditions make requesting assistance necessary to support ongoing operations.  Pursuant to the provisions of Section 1106 of the CARES Act, borrowers may apply to the Bank for loan forgiveness of all or a portion of the loan, subject to certain eligibility requirements and conditions.

 

 

The Bank is an SBA lender and began accepting applications under the CARES Act via its online application process on April 3, 2020.  As of December 31, 2020, the Bank had outstanding 1,008 SBA-PPP loans totaling $51.1 million.

 

The CARES Act also allows banks to elect to suspend requirements under GAAP for loan modifications related to the COVID-19 pandemic (for loans that were not more than 30 days past due as of December 31, 2019) that would otherwise be categorized as a TDR, including impairment for accounting purposes, until the earlier of 60 days after the termination date of the national emergency or December 31, 2020. Federal banking regulators are required to defer to the determination of the banks making such suspension. The Consolidated Appropriations Act, 2021, signed into law on December 27, 2020, extended this temporary relief until the earlier of 60 days after the termination date of the national emergency or January 1, 2022.

 

In addition, the CARES Act directed federal bank regulators to adopt interim final rules to lower the threshold under the CBLR from 9% to 8% and to provide a reasonable grace period for a community bank that falls below the threshold to regain compliance, in each case until the earlier of the termination date of the national emergency or December 31, 2020. In April 2020, the federal bank regulators issued two interim final rules implementing this directive. One interim final rule provides that, as of the second quarter 2020, banking organizations with leverage ratios of 8% or greater (and that meet the other existing qualifying criteria) may elect to use the CBLR framework. It also establishes a two-quarter grace period for qualifying community banking organizations whose leverage ratios fall below the 8% CBLR, so long as the banking organization maintains a leverage ratio of 7% or greater. The second interim final rule provides a transition from the temporary 8% CBLR requirement to a 9% CBLR requirement. It establishes a minimum CBLR of 8% for the second through fourth quarters of 2020, 8.5% for 2021, and 9% thereafter, and maintains a two-quarter grace period for qualifying community banking organizations whose leverage ratios fall no more than 100 basis points below the applicable CBLR requirement.

 

 

Item 1A.

Risk Factors.

 

Risks Related to Macroeconomic and Political Conditions

 

We may be adversely affected by economic conditions in our market area.

 

We are located in southwestern Virginia and northwestern North Carolina, and our local economy is heavily influenced by the furniture and textile industries, both of which have been in decline in recent years. Further changes in the economy may influence the growth rate of our loans and deposits, the quality of the loan portfolio and loan and deposit pricing. Higher unemployment rates may lead to future increases in past-due and nonperforming loans thus having a negative impact on the earnings of the Bank. An additional, significant decline in general economic conditions caused by inflation, recession, unemployment or other factors beyond our control, would impact these local economic conditions and the demand for banking products and services generally, which could negatively affect our financial condition and performance.

 

We may be adversely impacted by changes in market conditions.

 

We are directly and indirectly affected by fluctuations in market conditions, which are subject to rapid or unpredictable change. Market risk generally represents the risk that values of assets and liabilities or revenues will be adversely affected by changes in market conditions. As a financial institution, market risk is inherent in the financial instruments associated with our operations and activities, including loans, deposits, securities, short-term borrowings, long-term debt and trading account assets and liabilities. A few of the market conditions that may shift from time to time, thereby exposing us to market risk, include fluctuations in interest rates, equity and futures prices, and price deterioration or changes in value due to changes in market perception or actual credit quality of issuers. Our investment securities portfolio, in particular, may be impacted by market conditions beyond our control, including rating agency downgrades of the securities, defaults of the issuers of the securities, lack of market pricing of the securities, and inactivity or instability in the credit markets. Any changes in these conditions, in current accounting principles or interpretations of these principles could impact our assessment of fair value and thus the determination of other-than-temporary impairment of the securities in the investment securities portfolio.

 

The ongoing COVID-19 pandemic and measures intended to prevent its spread may adversely affect our business, financial condition and operations; the extent of such impacts are highly uncertain and difficult to predict.

 

Global health and economic concerns relating to the COVID-19 outbreak and government actions taken to reduce the spread of the virus have had a material adverse impact on the macroeconomic environment, and the outbreak has significantly increased economic uncertainty. The pandemic has resulted in federal, state and local authorities, including those who govern the markets in which we operate, implementing numerous measures to try to contain the virus.  These measures, including shelter in place orders and business limitations and shutdowns, have significantly contributed to rising unemployment and negatively impacted consumer and business spending.

 

The COVID-19 outbreak has adversely impacted and is likely to continue to adversely impact our workforce and operations and the operations of our customers and business partners. In particular, we may experience adverse effects due to a number of operational factors impacting us or our customers or business partners, including but not limited to:

 

●

credit losses resulting from financial stress experienced by our borrowers, especially those operating in industries most hard hit by government measures to contain the spread of the virus;

 

 

	●	operational failures, disruptions or inefficiencies due to changes in our normal business practices necessitated by our internal measures to protect our employees and government-mandated measures intended to slow the spread of the virus;
	●	possible business disruptions experienced by our vendors and business partners in carrying out work that supports our operations;
	●	decreased demand for our products and services due to economic uncertainty, volatile market conditions and temporary business closures;
	●	any financial liability, credit losses, litigation costs or reputational damage resulting from our origination of SBA-PPP loans; and
	●	heightened levels of cyber and payment fraud, as cyber criminals try to take advantage of the disruption and increased online activity brought about by the pandemic.

 

The extent to which the pandemic impacts our business, liquidity, financial condition and operations will depend on future developments, which are highly uncertain and are difficult to predict, including, but not limited to, its duration and severity, the actions to contain it or treat its impact, and how quickly and to what extent normal economic and operating conditions can resume. In addition, the rapidly changing and unprecedented nature of COVID-19 heightens the inherent uncertainty of forecasting future economic conditions and their impact on our loan portfolio, thereby increasing the risk that the assumptions, judgments and estimates used to determine the allowance for loan losses and other estimates are incorrect. Further, our loan deferral program could delay or make it difficult to identify the extent of asset quality deterioration during the deferral periods. As a result of these and other conditions, the ultimate impact of the pandemic is highly uncertain and subject to change, and we cannot predict the full extent of the impacts on our business, our operations or the global economy as a whole. To the extent any of the foregoing risks or other factors that develop as a result of COVID-19 materialize, it could exacerbate the risk factors discussed above, or otherwise materially and adversely affect our business, liquidity, financial condition and results of operations.

 

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

 

On March 27, 2020, President Trump signed the CARES Act, which included a $349 billion loan program administered through the SBA referred to as SBA-PPP.  Under the SBA-PPP, small businesses and other entities and individuals can apply for loans from existing SBA lenders and other approved regulated lenders that enroll in the program, subject to numerous limitations and eligibility criteria.  The Bank participated as a lender in the SBA-PPP.  The SBA-PPP opened on April 3, 2020; however, because of the short timeframe between the passing of the CARES Act and the opening of the SBA-PPP, there is some ambiguity in the laws, rules and guidance regarding the operation of the SBA-PPP, which exposes us to potential risks relating to noncompliance with the SBA-PPP.  Since then, the SBA and the U.S. Department of Treasury have provided additional guidance and clarity on the SBA-PPP through the issuance of over 20 interim final rules implementing the SBA-PPP.  On or about April 16, 2020, the SBA notified lenders that the $349 billion earmarked for the SBA-PPP was exhausted.  The SBA-PPP was then expanded by the Paycheck Protection Program and Health Care Enhancement Act in late April 2020, adding an additional $310 billion in funding while the Paycheck Protection Program Flexibility Act made certain changes to the SBA-PPP, by allowing for more time to spend the funds, and making it easier to get a loan fully forgiven.  Many of the provisions of the CARES Act, including the availability of SBA-PPP loans, were renewed or extended by the Coronavirus Response and Relief Supplemental Appropriations Act on December 21, 2020.  As of December 31, 2020, we had 1,008 SBA-PPP loans outstanding with an outstanding principal balance of $52.5 million, less unearned net fees of $1.4 million. 

 

Since the initiation of the SBA-PPP, several larger banks have been subject to litigation regarding the protocols and procedures that they used in processing applications for the SBA-PPP.  We may be exposed to the risk of similar litigation, from both customers and non-customers that approached us regarding the SBA-PPP loans, regarding our policies and procedures used in processing applications for the SBA-PPP. If any such litigation is filed against the Company or the Bank and is not resolved in a manner favorable to us, it could result in financial liability or adversely affect our reputation.  In addition, litigation can be costly regardless of outcome.  Any financial liability, litigation costs or reputation damage caused by SBA-PPP related litigation could have an adverse impact on our business, financial condition and results of operations.

 

We also 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 Bank, such as an issue with the eligibility of a borrower to receive a SBA-PPP loan, which may or may not be related to the ambiguity in the laws, rules and guidance regarding the operation of the SBA-PPP.  In the event of a loss resulting from a default on a SBA-PPP loan and a determination by the SBA that there was a deficiency in the manner in which the SBA-PPP loan was originated, funded, or serviced by us, 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 us.

 

 

Risks Related to Credit Risks

 

Our concentration in loans secured by real estate may increase our credit losses, which would negatively affect our financial results.

 

We offer a variety of secured loans, including commercial lines of credit, commercial term loans, real estate, construction, home equity, consumer and other loans. Many of our loans are secured by real estate (both residential and commercial) in our market area. At December 31, 2020, the Company had $562.3 million of such loans outstanding, or 84.67% of its total loans. A major change in the real estate market, such as deterioration in the value of this collateral, or in the local or national economy, could adversely affect our customers’ ability to pay these loans, which in turn could impact us. Risk of loan defaults and foreclosures are unavoidable in the banking industry, and we try to limit our exposure to this risk by monitoring our extensions of credit carefully. We cannot fully eliminate credit risk, and as a result credit losses may occur in the future.

 

Should our loan quality deteriorate, and our allowance for loan losses becomes inadequate, our results of operations may be adversely affected.

 

Our earnings are significantly affected by our ability to properly originate, underwrite and service loans. In addition, we maintain an allowance for loan losses that we believe is a reasonable estimate of known and inherent losses within our loan portfolio. We could sustain losses if we incorrectly assess the creditworthiness of our borrowers or fail to detect or respond to deterioration in asset quality in a timely manner. Through a periodic review and consideration of the loan portfolio, management determines the amount of the allowance for loan losses by considering general market conditions, credit quality of the loan portfolio, the collateral supporting the loans and performance of customers relative to their financial obligations.

 

The amount of future loan losses will be influenced by changes in economic, operating and other conditions, including changes in interest rates, which may be beyond our control, and these losses may exceed current estimates. Although we believe the allowance for loan losses is a reasonable estimate of known and inherent losses in the loan portfolio, we cannot precisely predict such losses or be certain that the loan loss allowance will be adequate in the future. While the risk of nonpayment is inherent in banking, we could experience greater nonpayment levels than we anticipate. Further deterioration in the quality of our loan portfolio could cause our interest income and net interest margin to decrease and our provisions for loan losses to increase further, which could adversely affect our results of operations and financial condition.

 

Federal and state regulators periodically review our allowance for loan losses and may require us to increase our provision for loan losses or recognize further loan charge-offs, based on judgments different than those of management. Any increase in the amount of the provision or loans charged-off as required by these regulatory agencies could have a negative effect on our operating results and financial condition.

 

Our small-to-medium sized business target market may have fewer financial resources to weather a downturn in the economy.

 

We target our business development and marketing strategy primarily to serve the banking and financial services needs of small and medium sized businesses. These businesses generally have less capital or borrowing capacity than larger entities. If general economic conditions adversely affect this major economic sector in our markets, our results of operations and financial condition may be adversely affected.

 

Risks Related to Liquidity and Interest Rate Risk

 

Our ability to maintain adequate sources of liquidity may be negatively impacted by the economic environment which could adversely affect our financial condition and results of operations.

 

In managing our consolidated balance sheet, we depend on cash and due from banks, federal funds sold, loan and investment security payments, core deposits, lines of credit with correspondent banks and lines of credit with the Federal Home Loan Bank to provide sufficient liquidity to meet our commitments and business needs, and to accommodate the transaction and cash management needs of clients. The availability of these funding sources is highly dependent upon the perception of the liquidity and creditworthiness of the financial institution, and such perception can change quickly in response to market conditions or circumstances unique to a particular company. Any event that limits our access to these sources, such as a decline in the confidence of debt purchasers, or our depositors or counterparties, may adversely affect our liquidity, financial position, and results of operations.

 

 

We may incur losses if we are unable to successfully manage interest rate risk.

 

Our profitability will depend in substantial part upon the spread between the interest rates earned on investments and loans and interest rates paid on deposits and other interest-bearing liabilities. Changes in interest rates will affect our operating performance and financial condition in diverse ways including the pricing of securities, loans and deposits and the volume of loan originations in our mortgage-origination office. We attempt to minimize our exposure to interest rate risk, but we will be unable to eliminate it. Our net interest spread will depend on many factors that are partly or entirely outside our control, including competition, federal economic, monetary and fiscal policies, and economic conditions generally.

 

Risks Related to Our Business and Industry

 

Our future success is dependent on our ability to compete effectively in the highly competitive banking industry.

 

We face vigorous competition from other banks and other financial institutions, including savings and loan associations, savings banks, finance companies and credit unions for deposits, loans and other financial services in our market area. A number of these banks and other financial institutions are significantly larger than we are and have substantially greater access to capital and other resources, as well as larger lending limits and branch systems, and offer a wider array of banking services. In addition, credit unions have been able to increasingly expand their membership definition and, because they enjoy a favorable tax status, may be able to offer more attractive loan and deposit pricing. To a limited extent, we also compete with other providers of financial services, such as money market mutual funds, brokerage firms, consumer finance companies, marketplace lenders and other financial technology firms, insurance companies and governmental organizations which may offer more favorable financing than we can. Many of our non-bank competitors are not subject to the same extensive regulations that govern us. As a result, these non-bank competitors have advantages over us in providing certain services. This competition may reduce or limit our margins and our market share and may adversely affect our results of operations and financial condition.

 

Our ability to operate profitably may be dependent on our ability to implement various technologies into our operations.

 

The market for financial services, including banking and consumer finance services, is increasingly affected by advances in technology, including developments in telecommunications, data processing, computers, automation, online banking and tele-banking. The pace of technological change has increased in the "fintech" environment, in which industry-changing technology-driven products and services are often introduced and adopted, including innovative ways that customers can make payments, access products, and manage accounts. Our ability to compete successfully in our market may depend on the extent to which we are able to exploit such technological changes. If we are not able to afford such technologies, properly or timely anticipate or implement such technologies, or effectively train our staff to use such technologies, our business, financial condition or operating results could be adversely affected.

 

Consumers may decide not to use banks to complete their financial transactions.

 

Technology and other changes are allowing parties to complete financial transactions through alternative methods that historically have involved banks. The activity and prominence of so-called marketplace lenders and other technological financial service companies have grown significantly over recent years and are expected to continue growing. In addition, consumers can now maintain funds that would have historically been held as bank deposits in brokerage accounts, mutual funds or general-purpose reloadable prepaid cards. Consumers can also complete transactions, such as paying bills and/or transferring funds directly without the assistance of banks. The process of eliminating banks as intermediaries, known as “disintermediation,” could result in the loss of fee income, as well as the loss of customer deposits and the related income generated from those deposits. If we are unable to address the competitive pressures that we face, we could lose market share, which could result in reduced net revenue and profitability and lower returns. The loss of these revenue streams and the lower cost of deposits as a source of funds could have a material adverse effect on our financial condition and results of operations.

 

 

Our exposure to operational risk may adversely affect our business.

 

We are exposed to many types of operational risk, including reputational risk, legal and compliance risk, the risk of fraud or theft by employees or outsiders, unauthorized transactions by employees or operational errors, including clerical or record-keeping errors or those resulting from faulty or disabled computer or telecommunications systems. Reputational risk, or the risk to our earnings and capital from negative public opinion, could result from our actual alleged conduct in any number of activities, including lending practices, corporate governance, regulatory compliance or the occurrence of any of the events or instances mentioned below, or from actions taken by government regulators or community organizations in response to that conduct. Negative public opinion could also result from adverse news or publicity that impairs the reputation of the financial services industry generally.

 

Further, if any of our financial, accounting, or other data processing systems fail or have other significant shortcomings, we could be adversely affected. We depend on internal systems and outsourced technology to support these data storage and processing operations. Our inability to use or access these information systems at critical points in time could unfavorably impact the timeliness and efficiency of our business operations. We could be adversely affected if one of our employees causes a significant operational break-down or failure, either as a result of human error or where an individual purposefully sabotages or fraudulently manipulates our operations or systems. We are also at risk of the impact of business disruptions resulting from natural disasters, pandemic, terrorism and international hostilities, including effects on our workforce or systems or for the effects of outages or other failures involving power or communications systems operated by others.

 

Misconduct by employees could include fraudulent, improper or unauthorized activities on behalf of clients or improper use of confidential information. We may not be able to prevent employee errors or misconduct, and the precautions we take to detect this type of activity might not be effective in all cases. Employee errors or misconduct could subject us to civil claims for negligence or regulatory enforcement actions, including fines and restrictions on our business. In addition, there have been instances where financial institutions have been victims of fraudulent activity in which criminals pose as customers to initiate wire and automated clearinghouse transactions out of customer accounts. Although we have policies and procedures in place to verify the authenticity of our customers, we cannot assure that such policies and procedures will prevent all fraudulent transfers. Such activity can result in financial liability and harm to our reputation.

 

If any of the foregoing risks materialize, it could have a material adverse affect on our business, financial condition and results of operations.

 

Natural disasters, severe weather events, acts of war or terrorism, pandemics or endemics, climate change and other external events could significantly impact our business.

 

Natural disasters, including severe weather events of increasing strength and frequency due to climate change, acts of war or terrorism, pandemics or endemics and other adverse external events could have a significant adverse impact on business operations of the Company, third parties who perform operational services for the Company or the Company’s borrowers and customers. Such events could affect the stability of the Company’s deposit base, impair the ability of borrowers to repay outstanding loans, impair the value of collateral securing loans, cause significant property damage, result in lost revenue or cause the Company to incur additional expenses. Although the Company’s management has established disaster recovery policies and procedures, the occurrence of any such event could have a material adverse effect on the Company’s business, which, in turn, could have a material adverse effect on the Company’s financial condition and results of operations.

 

 

Our operations depend upon third party vendors that perform services for us.

 

We are reliant upon certain external vendors to provide products and services necessary to maintain our day-to-day operations, including data processing and interchange and transmission services for the ATM network. Accordingly, our success depends on the services provided by these vendors, and our operations are exposed to risk that these vendors will not perform in accordance with the contracted service agreements. Although we maintain a system of policies and procedures designed to monitor and mitigate vendor risks, the failure of an external vendor to perform in accordance with the contracted arrangements under service agreements could disrupt our operations, which could have a material adverse impact on our business and, in turn, our financial condition and results of operations.

