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Section 1: 10-K (10-K)

10-K
Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM 10-K

 

 

ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)

OF THE SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended December 31, 2018

Commission File Number: 333-209052

 

 

PARKWAY ACQUISITION CORP.

(Exact name of registrant as specified in its charter)

 

 

 

Virginia   47-5486027

(State or other jurisdiction

of incorporation or organization)

 

(I.R.S. Employer

Identification No.)

 

101 Jacksonville Circle

Floyd, Virginia

  24091
(Address of principal executive offices)   (Zip Code)

(540) 745-4191

(Registrant’s telephone number, including area code)

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

None

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

None

 

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.    Yes  ☐    No  ☑

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.    Yes  ☐    No  ☑

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

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

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  ☑

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

 

Large accelerated filer      Accelerated filer  
Non-accelerated filer      Smaller reporting company  
     Emerging growth company  

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

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

State the aggregate market value of the voting and non-voting common equity held by non-affiliates computed by reference to the price at which the common equity was last sold, or the average bid and asked price of such common equity, as of the last business day of the registrant’s most recently completed second fiscal quarter. $61,433,021

Indicate the number of shares outstanding of each of the registrant’s classes of common stock, as of the latest practicable date. 6,213,275 shares of Common Stock as of March 28, 2019

DOCUMENTS INCORPORATED BY REFERENCE

None

 

 

 


Table of Contents

TABLE OF CONTENTS

 

         Page
Number
 

Part I

       1  

Item 1.

 

Business

     1  

Item 1A.

 

Risk Factors

     12  

Item 1B.

 

Unresolved Staff Comments

     18  

Item 2.

 

Properties

     18  

Item 3.

 

Legal Proceedings

     18  

Item 4.

 

Mine Safety Disclosures

     18  

Part II

       19  

Item 5.

 

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

     19  

Item 6.

 

Selected Financial Data

     19  

Item 7.

 

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

     20  

Item 7A.

 

Quantitative and Qualitative Disclosures About Market Risk

     39  

Item 8.

 

Financial Statements and Supplementary Data

     39  

Item 9.

 

Changes in and Disagreements with Accountants on Accounting and Financial Disclosure

     85  

Item 9A.

 

Controls and Procedures

     85  

Item 9B.

 

Other Information

     86  

Part III

       86  

Item 10.

 

Directors, Executive Officers and Corporate Governance

     86  

Item 11.

 

Executive Compensation

     91  

Item 12.

 

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

     95  

Item 13.

 

Certain Relationships and Related Transactions, and Director Independence

     96  

Item 14.

 

Principal Accounting Fees and Services

     97  

Part IV

       98  

Item 15.

 

Exhibits, Financial Statement Schedules

     98  

Item 16.

 

Form 10-K Summary

     99  

 

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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. Pursuant to the Great State merger, the Company acquired $145.5 million of assets, including $95.1 million in loans and assumed $133.0 million in liabilities, including $130.6 million of deposits, on July 1, 2018. Such accounts include preliminary estimated fair value adjustments, which are subject to change.

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, Watauga, Wilkes, and Yadkin, and the surrounding areas through twenty full-service banking offices and four 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 87.51% of the interest earning assets of the Bank at December 31, 2018, 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 Directors’ Loan Committee has the authority to approve loans up to $2.0 million of total indebtedness to a single customer. All loans in excess of that amount must be presented to the full Board of Directors of the Bank for ultimate approval or denial.

 

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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, 2018, the Bank had 43.94% of the loan portfolio in single and multi-family housing, 32.84% in non-farm, non-residential real estate loans, 6.21% in farm related real estate loans, and 6.23% in real estate construction and development loans.

The Bank’s loan portfolio includes commercial and agricultural production loans totaling 6.99% of the portfolio at December 31, 2018. Consumer and other loans make up approximately 3.79% 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 87.07% of the Bank’s total deposits at December 31, 2018. Certificates of deposit in denominations of $100,000 or more represented the remaining 12.93% of deposits at December 31, 2018.

Market Area

The Bank’s primary market area consists of:

 

   

all of Grayson County, Virginia

 

   

all of Floyd County, Virginia

 

   

all of Carroll County, Virginia

 

   

all of Wythe County, Virginia

 

   

all of Pulaski County, Virginia

 

   

all of Montgomery County, Virginia

 

   

portions of Roanoke County, Virginia

 

   

all of Alleghany County, North Carolina

 

   

all of Ashe County, North Carolina

 

   

all of Watauga County, North Carolina

 

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all of Wilkes County, North Carolina

 

   

all of Yadkin County, North Carolina

 

   

the City of Galax, Virginia

 

   

the City of Salem, Virginia

 

   

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 $31,002 in Grayson County, to a high of $38,623 in Yadkin County, based upon 2016 census data. Montgomery, Pulaski, Floyd, Wythe 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 Appalachia State University, while 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 $39,443 in Watauga County, to a high of $49,712 in Montgomery County, according to the 2016 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 $39,201 in Roanoke City, to a high of $60,380 in Roanoke County.

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, 2018, the Company had 211 total employees representing 206 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.

 

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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.

The 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 future regulatory rulemaking and interpretations. Certain provisions of the Dodd-Frank Act, as currently in effect, that have impacted or could impact the Company are set forth below:

 

   

Creation of a new agency, the Consumer Financial Protection Bureau (“CFPB”), that has rulemaking authority for a wide range of consumer protection laws that would apply to all banks and have broad powers to supervise and enforce consumer protection laws.

 

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Changes in standards for Federal preemption of state laws related to federally chartered institutions, such as the Bank, and their subsidiaries.

 

   

Permanent increase of deposit insurance coverage to $250 thousand and permission for depository institutions to pay interest on business checking accounts.

 

   

Changes in the assessment base for federal deposit insurance from the amount of insured deposits to consolidated assets less tangible capital, eliminates the ceiling on the size of the Deposit Insurance Fund (“DIF”), and increases the floor of the size of the DIF.

 

   

Prohibition on banks and their affiliates from engaging in proprietary trading and investing in and sponsoring certain unregistered investment companies (the “Volker Rule”).

The Economic Growth Act

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” of between 8 and 10 percent. Any qualifying depository institution or its holding company that exceeds the “community bank leverage ratio” will be considered to have met generally applicable leverage and risk-based regulatory capital requirements and any qualifying depository institution that exceeds the new ratio will be considered to be “well capitalized” under the prompt corrective action rules. 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.

It is difficult at this time to predict when or how any new standards under the Economic Growth Act will ultimately be applied to us or what specific impact the Economic Growth Act and implementing rules and regulations will have on community banks.

Deposit Insurance

The deposits of the Bank are insured by the DIF up to applicable limits and are subject to deposit insurance assessments to maintain the DIF. On April 1, 2011, the deposit insurance assessment base changed from total deposits to average total assets minus average tangible equity, pursuant to a rule issued by the FDIC as required by the Dodd-Frank Act.

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 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% upon full implementation), (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% upon full implementation), (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% upon full implementation), 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.

 

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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.

Based on management’s understanding and interpretation of the new capital rules, it believes that, as of December 31, 2018, 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 November 21, 2018, the federal banking regulators jointly issued a proposed rule that would permit qualifying banks that have less than $10 billion in total consolidated assets to elect to be subject to a 9% “community bank leverage ratio.” A qualifying bank that has chosen the proposed framework would not be required to calculate the existing risk-based and leverage capital requirements and 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%. This proposed rule has not been finalized and, as a result, the content and scope of any final rule, and its impact on the Bank (if any), cannot be determined at this time.

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.

 

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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.

 

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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, 2018 and 2017, the Company met the requirements for being classified as “well capitalized.”

As discussed under “Capital Requirements” above, federal banking regulators have jointly issued a proposed rule that would permit 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.

 

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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.

 

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The Dodd-Frank Act centralized responsibility for consumer financial protection by creating a new agency, the 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.

Anti-Money Laundering Legislation

The Company is subject to the Bank Secrecy Act and other anti-money laundering laws and regulations, including the USA Patriot Act of 2001. Among other things, these laws and regulations require the Company to take steps to prevent the use of the Company for facilitating the flow of illegal or illicit money, to report large currency transactions, and to file suspicious activity reports. The Company is also required to carry out a comprehensive anti-money laundering compliance program. Violations can result in substantial civil and criminal sanctions. In addition, provisions of the USA Patriot Act require the federal bank regulatory agencies to consider the effectiveness of a financial institution’s anti-money laundering activities when reviewing bank mergers and BHC acquisitions.

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.

 

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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, 2018, the Company had not been made aware of any instances of non-compliance with the final guidance.

Cybersecurity

In March 2015, federal regulators issued two related statements regarding cybersecurity. One statement indicates that financial institutions should design multiple layers of security controls to establish lines of defense and to ensure that their risk management processes also address the risk posed by compromised customer credentials, including security measures to reliably authenticate customers accessing internet-based services of the financial institution. The other statement indicates that a financial institution’s management is expected to maintain sufficient business continuity planning processes to ensure the rapid recovery, resumption and maintenance of the institution’s operations after a cyber-attack involving destructive malware. A financial institution is also expected to develop appropriate processes to enable recovery of data and business operations and address rebuilding network capabilities and restoring data if the institution or its critical service providers fall victim to this type of cyber-attack. If the Company fails to observe the regulatory guidance, it could be subject to various regulatory sanctions, including financial penalties.

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

 

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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.

 

Item 1A.

Risk Factors.

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

We are located in southwestern Virginia, 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.

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, 2018, the Company had $478.6 million of such loans outstanding, or 89.22% 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.

 

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

As of December 31, 2018, 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, we would pay higher insurance premiums to the FDIC, which would reduce our earnings.

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.

We may be adversely impacted by changes in market conditions.

We are directly and indirectly affected by changes in market conditions. 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.

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.

 

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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 natural disasters, terrorism and international hostilities on our systems or for the effects of outages or other failures involving power or communications systems operated by others.

 

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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.

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. 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, 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.

 

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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 may be subject to more 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%. The new capital conservation buffer requirement has been phased in beginning in January 2016 at 0.625% of risk-weighted assets and increased each year until fully implemented in January 2019. 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 recently passed 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.

The full impact of changes to federal tax laws is uncertain and may negatively impact our financial performance.

We are subject to changes in tax law that could increase our effective tax rates. These law changes may be retroactive to previous periods and, as a result, could negatively affect our current and future financial performance.

The Tax Cuts and Jobs Act (the “Tax Act”), the full impact of which is subject to further evaluation and analysis, is likely to have both positive and negative effects on our financial performance. For example, the new legislation resulted in a reduction in our federal corporate tax rate from 35% to 21% beginning in 2018, which has had and is expected to continue to have a favorable impact on our earnings and capital generation abilities. However, the new legislation also enacted limitations on certain deductions, such as the deduction of FDIC deposit insurance premiums, which will partially offset the anticipated increase in net earnings from the lower tax rate. Further, the full impact of the Tax Act may differ from the foregoing and from our expectations, possibly materially, due to changes in interpretations or in assumptions that we have made or that we make in 2019, guidance or regulations that may be promulgated, and other actions that we may take as a result of the Tax Act.

 

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Similarly, the Bank’s customers are likely to experience varying effects from both the individual and business tax provisions of the Tax Act. For example, changes to tax deductibility of business interest expense could impact business customer borrowing. Such effects, whether positive or negative, may have a corresponding impact on our business and the economy as a whole.

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. 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. Many of the provisions of the Dodd-Frank Act are subject both to further rulemaking and the discretion of applicable regulatory bodies. Although we cannot predict the full effect of the Dodd-Frank Act on our operations, it, as well as the future rules implementing its reforms, could impose significant additional costs on us, limit the products we offer, limit our ability to pursue business opportunities in an efficient manner, require us to increase our regulatory capital, impact the values of assets that we hold, significantly reduce our revenues or otherwise materially and adversely affect our businesses, financial condition, or results of operations. The ultimate impact of the final rules on our businesses and results of operations, however, will depend on regulatory interpretation and rulemaking, as well as the success of our actions to mitigate the negative earnings impact of certain provisions.

Combining the Company and Great State Bank may be more difficult, costly or time-consuming than we expect.

The success of the merger with Great State Bank will depend, in part, on our ability to realize the anticipated benefits and estimated cost savings from combining the businesses of the Company and Great State Bank. However, to realize these anticipated benefits and cost savings, we must successfully combine the businesses of the Company and Great State Bank. If we are not able to achieve these objectives, the anticipated benefits and cost savings of the merger may not be realized fully, or at all, or may take longer to realize than expected.

After the completion of the merger, we have integrated Great State Bank’s business into our own. The success of the merger will depend on a number of factors, including, but not limited to our ability to:

 

   

timely and successfully integrate the operations of the Company and Great State Bank;

 

   

retain key employees of the Company and Great State Bank, and retain and attract qualified personnel to, the combined company; and

 

   

maintain existing relationships with customers, suppliers and vendors of the Company and Great State Bank.

