Parkway Acquisition 10-K (Annual Report)

File Date: 2017-03-29

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, 2016

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 and posted on its corporate website, if any every interactive data file required to be submitted and posted 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 and post 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, or a smaller reporting company. See definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer      Accelerated filer  
Non-accelerated filer   ☐  (Do not check if a smaller reporting company)    Smaller reporting company  

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. $37,919,936. The registrant was not a public company as of the last business day of its most recently completed second fiscal quarter. The aggregate market value of its voting and non-voting common equity held by non-affiliates is calculated as of August 31, 2016, the date that the registrant’s common stock began trading.

Indicate the number of shares outstanding of each of the registrant’s classes of common stock, as of the latest practicable date. 5,021,376 shares of Common Stock as of March 21, 2017

DOCUMENTS INCORPORATED BY REFERENCE

None

 

 

 


Table of Contents

TABLE OF CONTENTS

 

         Page
Number
 

Part I

       1  

Item 1.

 

Business

     1  

Item 1A.

 

Risk Factors

     11  

Item 1B.

 

Unresolved Staff Comments

     15  

Item 2.

 

Properties

     15  

Item 3.

 

Legal Proceedings

     16  

Item 4.

 

Mine Safety Disclosures

     16  

Part II

       16  

Item 5.

 

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

     16  

Item 6.

 

Selected Financial Data

     17  

Item 7.

 

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

     18  

Item 7A.

 

Quantitative and Qualitative Disclosures About Market Risk

     36  

Item 8.

 

Financial Statements and Supplementary Data

     36  

Item 9.

 

Changes in and Disagreements with Accountants on Accounting and Financial Disclosure

     84  

Item 9A.

 

Controls and Procedures

     84  

Item 9B.

 

Other Information

     84  

Part III

       85  

Item 10.

 

Directors, Executive Officers and Corporate Governance

     85  

Item 11.

 

Executive Compensation

     89  

Item 12.

 

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

     91  

Item 13.

 

Certain Relationships and Related Transactions, and Director Independence

     92  

Item 14.

 

Principal Accounting Fees and Services

     93  

Part IV

       93  

Item 15.

 

Exhibits, Financial Statement Schedules

     93  

Item 16.

 

Form 10-K Summary

     94  

 

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PART I

 

Item 1. Business.

General

Parkway Acquisition Corp. (“Parkway,” the “Company,” “we,” “our” and “us”) was incorporated as a Virginia corporation on November 2, 2015. Parkway was formed as a business combination shell 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 and Plan of Merger (the “merger agreement”), providing for the combination of the three companies. Terms of the merger agreement called for Grayson and Cardinal to merge with and into Parkway, with Parkway as the surviving corporation (the “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 merger was completed on July 1, 2016. Grayson is considered the acquiror and Cardinal is considered the acquiree in the transaction for accounting purposes.

Upon completion of the 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. 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 surrounding areas through seventeen full-service banking offices and one loan production office. Effective March 13, 2017, the Bank changed its name to Skyline National Bank.

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 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 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 merger.

Lending Activities

The Bank’s lending services include real estate, commercial, agricultural, and consumer loans. The loan portfolio constituted 81.68% of the interest earning assets of the Bank at December 31, 2016, 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.

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, 2016, the Bank had 45.44% of the loan portfolio in single and multi-family housing, 31.20% in non-farm, non-residential real estate loans, 8.14% in farm related real estate loans, and 6.42% in real estate construction and development loans.

The Bank’s loan portfolio includes commercial and agricultural production loans totaling 6.33% of the portfolio at December 31, 2016. Consumer and other loans make up approximately 2.47% 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 fill the needs of the Bank’s customer base.

 

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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 89.22% of the Bank’s total deposits at December 31, 2016. Certificates of deposit in denominations of $100,000 or more represented the remaining 10.78% of deposits at December 31, 2016.

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

 

  •   the City of Galax, Virginia

 

  •   the City of Salem, Virginia

 

  •   the City of Roanoke, Virginia

Grayson, Carroll, and Alleghany 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 $28,892 in Grayson County, to a high of $35,319 in Alleghany County, based upon 2014 census data. Montgomery, Pulaski, Floyd and Wythe counties, while largely rural, are more economically diverse. Montgomery County is home to two major universities, Virginia Tech and Radford 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 $40,185 in Wythe County, to a high of $47,543 in Floyd County, according to the 2014 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 $39,530 in Roanoke City, to a high of $60,950 in Roanoke County.

 

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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. 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, 2016, the Company had 176 total employees representing 175 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.

Government Supervision and Regulation

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

Parkway Acquisition Corp.

The Company is qualified as 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 Board of Governors of the Federal Reserve System (the “FRB”). As a bank holding company, the Company is subject to supervision, regulation and examination by the FRB and is required to file various reports and additional information with the FRB. 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 Office of the Comptroller of the Currency (the “OCC”) and the Federal Deposit Insurance Corporation (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.

 

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The regulations of the OCC, the FDIC and the FRB 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 FRB 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 restructures the financial regulatory regime in the United States and has 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, a process which will take years to fully implement. The Company believes that short- and long-term compliance costs for the Company will be greater because of the Dodd-Frank Act. Certain provisions of the Dodd-Frank Act that could impact the Company are set forth below:

Creation of a new agency, 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.

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”).

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. 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.

 

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Capital Requirements

The FRB, the OCC and the FDIC have issued substantially similar risk-based and leverage capital guidelines applicable to all 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.

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 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 (increased from the prior requirement of 4%); (iii) a total capital ratio of 8% of risk-weighted assets (unchanged from the prior requirement); and (iv) a leverage ratio of 4% of total assets (unchanged from the prior requirement). When 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 as that buffer is phased in, 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 as that buffer is phased in, 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 as that buffer is phased in, 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 will be phased in beginning January 1, 2016, at 0.625% of risk-weighted assets, increasing by the same amount each year until fully implemented at 2.5% on January 1, 2019. The capital conservation buffer is designed to absorb losses during periods of economic stress. Banking institutions with a ratio of common equity Tier 1 to risk-weighted assets above the minimum but below the conservation buffer will face constraints on dividends, equity repurchases, and compensation based on the amount of the shortfall.

The rules also revised the “prompt corrective action” regulations pursuant to Section 38 of the FDIA by (i) introducing a common equity Tier 1 capital ratio requirement at each level (other than critically undercapitalized), with the required ratio being 6.5% for well-capitalized status; (ii) increasing the minimum Tier 1 capital ratio requirement for each category, with the minimum ratio for well-capitalized status being 8.0% (as compared to the prior ratio of 6.0%); and (iii) eliminating the current provision that provides that a bank with a composite supervisory rating of 1 may have a 3.0% Tier 1 leverage ratio and still be well-capitalized. These new thresholds were effective for the Bank as of January 1, 2015. The minimum total capital to risk-weighted assets ratio (10.0%) and minimum leverage ratio (5.0%) for well-capitalized status were unchanged by the final rules.

The new capital requirements also included changes in the risk weights of assets to better reflect credit risk and other risk exposures. These include a 150% risk weight (up from 100%) for certain high volatility commercial real estate acquisition, development and construction loans and nonresidential mortgage loans that are 90 days past due or otherwise on nonaccrual status, a 20% (up from 0%) credit conversion factor for the unused portion of a commitment with an original maturity of one year or less that is not unconditionally cancelable, a 250% risk weight (up from 100%) for mortgage servicing rights and deferred tax assets that are not deducted from capital, and increased risk-weights (from 0% to up to 600%) for equity exposures.