 

Our operations may be adversely affected by cybersecurity risks.

 

In the ordinary course of business, we collect and store sensitive data, including proprietary business information and personally identifiable information of our customers and employees, in systems and on networks. The secure processing, maintenance and use of this information is critical to our operations and business strategy. We have invested in accepted technologies and review processes and practices that are designed to protect our networks, computers and data from damage or unauthorized access. Despite these security measures, our computer systems and infrastructure may be vulnerable to attacks by hackers or breached due to employee error, malfeasance or other disruptions. The Bank has experienced fraudulent online banking enrollments to gain access to home equity lines of credit in the past. Risks and exposures related to cybersecurity attacks are expected to remain high for the foreseeable future due to the rapidly evolving nature and sophistication of these threats, as well as due to the expanding use of Internet banking, mobile banking and other technology-based products and services by the Bank and its customers. A breach of any kind could compromise systems and the information stored there could be accessed, damaged or disclosed. A breach in security could result in legal claims, regulatory penalties, reimbursement of fraudulent transfers, disruption in operations and damage to our reputation, which could adversely affect our business.

 

Our inability to successfully manage growth or implement our growth strategy may adversely affect our results of operations and financial condition.

 

A key aspect of our long-term business strategy is our continued growth and expansion. We may not be able to successfully implement this strategy if we are unable to identify attractive expansion locations or opportunities in the future. In addition, our successful implementation and management of growth will be contingent upon whether we can maintain appropriate levels of capital to support our growth, maintain control over expenses, maintain adequate asset quality, attract talented bankers and successfully integrate into the organization any branches or businesses acquired. As we continue to implement our growth strategy, we expect to incur increased personnel, occupancy and other operating expenses. In many cases, our expenses will increase prior to the income we expect to generate from the growth. For instance, in the case of new branches, we must absorb these expenses prior to or as we begin to generate new deposits, and there is a further time lag involved in redeploying the new deposits into attractively priced loans and other higher yielding earning assets. Thus, our plans to branch or expand loan or mortgage operations could depress earnings in the short run, even if we are able to efficiently execute our strategy.

 

In addition, our business strategy involves branch expansion in North Carolina, with several branches opening in new markets in western North Carolina in 2020. The banking business in western North Carolina is competitive, and the level of competition may increase further. There can be no assurance that Parkway will be able to successfully compete in this competitive market, or that we will be able to successfully manage additional growth in western North Carolina. Because of our limited participation in these new markets, there may be unexpected challenges and difficulties that could adversely affect our operations.

 

Risks Related to the Regulatory Environment

 

An inability to maintain our regulatory capital position could adversely affect our operations.

 

As of December 31, 2020, the Bank was classified as “well capitalized” for regulatory capital purposes. If we do not maintain the expected levels of regulatory capital in the future, it could increase the regulatory scrutiny on Parkway and the Bank, and the OCC could establish individual minimum capital ratios or take other regulatory actions against us. Further, if the Bank were no longer “well capitalized” for regulatory capital purposes, it would not be able to offer interest rates on deposit accounts that are significantly higher than the average rates in its market area. As a result, it may be more difficult for us to increase deposits. If we are not able to attract new deposits, our ability to fund our loan portfolio may be adversely affected. In addition, the Bank is subject to a capital conservation buffer designed to absorb losses during periods of economic stress.  Banking institutions with a ratio of common equity Tier 1 to risk-weighted assets above the minimum capital requirements but below the conservation buffer will face constraints on dividends, equity repurchases, and compensation based on the amount of the shortfall. We also could be required to pay higher insurance premiums to the FDIC if our capital position declines, which would reduce our earnings. Any of the foregoing could have a material adverse effect on our operations or financial condition.

 

 

Our profitability may suffer because of rapid and unpredictable changes in the highly regulated environment in which we operate.

 

We are subject to extensive supervision by several governmental regulatory agencies at the federal and state levels. Recently enacted, proposed and future banking legislation and regulations have had, and will continue to have, a significant impact on the financial services industry. These regulations, which are intended to protect depositors and not our shareholders, and the interpretation and application of them by federal and state regulators, are beyond our control, may change rapidly and unpredictably and can be expected to influence our earnings and growth. Our success depends on our continued ability to comply with these regulations.

 

We are subject to stringent capital requirements, which could adversely affect our results of operations and future growth.

 

In 2013, the Federal Reserve, the FDIC and the OCC approved a new rule that substantially amended the regulatory risk-based capital rules applicable to us. The final rule implemented the “Basel III” regulatory capital reforms and changes required by the Dodd-Frank Act. The final rule included new minimum risk-based capital and leverage ratios that became effective for us on January 1, 2015, and refined the definition of what constitutes “capital” for purposes of calculating these ratios. The new minimum capital requirements are: (i) a new common equity Tier 1 (“CET1”) capital ratio of 4.5%; (ii) a Tier 1 to risk-based assets capital ratio of 6%; (iii) a total capital ratio of 8%; and (iv) a Tier 1 leverage ratio of 4%. The final rule also established a “capital conservation buffer” of 2.5% above the new regulatory minimum capital ratios, and when fully effective on January 1, 2019, resulted in the following minimum ratios: (a) a common equity Tier 1 capital ratio of 7.0%; (b) a Tier 1 to risk-based assets capital ratio of 8.5%; and (c) a total capital ratio of 10.5%. An institution will be subject to limitations on paying dividends, engaging in share repurchases, and paying discretionary bonuses if its capital level falls below the buffer amount. These limitations will establish a maximum percentage of eligible retained income that can be utilized for such activities. In addition, the final rule provides for a number of new deductions from and adjustments to capital and prescribes a revised approach for risk weightings that could result in higher risk weights for a variety of asset categories.

 

While the Economic Growth Act requires that federal banking regulators establish a simplified leverage capital framework for smaller banks, these more stringent capital requirements for us could, among other things, result in lower returns on equity, require the raising of additional capital, adversely affect our future growth opportunities, and result in regulatory actions such as a prohibition on the payment of dividends or on the repurchase shares if we were unable to comply with such requirements.

 

Government measures to regulate the financial industry could materially affect our businesses, financial condition or results of operations.

 

As a financial institution, we are heavily regulated at the state and federal levels. Banking regulations generally are intended to protect depositors, not investors, and regulators have broad interpretive and enforcement powers beyond our control that may change rapidly and unpredictably and could influence our earnings and growth. Our success depends on our continued ability to comply with these regulations. Future changes in the laws or regulations or their interpretations or enforcement could be materially adverse to us and our shareholders.

 

Further, as a result of the financial crisis and related global economic downturn that began in 2008, we have faced, and expect to continue to face, increased public and legislative scrutiny as well as stricter and more comprehensive regulation of our financial services practices. In July 2010, the Dodd-Frank Act was signed into law and has increased our compliance costs in the short term. With the incoming Biden administration, a Democratic controlled Congress, and changes in leadership at federal agencies such as the CFPB, we expect that financial institutions will remain heavily regulated in the near future and that additional laws or regulations may be adopted further regulating specific banking practices. The ultimate impact of current or future legislation on our businesses and results of operations, will depend on regulatory interpretation and rulemaking, as well as the success of our actions to mitigate the negative earnings impact of certain provisions.

 

 

The Bank may be required to transition from the use of the London Interbank Offered Rate (“LIBOR”) index in the future.

 

The Bank has certain variable-rate loans indexed to LIBOR to calculate the loan interest rate. The United Kingdom Financial Conduct Authority, which regulates LIBOR, has previously announced that the continued availability of the LIBOR on the current basis is not guaranteed after 2021. In November 2020, the administrator of LIBOR announced it will consult on its intention to extend the retirement date of certain offered rates whereby the publication of the one week and two month LIBOR offered rates will cease after December 31, 2021; but, the publication of the remaining LIBOR offered rates will continue until June 30, 2023. Given consumer protection, litigation, and reputation risks, federal bank regulators have indicated that entering into new contracts that use LIBOR as a reference rate after December 31, 2021, would create safety and soundness risks and that they will examine bank practices accordingly. Therefore, the agencies encouraged banks to cease entering into new contracts that use LIBOR as a reference rate as soon as practicable and in any event by December 31, 2021.

 

It is difficult to predict whether and to what extent banks will continue to provide LIBOR submissions to the administrator of LIBOR or whether any additional reforms to LIBOR may be enacted in the United Kingdom or elsewhere. At this time, no consensus exists as to what rate or rates may become acceptable alternatives to LIBOR, and it is impossible to predict the effect of any such alternatives on the value of LIBOR-based variable-rate loans, as well as LIBOR-based securities, subordinated notes, trust preferred securities, or other securities or financial arrangements. The transition to alternative reference rate for new contracts, or the implementation of a substitute index or indices for the calculation of interest rates under the Bank’s existing loan agreements with borrowers or other financial arrangements, could change the Bank’s market risk profile, interest margin, interest spread and pricing models, may cause the Bank to incur significant expenses in effecting the transition, may result in reduced loan balances if borrowers do not accept a substitute index or indices, and may result in disputes or litigation with customers or other counter-parties over the appropriateness or comparability to LIBOR of the substitute index or indices, any of which could have a material adverse effect on the Bank’s results of operations.

 

Changes in accounting standards could impact reported earnings and capital.

 

The authorities that promulgate accounting standards, including the Financial Accounting Standards Board (the “FASB”), the SEC, and other regulatory authorities, periodically change the financial accounting and reporting standards that govern the preparation of the Company’s consolidated financial statements. These changes are difficult to predict and can materially impact how the Company records and reports its financial condition and results of operations. In some cases, the Company could be required to apply a new or revised standard retroactively, resulting in the restatement of financial statements for prior periods. Such changes could also impact the capital levels of the Company and the Bank, or require the Company to incur additional personnel or technology costs. Most notably, new guidance on the calculation of credit reserves using current expected credit losses, referred to as CECL, was finalized in June, 2016. The standard will be effective for the Company beginning January 1, 2023. To implement the new standard, the Company will incur costs related to data collection and documentation, technology and training. For additional information, see “Recent Accounting Pronouncements” in Note 1 of the consolidated financial statements. Although the Company is currently unable to reasonably estimate the impact of the new standard on its financial statements, adoption of the new standard could necessitate, among other things, higher loan loss reserve levels, and the Company expects to recognize a one-time cumulative effect adjustment to the allowance for loan losses during the quarter in which the standard becomes effective. If the Company is required to materially increase the level of the allowance for loan losses or incurs additional expenses to determine the appropriate level of the allowance for loan losses, such changes could adversely affect the Company’s capital levels, financial condition and results of operations.

 

 

Item 1B.

Unresolved Staff Comments.

 

None.

 

Item 2.

Properties.

 

The Company is headquartered at 101 Jacksonville Circle, Floyd, Virginia. The Bank is headquartered in the Main Office at 113 West Main Street, Independence, Virginia. The Bank operates branches at the following locations, all of which are owned by the Bank, except for the offices in Boone, Mocksville, and Willis, which are leased facilities:

 

East Independence Office – 802 East Main St., Independence, VA	276-773-2811	Full service
Elk Creek Office – 60 Comers Rock Rd., Elk Creek, VA	276-655-4011	Full service
Galax Office – 209 West Grayson St., Galax, VA	276-238-2411	Full service
Troutdale Office – 101 Ripshin Rd., Troutdale, VA	276-677-3722	Full service
Carroll Office – 8351 Carrollton Pike, Galax, VA	276-238-8112	Full service
Sparta Office – 98 South Grayson Street, Sparta NC	336-372-2811	Full service
Hillsville Office – 419 South Main Street, Hillsville, VA	276-728-2810	Full service
Whitetop Office – 16303 Highlands Parkway, Whitetop, VA	276-388-3811	Full service
Wytheville Office – 420 North 4th Street, Wytheville, VA	276-228-6050	Full service
Floyd Office - 101 Jacksonville Circle, Floyd, VA	540-745-4191	Full service
Cave Spring Office - 4094 Postal Drive, Roanoke, VA	540-774-1111	Full service
Christiansburg Office - 2145 Roanoke Street, Christiansburg, VA	540-381-8121	Full service
Fairlawn Office - 7349 Peppers Ferry Blvd., Radford, VA	540-633-1680	Full service
Roanoke Office – 3850 Keagy Rd., Roanoke, VA	540-387-4533	Full service
West Jefferson Office – 1055 Mount Jefferson Road, West Jefferson, NC	336-489-7811	Full service
Boone Office – 189 Boone Heights Drive, Boone, NC	828-264-4260	Full service
Wilkesboro Office – 1422 US Highway 421, Wilkesboro, NC	336-903-4948	Full service
Yadkinville Office – 516 Hawthorne Drive, Yadkinville, NC	336-849-4194	Full service
Mocksville Office – 119 Gaither Street, Mocksville, NC	336-849-4194	Full service
Lenoir Office – 509 Wilkesboro Blvd. NE, Lenoir, NC	828-750-6100	Full service
Hickory Office – 2900 Hwy 127 South, Hickory, NC	828-578-7400	Full service
Hudson Office – 537 Main Street, Hudson, NC	828-750-6076	Full service
Willis Office - 5598 B Floyd Highway South, Willis, VA	540-745-4191	Limited service/conducts normal teller transactions

 

The Bank has a conference center located at 203 E. Oxford Street, Floyd, Virginia, which is used for various board and committee meetings, as well as continuing education and training programs for bank employees. The Bank owns an operations center adjacent to the main office in Independence, Virginia. The Bank also leases an administrative office in the town of Wilkesboro, North Carolina. The Bank operates two loan production offices in leased facilities in the town of Blacksburg, Virginia, and the city of Shelby, North Carolina. The Bank purchased an existing vacant building in Pulaski, Virginia in May of 2019. The Bank anticipates opening this building as a full service branch facility in the future. The Bank purchased land in Christiansburg, Virginia in January of 2020. The Bank plans to construct a full service branch banking facility on the property and anticipates opening of this location in the 4^th quarter of 2021.

 

Item 3.

Legal Proceedings.

 

There are no material pending legal proceedings, other than ordinary routine litigation incidental to the business, to which the Company is a party or of which any of its property is subject.

 

Item 4.

Mine Safety Disclosures.

 

Not applicable.

 

 

PART II

 

Item 5.

Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchasers of Equity Securities.

 

The Company’s common stock is quoted on the OTC Markets Group’s OTCQX tier under the symbol “PKKW.” As of March 23, 2021, there were 6,035,775 shares of the Company’s common stock outstanding, held by 1,390 shareholders of record.

 

The Company’s common stock began quotation on the OTC Market on or about August 31, 2016, before which there was no trading market and no market price for the Company’s common stock. Any over-the-counter market quotations in the Company’s common stock reflect inter-dealer prices, without retail mark-up, mark-down or commission and may not represent actual transactions. The Company was incorporated under Virginia law on November 2, 2015, solely to facilitate the merger between Cardinal and Grayson that was completed on July 1, 2016.

 

Dividend Policy

 

The Company historically has paid dividends on its common stock on a semi-annual basis. The final determination of the timing, amount and payment of dividends on the Company’s common stock is at the discretion of the Company’s Board of Directors and will depend upon the earnings of the Company and its subsidiaries, principally the Bank, the financial condition of the Company and other factors, including general economic conditions and applicable governmental regulations and policies as discussed in “Item 1., Business – Government Supervision and Regulation – Dividends,” above.

 

The Company’s ability to distribute cash dividends will depend primarily on the ability of the Bank to pay dividends to it. As a national bank, the Bank is subject to certain restrictions on our reserves and capital imposed by federal banking statutes and regulations. Furthermore, under Virginia law, the Company may not declare or pay a cash dividend on its capital stock if it is insolvent or if the payment of the dividend would render it insolvent or unable to pay its obligations as they become due in the ordinary course of business. For additional information on these limitations, see “Item 1. Business – Government Supervision and Regulation – Dividends,” above.

 

Securities Authorized for Issuance Under Equity Compensation Plans

 

The following table summarizes information, as of December 31, 2020, relating to the Company’s stock-based compensation plans under which shares of common stock are authorized for issuance.

 

Equity Compensation Plan Information
		Number of Shares To Be Issued Upon Exercise of Outstanding Options, Warrants and Rights				Weighted-Average Exercise Price of Outstanding Options, Warrants and Rights				Number of Shares Remaining Available for Future Issuance Under Equity Compensation Plans
Equity compensation plans approved by shareholders: 2020 Equity Incentive Plan			-			$	-				300,000
Equity compensation plans not approved by shareholders (1)			-				-				-
Total			-			$	-				300,000

 

---

⁽¹⁾  The Company does not have any equity compensation plans that have not been approved by shareholders.

 

 

Stock Repurchases

 

In January 2019, the Board of Directors (“Board”) of the Company approved a stock repurchase plan. The Board has authorized an initial repurchase of up to 200,000 shares of its common stock from time to time for a period of two years ending in January 2021. In May 2020 the Board amended the plan to increase the shares by 150,000, bringing the aggregate total to 350,000 shares of common stock. In January 2021, the Board authorized the extension of the 182,500 shares remaining in the plan to January 2023. The Company intends to purchase shares periodically through privately negotiated transactions or in the open market in accordance with SEC rules. The actual timing, number and value of shares repurchased under the plan will be determined by management in its discretion and will depend on a number of factors, including the market price of the shares, general market and economic conditions, applicable legal requirements and other conditions. During 2019, we repurchased 76,000 shares of our common stock under our stock repurchase program at an average cost per share of $11.95 and a total cost of $908 thousand. During 2020, we repurchased 91,500 shares of our common stock under our stock repurchase program at an average cost per share of $11.05 and a total cost of $1.0 million.

 

The following table details the Company’s purchase of its common stock during the fourth quarter of 2020.

 

		Total number of shares purchased				Average price paid per Share				Total number of shares purchased as part of publicly announced program				Maximum number of shares that may yet be purchased under the plan
Purchased 10/1 through 10/31			-			$	-				-				197,500
Purchased 11/1 through 11/30			15,000			$	9.65				15,000				182,500
Purchased 12/1 through 12/31			-			$	-				-				182,500
Total			15,000			$	9.65				15,000

 

 

Item 6.

Selected Financial Data.