It is possible that the integration process could result in the loss of key employees, the disruption of ongoing business or inconsistencies in standards, controls, procedures and policies that adversely affect our ability to maintain relationships with clients, customers, depositors and employees or to achieve the anticipated benefits of the merger.

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 announced that the continued availability of the LIBOR on the current basis is not guaranteed after 2021. It is impossible 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 implementation of a substitute index or indices for the calculation of interest rates under the Bank’s loan agreements with borrowers or other financial arrangements may cause the Bank to incur significant expenses in effecting the transition, may result in reduced loan balances if borrowers do not accept the 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, 2020. 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.

 

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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, Salem, 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 St., Sparta NC

   336-372-2811    Full service

Hillsville Office – 419 South Main St., Hillsville, VA

   276-728-2810    Full service

Whitetop Office – 16303 Highlands Parkway, Whitetop, VA

   276-388-3811    Full service

Wytheville Office – 420 North 4th St., 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 St., Christiansburg, VA

   540-381-8121    Full service

Fairlawn Office - 7349 Peppers Ferry Blvd., Radford, VA

   540-633-1680    Full service

Salem Office - 1634 West Main St., Salem, VA

   540-387-4533    Full service

West Jefferson – 1055 Mount Jefferson Road, West Jefferson, NC

   336-489-7811    Full service

Boone – 189 Boone Heights Drive, Boone, NC

   828-264-4260    Full service

Wilkesboro – 1422 US Highway 421, Wilkesboro, NC

   336-903-4948    Full service

Yadkinville – 516 Hawthorne Drive, Yadkinville, NC

   336-849-4194    Full service
Willis Office - 5598 B Floyd Highway South, Willis, VA    540-745-4191    Limited service/conducts normal teller transactions

The Bank has two conference centers located at 558 East Main Street, Independence, Virginia, and 203 E. Oxford Street, Floyd, Virginia, which are 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 four loan production offices in leased facilities in the town of Blacksburg, Virginia, and the cities of Hickory, Lenoir, and Shelby, North Carolina. The Bank purchased an existing vacant building in Salem, Virginia in July of 2018. The Bank anticipates opening this building as a full service branch banking facility in June of 2019.

 

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.

 

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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 12, 2019, there were 6,213,275 shares of the Company’s common stock outstanding, held by 1,713 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. 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.

Following are the high and low prices of sales of common stock known to the Company, along with the dividends that were paid quarterly (per share).

 

     High      Low      Dividends  

2017

        

First quarter

     9.60        8.60        0.08

Second quarter

     10.50        9.55        0.00

Third quarter

     11.25        10.30        0.08  

Fourth quarter

     12.75        11.21        0.00

2018

        

First quarter

     12.99        12.10        0.10

Second quarter

     13.15        12.60        0.00

Third quarter

     13.30        13.00        0.10  

Fourth quarter

     13.20        10.90        0.00

Dividend Policy

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.

Stock Repurchases

The Company did not repurchase any shares of its common stock during 2018.

 

Item 6.

Selected Financial Data.

 

 

Financial Highlights1

 

 

 

     2018      2017      2016     2015     2014  

Summary of Operations

            

Interest income

   $ 26,186      $ 22,274      $ 17,562     $ 12,703     $ 12,996  

Interest expense

     1,901        1,474        1,728       2,226       2,600  
  

 

 

    

 

 

    

 

 

   

 

 

   

 

 

 

Net interest income

     24,285        20,800        15,834       10,477       10,396  

Provision for (reduction of) loan losses

     325        217        (5     (187     294  

Other income

     4,637        4,228        4,570       2,511       2,961  

Other expense

     22,857        19,280        16,816       11,580       11,902  

Income taxes

     1,214        3,104        1,175       598       295  
  

 

 

    

 

 

    

 

 

   

 

 

   

 

 

 

Net income

   $ 4,526      $ 2,427      $ 2,418     $ 997     $ 866  
  

 

 

    

 

 

    

 

 

   

 

 

   

 

 

 

Per Share Data

            

Net income

   $ .81      $ .48      $ .60     $ .58     $ .50  

Cash dividends declared

     .20        .16        .12       .10       —    

Book value

     12.17        11.39        11.05       17.83       17.43  

Year-end Balance Sheet Summary

            

Loans, net

   $ 532,970      $ 421,418      $ 408,548     $ 237,798     $ 218,805  

Investment securities

     45,428        50,675        62,540       56,050       69,037  

Total assets

     680,284        547,961        558,856       331,760       333,064  

Deposits

     601,868        488,441        499.387       279,876       282,136  

Stockholders’ equity

     75,622        57,182        55,466       30,656       29,698  

Selected Ratios

            

Return on average assets

     0.75%        0.44%        0.55%       0.30%       0.26%  

Return on average equity

     7.02%        4.28%        5.62%       3.22%       2.93%  

Average equity to average assets

     10.66%        10.32%        9.78%       9.33%       8.94%  

 

1 

In thousands of dollars, except per share data.

 

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Item 7.

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

 

 

Management’s Discussion and Analysis

 

 

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. Pursuant to the Great State merger, the Company acquired $145.5 million of assets, including $95.1 million in loans and assumed $133.0 million in liabilities, including $130.6 million of deposits, on July 1, 2018. Such accounts include preliminary estimated fair value adjustments, which are subject to change.

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, Watauga, Wilkes, and Yadkin, and the surrounding areas through twenty full-service banking offices and four loan production offices. As an 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 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 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.

 

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Management’s Discussion and Analysis

 

 

 

Parkway had net earnings of $4.5 million for 2018 compared to $2.4 million for 2017. Earnings in 2018 and 2017 were impacted significantly by the acquisition of Great State, including merger-related expenses during 2018 and the inclusion of Great State’s financial results beginning July 1, 2018. Interest income and interest expense increased due to the acquired loans and deposits, in addition to increases in interest rates earned on loans and paid on deposits. Non-recurring merger related expenses totaled approximately $2.0 million in 2018 and $748 thousand in 2017. Earnings in 2017 were also significantly impacted by a nonrecurring charge to income tax expense to reflect the impact of the Tax Cuts and Jobs Act which was signed into law on December 22, 2017. The new legislation reduced tax rates effective January 1, 2018, resulting in a re-measurement of the Company’s deferred tax assets and liabilities. The change in value of the Company’s deferred tax assets was recorded as an addition to 2017 income tax expense of $1.44 million.

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;

   

combining the Company and Great State may be more difficult than we expect, and we may not be able to realize the anticipated benefits and estimated cost savings in the proposed merger;

   

disruptions to customer and employee relationships and business operations caused by the Great State merger or otherwise;

   

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; and

   

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

 

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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, 2018 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.

 

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Management’s Discussion and Analysis

 

 

 

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

 

 

 

     2018     2017     2016  
           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

   $ 9,365     $ 106        1.13   $ 9,611     $ 48        0.50   $ 9,977     $ 37        0.37

Federal funds sold

     10,584       228        2.15     9,703       111        1.14     9,316       46        0.49

Investment securities

     50,504       1,278        2.53     59,210       1,393        2.35     51,027       1,195        2.34

Loans 1, 2

     476,900       24,574        5.15     417,723       20,722        4.96     325,723       16,284        5.00
  

 

 

   

 

 

    

 

 

   

 

 

   

 

 

    

 

 

   

 

 

   

 

 

    

 

 

 

Total

     547,353       26,186          496,247       22,274          396,043       17,562     
  

 

 

   

 

 

      

 

 

   

 

 

      

 

 

   

 

 

    

Yield on average interest-earning assets

          4.78          4.49          4.43
       

 

 

        

 

 

        

 

 

 

Non interest-earning assets:

                     

Cash and due from banks

     8,218            7,145            10,256       

Premises and equipment

     19,055            17,852            14,603       

Interest receivable and other

     35,400            33,449            22,279       

Allowance for loan losses

     (3,435          (3,539          (3,927     

Unrealized gain/(loss) on securities

     (1,283          (356          364       
  

 

 

        

 

 

        

 

 

      

Total

     57,955            54,551            43,575       
  

 

 

        

 

 

        

 

 

      

Total assets

   $ 605,308          $ 550,798          $ 439,618       
  

 

 

        

 

 

        

 

 

      

Interest-bearing liabilities:

                     

Demand deposits

   $ 115,409       194        0.17   $ 59,485       52        0.09   $ 42,848       44        0.10

Savings deposits

     117,479       347        0.30     143,895       342        0.24     107,546       247        0.23

Time deposits

     163,932       1,326        0.81     159,733       1,079        0.68     132,637       995        0.75

Borrowings

     1,757       34        1.94     37       1        1.93     11,412       442        3.87
  

 

 

   

 

 

    

 

 

   

 

 

   

 

 

    

 

 

   

 

 

   

 

 

    

 

 

 

Total

     398,577       1,901          363,150       1,474          294,443       1,728     
  

 

 

   

 

 

      

 

 

   

 

 

      

 

 

   

 

 

    

Cost on average interest-bearing liabilities

          0.48          0.41          0.59
       

 

 

        

 

 

        

 

 

 

Non interest-bearing liabilities:

                     

Demand deposits

     139,409            128,356            100,425       

Interest payable and other

     2,826            2,351            1,729       
  

 

 

        

 

 

        

 

 

      

Total

     142,235            130,707            102,154       
  

 

 

        

 

 

        

 

 

      

Total liabilities

     540,812            493,857            396,597       

Stockholder’s equity:

     64,496            56,941            43,021       
  

 

 

        

 

 

        

 

 

      

Total liabilities and stockholder’s equity

   $ 605,308          $ 550,798          $ 439,618       
  

 

 

        

 

 

        

 

 

      

Net interest income

     $ 24,285          $ 20,800          $ 15,834     
    

 

 

        

 

 

        

 

 

    

Net yield on interest-earning assets

          4.44          4.19          3.99
       

 

 

        

 

 

        

 

 

 

 

1

Includes nonaccural loans

2 

Interest income includes loan fees

 

23


Table of Contents

 

Management’s Discussion and Analysis

 

 

 

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

 

     2018 Compared to 2017     2017 Compared to 2016  
    

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

   $ 58     $ 59      $ (1   $ 11     $ 12     $ (1

Federal funds sold

     117       106        11       65       63       2  

Investment securities

     (115     121        (236     198       5       193  

Loans

     3,852       827        3,025       4,438       (131     4,569  
  

 

 

   

 

 

    

 

 

   

 

 

   

 

 

   

 

 

 

Total

     3,912       1,113        2,799       4,712       (51     4,763  
  

 

 

   

 

 

    

 

 

   

 

 

   

 

 

   

 

 

 

Interest-bearing liabilities:

             

Demand deposits

     142       70        72       8       (4     12  

Savings deposits

     5       21        (16     95       11       84  

Time deposits

     247       218        29       84       (100     184  

Borrowings

     33       —          33       (441     (1     (440
  

 

 

   

 

 

    

 

 

   

 

 

   

 

 

   

 

 

 

Total

     427       309        118       (254     (94     (160
  

 

 

   

 

 

    

 

 

   

 

 

   

 

 

   

 

 

 

Net interest income

   $ 3,485     $ 804      $ 2,681     $ 4,966     $ 43     $ 4,923  
  

 

 

   

 

 

    

 

 

   

 

 

   

 

 

   

 

 

 

 

(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.

 

 

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, 2018, total interest income increased by $3.9 million compared to the year ended December 31, 2017. As noted above, the Great State merger was completed on July 1, 2018; therefore, the operating results for 2018 include six months of combined earnings along with six months of Parkway earnings prior to the merger. As a result, the increase in interest income on loans for the year ended December 31, 2018 was due to increased volume resulting from the merger, along with increase in rates on loans. The increases in interest income on federal funds sold and interest-bearing deposits in banks were due more to increases in overnight borrowing rates established by the Federal Reserve. Interest expense on deposits increased by $394 thousand due to the addition of interest-bearing deposits from the Great State merger, along with increases in the rates paid on deposits. Amortization of premiums on acquired time deposits, which reduces interest expense, totaled $327 thousand for the year ended December 31, 2018, compared to $228 thousand for the year ended December 31, 2017. Interest on borrowings increased by $33 thousand due to overnight borrowings which were accessed in the second and third quarters of 2018 along with FHLB Advances that were acquired as part of the Great State merger. The effects of changes in volumes and rates on net interest income in 2018 compared to 2017, and 2017 compared to 2016 are shown in Table 2.

The aforementioned factors led to an increase in net interest income of $3.5 million or 16.75% for 2018 as compared to 2017. The net yield on interest-earning assets increased by 25 basis points to 4.44% in 2018 compared to 4.19% in 2017.