Based on management’s understanding and interpretation of the new capital rules, it believes that, as of December 31, 2016, the Banks meet all capital adequacy requirements under such rules on a fully phased-in basis as if such requirements were in effect as of such date.

 

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Dividends

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

In addition, under the current supervisory practices of the FRB, 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 FRB 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 FRB 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 FRB may order a bank holding company or its subsidiaries to terminate any activity or to terminate ownership or control of any subsidiary when the FRB 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 FRB 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 FRB 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 FRB 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.

 

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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

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

Safety and Soundness

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

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

The Federal Deposit Insurance Corporation Improvement Act

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

Reflecting changes under the new Basel III capital requirements, the relevant capital measures that became effective on January 1, 2015 for prompt corrective action are the total capital ratio, the common equity Tier 1 capital ratio, the Tier 1 capital ratio and the leverage ratio. A bank will be (i) well capitalized” if the institution has a total risk-based capital ratio of 10.0% or greater, a common equity Tier 1 capital ratio of 6.5% or greater, a Tier 1 risk-based capital ratio of 8.0% or greater, and a leverage ratio of 5.0% or greater, and is not subject to any capital directive order; (ii) “adequately capitalized” if the institution has a total risk-based capital ratio of 8.0% or greater, a common equity Tier 1 capital ratio of 4.5% or greater, a Tier 1 risk-based capital ratio of 6.0% or greater, and a leverage ratio of 4.0% or greater and is not “well capitalized”; (iii) “undercapitalized” if the institution has a total risk-based capital ratio that is less than 8.0%, a common equity Tier 1 capital ratio less than 4.5%, a Tier 1 risk-based capital ratio of less than 6.0% or a leverage ratio of less than 4.0%; (iv) “significantly undercapitalized” if the institution has a total risk-based capital ratio of less than 6.0%, a common equity Tier 1 capital ratio less than 3.0%, a Tier 1 risk-based capital ratio of less than 4.0% or a leverage ratio of less than 3.0%; and (v) “critically undercapitalized” if the institution’s tangible equity is equal to or less than 2.0% of average quarterly tangible assets. An institution may be downgraded to, or deemed to be in, a capital category that is

 

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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, 2016 and 2015, the Company met the requirements for being classified as “well capitalized.”

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

Branching

The Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994, as amended (the “Interstate Banking Act”), generally permits well capitalized bank holding companies to acquire banks in any state, and preempts all state laws restricting the ownership by a bank holding company of banks in more than one state. The Interstate Banking Act also permits a bank to merge with an out-of-state bank and convert any offices into branches of the resulting bank if both states have not opted out of interstate branching; and permits a bank to acquire branches from an out-of-state bank if the law of the state where the branches are located permits the interstate branch acquisition. Under the Dodd-Frank Act, a bank holding company or bank must be well capitalized and well managed to engage in an interstate acquisition. Bank holding companies and banks are required to obtain prior FRB 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.

 

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Consumer Financial Protection

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

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

 

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respect to the handling of customers’ personal information. Each institution must conduct an internal risk assessment of its ability to protect customer information. These privacy provisions generally prohibit a financial institution from providing a customer’s personal financial information to unaffiliated parties without prior notice and approval from the customer.

Incentive Compensation

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

The FRB will review, as part of the regular, risk-focused examination process, the incentive compensation arrangements of financial institutions, such as the Company, 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, 2016, the Company had not been made aware of any instances of non-compliance with the final guidance.

Volcker Rule

The Volcker Rule under the Dodd-Frank Act prohibits banks and their affiliates from engaging in proprietary trading and investing in and sponsoring hedge funds and private equity funds. The Volcker Rule, which became effective in July 2015, does not significantly impact the operations of the Company or the Bank, as they do not have any significant engagement in the businesses prohibited by the Volcker Rule.

Ability-to-Repay and Qualified Mortgage Rule

Pursuant to the Dodd-Frank Act, the CFPB issued a final rule on January 10, 2013 (effective on January 10, 2014), amending Regulation Z as implemented by the Truth in Lending Act, requiring mortgage lenders to make a reasonable and good faith determination based on verified and documented information that a consumer applying for a mortgage loan has a reasonable ability to repay the loan according to its terms. Mortgage lenders are required to determine consumers’ ability to repay in one of two ways. The first alternative requires the mortgage lender to consider the following eight underwriting factors when making the credit decision: (i) current or reasonably expected income or assets; (ii) current employment status; (iii) the monthly payment on the covered transaction; (iv) the monthly payment on any simultaneous loan; (v) the monthly payment for mortgage-related obligations; (vi) current debt obligations, alimony, and child support; (vii) the monthly debt-to-income ratio or residual income; and (viii) credit history. Alternatively, the mortgage lender can originate “qualified mortgages,” which are entitled to a presumption that the creditor making the loan satisfied the ability-to-repay requirements. In general, a “qualified mortgage” is a mortgage loan without negative amortization, interest-only payments, balloon payments, or terms exceeding 30 years. In addition, to be a qualified mortgage the points and fees paid by a consumer cannot exceed 3% of the total loan amount. Qualified mortgages that are “higher-priced” (e.g. subprime loans) garner a rebuttable presumption of compliance with the ability-to-repay rules, while qualified mortgages that are not “higher-priced” (e.g. prime loans) are given a safe harbor of compliance.

 

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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 FRB regulates money and credit conditions and interest rates to influence general economic conditions. These policies have a significant impact on overall growth and distribution of loans, investments and deposits; they affect interest rates charged on loans or paid for time and savings deposits. FRB 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, 2016, the Company had $375.7 million of such loans outstanding, or 91.20% 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

 

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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.

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

As of December 31, 2016, 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.

 

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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.

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. To a limited extent, we also compete with other providers of financial services, such as money market mutual funds, brokerage firms, consumer finance companies, 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. 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.

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.

 

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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.

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 amends the regulatory risk-based capital rules applicable to us. The final rule implements the “Basel III” regulatory capital reforms and changes required by the Dodd-Frank Wall Street Reform and Consumer Protection 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%, which is increased from 4%; (iii) a total capital ratio of 8%, which is unchanged from the current rules; and (iv) a Tier 1 leverage ratio of 4%. The final rule also establishes a “capital conservation buffer” of 2.5% above the new regulatory minimum capital ratios, and when fully effective in 2019, will result 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 will be phased in beginning in January 2016 at 0.625% of risk-weighted assets and would increase 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. In February 2015, the agencies increased the filing threshold to exempt holding companies under $1 billion concerning computing and reporting consolidated capital ratios. Therefore, currently, the new BASEL III ratios will be applicable to the Bank.

 

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The application of these more stringent capital requirements for us could, among other things, result in lower returns on equity, require the raising of additional capital, adversely affect our future growth opportunities, and result in regulatory actions such as a prohibition on the payment of dividends or on the repurchase shares if we were unable to comply with such requirements.

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

As a financial institution, we are heavily regulated at the state and federal levels. Banking regulations generally are intended to protect depositors, not investors, and regulators have broad interpretive and enforcement powers beyond our control that may change rapidly and unpredictably and could influence our earnings and growth. 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 have begun to be or will be phased in over the next several months or years and will be 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.

 

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 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
Hillsville Office - 185 South Main St., Hillsville, VA    276-728-2341    Full service
Salem Office - 1634 West Main St., Salem, VA    540-387-4533    Full service
Willis Office - 5598 B Floyd Highway South, Willis, VA    540-745-4191   

Limited

service/conducts

normal

teller

transactions

 

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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 also owns an operations center adjacent to the main office in Independence, Virginia and operates a loan production office in a leased facility in the town of Blacksburg, Virginia. The Bank anticipates closing the office at 185 South Main Street, Hillsville, Virginia, sometime in 2017.