 

Financial Highlights1

 

 

		2020				2019				2018				2017				2016
Summary of Operations
Interest income		$	31,744			$	30,802			$	26,186			$	22,274			$	17,562
Interest expense			3,440				2,869				1,901				1,474				1,728
Net interest income			28,304				27,933				24,285				20,800				15,834
Provision for (reduction of) loan losses			1,189				655				325				217				(5	)
Other income			5,297				4,915				4,637				4,228				4,570
Other expense			25,098				23,258				22,857				19,280				16,816
Income taxes			1,445				1,780				1,214				3,104				1,175
Net income		$	5,869			$	7,155			$	4,526			$	2,427			$	2,418
Per Share Data
Net income		$	.97			$	1.16			$	.81			$	.48			$	.60
Cash dividends declared			.26				.24				.20				.16				.12
Book value			14.08				13.27				12.17				11.39				11.05
Year-end Balance Sheet Summary
Loans, net		$	659,195			$	566,460			$	532,970			$	421,418			$	408,548
Investment securities			33,507				32,881				45,428				50,675				62,540
Total assets			855,387				706,290				680,284				547,961				558,856
Deposits			755,528				611,211				601,868				488,441				499,387
Stockholders’ equity			85,106				81,428				75,622				57,182				55,466
Selected Ratios
Return on average assets			0.75	%			1.05	%			0.75	%			0.44	%			0.55	%
Return on average equity			7.06	%			9.10	%			7.02	%			4.28	%			5.62	%
Average equity to average assets			10.60	%			11.51	%			10.66	%			10.32	%			9.78	%

 

---

¹         In thousands of dollars, except per share data.

 

 

Management’s Discussion and Analysis

 

Item 7.

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

 

Management’s Discussion and Analysis of Operations

 

Overview

 

Management’s Discussion and Analysis is provided to assist in the understanding and evaluation of Parkway Acquisition Corp’s. financial condition and its results of operations. The following discussion should be read in conjunction with the Company’s consolidated financial statements.

 

Parkway Acquisition Corp. (“Parkway” or the “Company”) was incorporated as a Virginia corporation on November 2, 2015. Parkway was formed as a business combination shell company for the purpose of completing a business combination transaction between Grayson Bankshares, Inc. (“Grayson”) and Cardinal Bankshares Corporation (“Cardinal”). On November 6, 2015, Grayson, Cardinal and Parkway entered into an agreement pursuant to which Grayson and Cardinal merged with and into Parkway, with Parkway as the surviving corporation (the “Cardinal merger”). The merger agreement established exchange ratios under which each share of Grayson common stock was converted to the right to receive 1.76 shares of common stock of Parkway, while each share of Cardinal common stock was converted to the right to receive 1.30 shares of common stock of Parkway. The exchange ratios resulted in Grayson shareholders receiving approximately 60% of the newly issued Parkway shares and Cardinal shareholders receiving approximately 40% of the newly issued Parkway shares. The Cardinal merger was completed on July 1, 2016. Grayson was considered the acquiror and Cardinal was considered the acquiree in the transaction for accounting purposes. Upon completion of the Cardinal merger, the Bank of Floyd, a wholly-owned subsidiary of Cardinal, was merged with and into Grayson National Bank (the “Bank’), a wholly-owned subsidiary of Grayson. Effective March 13, 2017, the Bank changed its name to Skyline National Bank.

 

On March 1, 2018, Parkway entered into a definitive agreement pursuant to which Parkway acquired Great State Bank (“Great State”), based in Wilkesboro, North Carolina. The agreement provided for the merger of Great State with and into the Bank, with the Bank as the surviving bank (the “Great State merger”). The transaction closed and the merger became effective on July 1, 2018. Each share of Great State common stock was converted into the right to receive 1.21 shares of Parkway common stock. The Company issued 1,191,899 shares and recognized $15.5 million in surplus in the Great State merger. Parkway was considered the acquiror and Great State was considered the acquiree in the transaction for accounting purposes.

 

The Bank was organized under the laws of the United States in 1900 and now serves the Virginia counties of Grayson, Floyd, Carroll, Wythe, Montgomery and Roanoke, and the North Carolina counties of Alleghany, Ashe, Burke, Caldwell, Catawba, Cleveland, Davie, Watauga, Wilkes, and Yadkin, and the surrounding areas, through twenty-four full-service banking offices and two loan production offices. As an Federal Deposit Insurance Corporation (“FDIC”) insured national banking association, the Bank is subject to regulation by the Comptroller of the Currency and the FDIC. Parkway is regulated by the Board of Governors of the Federal Reserve System.

 

For purposes of this annual report, all information contained herein as of and for periods prior to July 1, 2016 reflects the operations of Grayson prior to the Cardinal merger. Unless this report otherwise indicates or the context otherwise requires, all references to “Parkway” or the “Company” as of and for periods subsequent to July 1, 2016 refer to the combined company and its subsidiary as a combined entity after the Cardinal merger, and all references to the “Company” as of and for periods prior to July 1, 2016 are references to Grayson and its subsidiary as a combined entity prior to the Cardinal merger. All information contained herein as of and for periods prior to July 1, 2018 reflects the operations of Parkway prior to the Great State merger. Unless this report otherwise indicates or the context otherwise requires, all references to “Parkway” or the “Company” as of and for periods subsequent to July 1, 2018 refer to the combined company and its subsidiary as a combined entity after the Great State merger, and all references to “Parkway” or the “Company” as of and for periods prior to July 1, 2018 are references to Parkway and its subsidiary as a combined entity prior to the merger.

 

 

Management’s Discussion and Analysis

 

Parkway had net earnings of $5.9 million for 2020 compared to $7.2 million for 2019.  Earnings in 2020 were impacted significantly by the COVID-19 pandemic and the branch expansion into North Carolina markets during 2020.  Earnings for the year ended December 31, 2020 represented a return on average assets of 0.75% and a return on average equity of 7.06%, compared to 1.05% and 9.10%, respectively, for the year ended December 31, 2019.  The net interest margin was 3.96% in 2020, compared to 4.51% in 2019.  The net interest margin compression is a reflection of the exceptionally low interest rate environment due to swift reductions in short term interest rates late in the first quarter of 2020 as well as continual competitive pressure on loan rates.  

 

Forward Looking Statements

 

From time to time, the Company and its senior managers have made and will make forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Such statements may be contained in this report and in other documents that the Company files with the Securities and Exchange Commission. Such statements may also be made by the Company and its senior managers in oral or written presentations to analysts, investors, the media and others. Forward-looking statements can be identified by the fact that they do not relate strictly to historical or current facts. Also, forward-looking statements can generally be identified by words such as “may,” “could,” “should,” “would,” “believe,” “anticipate,” “estimate,” “seek,” “expect,” “intend,” “plan” and similar expressions.

 

Forward-looking statements provide management’s expectations or predictions of future conditions, events or results. They are not guarantees of future performance. By their nature, forward-looking statements are subject to risks and uncertainties. These statements speak only as of the date they are made. The Company does not undertake to update forward-looking statements to reflect the impact of circumstances or events that arise after the date the forward-looking statements were made. There are a number of factors, many of which are beyond the Company’s control that could cause actual conditions, events or results to differ significantly from those described in the forward-looking statements. These factors, some of which are discussed elsewhere in this report, include:

 

●

any required increase in our regulatory capital ratios;

●

inflation, interest rate levels and market and monetary fluctuations;

●

the difficult market conditions in our industry;

●

trade, monetary and fiscal policies and laws, including interest rate policies of the federal government;

●

applicable laws and regulations and legislative or regulatory changes;

●

the timely development and acceptance of new products and services of the Company;

●

the willingness of customers to substitute competitors’ products and services for the Company’s products and services;

●

the financial condition of the Company’s borrowers and lenders;

●

the Company’s success in gaining regulatory approvals, when required;

●

technological and management changes;

●

growth and acquisition strategies;

●

the Company’s critical accounting policies and the implementation of such policies;

●

lower-than-expected revenue or cost savings or other issues in connection with mergers and acquisitions and branch expansion;

●

changes in consumer spending and saving habits;

●

the strength of the United States economy in general and the strength of the local economies in which the Company conducts its operations;

●

the effects of the COVID-19 pandemic, including the Company’s credit quality and business operations, as well as its impact on general economic and financial market conditions; and,

●

the Company’s success at managing the risks involved in the foregoing.

 

 

Management’s Discussion and Analysis

 

Critical Accounting Policies

 

The Company’s financial statements are prepared in accordance with accounting principles generally accepted in the United States (“GAAP”). The notes to the audited consolidated financial statements included in the Annual Report for the year ended December 31, 2020 contain a summary of its significant accounting policies. Management believes the Company’s policies with respect to the methodology for the determination of the allowance for loan losses, and asset impairment judgments, such as the recoverability of intangible assets and other-than-temporary impairment of investment securities, involve a higher degree of complexity and require management to make difficult and subjective judgments that often require assumptions or estimates about highly uncertain matters. Accordingly, management considers the policies related to those areas as critical.

 

The allowance for loan losses is an estimate of the losses that may be sustained in the loan portfolio. The allowance is based on two basic principles of accounting: the first of which requires that losses be accrued when they are probable of occurring and estimable, and the second, which requires that losses be accrued based on the differences between the value of collateral, present value of future cash flows or values that are observable in the secondary market, and the loan balance.

 

The allowance for loan losses has three basic components: (i) the formula allowance, (ii) the specific allowance, and (iii) the unallocated allowance. Each of these components is determined based upon estimates that can and do change when the actual events occur. The formula allowance uses a historical loss view as an indicator of future losses and, as a result, could differ from the loss incurred in the future. However, since this history is updated with the most recent loss information, the errors that might otherwise occur are mitigated. The specific allowance uses various techniques to arrive at an estimate of loss. Historical loss information, expected cash flows and fair market value of collateral are used to estimate these losses. The use of these techniques is inherently subjective and our actual losses could be greater or less than the estimates. The unallocated allowance captures losses that are attributable to various economic events, industry or geographic sectors whose impact on the portfolio have occurred but have yet to be recognized in either the formula or specific allowance.

 

 

Management’s Discussion and Analysis

 

 

Table 1.   Net Interest Income and Average Balances (dollars in thousands)

 

		2020												2019												2018
						Interest												Interest												Interest
		Average				Income/				Yield/				Average				Income/				Yield/				Average				Income/				Yield/
		Balance				Expense				Cost				Balance				Expense				Cost				Balance				Expense				Cost
Interest-earning assets:
Interest-bearing deposits		$	45,758			$	214				0.47	%		$	19,082			$	288				1.51	%		$	9,365			$	106				1.13	%
Federal funds sold			639				3				0.47	%			9,413				249				2.65	%			10,584				228				2.15	%
Investment securities			32,976				757				2.30	%			42,915				1,088				2.54	%			50,504				1,278				2.53	%
Loans 1, 2			634,755				30,770				4.85	%			548,611				29,177				5.32	%			476,900				24,574				5.15	%
Total			714,128				31,744								620,021				30,802								547,353				26,186
Yield on average interest-earning assets											4.45	%											4.97	%											4.78	%
Non interest-earning assets:
Cash and due from banks			10,211												8,364												8,218
Premises and equipment			26,044												21,383												19,055
Interest receivable and other			38,130												37,310												35,400
Allowance for loan losses			(4,474	)											(3,768	)											(3,435	)
Unrealized gain/(loss) on securities			530												(263	)											(1,283	)
Total			70,441												63,026												57,955
Total assets		$	784,569											$	683,047											$	605,308
Interest-bearing liabilities:
Demand deposits		$	145,068				328				0.23	%		$	128,645				301				0.23	%		$	115,409				194				0.17	%
Savings deposits			138,344				415				0.30	%			124,441				389				0.31	%			117,479				347				0.30	%
Time deposits			192,519				2,604				1.35	%			184,501				2,162				1.17	%			163,932				1,326				0.81	%
Borrowings			12,894				93				0.72	%			3,077				17				0.55	%			1,757				34				1.94	%
Total			488,825				3,440								440,664				2,869								398,577				1,901
Cost on average interest-bearing liabilities											0.70	%											0.65	%											0.48	%
Non interest-bearing liabilities:
Demand deposits			208,530												160,858												139,409
Interest payable and other			4,038												2,913												2,826
Total			212,568												163,771												142,235
Total liabilities			701,393												604,435												540,812
Stockholder's equity:			83,176												78,612												64,496
Total liabilities and stockholder's equity		$	784,569											$	683,047											$	605,308
Net interest income						$	28,304											$	27,933											$	24,285
Net yield on interest-earning assets											3.96	%											4.51	%											4.44	%

 

1  Includes nonaccural loans

2  Interest income includes loan fees

 

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Management’s Discussion and Analysis

 

 

Table 2.   Rate/Volume Variance Analysis (dollars in thousands)

 

		2020 Compared to 2019												2019 Compared to 2018
		Interest Income/				Variance Attributable To(1)								Interest Income/				Variance Attributable To(1)
		Expense Variance				Rate				Volume				Expense Variance				Rate				Volume
Interest-earning assets:
Interest bearing deposits		$	(74	)		$	72			$	(146	)		$	182			$	44			$	138
Federal funds sold			(246	)			(115	)			(131	)			21				40				(19	)
Investment securities			(331	)			(96	)			(235	)			(190	)			2				(192	)
Loans			1,593				(2,059	)			3,652				4,603				810				3,793
Total			942				(2,198	)			3,140				4,616				896				3,720
Interest-bearing liabilities:
Demand deposits			27				(10	)			37				107				83				24
Savings deposits			26				(15	)			41				42				21				21
Time deposits			442				345				97				836				653				183
Borrowings			76				7				69				(17	)			330				(347	)
Total			571				327				244				968				1,087				(119	)
Net interest income		$	371			$	(2,525	)		$	2,896			$	3,648			$	(191	)		$	3,839

 

(1)	The variance in interest attributed to both volume and rate has been allocated to variance attributed to volume and variance attributed to rate in proportion to the absolute value of the change in each.

 

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Net Interest Income

 

Net interest income, the principal source of Company earnings, is the amount of income generated by earning assets (primarily loans and investment securities) less the interest expense incurred on interest-bearing liabilities (primarily deposits used to fund earning assets). Table 1 summarizes the major components of net interest income for the past three years and also provides yields and average balances.

 

For the year ended December 31, 2020 total interest income increased by $942 thousand compared to the year ended December 31, 2019.  The increase in interest income in 2020 was primarily due to organic loan growth in new and existing markets of $44.6 million and $81.9 million of SBA-PPP loans originated in 2020; however, yields were negatively impacted by the exceptionally low interest rate environment due to swift reductions in short term interest rates late in the first quarter of 2020 as well as continual competitive pressure on loan rates.  As a result interest income on loans increased by $1.6 million in 2020 compared to $4.6 million in 2019. Accretion of purchased loan discounts increased interest income by $1.2 million in 2020 compared to $1.8 million in 2019, representing a decrease of $592 thousand.  The decreases in interest income on federal funds sold, investment securities, and interest-bearing deposits in banks were due to the impact of short term interest rates decreases discussed above. Interest expense on deposits increased by $495 thousand for the year ended December 31, 2020 compared to the same period last year due to the addition of $78.4 million in interest-bearing deposits from 2019 to 2020.  A significant portion of the growth in interest-bearing deposits year-over-year is attributed to increased balances held by customers during the pandemic, new relationships developed from the SBA-PPP program, as well as organic growth in new and existing markets.

 

 

Management’s Discussion and Analysis

 

Amortization of premiums on acquired time deposits, which reduces interest expense, totaled $189 thousand in 2020, compared to $384 thousand in 2019, representing a decrease of $195 thousand.  The effects of changes in volumes and rates on net interest income in 2020 compared to 2019, and 2019 compared to 2018 are shown in Table 2.

 

The aforementioned factors led to an increase in net interest income of $371 thousand or 1.33% for 2020 as compared to 2019. The net yield on interest-earning assets decreased by 55 basis points to 3.96% in 2020 compared to 4.51% in 2019.

 

Provision for Credit Losses

 

The allowance for credit losses is established to provide for expected losses in the Company’s loan portfolio. Management determines the provision for credit losses required to maintain an allowance adequate to provide for probable losses. Some of the factors considered in making this decision are the levels and collectability of past due loans, volume of new loans, composition of the loan portfolio, and general economic outlook.

 

The provision for loan losses was $1.2 million for the year ended December 31, 2020, compared to $655 thousand for the year ended December 31, 2019. The increase in loan loss provisions from 2019 to 2020 was due primarily to overall growth in the loan portfolio due to organic growth of $44.6 million in new and existing markets, excluding SBA-PPP loans originated, as well as management’s assessment of the impact of the COVID-19 pandemic on certain qualitative and environmental factors.

 

The allowance for loan losses for SBA-PPP loans originated during 2020 were separately evaluated given the explicit government guarantee. This analysis, which incorporated historical experience with similar SBA guarantees and underwriting, concluded the likelihood of loss was remote and therefore these loans were assigned a zero expected credit loss in the allowance for loan losses.

 

The reserve for loan losses at December 31, 2020 was approximately 0.74% of total loans, compared to 0.68% at December 31, 2019. Management’s estimate of probable credit losses inherent in the acquired Great State and Cardinal loan portfolios was reflected as a purchase discount which will continue to be accreted into income over the remaining life of the acquired loans. As of December 31, 2020 and 2019, the remaining unaccreted discount on the acquired loan portfolios totaled $2.0 million and $3.2 million, respectively. Management believes the provision and the resulting allowance for loan losses are adequate. Additional information is contained in Tables 12 and 13, and is discussed in Nonperforming and Problem Assets.

 

Other Income

 

Noninterest income growth was a key factor in the Company’s 2020 financial results as year-over-year net interest margins were negatively impacted by the low interest rate environment, and the Fed’s lowering of rates paid on overnight funds.  Noninterest income increased by $382 thousand in 2020 compared to 2019, despite the decrease of $211 thousand in service charges on deposit accounts, due to reduced consumer spending as well as increased balances held by our customers.  Mortgage origination fees increased by $261 thousand in 2020 compared to 2019.  The mortgage department closed approximately $43.5 million of mortgage loans for the secondary market during 2020 compared to $24.0 million in 2019.  Gains from sales of available-for-sale securities totaled $315 thousand for the year ended December 31, 2020 compared to $49 thousand for the year ended December 31, 2019.  Noninterest income increased by $278 thousand in 2019 compared to 2018.  The increase was due to growth and expansion of fee-based products and a change in overdraft fees.  Included in other income are nonrecurring gains from sale of bank premises and equipment totaling $122 thousand in 2019.  There were no nonrecurring gains from sale of bank premises and equipment in 2020 or 2018.

 

 

Management’s Discussion and Analysis

 

 

Table 3.   Sources of Noninterest Income (dollars in thousands)

 

		2020				2019				2018
Service charges on deposit accounts		$	1,441			$	1,652			$	1,538
Increase in cash value of life insurance			449				442				433
Life insurance income			-				-				303
Mortgage originations fees			720				459				396
Safe deposit box rental			90				91				93
Gain on securities			315				49				5
ATM income			1,613				1,465				1,324
Investment services income			35				62				126
Merchant services income			191				190				171
Interchange income			186				196				126
Other income			257				309				122
Total noninterest income		$	5,297			$	4,915			$	4,637

 

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Other Expense

 

The major components of noninterest expense for the past three years are illustrated at Table 4.