 

24


Table of Contents

 

Management’s Discussion and Analysis

 

 

 

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 $325 thousand for the year ended December 31, 2018, compared to $217 thousand for the year ended December 31, 2017. Asset quality has remained relatively consistent over the past year; therefore, the increase in loan loss provisions from 2017 to 2018 was due primarily to overall growth in the loan portfolio. The reserve for loan losses at December 31, 2018 was approximately 0.65% of total loans, compared to 0.81% at December 31, 2017. 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, 2018, the remaining unaccreted discount on the acquired loan portfolios totaled $5.0 million. 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 consists of revenues generated from a broad range of financial services and activities. The majority of noninterest income is traditionally a result of service charges on deposit accounts including charges for overdrafts and fees charged for non-deposit services. Noninterest income increased by $409 thousand in 2018 compared to 2017. The increase was due to service-related income from the Company’s increased customer base following the merger with Great State as well as nonrecurring proceeds from life insurance contracts totaling $303 thousand in 2018. Securities gains decreased by $237 thousand for the year ended December 31, 2018 compared to the same period last year as increases in interest rates led to decreases in the market value of the Bank’s investment securities portfolio. Noninterest income decreased by $342 thousand in 2017 compared to 2016. The decrease was due to the nonrecurring bargain purchase gain of $891 thousand which was recognized in 2016 in connection with the Cardinal merger. Without this gain, noninterest income increased by $549 thousand in 2017, due primarily to increases in service charges and fees resulting from additional accounts acquired through the merger with Cardinal.

 

 

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

 

 

 

     2018      2017      2016  

Service charges on deposit accounts

   $ 1,538      $ 1,326      $ 1,256  

Increase in cash value of life insurance

     433        444        382  

Life insurance income

     303        —          —    

Mortgage originations fees

     396        293        167  

Safe deposit box rental

     93        94        78  

Gain on securities

     5        242        364  

ATM income

     1,324        967        750  

Investment services income

     126        84        133  

Merchant services income

     171        147        144  

Bargain purchase gain

     —          —          891  

Interchange income

     126        305        206  

Other income

     122        326        199  
  

 

 

    

 

 

    

 

 

 

Total noninterest income

   $ 4,637      $ 4,228      $ 4,570  
  

 

 

    

 

 

    

 

 

 

 

25


Table of Contents

 

Management’s Discussion and Analysis

 

 

 

Other Expense

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

Total noninterest expenses increased by $3.6 million, or 18.55% for the year ended December 31, 2018, compared to the year ended December 31, 2017. As noted above, the overall increase in expenses for the comparative periods was due primarily to the Great State merger, as the 2018 expenses reflect six months of combined operations. Accordingly, salaries and employee benefits increased by $1.5 million due to the increase in the number of employees, and occupancy expenses increased by $177 thousand due to the addition of six banking facilities. Data processing expense increased by $176 thousand due to the increased accounts and transaction volume. Nonrecurring merger related expenses totaled $2.0 million in 2018, compared to $748 thousand in 2017. The increase in noninterest expense in 2017, compared to 2016, was also due primarily to the Cardinal merger.

 

 

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

 

 

 

     2018      2017      2016  

Salaries & wages

   $ 9,034      $ 8,230      $ 6,772  

Employee benefits

     2,768        2,053        1,858  
  

 

 

    

 

 

    

 

 

 

Total personnel expense

     11,802        10,283        8,630  

Director fees

     370        327        257  

Occupancy expense

     1,260        1,083        815  

Data processing expense

     1,353        1,177        888  

Other equipment expense

     988        1,117        1,170  

FDIC/OCC assessments

     390        426        350  

Insurance

     121        129        127  

Professional fees

     452        430        327  

Advertising

     569        612        208  

Postage & freight

     362        311        235  

Supplies

     212        277        159  

Franchise tax

     438        397        270  

Telephone

     415        370        279  

Travel, dues & meetings

     490        414        299  

ATM expense

     423        388        355  

Foreclosure expenses

     32        44        79  

Core deposit intangible amortization

     578        282        142  

Merger related expenses

     1,978        748        1,483  

Other expense

     624        465        743  
  

 

 

    

 

 

    

 

 

 

Total noninterest expense

   $ 22,857      $ 19,280      $ 16,816  
  

 

 

    

 

 

    

 

 

 

 

The overhead efficiency ratio of noninterest expense to adjusted total revenue (net interest income plus noninterest income) was 79.03% in 2018, 77.03% in 2017, and 82.42% in 2016. The ratios for 2018 and 2017, without the effect of nonrecurring merger related costs, would have been 72.19% and 74.05%, respectively.

 

26


Table of Contents

 

Management’s Discussion and Analysis

 

 

 

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 $1.2 million in 2018 and $3.1 million in 2017, resulting in effective tax rates of 21.1% and 56.1%, respectively. The decrease in 2018 along with the increase in 2017 was due to a one-time charge of $1.4 million to reflect impact of the Tax Cuts and Jobs Act which was signed into law on December 22, 2017. The new legislation reduced tax rates effective January 1, 2018, resulting in a re-measurement of the Company’s deferred tax assets and liabilities.

Net deferred tax assets of $1.9 million, and $3.0 million existed at December 31, 2018 and 2017 respectively. At December 31, 2018, net deferred tax assets included $247 thousand of deferred tax assets applicable to unrealized losses on investment securities available for sale, and $276 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.

Analysis of Financial Condition

Average earning assets increased 10.30% from 2017 to 2018 due primarily to the Great State merger. Total earning assets represented 90.43% of total average assets in 2018 and 90.09% in 2017. The mix of average earning assets changed from 2017 to 2018 as average loans increased by $59.2 million, or 14.17% and average investment securities decreased by $8.7 million, or 14.70%.

 

 

Table 5. Average Asset Mix (dollars in thousands)

 

 

 

     2018     2017  
     Average
Balance
     %     Average
Balance
     %  

Earning assets:

          

Loans

   $ 476,900        78.79   $ 417,723        75.84

Investment securities

     50,504        8.34     59,210        10.75

Federal funds sold

     10,584        1.75     9,703        1.76

Deposits in other banks

     9,365        1.55     9,611        1.74
  

 

 

    

 

 

   

 

 

    

 

 

 

Total earning assets

     547,353        90.43     496,247        90.09
  

 

 

    

 

 

   

 

 

    

 

 

 

Non earning assets:

          

Cash and due from banks

     8,218        1.36     7,145        1.30

Premises and equipment

     19,055        3.14     17,852        3.24

Other assets

     35,400        5.85     33,449        6.07

Allowance for loan losses

     (3,435      -0.57     (3,539      -0.64

Unrealized gain (loss) on securities

     (1,283      -0.21     (356      -0.06
  

 

 

    

 

 

   

 

 

    

 

 

 

Total nonearning assets

     57,955        9.57     54,551        9.91
  

 

 

    

 

 

   

 

 

    

 

 

 

Total assets

   $ 605,308        100.00   $ 550,798        100.00
  

 

 

    

 

 

   

 

 

    

 

 

 

 

27


Table of Contents

 

Management’s Discussion and Analysis

 

 

 

Average loans for 2018 represented 78.79% of total average assets compared to 75.84% in 2017. Average federal funds sold decreased from 1.76% to 1.75% of total average assets while average investment securities decreased from 10.75% to 8.34% of total average assets over the same time period. The balances of nonearning assets to total average assets decreased from 9.91% to 9.57%.

Loans

Average loans totaled $476.9 million over the year ended December 31, 2018. This represents an increase of 14.17% from the average of $417.7 million for 2017. The increase was due primarily to loans acquired from the Great State merger. Average loans increased by 28.24% from 2016 to 2017.

The loan portfolio consists primarily of real estate and commercial loans. These loans accounted for 95.35% of the total loan portfolio at December 31, 2018. This is down slightly from the 95.67% that the two categories maintained at December 31, 2017. 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, 2018 are presented in Tables 6 and 7, respectively.

 

 

Table 6. Loan Portfolio Summary (dollars in thousands)

 

 

 

     December 31, 2018     December 31, 2017     December 31, 2016  
     Amount      %     Amount      %     Amount      %  

Construction and development

   $ 33,449        6.23   $ 25,475        6.00   $ 26,464        6.42

Residential, 1-4 families

     199,662        37.22     170,080        40.03     160,502        38.96

Residential, 5 or more families

     36,027        6.72     29,040        6.84     26,686        6.48

Farm land

     33,291        6.21     33,353        7.85     33,531        8.14

Nonfarm, nonresidential

     176,192        32.84     125,661        29.57     128,515        31.20
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Total real estate

     478,621        89.22     383,609        90.29     375,698        91.20

Agricultural

     4,600        0.86     2,792        0.66     2,779        0.67

Commercial

     32,891        6.13     22,880        5.38     23,307        5.66

Consumer

     7,396        1.38     5,868        1.38     5,491        1.33

Other

     12,957        2.41     9,722        2.29     4,693        1.14
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Total

   $ 536,465        100.00   $ 424,871        100.00   $ 411,968        100.00
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 
                  December 31, 2015     December 31, 2014  
                  Amount      %     Amount      %  

Construction and development

        $ 14,493        6.01   $ 17,158        7.70

Residential, 1-4 families

          112,781        46.76     110,519        49.56

Residential, 5 or more families

          12,203        5.06     8,606        3.86

Farm land

          31,512        13.06     28,570        12.81

Nonfarm, nonresidential

          52,463        21.75     43,046        19.30
       

 

 

    

 

 

   

 

 

    

 

 

 

Total real estate

          223,452        92.64     207,899        93.23

Agricultural

          1,383        0.57     1,338        0.60

Commercial

          11,399        4.73     8,954        4.02

Consumer

          3,962        1.64     3,816        1.71

Other

          1,020        0.42     984        0.44
       

 

 

    

 

 

   

 

 

    

 

 

 

Total

        $ 241,216        100.00   $ 222,991        100.00
       

 

 

    

 

 

   

 

 

    

 

 

 

 

 

28


Table of Contents

 

Management’s Discussion and Analysis

 

 

 

 

Table 7. Maturity Schedule of Loans, as of December 31, 2018 (dollars in thousands)

 

 

 

     Real      Agricultural      Consumer      Total  
     Estate      & Commercial      & Other      Amount      %  

Fixed rate loans:

              

Three months or less

   $ 4,375      $ 1,554      $ 4,273      $ 10,202        1.90

Over three to twelve months

     12,579        4,014        1,738        18,331        3.42

Over one to five years

     116,157        15,115        5,854        137,126        25.56

Over five years

     38,510        2,501        6,427        47,438        8.84
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total fixed rate loans

   $ 171,621      $ 23,184      $ 18,292      $ 213,097        39.72
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Variable rate loans:

              

Three months or less

   $ 6,486      $ 2,057      $ 151      $ 8,694        1.62

Over three to twelve months

     8,403        6,004        71        14,478        2.70

Over one to five years

     7,397        1,902        88        9,387        1.75

Over five years

     284,714        4,344        1,751        290,809        54.21
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total variable rate loans

   $ 307,000      $ 14,307      $ 1,751      $ 290,809        60.28
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total loans:

              

Three months or less

   $ 10,861      $ 3,611      $ 4,424      $ 18,896        3.52

Over three to twelve months

     20,982        10,018        1,809        32,809        6.12

Over one to five years

     123,554        17,017        5,942        146,513        27.31

Over five years

     323,224        6,845        8,178        338,247        63.05
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total loans

   $ 478,621      $ 37,491      $ 20,353      $ 536,465        100.00
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

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 5.15% in 2018 compared to an average yield of 4.96% in 2017. The increase in loan yields was due primarily to the Great State merger, along with repricing of loans at higher rates.

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 2018 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 $4.7 million from December 31, 2017 to December 31, 2018, while the average balance of investment securities carried throughout the year decreased by approximately $8.7 million from 2017 to 2018. The decrease in total amortized cost came as cash generated from liquidating investment securities was used to fund loan growth. The average yield of the investment portfolio increased to 2.53% for the year ended December 31, 2018 compared to 2.35% for 2017.