 

Item 3. Legal Proceedings.

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

 

Item 4. Mine Safety Disclosures.

Not applicable.

PART II

 

Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchasers of Equity Securities.

The Company’s common stock is quoted on the OTC Markets Group’s OTCQX tier under the symbol “PKKW.” As of March 28, 2017, there were 5,021,376 shares of the Company’s common stock outstanding, held by 1,543 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  

2016

        

Third quarter

     8.25        7.96        0.06  

Fourth quarter

     8.75        8.05        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.

 

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Stock Repurchases

The Company did not repurchase any shares of its common stock during 2016.

 

Item 6. Selected Financial Data.

Not applicable.

 

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Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.

 

 

Management’s Discussion and Analysis

 

 

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”) was incorporated as a Virginia corporation on November 2, 2015. Parkway was formed as a business combination shell 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 and Plan of Merger (the “merger agreement”), providing for the combination of the three companies. Terms of the merger agreement called for Grayson and Cardinal to merge with and into Parkway, with Parkway as the surviving corporation (the “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 merger was completed on July 1, 2016. Grayson is considered the acquiror and Cardinal is considered the acquiree in the transaction for accounting purposes.

Upon completion of the 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. 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 surrounding areas through seventeen full-service banking offices and one loan production office. Effective March 13, 2017, the Bank changed its name to Skyline National Bank. 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 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 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 merger.

Parkway Acquisition Corp. had net earnings of $2.4 million for 2016 compared to $997 thousand for 2015 and $866 thousand for 2014. Earnings in 2016 were impacted significantly by the above mentioned merger activity. Interest income and interest expense increased due to the acquired loans and deposits. Also in 2016, the Company recognized non-recurring merger related expenses of approximately $1.5 million, most of which were not tax deductible.

Forwarding 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.

 

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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;
  •   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.

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, 2016 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 values 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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Table 1. Net Interest Income and Average Balances (dollars in thousands)

 

 

 

     2016     2015     2014  
           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

   $ 9,977     $ 37        0.37   $ 608     $ 1        0.18   $ 451     $ —          0.06

Federal funds sold

     9,316       46        0.49     8,856       18        0.21     10,981       20        0.18

Investment securities

     51,027       1,195        2.34     62,487       1,495        2.39     71,225       1,690        2.37

Loans 1, 2

     325,723       16,284        5.00     227,650       11,189        4.92     216,243       11,286        5.22
  

 

 

   

 

 

    

 

 

   

 

 

   

 

 

    

 

 

   

 

 

   

 

 

    

 

 

 

Total

     396,043       17,562          299,601       12,703          298,900       12,996     
  

 

 

   

 

 

      

 

 

   

 

 

      

 

 

   

 

 

    

Yield on average interest-earning assets

          4.43          4.24          4.35
       

 

 

        

 

 

        

 

 

 

Non interest-earning assets:

                     

Cash and due from banks

     10,256            6,780            7,099       

Premises and equipment

     14,603            11,988            12,028       

Interest receivable and other

     22,279            17,125            19,366       

Allowance for loan losses

     (3,927          (3,855          (4,528     

Unrealized gain/(loss) on securities

     364            55            (1,574     
  

 

 

        

 

 

        

 

 

      

Total

     43,575            32,093            32,391       
  

 

 

        

 

 

        

 

 

      

Total assets

   $ 439,618          $ 331,694          $ 331,291       
  

 

 

        

 

 

        

 

 

      

Interest-bearing liabilities:

                     

Demand deposits

   $ 42,848       44        0.10   $ 26,653       21        0.08   $ 26,776       21        0.08

Savings deposits

     107,546       247        0.23     75,067       169        0.22     66,926       149        0.22

Time deposits

     132,637       995        0.75     104,745       1,162        1.11     122,741       1,555        1.27

Borrowings

     11,412       442        3.87     20,000       874        4.37     20,000       874        4.37
  

 

 

   

 

 

    

 

 

   

 

 

   

 

 

    

 

 

   

 

 

   

 

 

    

 

 

 

Total

     294,443       1,728          226,465       2,226          236,443       2,599     
  

 

 

   

 

 

      

 

 

   

 

 

      

 

 

   

 

 

    

Cost on average interest-bearing liabilities

          0.59          0.98          1.10
       

 

 

        

 

 

        

 

 

 

Non interest-bearing liabilities:

                     

Demand deposits

     100,425            73,167            64,468       

Interest payable and other

     1,729            1,125            760       
  

 

 

        

 

 

        

 

 

      

Total

     102,154            74,292            65,228       
  

 

 

        

 

 

        

 

 

      

Total liabilities

     396,597            300,757            301,671       

Stockholder’s equity:

     43,021            30,937            29,620       
  

 

 

        

 

 

        

 

 

      

Total liabilities and stockholder’s equity

   $ 439,618          $ 331,694          $ 331,291       
  

 

 

        

 

 

        

 

 

      

Net interest income

     $ 15,834          $ 10,477          $ 10,397     
    

 

 

        

 

 

        

 

 

    

Net yield on interest-earning assets

          3.99          3.50          3.48
       

 

 

        

 

 

        

 

 

 

 

1  Includes nonaccural loans
2  Interest income includes loan fees

 

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Table 2. Rate/Volume Variance Analysis (thousands)

 

     2016 Compared to 2015     2015 Compared to 2014  
     Interest     Variance     Interest     Variance  
     Income/     Attributable To     Income/     Attributable To  
     Expense                 Expense              
     Variance     Rate     Volume     Variance     Rate     Volume  

Interest-earning assets:

            

Interest bearing deposits

   $ 36     $ 2     $ 34     $ 1     $ 1     $ —    

Federal funds sold

     28       27       1       (1     3       (4

Investment securities

     (300     (30     (270     (195     14       (209

Loans

     5,095       185       4,910       (97     (673     576  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total

     4,859       184       4,675       (292     (655     363  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Interest-bearing liabilities:

            

Demand deposits

     23       6       17       —         —         —    

Savings deposits

     78       7       71       20       —         20  

Time deposits

     (167     (432     265       (393     (182     (211

Borrowings

     (432     (91     (341     —         —         —    
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total

     (498     (510     12       (373     (182     (191
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net interest income

   $ 5,357     $ 694     $ 4,663     $ 81     $ (473   $ 554  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

(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.

Total interest income in 2016 increased by 38.24% to $17.6 million from $12.7 million in 2015 after a decrease from $13.0 million in 2014. The increase in total interest income in 2016 was due primarily to the merger with Cardinal, which added approximately $157.9 million in loans and $16.0 million in investment securities to the Company’s earning assets. Competitive pressure in our markets continues to place downward pressure on new loan rates; however, overall loan yields increased slightly from 2015 to 2016 due to accretion of purchase discounts applied through the purchase accounting marks. Average yields on investment securities decreased slightly; however, the overall decrease in interest income on securities was due to the overall reduction in average balances from 2015 to 2016. The total yield on average interest-earning assets increased from 4.24% in 2015 to 4.43% in 2016. The overall increase in yield was due to the aforementioned increase in loan yields as well as to increases in yields on interest-bearing deposits in banks and federal funds sold, which came as a result of recent increases in overnight borrowing rates from the Federal Reserve. Total interest expense decreased by $498 thousand in 2016 and $373 thousand in 2015. The decrease in 2016 was due primarily to a reduction in higher-rate borrowings, while the decrease in 2015 came primarily as a result of lower interest rates combined with a decrease in average time deposits outstanding during the year. The effects of changes in volumes and rates on net interest income in 2016 compared to 2015, and 2015 compared to 2014 are shown in Table 2.