 

Total noninterest expenses increased by $1.8 million, or 7.91% for the year ended December 31, 2020, compared to the year ended December 31, 2019 reflecting additional costs associated with branching activities into new North Carolina markets. Salary and benefit cost increased by $1.4 million due to the increase in full time equivalent employees from December 31, 2019 to December 31, 2020.  Occupancy and equipment expenses increased by $287 thousand and data processing expenses increased by $219 thousand from 2019 to 2020, due to the addition of three branch facilities in 2020.  FDIC/OCC assessments increased by $171 thousand for the year ended December 31, 2020 compared to the year ended December 31, 2019 due to the Small Bank Assessment Credits received from the FDIC in 2019.  This increase was offset by a decrease in amortization of core deposit intangibles of $111 thousand for the year ended December 31, 2020, compared to same period in 2019. 

 

 

Management’s Discussion and Analysis

 

 

Table 4.   Sources of Noninterest Expense (dollars in thousands)

 

		2020				2019				2018
Salaries & wages		$	11,347			$	10,277			$	9,034
Employee benefits			3,256				2,968				2,768
Total personnel expense			14,603				13,245				11,802
Director fees			361				356				370
Occupancy expense			1,596				1,389				1,260
Data processing expense			1,765				1,546				1,353
Other equipment expense			1,029				1,047				988
FDIC/OCC assessments			383				212				390
Insurance			138				131				121
Professional fees			462				667				452
Advertising			683				603				569
Postage & freight			429				396				362
Supplies			279				223				212
Franchise tax			505				438				438
Telephone			370				371				415
Travel, dues & meetings			418				509				490
ATM expense			615				517				423
Foreclosure expenses			2				3				32
Core deposit intangible amortization			711				822				578
Merger related expenses			-				-				1,978
Other expense			749				783				624
Total noninterest expense		$	25,098			$	23,258			$	22,857

 

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The overhead efficiency ratio of noninterest expense to adjusted total revenue (net interest income plus noninterest income) was 74.69% in 2020, 70.80% in 2019, and 79.03% in 2018. The ratio for 2018, without the effect of nonrecurring merger related costs, would have been 72.19%.

 

Income Taxes

 

Income tax expense is based on amounts reported in the statements of income (after adjustments for non-taxable income and non-deductible expenses) and consists of taxes currently due plus deferred taxes on temporary differences in the recognition of income and expense for tax and financial statement purposes. The deferred tax assets and liabilities represent the future Federal income tax return consequences of those differences, which will either be taxable or deductible when the assets and liabilities are recovered or settled.

 

Income tax expense (substantially all Federal) was $1.4 million in 2020 and $1.8 million in 2019, resulting in effective tax rates of 19.8% and 19.9%, respectively.  The decrease in income tax expense of $335 thousand in 2020 was primarily due to the decreased in income before taxes of $1.6 million in 2020 compared to 2019.

 

Net deferred tax assets of $1.0 million, and $985 thousand existed at December 31, 2020 and 2019 respectively. At December 31, 2020, net deferred tax assets included $155 thousand of deferred tax assets applicable to unrealized gains on investment securities available for sale, and $293 thousand of deferred tax assets applicable to unfunded projected pension benefit obligations. Accordingly, these amounts were not charged to income but recorded directly to the related stockholders’ equity account.

 

 

Management’s Discussion and Analysis

 

Analysis of Financial Condition

 

Average earning assets increased 15.18% from 2019 to 2020 due to asset growth primarily reflected in increased loans, including SBA-PPP loans, and higher liquid asset balances due to deposit growth. Total earning assets represented 91.02% of total average assets in 2020 and 90.77% in 2019. The mix of average earning assets changed from 2019 to 2020 as average loans increased by $86.1 million, or 15.70%, average investment securities decreased by $9.9 million, or 23.16%, average federal funds sold decreased by $8.8 million, or 93.21%, and deposits in other banks increased by $26.7 million of 139.80%.

 

Table 5.   Average Asset Mix (dollars in thousands)

 

		2020								2019
		Average Balance				%				Average Balance				%
Earning assets:
Loans		$	634,755				80.91	%		$	548,611				80.32	%
Investment securities			32,976				4.20	%			42,915				6.28	%
Federal funds sold			639				0.08	%			9,413				1.38	%
Deposits in other banks			45,758				5.83	%			19,082				2.79	%
Total earning assets			714,128				91.02	%			620,021				90.77	%
Non earning assets:
Cash and due from banks			10,211				1.30	%			8,364				1.23	%
Premises and equipment			26,044				3.32	%			21,383				3.13	%
Other assets			38,130				4.86	%			37,310				5.46	%
Allowance for loan losses			(4,474	)			-0.57	%			(3,768	)			-0.55	%
Unrealized gain (loss) on securities			530				0.07	%			(263	)			-0.04	%
Total nonearning assets			70,441				8.98	%			63,026				9.23	%
Total assets		$	784,569				100.00	%		$	683,047				100.00	%

 

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Average loans for 2020 represented 80.91% of total average assets compared to 80.32% in 2019. Average federal funds sold decreased from 1.38% to 0.08% of total average assets while deposits in other banks increased from 2.79% to 5.83% of total average assets over the same time period. Average investment securities decreased from 6.28% in 2019 to 4.20% of total average assets in 2020. The balances of nonearning assets to total average assets decreased from 9.23% to 8.98%.

 

 

Management’s Discussion and Analysis

 

Loans

 

Average loans totaled $634.8 million over the year ended December 31, 2020. This represents an increase of 15.70% from the average of $548.6 million for 2019. The increase was due to SBA-PPP loans originated in addition to organic growth in new and existing markets of $44.6 million during 2020. Of the $81.9 million in SBA-PPP loans originated in April through August 2020, approximately $52.5 million with net deferred fees of $1.4 million remained on the balance sheet at December 31, 2020. Average loans increased by 15.04% from 2018 to 2019 due to loans acquired from the Great State merger along with organic loan growth of $33.9 million during 2019.

 

The loan portfolio consists primarily of real estate and commercial loans, including SBA-PPP loans.  These loans accounted for 96.97% of the total loan portfolio at December 31, 2020.  This is up from the 95.91% that the two categories maintained at December 31, 2019.  The amount of loans outstanding by type at December 31 of each of the past five years and the maturity distribution for variable and fixed rate loans as of December 31, 2020 are presented in Tables 6 and 7, respectively.

 

Table 6.   Loan Portfolio Summary (dollars in thousands)

 

		December 31, 2020								December 31, 2019								December 31, 2018
		Amount				%				Amount				%				Amount				%
Construction and development		$	46,053				6.93	%		$	39,649				6.95	%		$	33,449				6.23	%
Residential, 1-4 families			229,706				34.59	%			220,120				38.59	%			199,662				37.22	%
Residential, 5 or more families			50,187				7.56	%			33,554				5.88	%			36,027				6.72	%
Farm land			32,449				4.89	%			34,166				5.99	%			33,291				6.21	%
Nonfarm, nonresidential			203,886				30.70	%			190,817				33.46	%			176,192				32.84	%
Total real estate			562,281				84.67	%			518,306				90.87	%			478,621				89.22	%
Agricultural			3,127				0.47	%			3,697				0.65	%			4,600				0.86	%
Commercial			30,536				4.60	%			28,729				5.04	%			32,891				6.13	%
SBA-PPP			51,118				7.70	%			-				-	%			-				-	%
Consumer			7,127				1.07	%			7,250				1.27	%			7,396				1.38	%
Other			9,906				1.49	%			12,371				2.17	%			12,957				2.41	%
Total		$	664,095				100.00	%		$	570,353				100.00	%		$	536,465				100.00	%

 

		December 31, 2017								December 31, 2016
		Amount				%				Amount				%
Construction and development		$	25,475				6.00	%		$	26,464				6.42	%
Residential, 1-4 families			170,080				40.03	%			160,502				38.96	%
Residential, 5 or more families			29,040				6.84	%			26,686				6.48	%
Farm land			33,353				7.85	%			33,531				8.14	%
Nonfarm, nonresidential			125,661				29.57	%			128,515				31.20	%
Total real estate			383,609				90.29	%			375,698				91.20	%
Agricultural			2,792				0.66	%			2,779				0.67	%
Commercial			22,880				5.38	%			23,307				5.66	%
SBA-PPP			-				-	%			-				-	%
Consumer			5,868				1.38	%			5,491				1.33	%
Other			9,722				2.29	%			4,693				1.14	%
Total		$	424,871				100.00	%		$	411,968				100.00	%

 

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Management’s Discussion and Analysis

 

 

Table 7.   Maturity Schedule of Loans, as of December 31, 2020 (dollars in thousands)

 

						Commercial,
		Real				Agricultural &				Consumer				Total
		Estate				SBA-PPP				& Other				Amount				%
Fixed rate loans:
Three months or less		$	7,942			$	906			$	3,832			$	12,680				1.91	%
Over three to twelve months			14,618				2,651				478				17,747				2.67	%
Over one to five years			99,934				67,119				9,121				176,174				26.53	%
Over five years			44,501				3,671				1,700				49,872				7.51	%
Total fixed rate loans		$	166,995			$	74,347			$	15,131			$	256,473				38.62	%
Variable rate loans:
Three months or less		$	5,196			$	1,892			$	100			$	7,188				1.08	%
Over three to twelve months			12,661				5,809				113				18,583				2.80	%
Over one to five years			11,003				1,243				260				12,506				1.88	%
Over five years			366,426				1,490				1,429				369,345				55.62	%
Total variable rate loans		$	395,286			$	10,434			$	1,902			$	407,622				61.38	%
Total loans:
Three months or less		$	13,138			$	2,798			$	3,932			$	19,868				2.99	%
Over three to twelve months			27,279				8,460				591				36,330				5.47	%
Over one to five years			110,937				68,362				9,381				188,680				28.41	%
Over five years			410,927				5,161				3,129				419,217				63.13	%
Total loans		$	562,281			$	84,781			$	17,033			$	664,095				100.00	%

 

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Interest rates charged on loans vary with the degree of risk, maturity and amount of the loan. Competitive pressures, money market rates, availability of funds, and government regulations also influence interest rates. On average, loans yielded 4.85% in 2020 compared to an average yield of 5.32% in 2019. The decrease in loan yields was due to increasing competition in our markets for loans, in addition to a generally lower interest rate environment and the low rate of SBA-PPP loans, as well as a reduction in the overall impact of purchase accounting adjustment as the accretion of purchase loan discounts decreased by $370 thousand during 2020.

 

Investment Securities

 

The Company uses its investment portfolio to provide liquidity for unexpected deposit decreases or loan generation, to meet the Bank’s interest rate sensitivity goals, and to generate income.

 

Management of the investment portfolio has always been conservative with the majority of investments taking the form of purchases of U.S. Treasury, U.S. Government Agencies, U.S. Government Sponsored Enterprises and State and Municipal bonds, as well as investment grade corporate bond issues.  Management views the investment portfolio as a source of income, and purchases securities with the intent of retaining them until maturity.  However, adjustments are necessary in the portfolio to provide an adequate source of liquidity which can be used to meet funding requirements for loan demand and deposit fluctuations and to control interest rate risk.  Therefore, from time to time, management may sell certain securities prior to their maturity.  Table 8 presents the investment portfolio at the end of 2020 by major types of investments and contractual maturity ranges.  Investment securities in Table 8 may have repricing or call options that are earlier than the contractual maturity date.  Yields on tax exempt obligations are not computed on a tax-equivalent basis in Table 8.

 

The total amortized cost of investment securities decreased by approximately $46 thousand from December 31, 2019 to December 31, 2020, while the average balance of investment securities carried throughout the year decreased by approximately $9.9 million from 2019 to 2020.  The average yield of the investment portfolio decreased to 2.30% for the year ended December 31, 2020 compared to 2.54% for 2019.

 

 

Management’s Discussion and Analysis

 

 

Table 8.   Investment Securities - Maturity/Yield Schedule (dollars in thousands)

 

		December 31, 2020
		In One Year or Less				After One Through Five Years				After Five Through Ten Years				After Ten Years				Book Value 12/31/20				Market Value 12/31/20				Book Value 12/31/19				Book Value 12/31/18
Investment securities:
U.S. Government agencies		$	-			$	-			$	-			$	-			$	-			$	-			$	-			$	244
Mortgage-backed securities			-				969				5,678				8,565				15,212				15,684				19,540				25,627
Corporate securities			-				1,500				-				-				1,500				1,500				1,500				2,970
State and municipal securities			1,747				3,889				4,565				5,858				16,059				16,323				11,777				17,764
Total		$	1,747			$	6,358			$	10,243			$	14,423			$	32,771			$	33,507			$	32,817			$	46,605
Weighted average yields:
U.S. Government agencies			0.00	%			0.00	%			0.00	%			0.00	%			0.00	%
Mortgage-backed securities			0.00	%			2.15	%			2.12	%			1.48	%			1.76	%
Corporate securities			0.00	%			0.88	%			0.00	%			0.00	%			0.88	%
State and municipal securities			3.85	%			3.02	%			1.77	%			2.15	%			2.44	%
Total			3.85	%			2.38	%			1.97	%			1.75	%			2.05	%

 

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Deposits

 

The Company relies on deposits generated in its market area to provide the majority of funds needed to support lending activities and for investments in liquid assets. More specifically, core deposits (total deposits less certificates of deposit in denominations of $100,000 or more) are the primary funding source. The Company’s balance sheet growth is largely determined by the availability of deposits in its markets, the cost of attracting the deposits, and the prospects of profitably utilizing the available deposits by increasing the loan or investment portfolios. We believe that recent market conditions have resulted in depositors shopping for deposit rates more than in the past. An increased customer awareness of interest rates adds to the importance of rate management. The Company’s management must continuously monitor market pricing, competitor’s rates, and the internal interest rate spreads to maintain the Company’s growth and profitability. The Company attempts to structure rates so as to promote deposit and asset growth while at the same time increasing overall profitability of the Company.

 

Average total deposits for the year ended December 31, 2020 amounted to $684.5 million, which was an increase of $86.0 million, or 14.37% from 2019. A significant portion of the increase is attributed to increased balances held by customers during the pandemic, new relationships developed from the SBA-PPP program, as well as organic growth in new and existing markets. Average core deposits totaled $595.8 million in 2020 representing a 15.43% increase over the $516.2 million in 2019. The percentage of the Company’s average deposits that are interest-bearing decreased to 69.5% in 2020 compared to 73.1% in 2019 and 74.0% in 2018. This decrease is due to the average demand deposits, which earn no interest, increasing 29.64% from $160.9 million in 2019 to $208.5 million in 2020. Average deposits for the periods ended December 31, 2020, 2019, and 2018 are summarized in Table 9.

 

 

Management’s Discussion and Analysis

 

 

Table 9.   Deposit Mix (dollars in thousands)

 

		December 31, 2020												December 31, 2019
		Average Balance				% of Total Deposits				Average Rate Paid				Average Balance				% of Total Deposits				Average Rate Paid
Interest-bearing deposits:
Interest-bearing DDA accounts		$	86,696				12.7	%			0.12	%		$	75,498				12.6	%			0.12	%
Money market			58,372				8.5	%			0.39	%			53,147				8.9	%			0.40	%
Savings			138,344				20.2	%			0.30	%			124,441				20.8	%			0.31	%
Individual retirement accounts			44,044				6.5	%			1.19	%			44,581				7.5	%			1.13	%
Small denomination certificates			59,841				8.7	%			1.24	%			57,657				9.6	%			1.06	%
Large denomination certificates			88,634				12.9	%			1.51	%			82,263				13.7	%			1.27	%
Total interest-bearing deposits			475,931				69.5	%			0.70	%			437,587				73.1	%			0.65	%
Noninterest-bearing deposits			208,530				30.5	%			0.00	%			160,858				26.9	%			0.00	%
Total deposits		$	684,461				100.0	%			0.49	%		$	598,445				100.0	%			0.48	%

 

		December 31, 2018
		Average Balance				% of Total Deposits				Average Rate Paid
Interest-bearing deposits:
Interest-bearing DDA accounts		$	66,984				12.5	%			0.10	%
Money market			48,425				9.0	%			0.26	%
Savings			117,479				21.9	%			0.30	%
Individual retirement accounts			45,598				8.5	%			0.99	%
Small denomination certificates			55,700				10.4	%			0.57	%
Large denomination certificates			62,634				11.7	%			0.89	%
Total interest-bearing deposits			396,820				74.0	%			0.47	%
Noninterest-bearing deposits			139,409				26.0	%			0.00	%
Total deposits		$	536,229				100.0	%			0.35	%

 

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The average balance of certificates of deposit issued in denominations of $100,000 or more increased by $6.4 million, or 7.74%, for the year ended December 31, 2020 compared to December 31, 2019.  The strategy of management has been to support loan and investment growth with core deposits and not to aggressively solicit the more volatile, large denomination certificates of deposit.  Loan growth in 2020 was primarily funded through core deposit growth, in addition to reductions in investment securities, thus reducing management’s reliance on large denomination certificates of deposit for funding purposes.  Table 10 provides maturity information relating to certificates of deposit of $100,000 or more at December 31, 2020.

 

Table 10.   Large Denomination Certificate of Deposit Maturities (dollars in thousands)

 

Analysis of certificates of deposit of $100,000 or more at December 31, 2020:
Remaining maturity of three months or less		$	15,698
Remaining maturity over three months through six months			15,006
Remaining maturity over six months through twelve months			33,197
Remaining maturity over twelve months			26,874
Total certificates of deposit of $100,000 or more		$	90,775

 

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Management’s Discussion and Analysis

 

Equity

 

Stockholders’ equity totaled $85.1 million at December 31, 2020 compared to $81.4 million at December 31, 2019. The increase of $3.7 million was due to earnings of $5.9 million, plus other comprehensive income of $403 thousand, less common stock repurchases of $1.0 million, and the payment of dividends of $1.6 million. Book value increased from $13.27 per share at December 31, 2019 to $14.08 per share at December 31, 2020. 

 

Effective January 1, 2015, the federal banking regulators adopted rules to implement the Basel III regulatory capital reforms from the Basel Committee on Banking Supervision and certain provisions of the Dodd-Frank Act. The final rules required the Bank to comply with the following minimum capital ratios: (i) a new common equity Tier 1 capital ratio of 4.5% of risk-weighted assets; (ii) a Tier 1 capital ratio of 6% of risk-weighted assets; (iii) a total capital ratio of 8% of risk-weighted assets; and (iv) a leverage ratio of 4% of total assets.  As fully phased in on January 1, 2019, the rules require the Bank to maintain (i) a minimum ratio of common equity Tier 1 to risk-weighted assets of at least 4.5%, plus a 2.5% “capital conservation buffer” (which is added to the 4.5% common equity Tier 1 ratio, effectively resulting in a minimum ratio of common equity Tier 1 to risk-weighted assets of at least 7%), (ii) a minimum ratio of Tier 1 capital to risk-weighted assets of at least 6.0%, plus the 2.5% capital conservation buffer (which is added to the 6.0% Tier 1 capital ratio, effectively resulting in a minimum Tier 1 capital ratio of 8.5%), (iii) a minimum ratio of total capital to risk-weighted assets of at least 8.0%, plus the 2.5% capital conservation buffer (which is added to the 8.0% total capital ratio, effectively resulting in a minimum total capital ratio of 10.5%), and (iv) a minimum leverage ratio of 4%, calculated as the ratio of Tier 1 capital to average assets.