 

29


Table of Contents

 

Management’s Discussion and Analysis

 

 

 

 

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

 

 

 

     December 31, 2018                
     In One
Year or
Less
    After One
Through
Five Years
    After Five
Through
Ten Years
    After
Ten
Years
    Book
Value
12/31/18
    Market
Value
12/31/18
     Book
Value
12/31/17
     Book
Value
12/31/16
 

Investment securities:

                  

U.S. Government agencies

   $ —       $ 244     $ —       $ —       $ 244     $ 245      $ —        $ —    

Govt. sponsored enterprises

     —         —         —         —         —         —          —          2,046  

Mortgage-backed securities

     451       5,427       11,672       8,077       25,627       24,763        28,780        36,021  

Corporate securities

     —         1,470       1,500       —         2,970       2,789        3,016        3,061  

State and municipal securities

     252       7,889       2,399       7,224       17,764       17,631        19,542        22,282  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

    

 

 

    

 

 

 

Total

   $ 703     $ 15,030     $ 15,571     $ 15,301     $ 46,605     $ 45,428      $ 51,338      $ 63,410  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

    

 

 

    

 

 

 

Weighted average yields:

                  

U.S. Government agencies

     0.00     2.89     0.00     0.00     2.89        

Mortgage-backed securities

     2.81     2.21     2.15     2.34     2.23        

Corporate securities

     0.00     3.00     3.20     0.00     3.10        

State and municipal securities

     2.79     2.94     2.94     2.94     2.83        
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

         

Total

     2.81     2.55     2.37     2.62     2.52        
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

         

 

 

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, 2018 amounted to $536.2 million, which was an increase of $44.8 million, or 9.11% from 2017. The increase was due primarily to deposits acquired in the Great State merger. Average core deposits totaled $473.6 million in 2018 representing a 7.98% increase over the $438.6 million in 2017. The percentage of the Company’s average deposits that are interest-bearing has remained consistent in recent years at 73.8% in 2016, 73.9% in 2017, and 74.0% in 2018. Average demand deposits, which earn no interest, increased 8.61% from $128.4 million in 2017 to $139.4 million in 2018. Average deposits for the periods ended December 31, 2018, 2017, and 2016 are summarized in Table 9.

 

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Management’s Discussion and Analysis

 

 

 

Table 9. Deposit Mix (dollars in thousands)

 

 

 

     December 31, 2018     December 31, 2017  
     Average
Balance
     % of Total
Deposits
    Average
Rate Paid
    Average
Balance
     % of Total
Deposits
    Average
Rate Paid
 

Interest-bearing deposits:

              

Interest-bearing DDA accounts

   $ 66,984        12.5     0.10   $ 59,485        12.1     0.09

Money market

     48,425        9.0     0.26     42,711        8.7     0.21

Savings

     117,479        21.9     0.30     101,184        20.6     0.25

Individual retirement accounts

     45,598        8.5     0.99     47,045        9.6     0.91

Small denomination certificates

     55,700        10.4     0.57     59,820        12.2     0.41

Large denomination certificates

     62,634        11.7     0.89     52,868        10.7     0.76
  

 

 

    

 

 

   

 

 

   

 

 

    

 

 

   

 

 

 

Total interest-bearing deposits

     396,820        74.0     0.47     363,113        73.9     0.41

Noninterest-bearing deposits

     139,409        26.0     0.00     128,356        26.1     0.00
  

 

 

    

 

 

   

 

 

   

 

 

    

 

 

   

 

 

 

Total deposits

   $ 536,229        100.0     0.35   $ 491,469        100.0     0.30
  

 

 

    

 

 

   

 

 

   

 

 

    

 

 

   

 

 

 
                        December 31, 2016  
                        Average
Balance
     % of Total
Deposits
    Average
Rate Paid
 

Interest-bearing deposits:

              

Interest-bearing DDA accounts

          $ 42,848        11.2     0.10

Money market

            30,482        7.9     0.21

Savings

            77,064        20.1     0.24

Individual retirement accounts

            41,770        10.9     1.06

Small denomination certificates

            49,942        13.0     0.52

Large denomination certificates

            40,925        10.7     0.71
         

 

 

    

 

 

   

 

 

 

Total interest-bearing deposits

            283,031        73.8     0.45

Noninterest-bearing deposits

            100,425        26.2     0.00
         

 

 

    

 

 

   

 

 

 

Total deposits

          $ 383,456        100.0     0.33
         

 

 

    

 

 

   

 

 

 

The average balance of certificates of deposit issued in denominations of $100,000 or more increased by $9.8 million, or 18.47%, for the year ended December 31, 2018 due to the Great State merger. 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 2018 was primarily funded through reductions in interest bearing deposits in banks and 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, 2018.

 

 

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

 

 

 

Analysis of certificates of deposit of $100,000 or more at December 31, 2018:

 

Remaining maturity of three months or less

   $ 12,260  

Remaining maturity over three months through six months

     7,322  

Remaining maturity over six months through twelve months

     19,206  

Remaining maturity over twelve months

     39,022  
  

 

 

 

Total certificates of deposit of $100,000 or more

   $ 77,810  
  

 

 

 

 

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Management’s Discussion and Analysis

 

 

 

Equity

Stockholders’ equity totaled $75.6 million at December 31, 2018 compared to $57.2 million at December 31, 2017. $15.5 million of the increase is due to the issuance of common stock in connection with the merger with Great State. The remaining increase was due to earnings of $4.5 million, less a net change in accumulated other comprehensive losses totaling $457 thousand, and the payment of dividends of $1.1 million. Book value increased from $11.39 per share at December 31, 2017 to $12.17 per share at December 31, 2018. Tangible book value increased from $10.98 per share at December 31, 2017 to $11.03 per share at December 31, 2018.

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 will require the Company and 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% upon full implementation), (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% upon full implementation), (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% upon full implementation), and (iv) a minimum leverage ratio of 4%, calculated as the ratio of Tier 1 capital to average assets.

 

 

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

 

 

 

     2018     2017  

Tier 1 Capital

   $ 67,899     $ 53,483  

Unrealized gains on AFS preferred stock

     —         —    

Qualifying allowance for loan losses (limited to 1.25% of risk-weighted assets)

     3,525       3,479  
  

 

 

   

 

 

 

Total regulatory capital

   $ 71,424     $ 56,962  
  

 

 

   

 

 

 

Total risk-weighted assets

   $ 549,292     $ 433,604  
  

 

 

   

 

 

 

Tier 1 capital as a percentage of risk-weighted assets

     12.4     12.3

Common Equity Tier 1 capital as a percentage of risk-weighted assets

     12.4     12.3

Total regulatory capital as a percentage of risk-weighted assets

     13.0     13.1

Leverage ratio*

     10.1     9.8

*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, 2018, 2017, 2016, 2015, and 2014 are analyzed in Table 12.

 

 

Table 12. Nonperforming Assets (dollars in thousands)

 

 

 

     2018     2017     2016     2015     2014  

Nonperforming loans:

          

Nonaccrual loans

   $ 5,579     $ 5,335     $ 4,664     $ 1,589     $ 4,608  

Restructured loans

     6,961       7,743       9,239       10,008       10,525  

Loans past due 90 days or more and still accruing

     —         —         —         —         —    
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total nonperforming loans

     12,540       13,078       13,903       11,597       15,133  

Foreclosed assets

     753       —         70       408       657  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total nonperforming assets

   $ 13,293     $ 13,078     $ 13,973     $ 12,005     $ 15,790  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total nonperforming loans as a percentage to total loans

     2.3     3.1     3.4     4.8     6.8
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total nonperforming assets as a percentage to total assets

     2.0     2.4     2.5     3.6     4.7
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total nonperforming loans were 2.3% and 3.1% of total outstanding loans as of December 31, 2018 and 2017, respectively. The majority of the increase in nonaccrual loans from 2017 to 2018 came in the “commercial mortgage” category. Nonaccrual loans in this category increased by $546 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, 2018 and 2017, interest income recognized on loans in nonaccrual status was approximately $58 thousand and $181 thousand, respectively. Had these credits been current in accordance with their original terms, the gross interest income for these credits would have been approximately $277 thousand and $337 thousand, respectively for the years ended December 31, 2018 and 2017.

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 2017 to 2018 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.

The increase in foreclosed assets from 2017 to 2018 resulted from the transfer of a nonfarm, nonresidential property during the year. Sales and market adjustments of foreclosed assets in 2018 resulted in a net loss of $10 thousand. More information on nonperforming assets can be found in Note 6 of the “Notes to Consolidated Financial Statements” found in the company’s 2018 Annual Report.

 

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Management’s Discussion and Analysis

 

 

 

As of December 31, 2018 and 2017 we had loans with a current principal balance of $56.0 million and $38.2 million rated “Watch” or “Special Mention”. The increase was due primarily to the acquisition of loans in the Great state merger, along with loan risk rating reclassifications. 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”.    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, 2018 loans past due 30-89 days and still accruing totaled $863 thousand compared to $421 thousand at December 31, 2017.

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, 2018 totaled $6.2 million, or 1.2% 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, 2018 was approximately 0.65% of total loans, compared to 0.81% at December 31, 2017. 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, 2018, the remaining unaccreted discount on the acquired loan portfolios totaled $5.0 million. Management believes the provision and the resulting allowance for loan losses are adequate.

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 troubled debt restructurings (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.

 

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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)

 

 

 

     2018     2017     2016     2015     2014  

Allowance for loan losses, beginning

   $ 3,453     $ 3,420     $ 3,418     $ 4,185     $ 4,591  

Provision for (reduction of) loan losses, added

     325       217       (5     (187     294  

Charge-offs:

          

Commercial and agricultural

     (23     (27     (19     (1     (78

Real estate – construction

     (20     (33     (20     (186     (268

Real estate – mortgage

     (259     (182     (105     (469     (599

Consumer and other

     (175     (76     (70     (30     (4

Recoveries:

          

Commercial and agricultural

     9       33       8       10       15  

Real estate – construction

     —         56       98       16       17  

Real estate – mortgage

     147       23       81       23       185  

Consumer and other

     38       22       34       57       32  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net (charge-offs) recoveries

     (283     (184     7       (580     (700
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Allowance for loan losses, ending

   $ 3,495     $ 3,453     $ 3,420     $ 3,418     $ 4,185  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Ratio of net charge-offs during the period to average loans outstanding during the period

     0.06     0.04     0.00     0.26     0.32
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

 

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

 

 

 

     December 31, 2018     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
    Amount      % of
Loans to
Total Loans
 

Commercial and agricultural

   $ 281        6.99   $ 282        6.04   $ 210        6.33

Real estate – construction

     246        6.23     239        6.00     319        6.42

Real estate – mortgage

     2,874        82.99     2,852        84.29     2,783        84.78

Consumer and other

     94        3.79     80        3.67     108        2.47
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Total

   $ 3,495        100.00   $ 3,453        100.00   $ 3,420        100.00
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 
           December 31, 2015     December 31, 2014  
Balance at the end of the period applicable to:                 Amount      % of
Loans to
Total Loans
    Amount      % of
Loans to
Total Loans
 

Commercial and agricultural

        $ 136        5.30   $ 154        4.62

Real estate – construction

          344        6.01     591        7.70

Real estate – mortgage

          2,900        86.63     3,388        85.53

Consumer and other

          38        2.06     52        2.15
       

 

 

    

 

 

   

 

 

    

 

 

 

Total

        $ 3,418        100.00   $ 4,185        100.00
       

 

 

    

 

 

   

 

 

    

 

 

 

 

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Table of Contents

 

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, 2018 and 2017 is as follows:

 

     2018      2017  

Commitments to extend credit

   $ 76,977      $ 56,912  

Standby letters of credit

     1,227        1,106  
  

 

 

    

 

 

 
   $ 78,204      $ 58,018  
  

 

 

    

 

 

 

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 11.6% at December 31, 2018 compared to 12.4% at December 31, 2017. 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.

 

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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, 2018. 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, 2018, 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, 2018
Maturities/Repricing
 
     1 to 3
Months
    4 to 12
Months
    13 to 60
Months
    Over 60
Months
    Total  

Interest-Earning Assets:

          

Interest bearing deposits

   $ 12,159     $ —       $ —       $ —       $ 12,159  

Federal funds sold

     18,990       —         —         —         18,990  

Investments

     1,447       701       14,767       28,513       45,428  

Loans

     93,506       48,009       315,668       79,282       536,465  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total

   $ 126,102     $ 48,710     $ 330,435     $ 107,795     $ 613,042  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Interest-Bearing Liabilities:

          

Interest-bearing DDA accounts

   $ 77,861     $ —       $ —       $ —       $ 77,861  

Money market

     54,584       —         —         —         54,584  

Savings

     129,114       —         —         —         129,114  

Time deposits

     22,904       51,459       104,966       814       180,143  

Borrowings

     —         —         —         —         —    
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total

   $ 284,463     $ 51,459     $ 104,966     $ 814     $ 441,702  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Interest sensitivity gap

   $ (158,361   $ (2,749   $ 225,469     $ 106,981     $ 171,340  

Cumulative interest sensitivity gap

   $ (158,361   $ (161,110   $ 64,359     $ 171,340     $ 171,340  

Ratio of sensitivity gap to total earning assets

     -25.8     -0.4     36.8     17.5     27.9

Cumulative ratio of sensitivity gap to total earning assets

     -25.8     -26.3     10.5     27.9     27.9

 

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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, 2018.