The aforementioned factors led to an increase in net interest income of $5.4 million or 51.12% for 2016 as compared to 2015. The net yield on interest-earning assets increased by 49 basis points to 3.99% in 2016 compared to 3.50% in 2015.

 

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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 a negative $5 thousand for the year ended December 31, 2016, compared to a negative $187 thousand for the year ended December 31, 2015. The reserve for loan losses at December 31, 2016 was approximately 0.83% of total loans, compared to 1.42% at December 31, 2015. The decrease in the reserve percentage was due to the Cardinal acquisition and the application of purchase accounting guidance which required the elimination of Cardinal’s loan loss reserves. Management’s estimate of probable credit losses inherent in the acquired Cardinal loan portfolio was reflected as a purchase discount which will be accreted into income over the remaining life of the acquired loans. 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 $2.1 million, or 82.00%, to $4.6 million in 2016 from $2.5 million in 2015. The increase was due primarily to the Cardinal merger, as service charges and other account-based fees increased along with the increase in the number of accounts and greater overall deposit balances. The merger also resulted in the recognition of a non-recurring bargain purchase gain of $891 thousand, which is included in other income for the year ended December 31, 2016. The decrease in noninterest income from 2014 to 2015 was due to a higher level of securities gains in 2014.

 

 

Table 3. Sources of Noninterest Income (thousands)

 

 

 

     2016      2015      2014  

Service charges on deposit accounts

   $ 1,256      $ 1,008      $ 1,123  

Increase in cash value of life insurance

     382        290        297  

Mortgage origination fees

     167        45        23  

Safe deposit box rental

     78        62        63  

Gain on securities

     364        97        408  

ATM income

     750        653        643  

Investment services income

     133        95        90  

Merchant services income

     144        127        105  

Bargain purchase gain

     891        —          —    

Interchange income

     206        88        154  

Other income

     199        46        55  
  

 

 

    

 

 

    

 

 

 

Total noninterest income

   $ 4,570      $ 2,511      $ 2,961  
  

 

 

    

 

 

    

 

 

 

 

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Other Expense

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

Total noninterest expense increased by $5.2 million or 45.22% in 2016 after decreasing by $322 thousand, or 2.70% in 2015. The increase in 2016 was due primarily to the Cardinal merger. Personnel expense increased by $2.1 million from 2015 to 2016 as the number of employees increased from approximately 110 prior to the combination to 185 after the combination. Data processing expense increased by $327 thousand as the consolidation of the data processing systems of the two banks did not occur until early in 2017. Merger related expenses totaled $1.5 million in 2016, compared to $498 thousand in 2015, representing an increase of $985 thousand. The decrease in noninterest expense in 2015, compared to 2014, was due to a significant decrease in foreclosure related expenses.

 

 

Table 4. Sources of Noninterest Expense (thousands)

 

 

 

     2016      2015      2014  

Salaries & wages

   $ 6,772      $ 4,858      $ 4,760  

Employee benefits

     1,858        1,700        1,559  
  

 

 

    

 

 

    

 

 

 

Total personnel expense

     8,630        6,558        6,319  

Director fees

     257        173        177  

Occupancy expense

     815        613        634  

Data processing expense

     888        561        412  

Other equipment expense

     1,170        536        559  

FDIC/OCC assessments

     350        431        594  

Insurance

     127        111        116  

Professional fees

     327        179        294  

Advertising

     208        223        231  

Postage and freight

     235        148        141  

Supplies

     159        137        131  

Franchise tax

     270        172        163  

Telephone

     279        203        173  

Travel, dues & meetings

     299        178        139  

ATM expense

     355        226        318  

Foreclosure expenses

     79        14        971  

Merger related expense

     1,483        498        —    

Other expense

     885        619        530  
  

 

 

    

 

 

    

 

 

 

Total noninterest expense

   $ 16,816      $ 11,580      $ 11,902  
  

 

 

    

 

 

    

 

 

 

 

The overhead efficiency ratio of noninterest expense to adjusted total revenue (net interest income plus noninterest income) was 82.42% in 2016, 89.16% in 2015, and 89.11% in 2014. The ratios for 2016 and 2015, without the effect of nonrecurring merger related costs, would have been 75.14% was 85.32%, respectively.

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.

 

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Income tax expense (substantially all Federal) was $1.2 million in 2016, $598 thousand in 2015, and $295 thousand in 2014, resulting in effective tax rates of 32.7%, 37.5%, and 25.4% respectively. The increase in the effective rates in 2016 and 2015 was due to merger related costs, the majority of which are not deductible for tax purposes.

The Company’s deferred income tax benefits and liabilities result primarily from net operating loss carryforwards and other temporary differences (discussed above), such as the provisions for credit losses, valuation reserves, non-accrual interest income, depreciation, deferred compensation, deferred income, pension expense and investment security discount accretion.

Net deferred tax benefits of $5.9 million and $1.8 million are included in other assets at December 31, 2016 and 2015 respectively. At December 31, 2016, net deferred tax benefits included $295 thousand of deferred tax assets applicable to unrealized losses on investment securities available for sale, and $402 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 32.19% from 2015 to 2016 due primarily to the Cardinal merger. Total earning assets represented 90.09% of total average assets in 2016 and 90.32% in 2015. The mix of average earning assets changed from 2015 to 2016 as average loans increased by $98.1 million, or 43.08% and average investment securities decreased by $11.5 million, or 18.34%.

 

 

Table 5. Average Asset Mix (dollars in thousands)

 

 

 

     2016     2015  
     Average            Average         
     Balance      %     Balance      %  

Earning assets:

          

Loans

   $ 325,723        74.09   $ 227,650        68.63

Investment securities

     51,027        11.61     62,487        18.84

Federal funds sold

     9,316        2.12     8,856        2.67

Deposits in other banks

     9,977        2.27     608        0.18
  

 

 

    

 

 

   

 

 

    

 

 

 

Total earning assets

     396,043        90.09     299,601        90.32
  

 

 

    

 

 

   

 

 

    

 

 

 

Nonearning assets:

          

Cash and due from banks

     10,256        2.33     6,780        2.04

Premises and equipment

     14,603        3.32     11,988        3.62

Other assets

     22,279        5.07     17,125        5.16

Allowance for loan losses

     (3,927      -0.89     (3,855      -1.16

Unrealized gain on securities

     364        0.08     55        0.02
  

 

 

    

 

 

   

 

 

    

 

 

 

Total nonearning assets

     43,575        9.91     32,093        9.68
  

 

 

    

 

 

   

 

 

    

 

 

 

Total assets

   $ 439,618        100.00   $ 331,694        100.00
  

 

 

    

 

 

   

 

 

    

 

 

 

Average loans for 2016 represented 74.09% of total average assets compared to 68.63% in 2015. Average federal funds sold decreased from 2.67% to 2.12% of total average assets while average investment securities decreased from 18.84% to 11.61% of total average assets over the same time period. The balances of nonearning assets increased from 9.68% in 2015 to 9.91% in 2016.

 

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Loans

Average loans totaled $325.7 million over the year ended December 31, 2016. This represents an increase of 43.1% from the average of $227.7 million for 2015. The increase in 2016 was due primarily to loans acquired from Cardinal. Average loans increased by 5.28% from 2014 to 2015.