 

Under Basel III Capital requirements, a capital conservation buffer of 0.625% became effective beginning on January 1, 2016. The capital conservation buffer was gradually increased through January 1, 2019 to 2.50%. The capital conservation buffer is designed to absorb losses during periods of economic stress. Banks are now required to maintain levels that meet the required minimum plus the capital conservation buffer in order to make distributions, such as dividends, or discretionary bonus payments. The Banks’s capital conservation buffer is 5.10% as of December 31, 2020.

 

Table 11.   Bank’s Year-end Risk-Based Capital (dollars in thousands)

 

		2020				2019
Tier 1 Capital		$	79,240			$	74,726
Unrealized gains on AFS preferred stock			-				-
Qualifying allowance for loan losses (limited to 1.25% of risk-weighted assets)			4,936				3,926
Total regulatory capital		$	84,176			$	78,652
Total risk-weighted assets		$	642,612			$	581,235
Tier 1 capital as a percentage of risk-weighted assets			12.3	%			12.9	%
Common Equity Tier 1 capital as a percentage of risk-weighted assets			12.3	%			12.9	%
Total regulatory capital as a percentage of risk-weighted assets			13.1	%			13.5	%
Leverage ratio*			9.5	%			10.8	%

 

*

Tier 1 capital divided by average total assets for the quarter ended December 31 of each year.

 

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Management’s Discussion and Analysis

 

Nonperforming and Problem Assets

 

Certain credit risks are inherent in making loans, particularly commercial and consumer loans. Management prudently assesses these risks and attempts to manage them effectively. The Bank attempts to use shorter-term loans and, although a portion of the loans have been made based upon the value of collateral, the underwriting decision is generally based on the cash flow of the borrower as the source of repayment rather than the value of the collateral. The Bank also attempts to reduce repayment risk by adhering to internal credit policies and procedures. These policies and procedures include officer and customer limits, periodic loan documentation review and follow up on exceptions to credit policies.

 

Nonperforming assets at December 31, 2020, 2019, 2018, 2017, and 2016 are analyzed in Table 12.

 

Table 12.   Nonperforming Assets (dollars in thousands)

 

		2020				2019				2018				2017				2016
Nonperforming loans:
Nonaccrual loans		$	4,803			$	4,979			$	5,579			$	5,335			$	4,664
Restructured loans			3,844				4,695				6,961				7,743				9,239
Purchased credit-impaired loans on accrual status			116				128				-				-				-
Loans past due 90 days or more and still accruing			-				-				-				-				-
Total nonperforming loans			8,763				9,802				12,540				13,078				13,903
Foreclosed assets			-				-				753				-				70
Total nonperforming assets		$	8,763			$	9,802			$	13,293			$	13,078			$	13,973
Total nonperforming loans as a percentage to total loans			1.3	%			1.7	%			2.3	%			3.1	%			3.4	%
Total nonperforming assets as a percentage to total assets			1.0	%			1.4	%			2.0	%			2.4	%			2.5	%

 

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Total nonperforming loans were 1.3% and 1.7% of total outstanding loans as of December 31, 2020 and 2019, respectively. The majority of the decrease in nonaccrual loans from 2020 to 2019 came in the “commercial mortgage and farmland” categories. Nonaccrual loans in these categories decreased by $344 thousand. Loans are placed in nonaccrual status when, in management’s opinion, the borrower may be unable to meet payments as they become due. When interest accrual is discontinued, all unpaid accrued interest is reversed. Loans are removed from nonaccrual status when they are deemed a loss and charged to the allowance, transferred to foreclosed assets, or returned to accrual status based upon performance consistent with the original terms of the loan or a subsequent restructuring thereof. Management’s ability to ultimately resolve these loans either with or without significant loss will be determined, to a great extent, by general economic and real estate market conditions.

 

For the years ended December 31, 2020 and 2019, interest income recognized on loans in nonaccrual status was approximately $46 thousand and $47 thousand, respectively. Had these credits been current in accordance with their original terms, the gross interest income for these credits would have been approximately $210 thousand and $196 thousand, respectively for the years ended December 31, 2020 and 2019.

 

Restructured loans represent troubled debt restructurings (“TDRs”) that have returned to accrual status after a period of performance in accordance with their modified terms. The decrease in restructured loans from 2019 to 2020 came primarily in the form of principal reductions. A TDR is considered to be successful if the borrower maintains adequate payment performance under the modified terms and is financially stable.

 

There were no foreclosed assets in 2020 and 2019.  More information on nonperforming assets and loan modifications in response to COVID-19 can be found in Note 5 of the “Notes to Consolidated Financial Statements” found in the company’s 2020 Annual Report.

 

 

Management’s Discussion and Analysis

 

As of December 31, 2020 and 2019 we had loans with a current principal balance of $15.1 million and $7.4 million rated “Watch” or “Special Mention”.  The increase was due primarily to loan risk rating reclassifications as a result of loans that had a COVID-19 loan deferment.  The “Watch” classification is utilized by us when we have an initial concern about the financial health of a borrower that indicate above average risk.  We then gather current financial information about the borrower and evaluate our current risk in the credit.  After this review we will either move the loan to a higher risk rating category or move it back to its original risk rating.  Loans may be left rated “Watch” for a longer period of time if, in management’s opinion, there are risks that cannot be fully evaluated without the passage of time, and we want to review it on a more regular basis.  Assets that do not currently expose the Bank to sufficient risk to warrant a classification such as “Substandard” or “Doubtful” but otherwise possess weaknesses are designated “Special Mention”.  Loans rated as “Watch” or “Special Mention” are not considered “potential problem loans” until they are determined by management to be classified as “Substandard”. As of December 31, 2020, potential problem loans classified as substandard totaled $11.9 million compared to $13.4 million at December 31, 2019.  Past due loans are often regarded as a precursor to further credit problems which would lead to future increases in nonaccrual loans or other real estate owned.  As of December 31, 2020 loans past due 30-89 days and still accruing totaled $622 thousand compared to $1.1 million at December 31, 2019.

 

Certain types of loans, such as option ARM products, subprime loans and loans with initial teaser rates, can have a greater risk of non-collection than other loans. The Bank has not offered these types of loans in the past and does not offer them currently. Junior-lien mortgages can also be considered higher risk loans. Our junior-lien portfolio at December 31, 2020 totaled $4.0 million, or 0.61% of total loans. The charge-off rates in this category do not vary significantly from other real estate secured loans in the current year.

 

The allowance for loan losses is maintained at a level adequate to absorb potential losses. Some of the factors which management considers in determining the appropriate level of the allowance for loan losses are: past loss experience, an evaluation of the current loan portfolio, identified loan problems, the loan volume outstanding, the present and expected economic conditions in general, and in particular, how such conditions relate to the market area that the Bank serves. Bank regulators also periodically review the Bank’s loans and other assets to assess their quality. Loans deemed uncollectible are charged to the allowance. Provisions for loan losses and recoveries on loans previously charged off are added to the allowance. The reserve for loan losses at December 31, 2020 was approximately 0.74% of total loans, compared to 0.68% at December 31, 2019. Management’s estimate of probable credit losses inherent in the acquired Great State loan portfolio was reflected as a purchase discount which will continue to be accreted into income over the remaining life of the acquired loans in addition to the previously acquired loan portfolio from the merger with Cardinal Bankshares Corporation.  As of December 31, 2020 and 2019, the remaining unaccreted discount on the acquired loan portfolios totaled $2.0 million and $3.2 million, respectively. This remaining discount can be used for credit losses if a loss occurs on individual loans in the purchased portfolios.

 

To quantify the specific elements of the allowance for loan losses, the Bank begins by establishing a specific reserve for larger-balance, non-homogeneous loans, which have been identified as being impaired. This reserve is determined by comparing the principal balance of the loan with the net present value of the future anticipated cash flows or the fair market value of the related collateral. If the impaired loan is collateral dependent, then any excess in the recorded investment in the loan over the fair value of the collateral that is identified as uncollectible in the near term is charged off against the allowance for loan losses at that time. The bank also collectively evaluates for impairment smaller-balance TDRs. The specific component of the allowance for smaller-balance TDR loans is calculated on a pooled basis considering historical experience adjusted for qualitative factors. The bank then reviews certain loans in the portfolio and assigns grades to loans which have been reviewed. Loans which are adversely classified are given a specific allowance based on the historical loss experience of similar type loans in each adverse grade with further adjustments for external factors. The remaining portfolio is segregated into loan pools consistent with regulatory guidelines. An allocation is then made to the reserve for these loan pools based on the bank’s historical loss experience with further adjustments for external factors. The allowance is allocated according to the amount deemed to be reasonably necessary to provide for the possibility of losses being incurred within the respective categories of loans, although the entire allowance is available to absorb any actual charge-offs that may occur.

 

 

Management’s Discussion and Analysis

 

The provision for loan losses, net charge-offs, and the resulting allowance for loan losses, are detailed in Table 13. The allocation of the reserve for loan losses is detailed in Table 14.

 

Table 13.   Analysis of the Allowance for Loan Losses (dollars in thousands)

 

		2020				2019				2018				2017				2016
Allowance for loan losses, beginning		$	3,893			$	3,495			$	3,453			$	3,420			$	3,418
Provision for (reduction of) loan losses, added			1,189				655				325				217				(5	)
Charge-offs:
Commercial and agricultural			(37	)			(77	)			(23	)			(27	)			(19	)
Real estate – construction			(8	)			-				(20	)			(33	)			(20	)
Real estate – mortgage			(109	)			(109	)			(259	)			(182	)			(105	)
Consumer and other			(148	)			(212	)			(175	)			(76	)			(70	)
Recoveries:
Commercial and agricultural			6				10				9				33				8
Real estate – construction			4				-				-				56				98
Real estate – mortgage			76				77				147				23				81
Consumer and other			34				54				38				22				34
Net (charge-offs) recoveries			(182	)			(257	)			(283	)			(184	)			7
Allowance for loan losses, ending		$	4,900			$	3,893			$	3,495			$	3,453			$	3,420
Ratio of net charge-offs during the period to average loans outstanding during the period			0.03	%			0.05	%			0.06	%			0.04	%			0.00	%

 

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Table 14.   Allocation of the Allowance for Loan Losses (dollars in thousands)

 

		December 31, 2020								December 31, 2019								December 31, 2018
Balance at the end of the period applicable to:		Amount				% of Loans to Total Loans				Amount				% of Loans to Total Loans				Amount				% of Loans to Total Loans
Commercial and agricultural		$	293				5.07	%		$	211				5.69	%		$	281				6.99	%
SBA-PPP			-				7.70	%			-				-	%			-				-	%
Real estate – construction			499				6.93	%			305				6.95	%			246				6.23	%
Real estate – mortgage			3,994				77.74	%			3,233				83.92	%			2,874				82.99	%
Consumer and other			114				2.56	%			144				3.44	%			94				3.79	%
Total		$	4,900				100.00	%		$	3,893				100.00	%		$	3,495				100.00	%

 

		December 31, 2017								December 31, 2016
Balance at the end of the period applicable to:		Amount				% of Loans to Total Loans				Amount				% of Loans to Total Loans
Commercial and agricultural		$	282				6.04	%		$	210				6.33	%
SBA-PPP			-				-	%			-				-	%
Real estate – construction			239				6.00	%			319				6.42	%
Real estate – mortgage			2,852				84.29	%			2,783				84.78	%
Consumer and other			80				3.67	%			108				2.47	%
Total		$	3,453				100.00	%		$	3,420				100.00	%

 

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Management’s Discussion and Analysis

 

Financial Instruments with Off-Balance Sheet Risk

 

The Bank is party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments to extend credit and standby letters of credit. These instruments involve, to varying degrees, credit risk in excess of the amount recognized in the consolidated balance sheets.

 

The Bank’s exposure to credit loss in the event of nonperformance by the other party to the financial instrument for commitments to extend credit and standby letters of credit is represented by the contractual amount of those instruments. The Bank uses the same credit policies in making commitments and conditional obligations as for on-balance sheet instruments. A summary of the Bank’s commitments at December 31, 2020 and 2019 is as follows:

 

		2020				2019
Commitments to extend credit		$	111,778			$	95,190
Standby letters of credit			1,260				1,313
		$	113,038			$	96,503

 

Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The Bank evaluates each customer’s creditworthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary by the Bank upon extension of credit, is based on management’s credit evaluation of the party. Collateral held varies, but may include accounts receivable, inventory, property and equipment, residential real estate and income-producing commercial properties.

 

Standby letters of credit are conditional commitments issued by the Bank to guarantee the performance of a customer to a third party. Those guarantees are primarily issued to support public and private borrowing arrangements. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers. Collateral held varies as specified above and is required in instances which the Bank deems necessary.

 

Quantitative and Qualitative Disclosure about Market Risk

 

The principal goals of the Bank’s asset and liability management strategy are the maintenance of adequate liquidity and the management of interest rate risk. Liquidity is the ability to convert assets to cash to fund depositors’ withdrawals or borrowers’ loans without significant loss. Interest rate risk management balances the effects of interest rate changes on assets that earn interest or liabilities on which interest is paid, to protect the Bank from wide fluctuations in its net interest income which could result from interest rate changes.

 

Management must insure that adequate funds are available at all times to meet the needs of its customers. On the asset side of the balance sheet, maturing investments, loan payments, maturing loans, federal funds sold, and unpledged investment securities are principal sources of liquidity. On the liability side of the balance sheet, liquidity sources include core deposits, the ability to increase large denomination certificates, federal fund lines from correspondent banks, borrowings from the Federal Home Loan Bank, as well as the ability to generate funds through the issuance of long-term debt and equity.

 

The liquidity ratio (the level of liquid assets divided by total deposits plus short-term liabilities) was 15.0% at December 31, 2020 compared to 9.9% at December 31, 2019. These ratios are considered to be adequate by management.

 

The Bank uses cash and federal funds sold to meet its daily funding needs. If funding needs are met through holdings of excess cash and federal funds, then profits might be sacrificed as higher-yielding investments are foregone in the interest of liquidity. Therefore management determines, based on such items as loan demand and deposit activity, an appropriate level of cash and federal funds and seeks to maintain that level.

 

 

Management’s Discussion and Analysis

 

The primary goals of the investment portfolio are liquidity management and maturity gap management. As investment securities mature the proceeds are reinvested in federal funds sold if the federal funds level needs to be increased, otherwise the proceeds are reinvested in similar investment securities. The majority of investment security transactions consist of replacing securities that have been called or matured. The Bank keeps a portion of its investment portfolio in unpledged assets that are less than 60 months to maturity or next repricing date. These investments are a preferred source of funds in that they can be disposed of in most interest rate environments without causing significant damage to that quarter’s profits.

 

Interest rate risk is the effect that changes in interest rates would have on interest income and interest expense as interest-sensitive assets and interest-sensitive liabilities either reprice or mature. Management attempts to maintain the portfolios of interest-earning assets and interest-bearing liabilities with maturities or repricing opportunities at levels that will afford protection from erosion of net interest margin, to the extent practical, from changes in interest rates. Table 15 shows the sensitivity of the Bank’s balance sheet on December 31, 2020. This table reflects the sensitivity of the balance sheet as of that specific date and is not necessarily indicative of the position on other dates. At December 31, 2020 the Bank appeared to be cumulatively asset-sensitive (interest-earning assets subject to interest rate changes exceeding interest-bearing liabilities subject to changes in interest rates). However, in the one year window liabilities subject to changes in interest rates exceed assets subject to interest rate changes (non asset-sensitive).

 

Matching sensitive positions alone does not ensure the Bank has no interest rate risk. The repricing characteristics of assets are different from the repricing characteristics of funding sources. Thus, net interest income can be impacted by changes in interest rates even if the repricing opportunities of assets and liabilities are perfectly matched.

 

Table 15.   Interest Rate Sensitivity (dollars in thousands)

 

		December 31, 2020 Maturities/Repricing
		1 to 3 Months				4 to 12 Months				13 to 60 Months				Over 60 Months				Total
Interest-Earning Assets:
Interest bearing deposits		$	84,863			$	-			$	-			$	-			$	84,863
Federal funds sold			817				-				-				-				817
Investments			1,987				1,322				4,957				25,241				33,507
Loans			111,875				52,275				380,248				119,697				664,095
Total		$	199,542			$	53,597			$	385,205			$	144,938			$	783,282
Interest-Bearing Liabilities:
Interest-bearing DDA accounts		$	106,333			$	-			$	-			$	-			$	106,333
Money market			65,040				-				-				-				65,040
Savings			157,884				-				-				-				157,884
Time deposits			27,537				85,317				81,565				-				194,419
Borrowings			-				-				-				10,000				10,000
Total		$	356,794			$	85,317			$	81,565			$	10,000			$	533,676
Interest sensitivity gap		$	(157,252	)		$	(31,720	)		$	303,640			$	134,938			$	249,606
Cumulative interest sensitivity gap		$	(157,252	)		$	(188,972	)		$	114,668			$	249,606			$	249,606
Ratio of sensitivity gap to total earning assets			-20.1	%			-4.0	%			38.8	%			17.2	%			31.9	%
Cumulative ratio of sensitivity gap to total earning assets			-20.1	%			-24.1	%			14.6	%			31.9	%			31.9	%

 

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Management’s Discussion and Analysis

 

The Company uses a number of tools to monitor its interest rate risk, including simulating net interest income under various scenarios, monitoring the present value change in equity under the same scenarios, and monitoring the difference or gap between rate sensitive assets and rate sensitive liabilities over various time periods (as displayed in Table 15).

 

The earnings simulation model forecasts annual net income under a variety of scenarios that incorporate changes in the absolute level of interest rates, changes in the shape of the yield curve, and changes in interest rate relationships. Management evaluates the effect on net interest income and present value equity from gradual changes in rates of up to 400 basis points up or down over a 12-month period. Table 16 presents the Bank’s twelve-month forecasts for changes in net interest income and market value of equity resulting from changes in rates of up to 300 basis points up or down, as of December 31, 2020.