 

 

 

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

   $ 23,857     $ 24,473     $ 25,814     $ 27,001      $ 26,972     $ 26,977     $ 26,923  

Change

   $ (3,144   $ (2,528   $ (1,187   $ —        $ (29   $ (24   $ (78

Change percentage

     -11.64     -9.36     -4.40        -0.11     -0.09     -0.29

Market Value of Equity

   $ 97,463     $ 106,535     $ 119,116     $ 128,790      $ 130,531     $ 129,122     $ 126,403  

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

 

 

 

 

     2018     2017     2016  

Return on average assets

     0.75     0.44     0.55

Return on average equity

     7.02     4.28     5.62

Dividend payout ratio

     24.81     33.09     19.56

Average equity to average assets

     10.66     10.32     9.78

 

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Item 7A.

Quantitative and Qualitative Disclosures About Market Risk.

Not applicable.

 

Item 8.

Financial Statements and Supplementary Data.

 

39


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LOGO

 

Report of Independent Registered Public Accounting Firm

To the Stockholders and Board of Directors of Parkway Acquisition Corp.

Opinion on the Financial Statements

We have audited the accompanying consolidated balance sheets of Parkway Acquisition Corp. and its subsidiary (the “Company”) as of December 31, 2018 and 2017, the related consolidated statements of income, comprehensive income, changes in stockholders’ equity and cash flows for the years then ended, and the related notes to the consolidated financial statements (collectively, the “consolidated financial statements”). In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 2018 and 2017, 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 consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on the Company’s consolidated 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 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 consolidated 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 consolidated 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 consolidated 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 consolidated financial statements. We believe that our audits provide a reasonable basis for our opinion.

/s/ Elliott Davis, PLLC

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

Charlotte, North Carolina

March 29, 2019

Elliott Davis PLLC | www.elliottdavis.com

 

 

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Table of Contents

 

Consolidated Balance Sheets

December 31, 2018 and 2017

 

 

 

(dollars in thousands)    2018     2017  

Assets

    

Cash and due from banks

   $ 8,858     $ 6,367  

Interest-bearing deposits with banks

     12,159       8,739  

Federal funds sold

     18,990       7,769  

Investment securities available for sale

     45,428       50,675  

Restricted equity securities

     2,053       1,388  

Loans, net of allowance for loan losses of $3,495 at December 31, 2018 and $3,453 at December 31, 2017

     532,970       421,418  

Cash value of life insurance

     17,413       17,348  

Foreclosed assets

     753       —    

Properties and equipment, net

     20,685       17,646  

Accrued interest receivable

     2,084       1,737  

Core deposit intangible

     3,892       2,045  

Goodwill

     3,198       —    

Deferred tax assets, net

     1,853       2,965  

Other assets

     9,948       9,864  
  

 

 

   

 

 

 
   $ 680,284     $ 547,961  
  

 

 

   

 

 

 

Liabilities and Stockholders’ Equity

    

Liabilities

    

Deposits

    

Noninterest-bearing

   $ 160,166     $ 130,847  

Interest-bearing

     441,702       357,594  
  

 

 

   

 

 

 

Total deposits

     601,868       488,441  

Accrued interest payable

     89       46  

Other liabilities

     2,705       2,292  
  

 

 

   

 

 

 
     604,662       490,779  
  

 

 

   

 

 

 

Commitments and contingencies (Note 17)

    

Stockholders’ Equity

    

Preferred stock, no par value; 5,000,000 shares authorized, none issued

     —         —    

Common stock, no par value; 25,000,000 shares authorized, 6,213,275 and 5,021,376 issued and outstanding at December 31, 2018 and 2017, respectively

     —         —    

Surplus

     41,660       26,166  

Retained earnings

     35,929       32,526  

Accumulated other comprehensive income (loss)

     (1,967     (1,510
  

 

 

   

 

 

 
     75,622       57,182  
  

 

 

   

 

 

 
   $ 680,284     $ 547,961  
  

 

 

   

 

 

 

See Notes to Consolidated Financial Statements

 

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Table of Contents

 

Consolidated Statements of Income

Years ended December 31, 2018 and 2017

 

 

 

(dollars in thousands except share amounts)    2018      2017  

Interest income

     

Loans and fees on loans

   $ 24,574      $ 20,722  

Interest-bearing deposits with banks

     106        48  

Federal funds sold

     228        111  

Interest on taxable securities

     1,181        1,302  

Dividends

     97        91  
  

 

 

    

 

 

 
     26,186        22,274  
  

 

 

    

 

 

 

Interest expense

     

Deposits

     1,867        1,473  

Interest on borrowings

     34        1  
  

 

 

    

 

 

 
     1,901        1,474  
  

 

 

    

 

 

 

Net interest income

     24,285        20,800  

Provision for loan losses

     325        217  
  

 

 

    

 

 

 

Net interest income after provision for loan losses

     23,960        20,583  
  

 

 

    

 

 

 

Noninterest income

     

Service charges on deposit accounts

     1,538        1,326  

Other service charges and fees

     1,840        1,597  

Net realized gains on securities

     5        242  

Mortgage origination fees

     396        293  

Increase in cash value of life insurance

     433        444  

Life insurance income

     303        —    

Other income

     122        326  
  

 

 

    

 

 

 
     4,637        4,228  
  

 

 

    

 

 

 

Noninterest expenses

     

Salaries and employee benefits

     11,802        10,283  

Occupancy and equipment

     2,671        2,588  

Foreclosed asset expense, net

     32        44  

Data processing expense

     1,353        1,177  

FDIC Assessments

     231        272  

Advertising

     569        612  

Bank franchise tax

     438        397  

Director fees

     370        327  

Professional fees

     452        430  

Telephone expense

     415        370  

Core deposit intangible amortization

     578        282  

Merger related expenses

     1,978        748  

Other expense

     1,968        1,750  
  

 

 

    

 

 

 
     22,857        19,280  
  

 

 

    

 

 

 

Income before income taxes

     5,740        5,531  

Income tax expense related to ordinary operations

     1,214        1,669  

Income tax expense related to change in tax rate

     —          1,435  
  

 

 

    

 

 

 

Total income tax expense

     1,214        3,104  

Net income

   $ 4,526      $ 2,427  
  

 

 

    

 

 

 

Basic earnings per share

   $ 0.81      $ 0.48  
  

 

 

    

 

 

 

Weighted average shares outstanding

     5,622,224        5,021,376  
  

 

 

    

 

 

 

Dividends declared per share

   $ 0.20      $ 0.16  
  

 

 

    

 

 

 

See Notes to Consolidated Financial Statements

 

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Consolidated Statements of Comprehensive Income

Years ended December 31, 2018 and 2017

 

 

 

(dollars in thousands)    2018     2017  

Net Income

   $ 4,526     $ 2,427  
  

 

 

   

 

 

 

Other comprehensive income (loss)

    

Net change in pension reserve:

    

Change in pension reserve during the year

     (64     (67

Tax related to change in pension reserve

     13       23  

Unrealized gains (losses) on investment securities available for sale:

    

Unrealized gains (losses) arising during the year

     (509     449  

Tax related to unrealized (gains) losses

     107       (153

Reclassification of net realized gains during the year

     (5     (242

Tax related to realized gains

     1       82  
  

 

 

   

 

 

 

Total other comprehensive income (loss)

     (457     92  
  

 

 

   

 

 

 

Total comprehensive income

   $ 4,069     $ 2,519  
  

 

 

   

 

 

 

See Notes to Consolidated Financial Statements

 

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Consolidated Statements of Changes in Stockholders’ Equity

Years ended December 31, 2018 and 2017

 

 

 

(dollars in thousands except share amounts)                                       
     Common Stock            Retained     Accumulated
Other
Comprehensive
       
     Shares      Amount      Surplus     Earnings     Loss     Total  

Balance, December 31, 2016

     5,021,376      $ —        $ 26,166     $ 30,654     $ (1,354   $ 55,466  

Net income

     —          —          —         2,427       —         2,427  

Other comprehensive loss

     —          —          —         —         92       92  

Reclassification of accumulated other comprehensive loss due to tax rate change

     —          —          —         248       (248     —    

Dividends paid ($0.16 per share)

     —          —          —         (803     —         (803
  

 

 

    

 

 

    

 

 

   

 

 

   

 

 

   

 

 

 

Balance, December 31, 2017

     5,021,376      $ —        $ 26,166     $ 32,526     $ (1,510   $ 57,182  
  

 

 

    

 

 

    

 

 

   

 

 

   

 

 

   

 

 

 

Net income

     —          —          —         4,526       —         4,526  

Other comprehensive income

     —          —          —         —         (457     (457

Issuance of common stock in connection with acquisition of Great State Bank

     1,191,899        —          15,495       —         —         15,495  

Redemption of fractional shares Issued in acquisition of Great State Bank

     —          —          (1     —         —         (1

Dividends paid ($0.20 per share)

     —          —          —         (1,123     —         (1,123
  

 

 

    

 

 

    

 

 

   

 

 

   

 

 

   

 

 

 

Balance, December 31, 2018

     6,213,275      $ —        $ 41,660     $ 35,929     $ (1,967   $ 75,622  
  

 

 

    

 

 

    

 

 

   

 

 

   

 

 

   

 

 

 

See Notes to Consolidated Financial Statements

 

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Consolidated Statements of Cash Flows

Years ended December 31, 2018 and 2017

 

 

 

(dollars in thousands)    2018     2017  

Cash flows from operating activities

    

Net income

   $ 4,526     $ 2,427  

Adjustments to reconcile net income to net cash provided by operations:

    

Depreciation and amortization

     1,187       1,315  

Amortization of core deposit intangible

     578       282  

Accretion of loan discount and deposit premium, net

     (1,539     (1,245

Provision for loan loss

     325       217  

Deferred income taxes

     1,589       2,891  

Net realized gains on securities

     (5     (242

Accretion of discount on securities, net of amortization of premiums

     521       671  

Deferred compensation

     19       (50

Net realized loss on foreclosed assets

     10       23  

Life insurance income

     (303     —    

Changes in assets and liabilities:

    

Cash value of life insurance

     (434     (444

Accrued interest receivable

     (13     (5

Other assets

     (210     (4,127

Accrued interest payable

     3       (11

Other liabilities

     25       (1,604
  

 

 

   

 

 

 

Net cash provided by operating activities

     6,279       98  
  

 

 

   

 

 

 

Cash flows from investing activities

    

Activity in available for sale securities:

    

Purchases

     —         (1,914

Sales

     18,366       8,664  

Maturities/calls/paydowns

     5,252       4,893  

Purchase of restricted equity securities

     (142     (239

Net increase in loans

     (16,785     (12,070

Proceeds from life insurance contracts

     672       —    

Proceeds from the sale of foreclosed assets

     480       47  

Purchases of property and equipment, net of sales

     (2,830     (991

Cash received in business combination

     25,761       —    
  

 

 

   

 

 

 

Net cash provided by (used in) investing activities

     30,774       (1,610
  

 

 

   

 

 

 

Cash flows from financing activities

    

Net decrease in deposits

     (16,797     (10,718

Repayment of borrowings

     (2,000     —    

Cash paid for fractional shares

     (1     —    

Dividends paid

     (1,123     (803
  

 

 

   

 

 

 

Net cash used in financing activities

     (19,921     (11,521
  

 

 

   

 

 

 

Net increase (decrease) in cash and cash equivalents

     17,132       (13,033
  

 

 

   

 

 

 

Cash and cash equivalents, beginning

     22,875       35,908  
  

 

 

   

 

 

 

Cash and cash equivalents, ending

   $ 40,007     $ 22,875  
  

 

 

   

 

 

 

 

See Notes to Consolidated Financial Statements

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Consolidated Statements of Cash Flows, continued

Years ended December 31, 2018 and 2017

 

 

 

(dollars in thousands)    2018     2017  

Supplemental disclosure of cash flow information

    

Interest paid

   $ 1,858     $ 1,485  
  

 

 

   

 

 

 

Taxes paid

   $ 135     $ 70  
  

 

 

   

 

 

 

Supplemental disclosure of noncash investing activities

    

Effect on equity of change in net unrealized loss on available for sale securities

   $ (406   $ 136  
  

 

 

   

 

 

 

Effect on equity of change in unfunded pension liability

   $ (51   $ (44
  

 

 

   

 

 

 

Transfers of loans to foreclosed properties

   $ 1,163     $ —    
  

 

 

   

 

 

 

Business combinations

    

Assets acquired

   $ 145,455     $ —    

Liabilities assumed

     132,960       —    
  

 

 

   

 

 

 

Net assets

   $ 12,495     $ —    
  

 

 

   

 

 

 

Goodwill recorded

   $ 3,198     $ —    
  

 

 

   

 

 

 

Stock issued to acquire Great State Bank

   $ 15,495     $ —    
  

 

 

   

 

 

 

See Notes to Consolidated Financial Statements

 

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Notes to Consolidated Financial Statements

 

 

Note 1. Organization and Summary of Significant Accounting Policies

Organization

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. Pursuant to the Great State merger, the Company acquired $145.5 million of assets, including $95.1 million in loans and assumed $133.0 million in liabilities, including $130.6 million of deposits, on July 1, 2018. Such accounts include preliminary estimated fair value adjustments, which are subject to change.