The loan portfolio consists primarily of real estate and commercial loans. These loans accounted for 96.86% of the total loan portfolio at December 31, 2016. This is down slightly from the 97.37% that the two categories maintained at December 31, 2015. 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, 2016 are presented in Tables 6 & 7 respectively.

 

 

Table 6. Loan Portfolio Summary (dollars in thousands)

 

 

 

     December 31, 2016     December 31, 2015     December 31, 2014  
     Amount      %     Amount      %     Amount      %  

Construction and development

   $ 26,464        6.42   $ 14,493        6.01   $ 17,158        7.70

Residential, 1-4 families

     160,502        38.96     112,781        46.76     110,519        49.56

Residential, 5 or more families

     26,686        6.48     12,203        5.06     8,606        3.86

Farm land

     33,531        8.14     31,512        13.06     28,570        12.81

Nonfarm, nonresidential

     128,515        31.20     52,463        21.75     43,046        19.30
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Total real estate

     375,698        91.20     223,452        92.64     207,899        93.23

Agricultural

     2,779        0.67     1,383        0.57     1,338        0.60

Commercial

     23,307        5.66     11,399        4.73     8,954        4.02

Consumer

     5,491        1.33     3,962        1.64     3,816        1.71

Other

     4,693        1.14     1,020        0.42     984        0.44
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Total

   $ 411,968        100.00   $ 241,216        100.00   $ 222,991        100.00
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 
                  December 31, 2013     December 31, 2012  
                  Amount      %     Amount      %  

Construction and development

 

  $ 15,269        7.21   $ 15,650        7.62

Residential, 1-4 families

 

    99,666        47.08     99,410        48.40

Residential, 5 or more families

 

    7,181        3.39     3,920        1.91

Farm land

 

    30,074        14.21     31,462        15.32

Nonfarm, nonresidential

 

    43,725        20.65     34,850        16.97
       

 

 

    

 

 

   

 

 

    

 

 

 

Total real estate

 

    195,915        92.54     185,292        90.22

Agricultural

 

    1,420        0.67     1,695        0.82

Commercial

 

    9,346        4.42     10,755        5.23

Consumer

 

    4,104        1.94     6,001        2.92

Other

 

    913        0.43     1,664        0.81
       

 

 

    

 

 

   

 

 

    

 

 

 

Total

 

  $ 211,698        100.00   $ 205,407        100.00
       

 

 

    

 

 

   

 

 

    

 

 

 

 

 

25


Table of Contents

 

Management’s Discussion and Analysis

 

 

 

 

Table 7. Maturity Schedule of Loans (dollars in thousands), as of December 31, 2016

 

 

 

     Real      Agricultural      Consumer      Total  
     Estate      and Commercial      and Other      Amount      %  

Fixed rate loans:

              

Three months or less

   $ 7,019      $ 407      $ 1,350      $ 8,776        2.13

Over three to twelve months

     10,279        1,531        367        12,177        2.96

Over one year to five years

     51,656        7,775        3,922        63,353        15.38

Over five years

     44,337        2,179        2,267        48,783        11.84
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total fixed rate loans

   $ 113,291      $ 11,892      $ 7,906      $ 133,089        32.31
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Variable rate loans:

              

Three months or less

   $ 13,820      $ 2,453      $ 414      $ 16,687        4.05

Over three to twelve months

     10,235        2,815        22        13,072        3.17

Over one year to five years

     72,447        628        1,434        74,509        18.09

Over five years

     165,905        8,298        408        174,611        42.38
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total variable rate loans

   $ 262,407      $ 14,194      $ 2,278      $ 278,879        67.69
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total loans:

              

Three months or less

   $ 20,839      $ 2,860      $ 1,764      $ 25,463        6.18

Over three to twelve months

     20,514        4,346        389        25,249        6.13

Over one year to five years

     124,103        8,403        5,356        137,862        33.47

Over five years

     210,242        10,477        2,675        223,394        54.22
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total loans

   $ 375,698      $ 26,086      $ 10,184      $ 411,968        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 5.00% in 2016 compared to an average yield of 4.92% in 2015.

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 2016 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 increased by approximately $7.2 million from December 31, 2015 to December 31, 2016, while the average balance of investment securities carried throughout the year decreased by approximately $11.5 million from 2015 to 2016. The decrease came as cash generated from liquidating investment securities was used to repay borrowings. The average yield of the investment portfolio decreased to 2.34% for the year ended December 31, 2016 compared to 2.39% for 2015.

 

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Management’s Discussion and Analysis

 

 

 

 

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

 

 

 

     December 31, 2016                
     In One
Year or
Less
     After One
Through
Five Years
     After Five
Through
Ten Years
     After
Ten
Years
     Book
Value
12/31/16
     Market
Value
12/31/16
     Book
Value
12/31/15
     Book
Value
12/31/14
 
                         
                         

Investment Securities:

                       

U.S. Treasury securities

   $ —        $ —        $ —        $ —        $ —        $ —        $ 1,534      $ —    

U.S. Government agencies

     —          —          —          —          —          —          3        1,664  

Govt. sponsored enterprises

     —          1,997        —          49        2,046        2,209        15,327        15,596  

Mortgage-backed securities

     —          1,739        15,220        19,062        36,021        35,202        13,595        22,433  

Asset-backed securities

     —          —          —          —          —          —          1,989        4,989  

Corporate securities

     —          —          3,061        —          3,061        2,974        3,104        2,151  

State and municipal securities

     —          5,800        7,030        9,452        22,282        22,155        20,673        22,478  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ —        $ 9,536      $ 25,311      $ 28,563      $ 63,410      $ 62,540      $ 56,225      $ 69,311  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Weighted average yields:

 

                    

Govt. sponsored enterprises

     0.00%        1.55%        0.00%        0.00%        1.55%           

Mortgage-backed securities

     0.00%        1.80%        2.10%        2.01%        2.04%           

Corporate securities

     0.00%        0.00%        3.25%        0.00%        3.25%           

State and municipal securities

     0.00%        2.49%        2.92%        2.90%        2.80%           
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

          

Total

     0.00%        2.20%        2.46%        2.33%        2.36%           
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

          

 

 

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. 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. Management has reduced deposit rates in recent years due to relatively weak loan demand and the historically low returns available on alternative investments.

Average total deposits for the year ended December 31, 2016 amounted to $384.2 million, which was an increase of $104.5 million, or 37.38% from 2015. The increase was due to the Cardinal merger. Average core deposits totaled $343.2 million in 2016 representing a 37.71% increase over the $249.2 million in 2015. The percentage of the Company’s average deposits that are interest-bearing decreased from 73.8% in 2015 to 73.7% in 2016 as the acquired deposits had a similar mix to those of the Company. Average demand deposits, which earn no interest, increased 37.25% from $73.2 million in 2015 to $100.4 million in 2016. Average deposits for the periods ended December 31, 2016, 2015, and 2014 are summarized in Table 9.