 

Table 16.   Interest Rate Risk (dollars in thousands)

 

Rate Shocked Net Interest Income and Market Value of Equity
Rate Change		-300bp				-200bp				-100bp				0bp				+100bp				+200bp				+300bp
Net Interest Income:
Net interest income		$	27,450			$	27,344			$	27,257			$	27,428			$	27,750			$	28,225			$	28,789
Change		$	22			$	(84	)		$	(171	)		$	-			$	322			$	797			$	1,361
Change percentage			0.08	%			-0.31	%			-0.62	%							1.17	%			2.91	%			4.96	%
Market Value of Equity		$	143,221			$	120,322			$	100,699			$	103,395			$	107,985			$	113,365			$	117,768

 

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Impact of Inflation and Changing Prices

 

The consolidated financial statements and the accompanying notes presented elsewhere in this document have been prepared in accordance with generally accepted accounting principles which require the measurement of financial position and operating results in terms of historical dollars without considering the change in the relative purchasing power of money over time due to inflation. Unlike most industrial companies, virtually all Company assets and liabilities are monetary in nature, therefore the impact of inflation is reflected primarily in the increased cost of operations. As a result, interest rates have a greater impact on performance than do the effects of general levels of inflation. Interest rates do not necessarily move in the same direction or to the same extent as the prices of goods and services.

 

Table 17.   Key Financial Ratios

 

		2020				2019				2018
Return on average assets			0.75	%			1.05	%			0.75	%
Return on average equity			7.06	%			9.10	%			7.02	%
Dividend payout ratio			26.96	%			20.74	%			24.81	%
Average equity to average assets			10.60	%			11.51	%			10.66	%

 

---

 

 

Item 7A.

Quantitative and Qualitative Disclosures About Market Risk.

 

Not applicable.

 

Item 8.

Financial Statements and Supplementary Data.

 

 

 

 

Report of Independent Registered Public Accounting Firm

 

 

To the shareholders and the board of directors of Parkway Acquisition Corp. and Subsidiary

 

 

Opinion on the Financial Statements

We have audited the accompanying consolidated balance sheets of Parkway Acquisition Corp. and Subsidiary (the "Company") as of December 31, 2020 and 2019, the related consolidated statements of income, comprehensive income, changes in stockholders' equity, and cash flows, for each of the years then ended, and the related notes to the consolidated financial statements (collectively referred to as the "financial statements"). In our opinion, the financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 2020 and 2019, and the results of its operations and its cash flows for the years then ended, in conformity with accounting principles generally accepted in the United States of America.

 

Basis for Opinion

These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on the Company's financial statements based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) ("PCAOB") and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.

 

We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. As part of our audits we are required to obtain an understanding of internal control over financial reporting but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion.

 

Our audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion.

 

Critical Audit Matters

The critical audit matters communicated below are matters arising from the current period audit of the financial statements that were communicated or required to be communicated to the audit committee and that: (1) relate to accounts or disclosures that are material to the financial statements and (2) involved our especially challenging, subjective, or complex judgments. The communication of critical audit matters does not alter in any way our opinion on the financial statements, taken as a whole, and we are not, by communicating the critical audit matters below, providing separate opinions on the critical audit matters or on the accounts or disclosures to which they relate.

 

Allowance for Loan Losses

 

As described in Note 5 and Note 6 to the Company’s financial statements, the Company’s loan portfolio and associated allowance for loan losses (the “Allowance”) totaled $664.1 million and $4.9 million, respectively, at December 31, 2020. As described in Note 1 and Note 6 to the financial statements, the Company’s Allowance is an estimate of probable credit losses as of the balance sheet date and considers both unimpaired and impaired loans. Management’s determination of the allowance for loan losses related to the Company’s loan portfolio segment is generally based on the credit risk ratings and historical loss experience of individual borrowers, supplemented, as necessary, by credit judgment to address observed changes in trends and conditions, and other relevant environmental and economic factors such as concentrations of credit risk (geographic, large borrower, and industry), economic trends and conditions, changes in underwriting standards, experience and depth of lending staff, trends in delinquencies, and the level of net charge-offs (qualitative factor adjustments).

 

 

 

Auditing the Company’s Allowance involved a high degree of subjectivity due to the judgment involved in management’s identification and measurement of qualitative factor adjustments included in the estimate of the allowance for loan losses. 

 

The primary procedures we performed to address this critical audit matter included the following, among others:

 

●

We evaluated the relevance and the reasonableness of assumptions related to evaluation of the loan portfolio, current economic conditions, and other risk factors used in development of the qualitative factors for collectively evaluated loans.

●

We evaluated the reasonableness of assumptions and data used by the Company in developing the qualitative factors by comparing these data points to internally developed and third-party sources, and other audit evidence gathered.

●

Analytical procedures were performed to evaluate changes that occurred in the allowance for loan losses for loans collectively evaluated for impairment.

 

Goodwill Impairment Evaluation

 

As described in Notes 1 and 7 to the consolidated financial statements, the Company’s goodwill balance was $3.3 million at December 31, 2020.  The Company conducts periodic impairment analysis on goodwill at least annually or more often as conditions require. In conjunction with the Company’s annual evaluation of goodwill impairment, management performed a quantitative evaluation of goodwill impairment. The Company used a third-party valuation specialist to assist management in performing the impairment evaluation, which includes a quantitative analysis evaluating the estimated fair value of the reporting unit.

 

We identified management’s goodwill impairment evaluation as a critical audit matter because the methods and underlying assumptions in performing a quantitative test involves high levels of management judgment and in turn led to a high degree of auditor judgment and subjectivity in performing procedures and evaluating audit evidence related to management’s valuation methods and significant assumptions.

 

The primary procedures we performed to address this critical audit matter included the following, among others:

 

●

We validated completeness and accuracy of the inputs and historical data used in the analysis.

●

We validated the accuracy of the inputs to peer data used in the analysis.

●

We evaluated the reasonableness of the cash flow projections utilized in the discounted cash flow calculations by comparing the forecasts to historical results.

●

We used an internal valuation specialist to evaluate the methodologies and assumptions used by the Company in the fair value analysis.

●

We reviewed the sensitivity analysis of significant assumptions performed by the Company to evaluate changes in the fair value estimate resulting from changes in the assumptions.

 

/s/ Elliott Davis, PLLC

 

We have served as the Company's auditor since 1995.

 

Charlotte, North Carolina

March 24, 2021

 

 

Consolidated Balance Sheets December 31, 2020 and 2019

 

 

See Notes to Consolidated Financial Statements

 

 

Consolidated Statements of Income Years ended December 31, 2020 and 2019

 

 

See Notes to Consolidated Financial Statements

 

 

Consolidated Statements of Comprehensive Income Years ended December 31, 2020 and 2019

 

 

See Notes to Consolidated Financial Statements

 

 

Consolidated Statements of Changes in Stockholders’ Equity Years ended December 31, 2020 and 2019

 

 

See Notes to Consolidated Financial Statements

 

 

Consolidated Statements of Cash Flows Years ended December 31, 2020 and 2019

 

 

See Notes to Consolidated Financial Statements

 

 

Consolidated Statements of Cash Flows Years ended December 31, 2020 and 2019

 

 

See Notes to Consolidated Financial Statements

 

 

Notes to Consolidated Financial Statements

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Item 9.

Changes in and Disagreements With Accountants on Accounting and Financial Disclosure.

 

None.

 

Item 9A.

Controls and Procedures.

 

Disclosure Controls and Procedures

 

The Company, under the supervision and with the participation of management, including the Company’s Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of the design and operation of its disclosure controls and procedures as of the end of the period covered by this Annual Report on Form 10-K. Based on that evaluation, the Chief Executive Officer and Chief Financial Officer have concluded that the Company’s disclosure controls and procedures were effective as of December 31, 2020 to ensure that information required to be disclosed by the Company in reports that it files or submits under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the time periods specified in Securities and Exchange Commission rules and forms and that such information is accumulated and communicated to the Company’s management, including the Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure.

 

Internal Control over Financial Reporting

 

Management is also responsible for establishing and maintaining adequate internal control over the Company’s financial reporting (as defined in Rule 13a-15(f) promulgated under the Securities Exchange Act of 1934, as amended). Pursuant to Section 404 of the Sarbanes-Oxley Act of 2002, management has conducted and assessment of the design and effectiveness of its internal controls over financial reporting based on criteria established in Internal Control – Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”).

 

Management maintains a comprehensive system of internal control to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. The system of internal control provides for appropriate division of responsibility and is documented by written policies and procedures that are communicated to employees. Those policies and procedures: 1) pertain to the maintenance of records that in reasonable detail accurately and fairly reflect the transactions and disposition of the assets of the Company, 2) provide reasonable assurance that receipts and expenditures of the Company are being made only in accordance with authorizations of management and directors, 3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the Company’s assets that could have a material effect on the financial statements. Management recognizes that there are inherent limitations in the effectiveness of any internal control system, including the possibility of human effort and the circumvention or overriding of internal controls. Accordingly, even effective internal control over financial reporting can provide only reasonable assurance with respect to financial statement preparation. Changes in conditions will also impact the internal control effectiveness over time. The Company maintains an internal auditing program, under the supervision of the Audit Committee of the Board of Directors, which independently assesses the effectiveness of the system of internal control and recommends possible improvements.

 

Under the supervision and with the participation of the Company’s management, including its Chief Executive Officer and Chief Financial Officer, the Company has evaluated the effectiveness of its internal control over financial reporting as of December 31, 2020, using the 2013 Internal Control – Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based upon this evaluation, the Chief Executive Officer and the Chief Financial Officer have concluded as of December 31, 2020, the Company’s internal control over financial reporting is adequate and effective and meets the criteria of the Internal Control – Integrated Framework.

 

Management’s assessment did not determine any material weaknesses within the Company’s internal control structure. There were no changes in the Company’s internal control over financial reporting during the Company’s quarter ended December 31, 2020 that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

 

 

This annual report does not include an attestation report of the Company’s registered public accounting firm, regarding internal control over financial reporting. Management’s report was not subject to attestation by the Company’s registered public accounting firm pursuant to rules of the securities and Exchange Commission that permit the Company to provide only management’s report in this annual report.         

 

Item 9B.

Other Information.

 

None.

 

PART III

 

Item 10.

Directors, Executive Officers and Corporate Governance.

 

Directors

 

The following biographical information discloses each director’s age and business experience, and the year that each individual was first elected to the Board of Directors of the Company. Previous service on the boards of Grayson, Cardinal, or Great State prior to the merger with and into Parkway is also disclosed, as are the specific skills or attributes that qualify each director for service on the Board of Directors.

 

Thomas M. Jackson, Jr. (63) – Mr. Jackson has been Chairman of the Board of Parkway since its inception in November 2015.  Previously he was named a board member for Grayson and Grayson National Bank in 2002 and was elected Chairman in 2012.  Mr. Jackson is a practicing attorney of Jackson Law Group, PLLC, with offices in Hillsville and Wytheville, Virginia and has a black angus beef farm at his family home place in Wythe County. He was elected to the Virginia House of Delegates in 1987 and served as a 6^th District Representative until 2002. Following his retirement from the General Assembly, he was appointed to the Virginia State Board of Education for a four year term, serving as Board of Education President the last three years. Mr. Jackson’s knowledge of real estate and contract law assists Skyline National Bank in its real estate and commercial lending activities. Through his service in the legislature and his current legal practice he has gained extensive knowledge of the communities served by Parkway and Skyline National Bank.

 

James W. Shortt (58) – Mr. Shortt has been a director of Parkway since its inception in November 2015 and has served as Vice Chairman since June 2016. Mr. Shortt served as a director of Cardinal and the Bank of Floyd from 2012 to 2016, serving as Vice Chairman from 2012 to 2015 and Chairman from 2015 to 2016. He is the founder and owner of James W. Shortt & Associates, P.C., a general practice law firm with its principal office in Floyd, Virginia. Mr. Shortt is particularly qualified to serve on the Board by virtue of his legal background, especially with regard to his knowledge of real estate law and corporate and business transactions. Mr. Shortt has been practicing law in Virginia since 1988. Mr. Shortt is a graduate of the University of Richmond School of Law and Virginia Tech.

 

Jacky K. Anderson (69) – Mr. Anderson has been a director of Parkway since its inception in November 2015. He served as a director of Grayson and Grayson National Bank from 1992 to 2016. Mr. Anderson retired from Grayson and Grayson National Bank in 2013 where he served as President and Chief Executive Officer of Grayson and Grayson National Bank from 2000 to 2013. Mr. Anderson began working for Grayson National Bank in 1971, giving him over 49 years of experience in the banking industry. During his tenure Mr. Anderson gained in-depth knowledge of the laws and regulations applicable to the banking industry and developed extensive customer and community relationships.

 

Dr. J. Howard Conduff, Jr. (62) – Dr. Conduff has been a director of Parkway since its inception in November 2015. He served as a director of Cardinal and the Bank of Floyd for many years, representing a third-generation family member to serve on the Cardinal Board. Dr. Conduff is a private practice dentist in Floyd, Virginia. He is a community leader in the Bank’s market area where he serves on numerous civic boards. Dr. Conduff has substantial banking experience due to the length of his service on the Cardinal Board. He currently serves as Chairman of the Compensation Committee for Parkway. Dr. Conduff is a graduate of the Virginia Military Institute and the MCV School of Dentistry.

 

 

Blake M. Edwards, Jr. (55) – Mr. Edwards, President and Chief Executive Officer of Parkway and Skyline National Bank since January 2019, previously served as the Senior Executive Vice President and Chief Financial Officer of Parkway and Skyline from November 2015 to December 2018. Prior to that he served as the Chief Financial Officer of Grayson and Grayson National Bank since 1999, and as Senior Executive Vice President since 2013. Before joining Grayson, Mr. Edwards worked with a public accounting firm where his primary focus was providing audit and advisory services to community banks. He is a graduate of Radford University and has also attended the AICPA’s School of Banking at the University of Virginia and the Graduate School of Bank Investments and Financial Management at the University of South Carolina. Mr. Edwards currently serves as a member of the Joint Governing Board of DLP, Twin County Regional Healthcare, Inc., as President of the Blue Ridge Discovery Center, and as a member of the Government Relations Committee of the Virginia Bankers Association.

 

Bryan L. Edwards (70) – Mr. Edwards has been a director of Parkway since its inception in November 2015.  He served as a director of Grayson and Grayson National Bank from 2005 to 2016. Mr. Edwards currently serves as the president of the Alleghany County Chamber of Economic Development.  Mr. Edwards served as the manager of the Town of Sparta, North Carolina from 2004 until his retirement in September of 2020. Prior to that he served as Human Resources/Special Projects & Purchasing Director for NAPCO, Inc., a manufacturing company, also in Sparta. He is also a North Carolina licensed real estate broker. His experience allows him to provide working knowledge of local governments and tax authorities as well as insight into local economic and real estate market conditions. Mr. Edwards also serves on the Board of Directors of Blue Ridge Energy, a rural electric cooperative based in Lenoir, North Carolina, since 2007.  He is past Chairman of the Virginia-Carolina Water Authority in Independence, VA.

 

T. Mauyer Gallimore (78) – Mr. Gallimore has been a director of Parkway since its inception in November 2015. He served as a director of Cardinal and the Bank of Floyd from 2012 to 2016. Mr. Gallimore is a native of Floyd, Virginia and he has been a small business owner in Floyd County for over 40 years. Mr. Gallimore is the retired owner and founder of Blue Ridge Land and Auction Co., Inc. and has over 30 years of experience as a Certified Real Estate Appraiser. His in depth knowledge of the real estate market in our primary service areas is a valuable resource for our board and management as the majority of the Bank’s loans are secured by real estate. 

 

Melissa Gentry (56) – Ms. Gentry has been a director of Parkway since June 2016. She was appointed to the board of Cardinal in April 2016. Ms. Gentry is the Controller and Chief Financial Officer of Shelor Motor Mile, Inc., where she oversees all financial, accounting and recordkeeping functions for 31 affiliated entities. These entities include automotive sales and service, consumer finance, insurance sales, real estate investment, construction and development, restaurants and retail stores representing approximately $350 million in annual revenues and over $200 million in inventories and properties. Her business experience gives her vast insight into economic conditions in and around the New River Valley and her accounting expertise is a significant asset for the board and management. Ms. Gentry is a graduate of Virginia Tech and is currently serving on the Board of Directors for two non-profit organizations: New River Valley Health Foundation and Friends of Calfee Park. Ms. Gentry has previously served on the Board for Carilion New River Valley Medical Center.

 

R. Devereux Jarratt (79) – Mr. Jarratt has been a director of Parkway since its inception in November 2015. He served as a director of Cardinal and the Bank of Floyd from 2013 to 2016. Prior to retiring on December 31, 2014, he had been the Chief Executive Officer of Physicians Care of Virginia since January 1996. Mr. Jarratt has 22 years of experience in the banking industry with various banking institutions, including First National Exchange Bank, Dominion Bankshares Corporation and First Union. Mr. Jarratt has an undergraduate degree in economics, a graduate degree in accounting and is a graduate of the Stonier Graduate School of Banking. His vast business experience, including direct banking experience, combined with his in-depth knowledge of the Cardinal legacy customers and shareholders, are significant assets to the Board.

 

Theresa S. Lazo (64) – Mrs. Lazo has been a director of Parkway since its inception in November 2015. She served as a director of Grayson and Grayson National Bank from 2011 to 2016. Mrs. Lazo currently serves on the Board of Directors of Oak Hill Academy, and she previously served on the Board of Directors of the Chestnut Creek School of the Arts from 2007 to 2014. She also served six years on the Arts Council of the Twin Counties where she held the offices of treasurer, vice president and president at various times during her tenure. Mrs. Lazo served nine years on the Galax City School Board. Through her vast experience with local non-profit organizations and public institutions she has developed extensive personal relationships within the communities served by Parkway and Skyline National Bank and offers a unique perspective on our markets.

 

 

W. David McNeill (64) – Mr. McNeill has been a director of Parkway since July 2018.  He was one of the Founders of Great State Bank and served on the Board of Directors from 2008 to 2018.  Mr. McNeill is owner and operator of Carolina Kia of High Point, Carolina Hyundai of High Point, McNeill Nissan of Wilkesboro and McNeill Chevrolet Buick of Wilkesboro.  He is also owner of Carolina Automotive Group, which is primarily a real estate company owning the properties the dealerships do business on. Mr. McNeill is a graduate of UNC -Chapel Hill.

 

Frank A. Stewart (59) – Mr. Stewart has been a director of Parkway since July 2018.  He served as director of Great State Bank from 2009 to 2018.  Mr. Stewart has also served in various capacities including Chairman of the Gardner-Webb University Board of Trustees for three years. He received an Honorary Doctorate Degree in Humanities from Gardner-Webb University in May 2016 and has served on the Gardner-Webb University President’s Advisory Board. He was appointed by the North Carolina Speaker of the House to the Rural Infrastructure Authority and most recently to the North Carolina Ports Authority. Formerly, Mr. Stewart served on the Cleveland Community College Foundation Board of Directors, Coastal Carolina National Bank Board of Directors, on the United Way of Cleveland County Board, and the State Board of the USO of North Carolina.  Appointed by the Governor, Frank completed two terms on the North Carolina Advisory Commission on Military Affairs. Mr. Stewart is President of Premier Body Armor, LLC of Kings Mountain, NC.  He is also the owner of Stewart Realty and Stewart Property Management.  Previously, he was the owner and founder of Ultra Machine and Fabricating, a sub-contractor manufacturer for several major defense contractors, from 1989 to 2015. Mr. Stewart’s strong leadership and commitment to excellence is an asset to the board.  Mr. Stewart was born in Barranquilla, Columbia. He moved to the United States in 1982 and received his citizenship in 1992.  Mr. Stewart is a graduate of UNC Charlotte with a Bachelor’s Degree in Business Administration.