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, Watauga, Wilkes, and Yadkin, and the surrounding areas through twenty full-service banking offices and four loan production offices. As an 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.

Critical Accounting Policies

Management believes the policies with respect to the methodology for the determination of the allowance for loan losses, and asset impairment judgments involve a higher degree of complexity and require management to make difficult and subjective judgments which often require assumptions or estimates about highly uncertain matters. Changes in these judgments, assumptions or estimates could cause reported results to differ materially. These critical policies and their application are periodically reviewed with the Audit Committee and the Board of Directors.

Principles of Consolidation

The consolidated financial statements include the accounts of the Company and the Bank, which is wholly owned. All significant, intercompany transactions and balances have been eliminated in consolidation.

 

 

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Notes to Consolidated Financial Statements

 

 

 

Note 1. Organization and Summary of Significant Accounting Policies, continued

 

Business Segments

The Company reports its activities as a single business segment. In determining the appropriateness of segment definition, the Company considers components of the business about which financial information is available and regularly evaluated relative to resource allocation and performance assessment.

Business Combinations

Generally, acquisitions are accounted for under the acquisition method of accounting in accordance with Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) 805, Business Combinations. A business combination occurs when the Company acquires net assets that constitute a business, or acquires equity interests in one or more other entities that are businesses and obtains control over those entities. Business combinations are effected through the transfer of consideration consisting of cash and/or common stock and are accounted for using the acquisition method. Accordingly, the assets and liabilities of the acquired entity are recorded at their respective fair values as of the closing date of the acquisition. Determining the fair value of assets and liabilities, especially the loan portfolio, is a complicated process involving significant judgment regarding methods and assumptions used to calculate estimated fair values. Fair values are subject to refinement for up to one year after the closing date of the acquisition as information relative to closing date fair values becomes available. The results of operations of an acquired entity are included in our consolidated results from the closing date of the merger, and prior periods are not restated. No allowance for loan losses related to the acquired loans is recorded on the acquisition date because the fair value of the loans acquired incorporates assumptions regarding future credit losses. The fair value estimates associated with the acquired loans include estimates related to expected prepayments and the amount and timing of expected principal, interest and other cash flows.

Use of Estimates

The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.

Material estimates that are particularly susceptible to significant change relate to the determination of the allowance for loan losses and the valuation of real estate acquired in connection with foreclosures or in satisfaction of loans. In connection with the determination of the allowances for loan and foreclosed real estate losses, management obtains independent appraisals for significant properties.

Substantially all of the Bank’s loan portfolio consists of loans in its market area. Accordingly, the ultimate collectability of a substantial portion of the Bank’s loan portfolio and the recovery of a substantial portion of the carrying amount of foreclosed real estate are susceptible to changes in local market conditions. The regional economy is diverse, but influenced to an extent by the manufacturing and agricultural segments.

While management uses available information to recognize loan and foreclosed real estate losses, future additions to the allowances may be necessary based on changes in local economic conditions. In addition, regulatory agencies, as a part of their routine examination process, periodically review the Bank’s allowances for loan and foreclosed real estate losses. Such agencies may require the Bank to recognize additions to the allowances based on their judgments about information available to them at the time of their examinations. Because of these factors, it is reasonably possible that the allowances for loan and foreclosed real estate losses may change materially in the near term.

The Company seeks strategies that minimize the tax effect of implementing their business strategies. As such, judgments are made regarding the ultimate consequence of long-term tax planning strategies, including the likelihood of future recognition of deferred tax benefits. The Company’s tax returns are subject to examination by both Federal and State authorities. Such examinations may result in the assessment of additional taxes, interest and penalties. As a result, the ultimate outcome, and the corresponding financial statement impact, can be difficult to predict with accuracy.

 

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Table of Contents

 

Notes to Consolidated Financial Statements

 

 

 

Note 1. Organization and Summary of Significant Accounting Policies, continued

Use of Estimates, continued

 

Accounting for pension benefits, costs and related liabilities are developed using actuarial valuations. These valuations include key assumptions determined by management, including the discount rate and expected long-term rate of return on plan assets. Material changes in pension costs may occur in the future due to changes in these assumptions.

Cash and Cash Equivalents

For purposes of reporting cash flows, cash and cash equivalents includes cash and amounts due from banks (including cash items in process of collection), interest-bearing deposits with banks and federal funds sold.

Trading Securities

The Company does not hold securities for short-term resale and therefore does not maintain a trading securities portfolio.

Securities Held to Maturity

Bonds, notes, and debentures for which the Company has the positive intent and ability to hold to maturity are reported at cost, adjusted for premiums and discounts that are recognized in interest income using the interest method over the period to maturity. The Company does not currently hold any securities classified as held to maturity.

Securities Available for Sale

Available for sale securities are reported at fair value and consist of bonds, notes, debentures, and certain equity securities not classified as trading securities or as held to maturity securities.

Unrealized holding gains and losses, net of tax, on available for sale securities are reported as a net amount in a separate component of accumulated other comprehensive income. Realized gains and losses on the sale of available for sale securities are determined using the specific-identification method. Premiums and discounts are recognized in interest income using the interest method over the period to maturity.

Declines in the fair value of individual held to maturity and available for sale securities below cost that are other than temporary are reflected as write-downs of the individual securities to fair value. Related write-downs are included in earnings as realized losses.

Loans Receivable

Loans receivable that management has the intent and ability to hold for the foreseeable future or until maturity or pay-off are reported at their outstanding principal amount adjusted for any charge-offs and the allowance for loan losses. Loan origination costs are capitalized and recognized as an adjustment to yield over the life of the related loan.

Interest is accrued and credited to income based on the principal amount outstanding. The accrual of interest on impaired loans is discontinued 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. Interest income is subsequently recognized only to the extent cash payments are received. Payments received are first applied to principal, and any remaining funds are then applied to interest. When facts and circumstances indicate the borrower has regained the ability to meet the required payments, the loan is returned to accrual status. Past due status of loans is determined based on contractual terms.

Purchased Performing Loans – The Company accounts for performing loans acquired in business combinations using the contractual cash flows method of recognizing discount accretion based on the acquired loans’ contractual cash flows. Purchased performing loans are recorded at fair value, including a credit discount. The fair value discount is accreted as an adjustment to yield over the estimated lives of the loans. There is no allowance for loan losses established at the acquisition date for purchased performing loans. A provision for loan losses is recorded for any further deterioration in these loans subsequent to the acquisition

 

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Table of Contents

 

Notes to Consolidated Financial Statements

 

 

 

Note 1. Organization and Summary of Significant Accounting Policies, continued

Loans Receivable, continued

 

Purchased Credit-Impaired (PCI) Loans – Loans purchased with evidence of credit deterioration since origination, and for which it is probable that all contractually required payments will not be collected, are considered credit impaired. Evidence of credit quality deterioration as of the purchase date may include statistics such as internal risk grade and past due and nonaccrual status. Purchased impaired loans generally meet the Company’s definition for nonaccrual status. PCI loans are initially measured at fair value, which reflects estimated future credit losses expected to be incurred over the life of the loan. Accordingly, the associated allowance for credit losses related to these loans is not carried over at the acquisition date. Any excess of cash flows expected at acquisition over the estimated fair value is referred to as the accretable yield and is recognized into interest income over the remaining life of the loan when there is a reasonable expectation about the amount and timing of such cash flows. The difference between contractually required payments at acquisition and the cash flows expected to be collected at acquisition is referred to as the nonaccretable difference, and is available to absorb credit losses on those loans. Subsequent decreases to the expected cash flows will generally result in a provision for loan losses. Subsequent significant increases in cash flows result in a reversal of the provision for loan losses to the extent of prior charges, or a reclassification of the nonaccretable difference with a positive impact on future interest income.

Allowance for Loan Losses

The allowance for loan losses is established as losses are estimated to have occurred through a provision for loan losses charged to earnings. Loan losses are charged against the allowance when management believes the uncollectability of a loan balance, or portion thereof, is confirmed. Subsequent recoveries, if any, are credited to the allowance.

The allowance for loan losses is evaluated on a regular basis by management and is based upon management’s periodic review of the collectability of the loans in light of historical experience, the nature and volume of the loan portfolio, adverse situations that may affect the borrower’s ability to repay, estimated value of any underlying collateral and prevailing economic conditions. This evaluation is inherently subjective as it requires estimates that are susceptible to significant revision as more information becomes available.

The allowance consists of specific, general and unallocated components. The specific component is calculated on an individual basis for larger-balance, non-homogeneous loans, which are considered impaired. A specific allowance is established when the discounted cash flows, collateral value (less disposal costs), or observable market price of the impaired loan is lower than its carrying value. The specific component of the allowance for smaller-balance loans whose terms have been modified in a troubled debt restructuring (TDR) is calculated on a pooled basis considering historical experience adjusted for qualitative factors. The general component covers non-impaired loans and is based on historical loss experience adjusted for qualitative factors. An unallocated component is maintained to cover uncertainties that could affect management’s estimate of probable losses. The unallocated component of the allowance reflects the margin of imprecision inherent in the underlying assumptions used in the methodologies for estimating specific and general losses in the portfolio.

A loan is considered impaired when, based on current information and events, it is probable that we will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. Factors considered by management in determining impairment include payment status, collateral value, and the probability of collecting scheduled principal and interest payments when due. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired. Management determines the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrower’s prior payment record, and the amount of the shortfall in relation to the principal and interest owed. Impairment is measured on a loan by loan basis for all loans by either the present value of expected future cash flows discounted at the loan’s effective interest rate, the loan’s obtainable market price, or the fair value of the collateral if the loan is collateral dependent.

Large groups of smaller balance homogeneous loans are collectively evaluated for impairment. Accordingly, the Bank does not separately identify individual consumer and residential loans for impairment disclosures, unless such loans are the subject of a restructuring agreement.

 

50


Table of Contents

 

Notes to Consolidated Financial Statements

 

 

 

Note 1. Organization and Summary of Significant Accounting Policies, continued

 

Troubled Debt Restructurings

Under GAAP, the Bank is required to account for certain loan modifications or restructurings as “troubled debt restructurings” or “troubled debt restructured loans.” In general, the modification or restructuring of a debt constitutes a troubled debt restructuring if the Bank for economic or legal reasons related to the borrower’s financial difficulties grants a concession to the borrower that the Bank would not otherwise consider. Debt restructuring or loan modifications for a borrower do not necessarily always constitute a troubled debt restructuring, however, and troubled debt restructurings do not necessarily result in non-accrual loans.

Property and Equipment

Land is carried at cost. Bank premises, furniture and equipment are carried at cost, less accumulated depreciation and amortization computed principally by the straight-line method over the following estimated useful lives:

 

     Years  

Buildings and improvements

     10-40  

Furniture and equipment

     5-12  

Foreclosed Assets

Real estate properties acquired through, or in lieu of, loan foreclosure are to be sold and are initially recorded at fair value less anticipated cost to sell at the date of foreclosure, establishing a new cost basis. After foreclosure, valuations are periodically performed by management and the real estate is carried at the lower of carrying amount or fair value less cost to sell. Revenue and expenses from operations and changes in the valuation allowance are included in foreclosure expense on the consolidated statements of income.

Pension Plan

Prior to the Cardinal merger, both Grayson National Bank (Grayson) and Bank of Floyd (Floyd) had qualified noncontributory defined benefit pension plans in place which covered substantially all of each bank’s employees. The benefits in each plan are primarily based on years of service and earnings. Both Grayson and Floyd plans were amended to freeze benefit accruals for all eligible employees prior to the effective date of the Cardinal merger. Grayson’s plan is a single-employer plan, the funded status of which is measured as the difference between the fair value of plan assets and the projected benefit obligation. Floyd’s plan is a multi-employer plan for accounting purposes and is a multiple-employer plan under the Employee Retirement Income Security Act of 1974 and the Internal Revenue Code.

Transfers of Financial Assets

Transfers of financial assets are accounted for as sales, when control over the assets has been surrendered. Control over transferred assets is deemed to be surrendered when (1) the assets have been isolated from the Bank; (2) the transferee obtains the right (free of conditions that constrain it from taking advantage of that right) to pledge or exchange the transferred assets; and (3) the Bank does not maintain effective control over the transferred assets through an agreement to repurchase them before their maturity or the ability to unilaterally cause the holder to return specific assets.

 

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Notes to Consolidated Financial Statements

 

 

 

Note 1. Organization and Summary of Significant Accounting Policies, continued

 

Goodwill and Other Intangible Assets

Goodwill arises from business combinations and is generally determined as the excess of fair value of the consideration transferred, plus the fair value of any noncontrolling interests in the acquire, over the fair value of the nets assets acquired and liabilities assumed as of the acquisition date. Goodwill and intangible assets acquired in a purchase business combination and determined to have an indefinite useful life are not amortized, but tested for impairment at least annually or more frequently in events and circumstances exists that indicate that a goodwill impairment test should be performed. The Company has selected July 1, 2019 as the date to perform the annual impairment test. Intangible assets with definite useful lives are amortized over their estimated useful lives to their estimated residual values. Goodwill is the only intangible asset with an indefinite life on our balance sheet.