 

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Management’s Discussion and Analysis

 

 

 

Table 9. Deposit Mix (dollars in thousands)

 

 

 

     December 31, 2016     December 31, 2015  
     Average
Balance
     % of Total
Deposits
    Average
Rate
Paid
    Average
Balance
     % of Total
Deposits
    Average
Rate Paid
 

Interest-bearing deposits:

              

NOW Accounts

   $ 42,848        11.2     0.10   $ 26,653        9.5     0.08

Money Market

     30,482        7.9     0.21     19,191        6.9     0.15

Savings

     77,064        20.1     0.24     55,876        20.0     0.25

Individual retirement accounts

     41,770        10.9     1.06     36,756        13.1     1.58

Small denomination certificates

     49,942        13.0     0.52     37,592        13.4     0.63

Large denomination certificates

     40,925        10.7     0.71     30,397        10.9     1.12
  

 

 

    

 

 

   

 

 

   

 

 

    

 

 

   

 

 

 

Total interest-bearing deposits

     283,031        73.8     0.45     206,465        73.8     0.65

Noninterest-bearing deposits

     100,425        26.2     0.00     73,167        26.2     0.00
  

 

 

    

 

 

   

 

 

   

 

 

    

 

 

   

 

 

 

Total deposits

   $ 383,456        100.0     0.33   $ 279,632        100.0     0.48
  

 

 

    

 

 

   

 

 

   

 

 

    

 

 

   

 

 

 
                        December 31, 2014  
                        Average
Balance
     % of Total
Deposits
    Average
Rate Paid
 

Interest-bearing deposits:

              

NOW Accounts

          $ 26,776        9.5     0.08

Money Market

            18,029        6.4     0.15

Savings

            48,897        17.4     0.25

Individual retirement accounts

            40,960        14.6     2.02

Small denomination certificates

            45,108        16.1     0.69

Large denomination certificates

            36,673        13.1     1.13
         

 

 

    

 

 

   

 

 

 

Total interest-bearing deposits

            216,443        77.1     0.80

Noninterest-bearing deposits

            64,468        22.9     0.00
         

 

 

    

 

 

   

 

 

 

Total deposits

          $ 280,911        100.0     0.61
         

 

 

    

 

 

   

 

 

 

The average balance of certificates of deposit issued in denominations of $100,000 or more increased by $10.5 million, or 34.63%, for the year ended December 31, 2016. 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 2016 was primarily funded through reductions in investment securities and cash received through the merger, 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, 2016.

 

 

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

 

 

 

Analysis of certificates of deposit of $100,000 or more at December 31, 2016:

 

Remaining maturity of three months or less

   $ 7,718  

Remaining maturity over three months through six months

     8,477  

Remaining maturity over six months through twelve months

     14,470  

Remaining maturity over twelve months

     23,742  
  

 

 

 

Total certificates of deposit of $100,000 or more

   $ 54,407  
  

 

 

 

 

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Management’s Discussion and Analysis

 

 

 

Equity

Stockholders’ equity amounted to $55.5 million at December 31, 2016, an 80.93% increase from the 2015 year-end total of $30.7 million. The increase resulted from the issuance of stock in connection with the merger totaling $23.5 million, earnings of $2.4 million less net changes in pension reserves and unrealized depreciation of investment securities classified as available for sale totaling $630 thousand, and the payment of dividends of $473 thousand.

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 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 (increased from the prior requirement of 4%); (iii) a total capital ratio of 8% of risk-weighted assets (unchanged from the prior requirement); and (iv) a leverage ratio of 4% of total assets (unchanged from the prior requirement). When 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 as that buffer is phased in, 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 as that buffer is phased in, 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 as that buffer is phased in, 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.

At December 31, 2014, the Bank was under a formal agreement with the OCC and subject to individual minimum capital ratios established by the OCC. The formal agreement was terminated on April 24, 2015 and the individual minimum capital ratios were not in effect at December 31, 2015.

 

 

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

 

 

 

     2016     2015  

Tier 1 capital

   $ 50,111     $ 29,686  

Unrealized gains on AFS prefereed stock

     107       —    

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

     3,439       3,267  
  

 

 

   

 

 

 

Total regulatory capital

   $ 53,657     $ 32,953  
  

 

 

   

 

 

 

Total risk-weighted assets

   $ 421,801     $ 257,891  
  

 

 

   

 

 

 

Tier 1 capital as a percentage of risk-weighted assets

     11.9     11.5

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

     11.9     11.5

Total regulatory capital as a percentage of risk-weighted assets

     12.7     12.8

Leverage ratio*

     9.0     8.9

*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, 2016, 2015, 2014, 2013 and 2012 are analyzed in Table 12.

 

 

Table 12. Nonperforming Assets (dollars in thousands)

 

     At December 31,  
     2016     2015     2014     2013     2012  

Nonperforming loans:

          

Nonaccrual loans

   $ 4,664     $ 1,589     $ 4,608     $ 11,858     $ 14,477  

Restructured loans

     9,239       10,008       10,525       9,216       8,916  

Loans past due 90 days or more and still accruing

     —         —         —         83       209  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total nonperforming loans

     13,903       11,597       15,133       21,157       23,602  

Foreclosed assets

     70       408       657       2,197       2,748  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total nonperforming assets

   $ 13,973     $ 12,005     $ 15,790     $ 23,354     $ 26,350  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total nonperforming loans as a percentage to total loans

     3.4     4.8     6.8     10.0     11.5
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total nonperforming assets as a percentage to total assets

     2.5     3.6     4.7     7.0     7.8
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total nonperforming loans were 3.4% and 4.8% of total outstanding loans as of December 31, 2016 and 2015, respectively. The majority of the increase in nonaccrual loans from 2015 to 2016 came in the “farmland” category. Nonaccrual loans in this category increased by $2.8 million. 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, 2016 and 2015, interest income recognized on loans in nonaccrual status was approximately $44 thousand and $49 thousand, respectively. Had these credits been current in accordance with their original terms, the gross interest income for these credits would have been approximately $167 thousand and $293 thousand, respectively for the years ended December 31, 2016 and 2015.

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 2015 to 2016 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 Bank experienced a TDR success rate of approximately 87.1% and 88.6% as of December 31, 2016 and 2015, respectively.

 

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Management’s Discussion and Analysis

 

 

 

The decrease in foreclosed assets from 2015 to 2016 resulted primarily from the sale of multiple 1-4 family residential real estate properties during the year. Sales and market adjustments of foreclosed assets in 2016 resulted in a net gain of $37 thousand. More information on nonperforming assets can be found in Note 5 of the “Notes to Consolidated Financial Statements” found in the company’s 2016 Annual Report.

As of December 31, 2016 and 2015 we had loans with a current principal balance of $40.0 million and $24.7 million rated “Watch” or “Special Mention”. The increase was due primarily to loans acquired from Cardinal. 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, 2016 loans past due 30-89 days and still accruing totaled $909 thousand compared to $1.3 million at December 31, 2015.

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, 2016 totaled $5.3 million, or 1.3% 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.