 

John Michael Turman (74) – Mr. Turman has been a director of Parkway since July 2016. He is a long-time resident of Floyd County and has led a variety of businesses in southwest Virginia relating to land, lumber, real estate development, manufacturing, and retail sales. Mr. Turman has developed extensive personal and business relationships throughout the Bank’s market area giving him significant knowledge of both current and potential customers as well as shareholders of Parkway and Skyline. He attended the University of Virginia’s College at Wise and has served on the local Industrial Development Authority.

 

J. David Vaughan (53) – Mr. Vaughan has been a director of Parkway since its inception in November 2015. He served on the board of Grayson and Grayson National Bank from 1999 to 2016. He is the managing partner of My Home Furnishings, LLC, a distributor specializing in youth furniture, located in Mt. Airy, North Carolina, and serves as President of Vaughan Furniture, Incorporated, a furniture distributor located in Galax, Virginia. The furniture industry has historically played a significant role in the local economy of many of the communities served by Parkway and Skyline National Bank, and furniture manufacturing still provides a significant source of employment within those communities. Mr. Vaughan’s direct knowledge of this industry combined with his financial and managerial experience makes him a valuable resource to the Board. Mr. Vaughan also serves on the Boards of Directors for Vaughan Furniture Company, Inc., Big “V” Wholesale Company, Inc., the Vaughan Foundation, and Galax Hope House Ministries, Inc.

 

Executive Officers Who Are Not Directors

 

Lori C. Vaught (47) – Mrs. Vaught, Executive Vice President and Chief Financial Officer of Parkway and Skyline National Bank since January 2019, previously served as Controller of Skyline National Bank and its predecessor Grayson National Bank from August 2012 to January 2019. She also served as Grayson National Bank’s Vice President of Loan Operations from September 2002 to August 2012. Prior to those positions, she worked with two local public accounting firms with a primary focus on audit and tax services. She earned a Bachelor of Business Administration with a concentration in Accounting from Radford University. She serves as a member of the CFO Committee for the Virginia Bankers Association.

 

Beth R. Worrell (47) – Ms. Worrell, Executive Vice President and Chief Risk Officer of Skyline National Bank since January 2019, previously served as an independent consultant to community banks in Virginia and North Carolina, providing outsourced audit, credit review, and compliance services. Ms. Worrell also worked as a shareholder with a large regional public accounting firm where her work was also focused on community banks. She has a Bachelor of Arts degree in Mathematics and a Bachelor of Science degree in Business with a concentration in Accounting from Emory & Henry College. Ms. Worrell is a Certified Public Accountant and currently serves as Treasurer for the Chestnut Creek School of the Arts.

 

 

Rodney R. Halsey (52) – Mr. Halsey, Executive Vice President and Chief Operations Officer of Skyline National Bank, previously worked for Grayson National Bank since 1992, when he began his career as Grayson National Bank’s Loan Review Officer. From 1996 to 2001, Mr. Halsey served as Grayson National Bank’s Assistant Vice President and Loan Officer. In 2002, he was promoted to Vice President of Information Systems/Loan Officer, and in 2009, Mr. Halsey was promoted to Senior Vice President of Information Systems/Commercial Loan Officer. In 2011, Mr. Halsey was named the Chief Operating Officer of Grayson National Bank. Mr. Halsey has previously served on the Alleghany Memorial Hospital Foundation and the Mount Rogers Planning District Loan Fund Board.  He currently serves on the Board of Trustees for Oak Hill Academy and the Wytheville Community College Educational Foundation.  Mr. Halsey graduated from Appalachian State University with a degree in Business Administration.

 

C. Greg Edwards (63) – Mr. Edwards, Executive Vice President and Regional President, North Carolina for Skyline National Bank, previously served as President and Chief Executive Officer of Great State Bank from 2008 until its acquisition by Skyline National Bank in 2018.  He was a member of the organizing group of Great State Bank and was elected to the board and President & CEO positions at the time the bank incorporated and began operations during July 2008.  He previously served as a senior credit officer for Northwestern National Bank (formerly Wilkes National Bank) from 1994 until that bank was acquired by Integrity Financial Corp. (the parent company of Catawba Valley Bank) in 2002.  Following that transaction, he joined Bank of Granite in April 2003 where he served as Senior Vice President and County Executive in Wilkes County until he joined the Great State Bank organizing group in December 2006.  Mr. Edwards has 40 years of commercial banking experience and served in loan review, credit administration and lending roles prior to the positions above with Southern National Bank, First Union National Bank and Northwestern Bank. 

 

Jonathan L. Kruckow (36) – Mr. Kruckow, Executive Vice President and Regional President, Virginia for Skyline National Bank, previously worked for Grayson National Bank since 2012, when he served as Senior Vice President of Commercial Lending. Prior to joining Grayson, he worked for a large regional bank in the local market where his primary focus was providing commercial banking services for small to mid-sized businesses. He is a graduate of Virginia Tech, the VBA’s School of Bank Management at the University of Virginia, and the Graduate School of Banking at Louisiana State University. Mr. Kruckow currently serves on the VBA’s Lending Executives Committee, the VBA’s School of Bank Management Board of Trustees, the Board of Directors for Virginia Title Center, and the Board of Directors of Virginia’s Industrial Advancement Alliance.

 

Milo L. Cockerham (34) – Mr. Cockerham, Executive Vice President and Chief Retail Banking Officer of Skyline National Bank, joined Skyline National Bank as a consultant in December of 2016 to help with the systems conversion of the merger of Grayson National Bank and Bank of Floyd. He now leads our network of 24 retail branch locations. Mr. Cockerham has 12 years of experience in the banking and financial services industry. Prior to joining Skyline, he served in a managerial role assisting with branch operations in a large branch network for a community bank in North Carolina. Mr. Cockerham is a graduate of Emory & Henry College with a BA in Economics and a BS in Business Management. He is a graduate of the Graduate School of Banking at Louisiana State University.  He also serves as a member of the Retail Banking Executives Committee for the Virginia Bankers Association and serves as a board member on the Galax Foundation for Excellence.

 

 

Corporate Governance

 

General

 

The business and affairs of the Company are managed under the direction of the Board of Directors in accordance with the Virginia Stock Corporation Act and the Company’s Articles of Incorporation and Bylaws. Members of the Board are kept informed of the Company’s business through discussions with the Chairman of the Board, the President and Chief Executive Officer and other officers, by reviewing materials provided to them and by participating in meetings of the Board and its committees.

 

Code of Ethics

 

The Board of Directors has approved a Code of Ethics for Executive Officers and Financial Managers for the Company’s Chief Executive Officer and Chief Financial Officer. The Code addresses such topics as protection and proper use of Company assets, compliance with applicable laws and regulations, conflicts of interest and insider trading. A copy of the Code will be provided, without charge, to any shareholder upon written request to the Secretary of the Company, whose address is 101 Jacksonville Circle, Floyd, Virginia 24091.

 

Committees of the Board

 

The Company has an Audit Committee and a Compensation Committee. The Company does not have a standing Nomination Committee.

 

Audit Committee. The Audit Committee assists the Board of Directors in fulfilling the Board’s oversight responsibility to the shareholders relating to the integrity of the Company’s financial statements, the Company’s compliance with legal and regulatory requirements, the qualifications, independence and performance of the Company’s independent auditor and the performance of the internal audit function. The Audit Committee is directly responsible for the appointment, compensation, retention and oversight of the work of the independent auditor engaged for the purpose of preparing or issuing an audit report or performing other audit, review or attestation services for the Company.

 

The members of the Audit Committee are Frank A. Stewart, Chairman, Melissa Gentry, Vice Chair, Theresa S. Lazo, John Michael Turman, and T. Mauyer Gallimore, each of whom is independent as that term is defined by the Nasdaq Stock Market.

 

The Company has not currently designated an “audit committee financial expert.” The Company is located in a rural community where such expertise is limited; however, the Board believes that the current members of the Audit Committee have the ability to understand financial statements and generally accepted accounting principles, the ability to assess the general application of such principles in connection with the accounting for estimates, accruals and reserves, an understanding of internal controls and procedures for financial reporting and an understanding of audit committee functions. The Audit Committee met five times during the year ended December 31, 2020.

 

Compensation Committee. The Compensation Committee reviews senior management’s performance and compensation and reviews and sets guidelines for compensation of all employees. All decisions by the Compensation Committee relating to the compensation of the Company’s executive officers are reported to the full Board of Directors.

 

The members of the Compensation Committee are Dr. J. Howard Conduff, Jr., Chairman, Bryan L. Edwards, Vice Chair, Thomas M. Jackson, Jr., Jacky K. Anderson, and James W. Shortt. Each member, with the exception Jacky K. Anderson, is independent as that term is defined by the Nasdaq Stock Market. The Compensation Committee met three times during the year ended December 31, 2020.

 

 

Director Nomination Process.  The Board does not believe it needs a separate nominating committee because the full Board is comprised predominantly of independent directors, with the exception of Messrs. Anderson and Edwards, and has the time and resources to perform the function of selecting board nominees. When the Board performs its nominating function, the Board acts in accordance with the Company’s Articles of Incorporation and Bylaws but does not have a separate charter related to the nomination process.

 

In identifying potential nominees with desired levels of diversification, the Board of Directors takes into account such factors as it deems appropriate, including the current composition of the Board, the range of talents, experiences and skills that would best complement those that are already represented on the Board, the balance of management and independent Directors, Director representation in geographic areas where the Company operates, and the need for specialized expertise. The Board considers candidates for Board membership suggested by its members and by management, and the Board will consider candidates suggested informally by a shareholder of the Company.

 

Shareholders entitled to vote for the election of directors may submit candidates for formal consideration by the Company if the Company receives timely written notice, in proper form, for each such recommended director nominee. If the notice is not timely and in proper form, the nominee will not be considered by the Company.

 

Item 11.

Executive Compensation.

 

Objectives of Parkway’s Executive Compensation Program

 

The primary objective of Parkway’s executive compensation program is to attract and retain highly skilled and motivated executive officers who will manage Parkway in a manner to promote its growth and profitability and advance the interest of its shareholders. Additional objectives of Parkway’s executive compensation program include the following:

 

•

to align executive pay with shareholders’ interests;

 

•

to recognize individual initiative and achievements; and

 

•

to unite the entire executive management team to a common objective.

 

Executive Compensation Principles

 

Parkway’s executive compensation program is not as complex as those of many companies of similar size and nature. Parkway’s program consists of base salaries, cash payments in the form of annual bonuses and long-term benefits in the form of pension and supplemental executive retirement plans. Executive officers also participate in Parkway’s 401(k) plan.

 

During 2020, Parkway’s shareholders approved the 2020 Equity Incentive Plan, pursuant to which Parkway may issue up to 300,000 shares of common stock in the form of stock options, stock awards, restricted stock units, and stock appreciation rights.

 

How Executive Pay Levels are Determined

 

The Compensation Committee regularly reviews Parkway’s executive compensation program and its elements. All decisions by the Compensation Committee relating to the compensation of Parkway’s executive officers are reported to the Board. The Compensation Committee also engages Pearl Meyer & Partners, LLC, an independent, third-party compensation consulting firm to assist with the design and implementation of the Company’s overall executive compensation program. Pearl Meyer & Partners, LLC also compiles the comparative industry market data that the committee uses to assess overall compensation competitiveness.

 

The role of the Chief Executive Officer in determining executive compensation is limited to input in the performance evaluation of the other named executive officers. The Chief Executive Officer has no input in the determination of his own compensation. Likewise, the other named executive officers have no role in the determination of their own executive compensation.

 

 

In determining the compensation of our executive officers, the Compensation Committee evaluates total overall compensation, as well as the mix of salary, cash bonuses and other long-term compensation, using a number of factors including the following:

 

•

Parkway’s financial and operating performance, measured by attainment of strategic objectives and operating results;

 

•

the duties, responsibilities and performance of each executive officer of Parkway, including the achievement of identified goals for the year as they pertain to the areas of Parkway’s operations for which the executive is personally responsible and accountable;

 

•

historical cash and other compensation levels; and

 

•

comparative industry market data to assess compensation competitiveness.

 

 

SUMMARY COMPENSATION TABLE

 

Immediately below is a table setting forth the compensation paid to the President and Chief Executive Officer of Parkway, the Executive Vice President and Regional President, Virginia of Skyline National Bank and the Executive Vice President and Chief Risk Officer of Skyline National Bank.

 

Name and Principal Position		Year		Salary ($)				Bonus ($)				All Other Compensation ($)(2)				Total ($)
Blake M. Edwards, Jr. (1)		2020			300,000				57,000				15,407				372,407
President and Chief Executive Officer		2019			285,000				36,000				15,162				336,162
Jonathan L. Kruckow		2020			170,000				22,400				10,000				202,400
Executive Vice President and		2019			160,000				15,500				9,080				184,580
Regional President, Virginia
Beth R. Worrell		2020			170,000				23,100				7,149				200,249
Executive Vice President and Chief Risk Officer

 

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(1)	Mr. Edwards was appointed as President and Chief Executive Officer effective January 1, 2019. Prior to his appointment he served as Senior Executive VP and Chief Financial Officer.

(2)	Includes matching and discretionary contributions under the Company’s 401(k) plan.

 

Supplemental Discussion of Compensation

 

Parkway has an employment agreement with Blake M. Edwards and change in control agreements with Mr. Kruckow and Ms. Worrell as described below. All compensation that Parkway pays to its named executive officers is determined as described above.

 

Stock Options and Equity-Based Awards

 

No stock options or other stock-based awards were granted to any of Parkway’s employees during the fiscal year ended December 31, 2020. In addition, no such options or awards were exercised during the fiscal year ended December 31, 2020 or held at December 31, 2020 by any such employees.

 

Parkway has not yet issued any awards pursuant to the 2020 Equity Incentive Plan. Parkway anticipates making awards under the plan in 2021, consistent with its goal of promoting the Company’s long-term financial success and growth in shareholder value while further aligning the interests of key employees, directors and shareholders.

 

Pension Benefits

 

Prior to the merger, both Grayson and Cardinal had qualified noncontributory defined benefit pension plans which covered substantially all of their employees. The benefits are primarily based on years of service and earnings. Both Grayson and Cardinal plans were amended to freeze benefit accruals for all eligible employees prior to the effective date of the merger.

 

 

Nonqualified Deferred Compensation

 

Deferred compensation plans have been adopted for certain executive officers and members of the Board of Directors for future compensation upon retirement. Under plan provisions aggregate annual payments ranging from $1,992 to $37,200 are payable for ten years certain, generally beginning at age 65. Reduced benefits apply in cases of early retirement or death prior to the benefit date, as defined in the plan.

 

In addition, the Company adopted supplemental executive retirement plan (the “SERP”) for Blake M. Edwards, in November 2017. The SERP provides for a retirement benefit of $80,000 per year, payable monthly and continuing for the executive’s lifetime, beginning upon the later of the executive’s separation from service with the Bank or reaching age 65, subject to the vesting schedule set forth in the SERP agreement. Reduced benefits apply in cases of early retirement. In addition, the SERP agreements provide that the executive’s retirement benefit will be fully vested upon a Change in Control, as defined in the SERP agreement.

 

Payments upon Termination of Employment or a Change of Control

 

Employment Agreement of Blake M. Edwards

 

On June 1, 2019, the Company entered into a new executive employment agreement with Blake M. Edwards, the Company’s current President and Chief Executive Officer.

 

The term of Mr. Edwards’s employment under Mr. Edwards’s employment agreement began on June 1, 2019 and will continue for a term of three years, unless terminated earlier in accordance with its terms. After the expiration of this initial term, Mr. Edwards’s employment agreement will automatically extend for successive one-year periods, unless either Mr. Edwards or the Company elect not to so extend. The employment agreement provides for an initial base salary of $285,000 per year. Mr. Edwards will be eligible to be considered for incentive compensation, if any, in an amount determined appropriate by the Company based on the recommendation of the Compensation Committee of the Company’s Board of Directors. He is also entitled to participate in the Company’s employee benefit plans and programs for which he is or will be eligible.

 

Mr. Edwards’s employment agreement provides for the termination of Mr. Edwards’s employment by the Company without “Cause” or by him for “Good Reason” in the absence of a “Change in Control” (as those terms are defined in the employment agreement). In such cases, Mr. Edwards will be entitled to receive his then-current base salary for the lesser of the remainder of the term or 18 months. Mr. Edwards’s employment agreement also provides for the termination of Mr. Edwards’s employment by the Company following a “Change in Control” or by him for “Good Reason” following a “Change in Control.” In such cases, Mr. Edwards will be entitled to receive, among other things, a lump sum amount equal to 2.99 times the sum of his base salary and highest annual bonus during the two years preceding the Change in Control. Mr. Edwards’s entitlement to the foregoing severance payments is subject to Mr. Edwards’s release and waiver of claims against the Company and his compliance with certain restrictive covenants as provided in the employment agreement.

 

In the event that Mr. Edwards is terminated by the Company as a result of a “Permanent Disability” (as defined in the employment agreement), Mr. Edwards will be entitled to receive a lump sum payment equal to 90 days of his then-current base salary. Mr. Edwards will not be entitled to any compensation or other benefits under his employment agreement if his employment is terminated upon his death, by the Company for “Cause,” or by him in the absence of “Good Reason.”

 

Mr. Edwards’s employment agreement contains restrictive covenants relating to the protection of confidential information, non-disclosure, non-competition and non-solicitation. The non-compete and non-solicitation covenants generally continue for a period of 24 months following the last day of Mr. Edwards’ employment.

 

Change in Control Agreement with Jonathan L. Kruckow

 

On June 1, 2019, the Company entered into a change in control agreement with Jonathan L. Kruckow, the Company’s Executive Vice President and Regional President, Virginia. On May 19, 2020 the Company amended the change in control agreement to extend the term of such agreement for one year from May 31, 2020 to May 31, 2021.

 

 

Mr. Kruckow’s change in control agreement provides that if the Mr. Kruckow’s employment is terminated by the Company without “Cause” or by him for “Good Reason” within 12 months following a “Change in Control Event” (as those terms are defined in the change in control agreement), the Company will make a severance payment to Mr. Kruckow equal to his annualized base salary. Mr. Kruckow’s entitlement to the foregoing severance payment is subject to Mr. Kruckow’s release and waiver of claims against the Company and his compliance with certain restrictive covenants as provided in the change in control agreement.