Other intangible assets consist of core deposit intangibles that represent the value of long-term deposit relationships acquired in a business combination. Core deposit intangibles are amortized over the estimated useful lives of the deposit accounts acquired (generally twenty years on an accelerated basis). For the core deposit intangible as a result of the Great State merger, we used an estimated useful life of seven years.

Revenue Recognition

On January 1, 2018, we adopted the requirements of Accounting Standards Update (“ASU”) 2014-9, Revenue from Contracts with Customers (“ASU Topic 606”). The Company completed its overall assessment of revenue streams and review of related contracts potentially affected by the ASU, including deposit related fees, interchange fees, merchant income, and annuity and insurance commissions. Based on this assessment, the Company concluded that ASU 2014-09 did not materially change the method in which the Company currently recognizes revenue for these revenue streams. The Company also completed its evaluation of certain costs related to these revenue streams to determine whether such costs should be presented as expenses or contra-revenue (i.e., gross vs. net). Based on its evaluation, the Company determined that ASU 2014-09 did not materially change the method in which the Company currently classifies certain costs associated with the related revenue streams. The Company adopted ASU 2014-09 and its related amendments on its required effective date of January 1, 2018 utilizing the modified retrospective approach. Since there was no net income impact upon adoption of the new guidance, a cumulative effect adjustment to opening retained earnings was not deemed necessary.

Income Taxes

Provision for income taxes is based on amounts reported in the statements of income (after exclusion of non-taxable income such as interest on state and municipal securities) 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. Deferred tax assets and liabilities are included in the financial statements at currently enacted income tax rates applicable to the period in which the deferred tax assets or liabilities are expected to be realized or settled. As changes in tax laws or rates are enacted, deferred tax assets and liabilities are adjusted through the provision for income taxes.

Deferred income tax expense results from changes in deferred tax assets and liabilities between periods. Deferred tax assets are recognized if it is more likely than not, based on the technical merits, that the tax position will be realized or sustained upon examination. The term more likely than not means a likelihood of more than 50 percent; the terms examined and upon examination also include resolution of the related appeals or litigation processes, if any. A tax position that meets the more likely than not recognition threshold is initially and subsequently measured as the largest amount of tax benefit that has a greater than 50 percent likelihood of being realized upon settlement with a taxing authority that has full knowledge of all relevant information. The determination of whether or not a tax position has met the more likely than not recognition threshold considers the facts, circumstances, and information available at the reporting date and is subject to management’s judgment. Deferred tax assets are reduced by a valuation allowance if, based on the weight of evidence available, it is more likely than not that some portion or all of a deferred tax asset will not be realized.

 

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Table of Contents

 

Notes to Consolidated Financial Statements

 

 

 

Note 1. Organization and Summary of Significant Accounting Policies, continued

Income Taxes, continued

 

The Company has early adopted ASU 2018-02, “Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income” which is considered a change in accounting principle. Because the required adjustment of deferred taxes is required to be included in income from continuing operations, the tax effects of items within accumulated other comprehensive income (commonly referred to as “stranded” tax effects) would not reflect the appropriate tax rate. Adoption of this ASU eliminates the “stranded” tax effects associated with the change in the federal corporate income tax rate in the Tax Cuts and Jobs Act of 2017. The Company has reclassified “stranded” tax effects totaling $248 thousand from accumulated other comprehensive loss to retained earnings and these reclassified amounts are reflected in the accompanying consolidated statements of changes in stockholders’ equity.

Comprehensive Income

Comprehensive income consists of net income and other comprehensive income (loss). Other comprehensive income (loss) includes unrealized gains and losses on securities available for sale and changes in the funded status of the pension plan which are also recognized as separate components of equity. The accumulated balances related to each component of other comprehensive income (loss) are as follows:

 

(dollars in thousands)    Unrealized Gains
And Losses
On Available for
Sale Securities
     Defined Benefit
Pension Items
     Total  

Balance, December 31, 2016

   $ (574    $ (780    $ (1,354

Other comprehensive income (loss) before reclassifications

     296        (44      252  

Amounts reclassified from accumulated other comprehensive loss

     (160      —          (160

Amounts reclassified to retained earnings from other comprehensive loss due to tax rate change

     (85      (163      (248
  

 

 

    

 

 

    

 

 

 

Balance, December 31, 2017

   $ (523    $ (987    $ (1,510
  

 

 

    

 

 

    

 

 

 

Balance, December 31, 2017

   $ (523    $ (987    $ (1,510

Other comprehensive income (loss) before reclassifications

     (402      (51      (453

Amounts reclassified from accumulated other comprehensive loss

     (4      —          (4
  

 

 

    

 

 

    

 

 

 

Balance, December 31, 2018

   $ (929    $ (1,038    $ (1,967
  

 

 

    

 

 

    

 

 

 

Advertising Expense

The Company expenses advertising costs as they are incurred. Advertising expense for the years presented is not material.

Basic Earnings per Share

Basic earnings per share is computed by dividing income available to common stockholders by the weighted average number of common shares outstanding during the period, after giving retroactive effect to stock splits and dividends.

Off-Balance Sheet Credit Related Financial Instruments

In the ordinary course of business, the Company has entered into commitments to extend credit, including commitments under line of credit arrangements, commercial letters of credit, and standby letters of credit. Such financial instruments are recorded when they are funded.

 

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Table of Contents

 

Notes to Consolidated Financial Statements

 

 

 

Note 1. Organization and Summary of Significant Accounting Policies, continued

 

Fair Value of Financial Instruments

Fair values of financial instruments are estimated using relevant market information and other assumptions, as more fully disclosed in Note 13. Fair value estimates involve uncertainties and matters of significant judgment. Changes in assumptions or in market conditions could significantly affect the estimates.

Reclassification

Certain reclassifications have been made to the prior years’ financial statements to place them on a comparable basis with the current presentation. Net income and stockholders’ equity previously reported were not affected by these reclassifications.

Recent Accounting Pronouncements

The following accounting standards may affect the future financial reporting by the Company:

In February 2016, the FASB amended the Leases topic of the Accounting Standards Codification to revise certain aspects of recognition, measurement, presentation, and disclosure of leasing transactions. The amendments will be effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. Early adoption is permitted.

We expect to adopt the guidance using the modified retrospective method and practical expedients for transition. The practical expedients allow us to largely account for our existing leases consistent with current guidance except for the incremental balance sheet recognition for lessees. We have performed an evaluation of our leasing contracts and activities. We have developed our methodology to estimate the right-of use assets and lease liabilities, which is based on the present value of lease payments. At December 31, 2018 future minimum lease payments were approximately $334 thousand. Based on our evaluation the adoption of the guidance will be immaterial to our financial position, results of operations, and cash flows. There will not be a material change to the timing of expense recognition.

In June 2016, the FASB issued guidance to change the accounting for credit losses and modify the impairment model for certain debt securities. The amendments will be effective for the Company for reporting periods beginning after December 15, 2019. Early adoption is permitted for all organizations for periods beginning after December 15, 2018.

The Company will apply the amendments to the ASU through a cumulative-effect adjustment to retained earnings as of the beginning of the year of adoption. While early adoption is permitted beginning in first quarter 2019, we do not expect to elect that option. We are evaluating the impact of the ASU on our consolidated financial statements. We expect the ASU will result in an increase in the recorded allowance for loan losses given the change to estimated losses over the contractual life of the loans adjusted for expected prepayments. The majority of the increase results from longer duration portfolios. In addition to our allowance for loan losses, we will also record an allowance for credit losses on debt securities instead of applying the impairment model currently utilized. The amount of the adjustments will be impacted by each portfolio’s composition and credit quality at the adoption date as well as economic conditions and forecasts at that time.

In January 2017, the FASB updated the Accounting Changes and Error Corrections and the Investments—Equity Method and Joint Ventures Topics of the Accounting Standards Codification. The ASU incorporates into the Accounting Standards Codification recent SEC guidance about disclosing, under SEC SAB Topic 11.M, the effect on financial statements of adopting the revenue, leases, and credit losses standards. The ASU was effective upon issuance. The Company is currently evaluating the impact on additional disclosure requirements as each of the standards is adopted, however it does not expect these amendments to have a material effect on its financial position, results of operations or cash flows.

 

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Table of Contents

 

Notes to Consolidated Financial Statements

 

 

 

Note 1. Organization and Summary of Significant Accounting Policies, continued

Recent Accounting Pronouncements, continued

 

In January 2017, the FASB amended the Goodwill and Other Topic of the Accounting Standards Codification to simplify the accounting for goodwill impairment for public business entities and other entities that have goodwill reported in their financial statements and have not elected the private company alternative for the subsequent measurement of goodwill. The amendment removes Step 2 of the goodwill impairment test. A goodwill impairment will now be the amount by which a reporting unit’s carrying value exceeds its fair value, not to exceed the carrying amount of goodwill. The effective date and transition requirements for the technical corrections will be effective for the Company for reporting periods beginning after December 15, 2019. Early adoption is permitted for interim or annual goodwill impairment tests performed on testing dates after January 1, 2017. The Company does not expect these amendments to have a material effect on its financial statements.

In March 2017, the FASB amended the requirements in the Receivables—Nonrefundable Fees and Other Costs Topic of the Accounting Standards Codification related to the amortization period for certain purchased callable debt securities held at a premium. The amendments shorten the amortization period for the premium to the earliest call date. The amendments will be effective for the Company for interim and annual periods beginning after December 15, 2018. Early adoption is permitted. The Company does not expect these amendments to have a material effect on its financial statements.

In February 2018, the FASB amended the Financial Instruments Topic of the Accounting Standards Codification. The amendments clarify certain aspects of the guidance issued in ASU 2016-01. The amendments are effective for fiscal years beginning after December 15, 2017, and interim periods within those fiscal years beginning after June 15, 2018. All entities may early adopt these amendments for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years, as long as they have adopted ASU 2016-01. The Company does not expect these amendments to have a material effect on its financial statements.

In March 2018, the FASB updated the Debt Securities and the Regulated Operations Topics of the Accounting Standards Codification. The amendments incorporate into the Accounting Standards Codification recent SEC guidance which was issued in order to make the relevant interpretive guidance consistent with current authoritative accounting and auditing guidance and SEC rules and regulations. The amendments were effective upon issuance. The Company does not expect these amendments to have a material effect on its financial statements.

In March 2018, the FASB updated the Income Taxes Topic of the Accounting Standards Codification. The amendments incorporate into the Accounting Standards Codification recent SEC guidance related to the income tax accounting implications of the Tax Cuts and Jobs Act. The amendments were effective upon issuance. The Company does not expect these amendments to have a material effect on its financial statements.

In May 2018, the FASB amended the Financial Services—Depository and Lending Topic of the Accounting Standards Codification to remove outdated guidance related to Circular 202. The amendments were effective upon issuance and did not have a material effect on the financial statements.

In July 2018, the FASB amended the Leases Topic of the Accounting Standards Codification to make narrow amendments to clarify how to apply certain aspects of the new leases standard. The amendments are effective for reporting periods beginning after December 15, 2018. The Company does not expect these amendments to have a material effect on its financial statements.

In July 2018, the FASB amended the Leases Topic of the Accounting Standards Codification to give entities another option for transition and to provide lessors with a practical expedient. The amendments will be effective for the Company for reporting periods beginning after December 15, 2018. The Company does not expect these amendments to have a material effect on its financial statements.

 

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Table of Contents

 

Notes to Consolidated Financial Statements

 

 

 

Note 1. Organization and Summary of Significant Accounting Policies, continued

Recent Accounting Pronouncements, continued

 

In August 2018, the FASB amended the Fair Value Measurement Topic of the Accounting Standards Codification. The amendments remove, modify, and add certain fair value disclosure requirements based on the concepts in the FASB Concepts Statement, Conceptual Framework for Financial Reporting—Chapter 8: Notes to Financial Statements. The amendments are effective for all entities for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2019. Early adoption is permitted. An entity is permitted to early adopt any removed or modified disclosures upon issuance of this ASU and delay adoption of the additional disclosures until their effective date. The Company does not expect these amendments to have a material effect on its financial statements.

In August 2018, the FASB amended the Intangibles—Goodwill and Other Topic of the Accounting Standards Codification to align the requirements for capitalizing implementation costs incurred in a hosting arrangement that is a service contract with the requirements for capitalizing implementation costs incurred to develop or obtain internal-use software. The amendments will be effective for the Company for fiscal years beginning after December 15, 2019. Early adoption is permitted. The Company does not expect these amendments to have a material effect on its financial statements.