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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Table of Contents

 

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 (thousands)

 

 

 

     2016     2015     2014     2013     2012  

Allowance for loan losses, beginning

   $ 3,418     $ 4,185     $ 4,591     $ 4,957     $ 4,942  

Provision for (reduction of) loan losses, added

     (5     (187     294       1,233       1,542  

Charge-offs:

          

Commercial and agricultural

     (19     (1     (78     (129     (94

Real estate - construction

     (20     (186     (268     (337     (93

Real estate - mortgage

     (105     (469     (599     (1,110     (1,502

Consumer and other

     (70     (30     (4     (90     (87

Recoveries:

          

Commercial and agricultural

     8       10       15       20       47  

Real estate - construction

     98       16       17       —         32  

Real estate - mortgage

     81       23       185       37       151  

Consumer and other

     34       57       32       10       19  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net (charge-offs) recoveries

     7       (580     (700     (1,599     (1,527
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Allowance for loan losses, ending

   $ 3,420     $ 3,418     $ 4,185     $ 4,591     $ 4,957  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

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

     0.00     0.26     0.32     0.77     0.73
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

 

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

 

 

 

     December 31, 2016     December 31, 2015     December 31, 2014  

 

Balance at the end of the period to applicable to:

   Amount      % of
Loans to
Total Loans
    Amount      % of
Loans to

Total Loans
    Amount      % of
Loans to
Total Loans
 

Commercial and agricultural

   $ 210        6.33   $ 136        5.30   $ 154        4.62

Real estate - construction

     319        6.42     344        6.01     591        7.69

Real estate - mortgage

     2,783        84.78     2,900        86.63     3,388        85.54

Consumer and other

     108        2.47     38        2.06     52        2.15
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Total

   $ 3,420        100.00   $ 3,418        100.00   $ 4,185        100.00
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 
                  December 31, 2013     December 31, 2012  
Balance at the end of the period applicable to:                 Amount      % of
Loans to
Total Loans
    Amount      % of
Loans to
Total Loans
 

Commercial and agricultural

        $ 201        5.09   $ 257        6.06

Real estate - construction

          468        7.21     454        7.62

Real estate - mortgage

          3,826        85.33     4,111        82.59

Consumer and other

          96        2.37     135        3.73
       

 

 

    

 

 

   

 

 

    

 

 

 

Total

        $ 4,591        100.00   $ 4,957        100.00
       

 

 

    

 

 

   

 

 

    

 

 

 

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.

 

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Management’s Discussion and Analysis

 

 

 

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, 2016 and 2015 is as follows:

 

     2016      2015  

Commitments to extend credit

   $ 54,667      $ 23,813  

Standby letters of credit

     —          —    
  

 

 

    

 

 

 
   $ 54,667      $ 23,813  
  

 

 

    

 

 

 

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 17.6% at December 31, 2016 compared to 13.4% at December 31, 2015. The Cardinal merger resulted in an overall increase in cash and cash equivalents, such as federal funds sold and interest bearing deposits in banks. 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, 2016. 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, 2016, 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, 2016
Maturities/Repricing
 
     1 to 3
Months
    4 to 12
Months
    13 to 60
Months
    Over 60
Months
    Total  

Interest-Earning Assets:

          

Interest bearing deposits

   $ 19,399     $ —       $ —       $ —       $ 19,399  

Federal funds sold

     9,294       —         —         —         9,294  

Investments

     7,479       —         22,946       32,115       62,540  

Loans

     81,488       34,795       218,804       76,881       411,968  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total

   $ 117,660     $ 34,795     $ 241,750     $ 108,996     $ 503,201  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Interest-Bearing Liabilities:

          

NOW accounts

   $ 64,825     $ —       $ —       $ —       $ 64,825  

Money market

     43,691       —         —         —         43,691  

Savings

     96,000       —         —         —         96,000  

Time Deposits

     20,799       57,689       89,159       —         167,647  

Borrowings

     —         —         —         —         —    
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total

   $ 225,315     $ 57,689     $ 89,159     $ —       $ 372,163  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Interest sensitivity gap

   $ (107,655   $ (22,894   $ 152,591     $ 108,996     $ 131,038  

Cumulative interest sensitivity gap

   $ (107,655   $ (130,549   $ 22,042     $ 131,038     $ 131,038  

Ratio of sensitivity gap to total earning assets

     -21.4     -4.5     30.3     21.6     26.0

Cumulative ratio of sensitivity gap to total earning assets

     -21.4     -25.9     4.4     26.0     26.0

 

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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, 2016.

 

 

 

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

   $ 19,047     $ 19,130     $ 19,426     $ 20,168      $ 20,228     $ 20,325     $ 20,433  

Change

   $ (1,121   $ (1,038   $ (742   $ —        $ 60     $ 157     $ 265  

Change percentage

     -5.56     -5.15     -3.68        0.30     0.78     1.31

Market Value of Equity

   $ 89,297     $ 83,327     $ 88,382     $ 94,356      $ 95,364     $ 94,123     $ 91,815  

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

 

 

 

     2016     2015     2014  

Return on average assets

     0.55     0.30     0.26

Return on average equity

     5.62     3.22     2.93

Dividend payout ratio¹

     19.56     17.24     0.00

Average equity to average assets

     9.78     9.33     8.94

 

¹  The Company did not pay dividends in 2014.

 

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Table of Contents
Item 7A. Quantitative and Qualitative Disclosures About Market Risk.

Not applicable.

 

Item 8. Financial Statements and Supplementary Data

 

36


Table of Contents

LOGO

Dear Fellow Shareholders:

It is our pleasure to present the year end 2016 Financial Report for Parkway Acquisition Corp. and Skyline National Bank. 2016 marked a significant year in the history of our company as we completed the merger in which Grayson Bankshares, Inc. and Cardinal Bankshares Corp, joined forces to become Parkway Acquisition Corp. The Bank of Floyd was then merged into Grayson National Bank, which has recently been re-branded and introduced to the market as Skyline National Bank!

We are excited about the promise of our new brand and proud of the Grayson and Floyd legacies it will carry forward. We are extremely pleased with how well Skyline National Bank is being received in the marketplace and look forward to delivering on our promise to be “Always our best.” With that in mind, we have extended our service hours for most branch locations and extended our Skyline Support Call Center hours for telephone support. While our conversion process created a few unavoidable inconveniences for our customers (new debit cards had to be activated and new online and mobile apps had to be initiated, etc.), we are confident that our customers will enjoy the many enhancements to our services and product offerings going forward.

Financially, we ended the year with total assets of $559 million, net loans of $409 million, and total deposits of $499 million. Our equity at year end was $55 million, representing a tangible book value of $10.58 per share. Earnings for the year totaled $2.4 million, or $0.60 per weighted average share.

As you can see, our financial results were in line with our projections for the first year of combination. Although it is still early in the year, we believe that our 2017 financial performance will also be in line with the projections we shared in our meetings prior to the combination. Most of the non-recurring costs associated with the merger will have been recognized by the end of the first quarter of 2017. With the systems conversion and other merger-related activities behind us, we will then shift our focus to the realization of operating efficiencies and incremental income opportunities that we believe our combination will make possible.

In mid-March, you should have received your semi-annual dividend of ..08 cents per share, an increase of .02 cents from the September 2016 dividend amount. Your Board of Directors will address dividends again in the Fall of 2017. If you have not already done so, we encourage you to be in touch with our transfer agent, Computershare, to complete the transfer of your Grayson and Cardinal shares into shares of Parkway.

We look forward to seeing you at our 2017 Annual Shareholders’ Meeting which will be held on Tuesday, May 9th at the Wytheville Meeting Center in Wytheville, Virginia beginning at 1:00 PM. We always appreciate the opportunity to visit with our shareholders, listen to your comments, and answer any questions you may have.

Always Our Best,

 

LOGO

Allan Funk

President and CEO

 

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LOGO

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Board of Directors and Stockholders

Parkway Acquisition Corp.

We have audited the accompanying consolidated balance sheets of Parkway Acquisition Corp. (formerly known as Grayson Bankshares, Inc.) and subsidiary (the “Company”) as of December 31, 2016 and 2015, and the related consolidated statements of income, comprehensive income, changes in stockholders’ equity and cash flows for the years then ended. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, 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. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Parkway Acquisition Corp. and subsidiary as of December 31, 2016 and 2015, and the results of their operations and their cash flows for the years then ended, in conformity with U.S. generally accepted accounting principles.