 

Mr. Kruckow will not be entitled to any compensation or other benefits under his change in control agreement if (a) the Company terminates his employment for “Cause,” (b) he voluntarily terminates his employment for other than “Good Reason,” or (c) his employment terminates or is terminated due to his death, “Retirement” or pursuant to a “Determination of Long Term Incapacity” (as those terms are defined in the change in control agreement). Subject to certain limited exceptions provided in the change in control agreement, the Company’s obligation to make severance payments under Mr. Kruckow’s change in control agreement expires on May 31, 2021.

 

Mr. Kruckow’s change in control agreement contains restrictive covenants relating to the protection of confidential information, non-disclosure, non-competition and non-solicitation. The non-compete and non-solicitation covenants generally continue for a period of 12 months following the last day of Mr. Kruckow’s employment.

 

Following any termination of employment or a change in control, the Company’s named executive officers are entitled to certain pension benefits and deferred compensation, as described above, and benefits under various health and insurance plans, which are available generally to all employees.

 

Change in Control Agreement with Beth R. Worrell

 

On June 1, 2019, the Company entered into a change in control agreement with Beth R. Worrell, the Company’s Executive Vice President and Chief Risk Officer. On May 19, 2020 the Company amended the change in control agreement to extend the term of such agreement for one year from May 31, 2020 to May 31, 2021.

 

Ms. Worrell’s change in control agreement provides that if Ms. Worrell’s employment is terminated by the Company without “Cause” or by her for “Good Reason” within 12 months following a “Change in Control Event” (as those terms are defined in the change in control agreement), the Company will make a severance payment to Ms. Worrell equal to two times her annualized base salary.  Ms. Worrell’s entitlement to the foregoing severance payment is subject to Ms. Worrell’s release and waiver of claims against the Company and her compliance with certain restrictive covenants as provided in the change in control agreement.

 

Ms. Worrell will not be entitled to any compensation or other benefits under her change in control agreement if (a) the Company terminates her employment for “Cause,” (b) she voluntarily terminates her employment for other than “Good Reason,” or (c) her employment terminates or is terminated due to her death, “Retirement” or pursuant to a “Determination of Long Term Incapacity” (as those terms are defined in the change in control agreement). Subject to certain limited exceptions provided in the change in control agreement, the Company’s obligation to make severance payments under Ms. Worrell’s change in control agreement expires on May 31, 2021.

 

Ms. Worrell’s change in control agreement contains restrictive covenants relating to the protection of confidential information, non-disclosure, non-competition and non-solicitation. The non-compete and non-solicitation covenants generally continue for a period of 12 months following the last day of Ms. Worrell’s employment.

 

Following any termination of employment or a change in control, the Company’s named executive officers are entitled to certain pension benefits and deferred compensation, as described above, and benefits under various health and insurance plans, which are available generally to all employees.

 

 

Director Compensation

 

The following table shows the compensation earned by each of the non-employee directors during 2020. Fees may also include reimbursement for ordinary business expenses such as lodging, meals, and mileage.

 

 

Name		Fees Paid ($)
Jacky K. Anderson			28,158
Dr. J. Howard Conduff, Jr.			26,507
Bryan L. Edwards			28,094
T. Mauyer Gallimore			22,063
Melissa Gentry			26,618
Thomas M. Jackson, Jr.			33,582
R. Devereux Jarratt			27,440
Theresa S. Lazo			27,263
W. David McNeill			27,029
James W. Shortt			29,113
Frank A. Stewart			25,471
John Michael Turman			25,341
J. David Vaughan			28,901

 

The Chairman of the Board receives fees of $1,000 per meeting and a monthly retainer of $400. Effective October 2020, the Vice Chairman of the Board receives fees of $900 per meeting and a monthly retainer of $350. All other directors receive $750 per meeting and a monthly retainer of $300. Additionally, $400 is paid to all directors for each committee meeting attended.

 

Blake M. Edwards, the Company’s President and Chief Executive Officer and a director of the Company, did not receive any compensation for his services as a director.

 

 

Item 12.

Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters.

 

The following table sets forth information as of March 23, 2021 regarding the number of shares of Parkway common stock beneficially owned by each director, each named executive officer and by all directors and executive officers as a group. Beneficial ownership includes shares, if any, held in the name of the spouse, minor children or other relatives of the director or executive officer living in such person’s home, as well as shares, if any, held in the name of another person under an arrangement whereby the director or executive officer can vest title in himself at once or at some future time.

 

Amount and Nature of Beneficial Ownership⁽¹⁾

 

Name of Beneficial Owner		Shares of Parkway Common Stock				Percent of Class
Directors and Named Executive Officers:
Jacky K. Anderson			2,112	(2)
Dr. J. Howard Conduff, Jr.			131,780	(3)			2.18	%
Bryan L. Edwards			1,408				*
T. Mauyer Gallimore			8,151	(4)			*
Melissa Gentry			4,500				*
Thomas M. Jackson, Jr.			11,120				*
R. Devereux Jarratt			36,951				*
Theresa S. Lazo			18,079	(5)			*
W. David McNeill			23,516				*
James W. Shortt			4,343	(6)			*
Frank A. Stewart			113,740				1.88	%
John Michael Turman			13,279	(7)			*
J. David Vaughan			9,783	(8)			*
Blake M. Edwards, Jr.			1,056				*
Jonathan L. Kruckow			200				*
Beth R. Worrell			200	(9)			*
All of Parkway’s directors, executive officers, and executive officers of Skyline as a group (20 individuals)			408,502				6.77	%

 

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(1)	Based on 6,035,775 shares of Parkway common stock outstanding as of March 23, 2021.

(2)	Shares are held jointly with children and former spouse.

(3)	Includes 11,163 shares owned jointly with his spouse and 8,297 shares owned by his sons.

(4)	Includes 7,501 shares owned jointly with his spouse.

(5)	Includes 2,914 shares owned jointly with her spouse.

(6)	Includes 3,076 shares owned jointly with his spouse.

(7)	Shares are held jointly with spouse.

(8)	Includes 1,526 shares owned jointly with his children.
(9)	Shares are held jointly with spouse.

*	Represents less than 1% of outstanding common stock

 

 

Security Ownership of Certain Beneficial Owners

 

The following table sets forth information as of March 23, 2021, unless otherwise noted, regarding the number of shares of Parkway common stock beneficially owned by all persons known by us who own, or will own under certain conditions, five percent or more of our outstanding shares of Parkway’s common stock.

 

Name and Address of Beneficial Owner		Amount and Nature of Beneficial Ownership				Percent of Class (1)
Joseph Stilwell 111 Broadway, 12th Floor
New York, New York 10006.			306,358	(2)			5.08	%

 

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(1)	Based on 6,035,775 shares of Parkway common stock outstanding as of March 23, 2021.

(2)

According to a Schedule 13D filed jointly by Stilwell Value Partners VII, L.P. (“Stilwell Value Partners VII”), Stilwell Activist Fund, L.P. (“Stilwell Activist Fund”), Stilwell Activist Investments, L.P. (“Stilwell Activist Investments”), Stilwell Value LLC, the general partner of Stilwell Value Partners VII, Stilwell Activist Fund, and Stilwell Activist Investments, and Joseph Stilwell, the managing member and owner of Stilwell Value LLC, on May 27, 2020, the group reported that each of Stilwell Value Partners VII, Stilwell Activist Fund, Stilwell Activist Investments, Stilwell Value LLC and Joseph Stilwell each have shared voting power and shared dispositive power over 306,358 shares of Parkway common stock.

 

 

Item 13.

Certain Relationships and Related Transactions, and Director Independence.

 

Some of the directors and officers of Parkway are at present, as in the past, customers of Skyline National Bank, and Skyline National Bank has had, and expects to have in the future, banking relationships in the ordinary course of its business with directors, officers, principal shareholders, and their associates, on substantially the same terms, including interest rates and collateral on loans, as those prevailing at the same time for comparable transactions with persons not related to Parkway. These transactions do not involve more than the normal risk of collectability or present other unfavorable features. The aggregate outstanding balance of loans to directors, executive officers, and their associates, as a group, at December 31, 2020 totaled $12.4 million or 14.60% of Parkway’s equity capital at that date.

 

There are no legal proceedings to which any director, officer, or principal shareholder, or any affiliate thereof, is a party that would be material and adverse to Parkway.

 

The Company has not adopted a formal policy that covers the review and approval of related person transactions by the Board of Directors. The Board of Directors, however, does review all such transactions that are proposed to it for approval. During such a review, the Board will consider, among other things, the related person’s relationship to Parkway, the facts and circumstances of the proposed transaction, the aggregate dollar amount of the transaction, the related person’s relationship to the transaction, and any other material information. Parkway’s Audit Committee also has the responsibility to review significant conflicts of interest involving directors or executive officers.

 

Independence of Directors

 

The Board of Directors in its business judgment has determined that the following twelve of its fourteen members are independent as that term is defined by the Nasdaq Stock Market: Dr. J. Howard Conduff, Jr., Bryan L. Edwards, T. Mauyer Gallimore, Melissa Gentry, Thomas M. Jackson, Jr., R. Devereux Jarratt, Theresa S. Lazo, W. David McNeill, James W. Shortt, Frank A. Stewart, John Michael Turman, and J. David Vaughan.

 

The Board considered the following transactions between us and certain of our directors or their affiliates to determine whether such director was independent under the above standards:

 

●

Prior to the Cardinal merger, Grayson had an advisory agreement in place with Mr. Anderson under which he was paid for various consultative and advisory services related to customer, shareholder, and employee related issues. The agreement expired in September of 2014. Mr. Anderson also served as President and Chief Executive Officer of Grayson from June 2000 until his retirement in September 2013.

 

Additional information about committees is included in “Corporate Governance – Committees of the Board” in Item 10.

 

 

Item 14.

Principal Accountant Fees and Services.

 

Audit Fees

 

The aggregate fees billed by Elliott Davis, PLLC for professional services rendered for the audit of the Company’s annual financial statements for the fiscal years ended December 31, 2020 and 2019, and for the review of the financial statements included in the Company’s Quarterly Reports on Form 10-Q, and services that are normally provided in connection with statutory and regulatory filings and engagements, were $100,000 for 2020 and $104,400 for 2019.

 

Audit Related Fees

 

The aggregate fees billed by Elliott Davis, PLLC for professional services for assurance and related services that are reasonably related to the performance of the audit or review of the Company’s financial statements and not reported under the heading “Audit Fees” above were $2,800 for 2020.  During 2020, these services consisted of the review of the Form S-8. There were no audit related fees in 2019.

 

Tax Fees

 

The aggregate fees billed by Elliott Davis, PLLC for professional services for tax compliance, tax advice and tax planning were $12,150 for 2020 and $16,125 for 2019.  During 2020 and 2019, these services generally included Federal and state income tax return preparation.

 

All Other Fees

 

No fees for other services were billed by Elliott Davis, PLLC for the fiscal years ended December 31, 2020 or 2019.

 

Pre-Approval Policies and Procedures

 

All audit related services, tax services and other services were pre-approved by the Audit Committee, which concluded that the provision of such services by Elliott Davis, PLLC was compatible with the maintenance of that firms’ independence in the conduct of their auditing functions.  The Audit Committee’s Charter provides for pre-approval of audit, audit-related and tax services. The Charter authorizes the Audit Committee to delegate to one or more of its members pre-approval authority with respect to permitted services.

 

 

PART IV

 

Item 15.

Exhibits, Financial Statement Schedules.

 

(a)          (1) The response to this portion of Item 15 is included in Item 8 above.

(2) The response to this portion of Item 15 is included in Item 8 above.

(3) The following documents are attached hereto or incorporated herein by reference to Exhibits:

 

Exhibit No.	Description
2.1	Agreement and Plan of Merger, dated as of November 6, 2015, by and among Parkway Acquisition Corp., Grayson Bankshares, Inc. and Cardinal Financial Corp. (attached as Exhibit 2.1 to the Company’s Registration Statement on Form S-4 filed on January 20, 2016, and incorporated herein by reference).
2.2	Agreement and Plan of Merger, dated as of March 1, 2018, by and among Parkway Acquisition Corp., Skyline National Bank and Great State Bank (attached as Exhibit 2.1 to the Company’s Current Report on Form 8-K filed March 7, 2018, and incorporated herein by reference).
3.1	Articles of Incorporation of Parkway Acquisition Corp. (attached as Exhibit 3.1 to the Company's Registration Statement on Form S-4 filed on January 20, 2016, and incorporated herein by reference).
3.2	Amended and Restated Bylaws of Parkway Acquisition Corp. (attached as Exhibit 3.1 to the Company's Current Report on Form 8-K filed on February 21, 2019, and incorporated herein by reference).
4.1	Form of Common Stock Certificate of Parkway Acquisition Corp. (attached as Exhibit 4.1 to the Company's Registration Statement on Form S-4 filed on January 20, 2016, and incorporated herein by reference).
10.1	Supplemental Executive Retirement Plan, dated November 22, 2017, for the benefit of Blake M. Edwards (attached as Exhibit 10.5 to the Company’s Current Report on Form 8-K filed November 29, 2017, and incorporated herein by reference).
10.2	Supplemental Executive Retirement Plan, dated November 22, 2017, for the benefit of Rodney R. Halsey (attached as exhibit 10.7 to the Company’s Annual Report on 10-K filed on March 29, 2019, and incorporated herein by reference).
10.3	Executive Employment Agreement, dated June 1, 2019, by and between Parkway Acquisition Corp. and Blake M. Edwards (attached as Exhibit 10.1 to the Company’s Current Report on Form 8-K filed June 6, 2019, and incorporated herein by reference).
10.4	Change in Control Agreement, dated June 1, 2019, by and between Parkway Acquisition Corp. and Rodney R. Halsey (attached as Exhibit 10.2 to the Company’s Current Report on Form 8-K filed June 6, 2019, and incorporated herein by reference).
10.5	Change in Control Agreement, dated June 1, 2019, by and between Parkway Acquisition Corp. and Lorina C. Vaught (attached as Exhibit 10.3 to the Company’s Current Report on Form 8-K filed June 6, 2019, and incorporated herein by reference).
10.6	Employment Agreement, dated March 1, 2018 and effective upon the merger of Great State Bank into Skyline National Bank, by and between Parkway Acquisition Corp., Skyline National Bank and C. Greg Edwards (attached as Exhibit 10.7 to the Company’s Registration Statement on Form S-4 filed on April 13, 2018, and incorporated herein by reference).
10.7	Change in Control Agreement, dated June 1, 2019, by and between Parkway Acquisition Corp. and Jonathan L. Kruckow (attached as Exhibit 10.7 to the Company’s Annual Report on Form 10-K filed March 24, 2020, and incorporated herein by reference).
10.8	Change in Control Agreement, dated June 1, 2019, by and between Parkway Acquisition Corp. and Beth R. Worrell.
10.9	Parkway Acquisition Corp. 2020 Equity Incentive Plan (attached as Exhibit 10.1 to the Company’s Quarterly Report on 10-Q filed on November 13, 2020 and incorporated herein by reference).
10.10	Form of Restricted Stock Award Agreement.
21.1	Subsidiaries of the Company
23.1	Consent of Elliott Davis, PLLC.
31.1	Rule 15(d)-14(a) Certification of Chief Executive Officer.
31.2	Rule 15(d)-14(a) Certification of Chief Financial Officer.

 

 

32.1

Statement of Chief Executive Officer and Chief Financial Officer Pursuant to 18 U.S.C. Section 1350.

101

The following materials from the Annual Report on Form 10-K for the year ended December 31, 2020, formatted in eXtensible Business Reporting Language (XBRL): (i) Consolidated Balance Sheets, (ii) Consolidated Statements of Income, (iii) Consolidated Statements of Comprehensive Income, (iv) Consolidated Statements of Changes in Stockholders’ Equity, (v) Consolidated Statements of Cash Flows and (vi) Notes to Consolidated Financial Statements.

 

(b)

Exhibits

See Item 15(a)(3) above.

 

(c)	Financial Statement Schedules

See Item 15(a)(2) above.

 

Item 16.

Form 10-K Summary

 

None

 

 

SIGNATURES

 

Pursuant to the requirements of Section 13 or 15(d) 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.

 

	PARKWAY ACQUISITION CORP.
Date: March 24, 2021	By:	/s/ Blake M. Edwards
		Blake M. Edwards President and Chief Executive Officer (Principal Executive Officer)

 

Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated on March 24, 2021.

 

Date: March 24, 2021	By:	/s/ Blake M. Edwards
		Blake M. Edwards President, Chief Executive Officer and Director (Principal Executive Officer)
Date: March 24, 2021	By:	/s/ Lori C. Vaught
		Lori C. Vaught Chief Financial Officer (Principal Financial and Accounting Officer)
Date: March 24, 2021	By:	/s/ Thomas M. Jackson, Jr.
		Thomas M. Jackson, Jr. Chairman of the Board
Date: March 24, 2021	By:	/s/ James W. Shortt
		James W. Shortt Vice Chairman
Date: March 24, 2021	By:	/s/ Melissa Gentry
		Melissa Gentry Director
Date: March 24, 2021	By:	/s/ Jacky K. Anderson
		Jacky K. Anderson Director
Date: March 24, 2021	By:	/s/ Bryan L. Edwards
		Bryan L. Edwards Director
Date: March 24, 2021	By:	/s/ J. David Vaughan
		J. David Vaughan Director
Date: March 24, 2021	By:	/s/ Theresa S. Lazo
		Theresa S. Lazo Director

 

 

Date: March 24, 2021	By:	/s/ J. Howard Conduff, Jr.
		J. Howard Conduff, Jr. Director
Date: March 24, 2021	By:	/s/ T. Mauyer Gallimore
		T. Mauyer Gallimore Director
Date: March 24, 2021	By:	/s/ R. Devereux Jarratt
		R. Devereux Jarratt Director
Date: March 24, 2021	By:	/s/ John Michael Turman
		John Michael Turman Director
Date: March 24, 2021	By:	/s/ W. David McNeill
		W. David McNeill Director
Date: March 24, 2021	By:	/s/ Frank A. Stewart
		Frank A. Stewart Director

 

 

 

 

Supplemental Information to be Furnished With Reports Filed Pursuant to Section 15(d) of the Act by Registrants

Which Have Not Registered Securities Pursuant to Section 12 of the Act

 

As of the date of this report, we have not sent any annual reports or proxy materials to our stockholders. We intend to deliver (i) our annual report to stockholders for the fiscal year ended December 31, 2020 and (ii) our proxy materials for our 2021 Annual Meeting to our stockholders subsequent to the filing of this report.  We will furnish copies of the annual report and the proxy materials to the SEC when we deliver such materials to our stockholders.