In October 2018, the FASB amended the Derivatives and Hedging Topic of the Accounting Standards Codification to expand the list of U.S. benchmark interest rates permitted in the application of hedge accounting. The amendments will be effective for the Company for fiscal years beginning after December 15, 2018. Early adoption is permitted. The Company does not expect these amendments to have a material effect on its financial statements.

In November 2018, the FASB amended the Collaborative Arrangements Topic of the Accounting Standards Codification to clarify the interaction between the guidance for certain collaborative arrangements and the new revenue recognition financial accounting and reporting standard. The amendments will be effective for the Company for fiscal years beginning after December 15, 2019, and interim periods within those fiscal years. Early adoption is permitted. The Company does not expect these amendments to have a material effect on its financial statements.

In December 2018, the FASB issued guidance that providing narrow-scope improvements for lessors, that provides relief in the accounting for sales, use and similar taxes, the accounting for other costs paid by a lessee that may benefit a lessor, and variable payments when contracts have lease and non-lease components. The amendments will be effective for the Company for reporting periods beginning after December 15, 2018. Early adoption is permitted. The Company does not expect these amendments to have a material effect on its financial statements.

Other accounting standards that have been issued or proposed by the FASB or other standards-setting bodies are not expected to have a material impact on the Company’s consolidated financial position, results of operations or cash flows.

Note 2. Business Combinations

On July 1, 2018, Parkway completed its merger with Great State as discussed above in Note 1. Parkway is considered the acquiring entity in this business combination for accounting purposes. Under the terms of the merger agreement, each share of Great State common stock was converted to 1.21 shares of common stock of Parkway which resulted in the issuance of 1,191,899 shares of Parkway stock in the merger. The Company engaged a third party to calculate fair values of all assets and liabilities acquired in the transaction. These valuations are not final and may be refined for up to one year following the merger date.

 

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Table of Contents

 

Notes to Consolidated Financial Statements

 

 

 

Note 2. Business Combinations, continued

 

The following table presents the Great State assets acquired and liabilities assumed as of July 1, 2018 as well as the related fair value adjustments and determination of goodwill.

 

(dollars in thousands)    As Reported by
Great State
     Fair Value
Adjustments
            As Reported by
Parkway
 

Assets

           

Cash and cash equivalents

   $ 25,761      $ —          —        $ 25,761  

Investment securities

     19,630        (229      (a)        19,401  

Restricted equity securities

     523        —          —          523  

Loans

     97,549        (2,441      (b)        95,108  

Allowance for loan losses

     (1,436      1,436        (c)        —    

Property and equipment

     1,207        189        (d)        1,396  

Intangible assets

     —          2,425        (e)        2,425  

Accrued interest receivable

     334        —          —          334  

Other assets

     599        (92      (f)        507  
  

 

 

    

 

 

       

 

 

 

Total assets acquired

   $ 144,167      $ 1,288         $ 145,455  
  

 

 

    

 

 

       

 

 

 

Liabilities

           

Deposits

   $ 129,611      $ 940        (g)      $ 130,551  

Borrowings

     2,000        —          —          2,000  

Accrued interest payable

     40        —          —          40  

Other liabilities

     352        17        (h)        369  
  

 

 

    

 

 

       

 

 

 

Total liabilities acquired

   $ 132,003      $ 957         $ 132,960  
  

 

 

    

 

 

       

 

 

 

Net assets acquired

              12,495  

Elimination of Company’s existing investment in Great State

              198  

Stock consideration

              15,495  
           

 

 

 

Goodwill

            $ 3,198  
           

 

 

 

Explanation of fair value adjustments:

 

  (a)

Reflects the opening fair value of securities portfolio, which was established as the new book basis of the portfolio.

 

  (b)

Reflects the fair value adjustment based on the Company’s third party valuation report.

 

  (c)

Existing allowance for loan losses eliminated to reflect accounting guidance.

 

  (d)

Estimated adjustment to Great State’s real property based upon third-party appraisals and the Company’s evaluation of equipment and other fixed assets.

 

  (e)

Reflects the recording of the estimated core deposit intangible based on the Company’s third party valuation report.

 

  (f)

Recording of deferred tax asset generated by the net fair value adjustments (tax rate = 21%).

 

  (g)

Estimated fair value adjustment to time deposits based on the Company’s third party valuation report on deposits assumed.

 

  (h)

Reflects the fair value adjustment based on the Company’s evaluation of acquired other liabilities.

 

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Table of Contents

 

Notes to Consolidated Financial Statements

 

 

 

Note 2. Business Combinations, continued

 

The merger was accounted for under the acquisition method of accounting. The assets and liabilities of Great State have been recorded at their estimated fair values and added to those of Parkway for periods following the merger date. Valuations of acquired Great State assets and liabilities may be refined for up to one year following the merger date.

There are two methods to account for acquired loans as part of a business combination. Acquired loans that contain evidence of credit deterioration on the date of purchase are carried at the net present value of expected future proceeds in accordance with FASB ASC 310-30. All other acquired loans are recorded at their initial fair value, adjusted for subsequent advances, pay downs, amortization or accretion of any premium or discount on purchase, charge-offs and any other adjustment to carrying value in accordance with ASC 310-20.

In determining the fair values of acquired loans without evidence of credit deterioration at the date of acquisition, management includes (i) no carryover of any previously recorded allowance for loan losses and (ii) an adjustment of the unpaid principal balance to reflect an appropriate market rate of interest, given the risk profile and grade assigned to each loan. This adjustment is then accreted into earnings as a yield adjustment, using the effective yield method, over the remaining life of each loan.

To the extent that current information indicates it is probable that the Company will collect all amounts according to the contractual terms thereof, such loan is not considered impaired and is not considered in the determination of the required allowance for loan losses. To the extent that current information indicates it is probable that the Company will not be able to collect all amounts according to the contractual terms thereon, such loan is considered impaired and is considered in the determination of the required level of allowance for loan and lease losses.

Subsequent to the acquisition date, increases in cash flows expected to be received in excess of the Company’s initial estimates are reclassified from nonaccretable difference to accretable yield and are accreted into interest income on a level-yield basis over the remaining life of the loan. Decreases in cash flows expected to be collected are recognized as impairment through the provision for loan losses.

Supplemental Pro Forma Information (dollars in thousands except per share data)

The table below presents supplemental pro forma information as if the Great State acquisition had occurred at the beginning of the earliest period presented, which was January 1, 2017. Pro forma results include adjustments for amortization and accretion of fair value adjustments and do not include any projected cost savings or other anticipated benefits of the merger. Therefore, the pro forma financial information is not indicative of the results of operations that would have occurred had the transactions been effected on the assumed date. Pre-tax merger-related costs of $2.0 million and $748 thousand are included in the Company’s consolidated statements of income for the years ended December 31, 2018 and 2017 and are not included in the pro forma statements below.

 

     Year Ended  
     December 31,  
     2018      2017  
     (Unaudited)      (Unaudited)  

Net interest income

   $ 23,956      $ 21,279  

Net income (a)

   $ 4,266      $ 2,743  

Basic and diluted weighted average shares outstanding (b)

     6,213,275        6,213,275  

Basic and diluted earnings per common share

   $ 0.69      $ 0.44  

 

(a)

Supplemental pro forma net income includes the impact of certain fair value adjustments. Supplemental pro forma net income does not include assumptions on cost savings or the impact of merger-related expenses.

(b)

Weighted average shares outstanding includes the full effect of the common stock issued in connection with the Great State acquisition as of the earliest reporting date.

It is impractical to disclose the net interest income, non-interest income, and net income of Great State from the acquisition date of July 1, 2018 through December 31, 2018 due to the system conversion that occurred on September 7, 2018, which resulted in the combining of the operations of Great State into Parkway.

 

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Notes to Consolidated Financial Statements

 

 

 

Note 3. Restrictions on Cash

To comply with banking regulations, the Bank is required to maintain certain average cash reserve balances. The daily average cash reserve requirement was approximately $6.3 million and $3.6 million for the periods including December 31, 2018 and 2017, respectively.

Note 4. Investment Securities

Debt and equity securities have been classified in the consolidated balance sheets according to management’s intent. The amortized cost of securities and their approximate fair values at December 31 follow:

 

(dollars in thousands)    Amortized
Cost
     Unrealized
Gains
     Unrealized
Losses
     Fair
Value
 

2018

           

Available for sale:

           

U.S. Government Agencies

   $ 244      $ 1      $ —        $ 245  

Mortgage-backed securities

     25,627        1        (865      24,763  

Corporate securities

     2,970        —          (181      2,789  

State and municipal securities

     17,764        31        (164      17,631  
  

 

 

    

 

 

    

 

 

    

 

 

 
   $ 46,605      $ 33      $ (1,210    $ 45,428  
  

 

 

    

 

 

    

 

 

    

 

 

 

2017

           

Available for sale:

           

Mortgage-backed securities

   $ 28,780      $ —        $ (626    $ 28,154  

Corporate securities

     3,016        —          (80      2,936  

State and municipal securities

     19,542        155        (112      19,585  
  

 

 

    

 

 

    

 

 

    

 

 

 
   $ 51,338      $ 155      $ (818    $ 50,675  
  

 

 

    

 

 

    

 

 

    

 

 

 

Restricted equity securities were $2.1 million and $1.4 million at December 31, 2018 and 2017, respectively. Restricted equity securities consist of investments in stock of the Federal Home Loan Bank of Atlanta (FHLB), CBB Financial Corp., Pacific Coast Bankers Bank, and the Federal Reserve Bank of Richmond, all of which are carried at cost. All of these entities are upstream correspondents of the Bank. The FHLB requires financial institutions to make equity investments in the FHLB in order to borrow money. The Bank is required to hold that stock so long as it borrows from the FHLB. The Federal Reserve requires Banks to purchase stock as a condition for membership in the Federal Reserve System. The Bank’s stock in CBB Financial Corp. and Pacific Coast Bankers Bank is restricted only in the fact that the stock may only be repurchased by the respective banks.

The following tables details unrealized losses and related fair values in the Company’s held to maturity and available for sale investment securities portfolios. This information is aggregated by the length of time that individual securities have been in a continuous unrealized loss position as of December 31, 2018 and 2017.

 

     Less Than 12 Months     12 Months or More     Total  
(dollars in thousands)    Fair
Value
     Unrealized
Losses
    Fair
Value
     Unrealized
Losses
    Fair
Value
     Unrealized
Losses
 

2018

               

Available for sale:

               

Mortgage-backed securities

   $ 450      $ (1   $ 24,227      $ (864   $ 24,677      $ (865

Corporate securities

     —          —         2,789        (181     2,789        (181

State and municipal securities

     5,518        (19     6,834        (145     12,352        (164
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Total securities available for sale

   $ 5,968      $ (20   $ 33,850      $ (1,190   $ 39,818      $ (1,210
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

2017

               

Available for sale:

               

Mortgage-backed securities

   $ 15,791      $ (324   $ 12,361      $ (302   $ 28,152      $ (626

Corporate securities

     1,506        (10     1,430        (70     2,936        (80

State and municipal securities

     5,284        (44     2,758        (68     8,042        (112
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Total securities available for sale

   $ 22,581      $ (378   $ 16,549      $ (440   $ 39,130      $ (818
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

 

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Table of Contents

 

Notes to Consolidated Financial Statements

 

 

 

Note 4. Investment Securities, continued

 

At December 31, 2018, 46 debt securities with unrealized losses had depreciated 2.95 percent from their total amortized cost basis. Management evaluates securities for other-than-temporary impairment at least on a quarterly basis, and more frequently when economic or market concerns warrant such evaluation. Consideration is given to the length of time and the extent to which the fair value has been less than cost, and the financial condition and near-term prospects of the issuer. The relative significance of these and other factors will vary on a case by case basis. In analyzing an issuer’s financial condition, management considers whether the securities are issued by the federal government or its agencies, whether downgrades by bond rating agencies have occurred, the results of reviews of the issuer’s financial condition and the issuer’s anticipated ability to pay the contractual cash flows of the investments. Since the Company intends to hold all of its investment securities until maturity, and it is more likely than not that the Company will not have to sell any of its investment securities before unrealized losses have been recovered, and the Company expects to recover the entire amount of the amortized cost basis of all its securities, none of the securities are deemed other than temporarily impaired at December 31, 2018. Management continues to monitor all of these securities with a high degree of scrutiny. There can be no assurance that the Company will not conclude in future periods that conditions existing at that time indicate some or all of these securities are other than temporarily impaired, which could require a charge to earnings in such periods.

Proceeds from the sales of investment securities available for sale were $18.4 and $8.7 million for the years ended December 31, 2018 and 2017, respectively. Gross realized gains and losses for the years ended December 31 are as follows:

 

(dollars in thousands)    2018      2017  

Realized gains

   $ 9      $ 257  

Realized losses

     (4      (15
  

 

 

    

 

 

 
   $ 5      $ 242