/s/ Elliott Davis Decosimo, PLLC

Charlotte, North Carolina

March 29, 2017

Elliott Davis Decosimo PLLC | www.elliottdavis.com

 

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Table of Contents

 

Consolidated Balance Sheets

December 31, 2016 and 2015

 

 

 

(dollars in thousands)    2016     2015  

Assets

    

Cash and due from banks

   $ 7,215     $ 5,678  

Interest-bearing deposits with banks

     19,399       51  

Federal funds sold

     9,294       2,326  

Investment securities available for sale

     62,540       56,050  

Restricted equity securities

     1,149       972  

Loans, net of allowance for loan losses of $3,420 at December 31, 2016 and $3,418 at December 31, 2015

     408,548       237,798  

Cash value of life insurance

     16,850       9,978  

Foreclosed assets

     70       408  

Property and equipment, net

     17,970       11,756  

Accrued interest receivable

     1,732       1,293  

Core deposit intangible

     2,327       —    

Deferred tax assets, net

     5,872       1,777  

Other assets

     5,890       3,673  
  

 

 

   

 

 

 
   $ 558,856     $ 331,760  
  

 

 

   

 

 

 

Liabilities and Stockholders’ Equity

    

Liabilities

    

Deposits

    

Noninterest-bearing

   $ 127,224     $ 80,593  

Interest-bearing

     372,163       199,283  
  

 

 

   

 

 

 

Total deposits

     499,387       279,876  

Borrowings

     —         20,000  

Accrued interest payable

     57       169  

Other liabilities

     3,946       1,059  
  

 

 

   

 

 

 
     503,390       301,104  
  

 

 

   

 

 

 

Commitments and contingencies (Note 16)

    

Stockholders’ equity

    

Preferred stock, $25 par value; 500,000 shares authorized; none issued

     —         —    

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

     —         —    

Common stock, no par value; 25,000,000 shares authorized; 5,021,376 and none issued and outstanding at December 31, 2016 and 2015, respectively

     —         —    

Common stock, $1.25 par value; 2,000,000 shares authorized; none and 1,718,968 shares issued and outstanding at December 31, 2016 and 2015, respectively

     —         2,149  

Surplus

     26,166       522  

Retained earnings

     30,654       28,709  

Accumulated other comprehensive loss

     (1,354     (724
  

 

 

   

 

 

 
     55,466       30,656  
  

 

 

   

 

 

 
   $ 558,856     $ 331,760  
  

 

 

   

 

 

 

See Notes to Consolidated Financial Statements

LOGO

 

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Table of Contents

 

Consolidated Statements of Income

Years ended December 31, 2016 and 2015

 

 

 

(dollars in thousands except share amounts)    2016     2015  

Interest income

    

Loans and fees on loans

   $ 16,284     $ 11,189  

Interest-bearing deposits in banks

     37       1  

Federal funds sold

     46       18  

Investment securities:

    

Taxable

     1,129       1,434  

Exempt from federal income tax

     3       20  

Dividends

     63       41  
  

 

 

   

 

 

 
     17,562       12,703  
  

 

 

   

 

 

 

Interest expense

    

Deposits

     1,286       1,352  

Interest on borrowings

     442       874  
  

 

 

   

 

 

 
     1,728       2,226  
  

 

 

   

 

 

 

Net interest income

     15,834       10,477  

Provision for loan losses

     (5     (187
  

 

 

   

 

 

 

Net interest income after provision for loan losses

     15,839       10,664  
  

 

 

   

 

 

 

Noninterest income

    

Service charges on deposit accounts

     1,256       1,008  

Other service charges and fees

     1,346       1,051  

Net realized gains on securities

     364       97  

Mortgage loan origination fees

     167       45  

Increase in cash value of life insurance

     382       290  

Bargain purchase gain

     891       —    

Other income

     164       20  
  

 

 

   

 

 

 
     4,570       2,511  
  

 

 

   

 

 

 

Noninterest expense

    

Salaries and employee benefits

     8,630       6,558  

Occupancy and equipment

     1,985       1,149  

Foreclosed asset expense, net

     79       14  

Data processing expense

     888       561  

FDIC assessments

     247       302  

Advertising

     211       223  

Bank franchise tax

     270       172  

Director fees

     257       173  

Merger related expense

     1,483       498  

Other expense

     2,766       1,930  
  

 

 

   

 

 

 
     16,816       11,580  
  

 

 

   

 

 

 

Income before income taxes

     3,593       1,595  

Income tax expense

     1,175       598  
  

 

 

   

 

 

 

Net income

   $ 2,418     $ 997  
  

 

 

   

 

 

 

Basic earnings per share

   $ 0.60     $ 0.58  
  

 

 

   

 

 

 

Weighted average shares outstanding

     4,026,114       1,718,968  
  

 

 

   

 

 

 

Dividends declared per share

   $ 0.12     $ 0.10  
  

 

 

   

 

 

 

See Notes to Consolidated Financial Statements

 

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Consolidated Statements of Comprehensive Income

Years ended December 31, 2016 and 2015

 

 

 

(dollars in thousands)    2016     2015  

Net income

   $ 2,418     $ 997  
     

 

 

   

 

 

 

Other comprehensive loss

    

Net change in pension reserve:

    

Change in pension reserve during the year

     (261     (307

Tax related to change in pension reserve

     89       104  

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

    

Unrealized (losses) gains arising during the year

     (331     196  

Tax related to unrealized losses (gains)

     113       (66

Reclassification of net realized gains during the year

     (364     (97

Tax related to realized gains

     124       33  
     

 

 

   

 

 

 

Total other comprehensive loss

     (630     (137
     

 

 

   

 

 

 

Total comprehensive income

   $ 1,788     $ 860  
     

 

 

   

 

 

 

See Notes to Consolidated Financial Statements

LOGO LOGO

 

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Consolidated Statements of Changes in Stockholders’ Equity

Years ended December 31, 2016 and 2015

 

 

 

(dollars in thousands except share amounts)                                     
     Common Stock           Retained
Earnings
    Accumulated
Comprehensive

Loss
       
     Shares     Amount     Surplus         Total  

Balance, December 31, 2014

     1,718,968     $ 2,149     $ 522     $ 27,884     $ (587   $ 29,968  

Net income

     —         —         —         997       —         997  

Other comprehensive loss

     —         —         —         —         (137     (137

Dividends paid ($.10 per share)

     —         —         —         (172     —         (172
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balance, December 31, 2015

     1,718,968     $ 2,149     $ 522     $ 28,709     $ (724   $ 30,656  

Net income

     —         —         —         2,418       —         2,418  

Other comprehensive loss

     —         —         —         —         (630     (630

Conversion of common stock in connection with new holding company on July 1, 2016:

            

Exchange of Grayson common stock, $1.25 par value

     (1,718,968     (2,149     —         —         —         (2,149

For Parkway common stock, no par value

     3,025,384       —         2,149       —         —         2,149  

Issuance of common stock in connection with acquisition of

            

Cardinal Bankshares Corp

     1,996,453       —         23,500       —         —         23,500  

Redemption of fractional shares issued in acquisition of Cardinal

            

Bankshares Corp

     (461     —         (5     —         —         (5

Dividends paid prior to conversion

     —         —         —         (172     —         (172

Dividends paid ($0.06 per share)

     —         —         —         (301     —         (301
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balance, December 31, 2016

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

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

See Notes to Consolidated Financial Statements

LOGO

 

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Table of Contents

 

Consolidated Statements of Cash Flows

Years ended December 31, 2016 and 2015

 

 

 

(dollars in thousands)    2016     2015  

Cash flows from operating activities

    

Net income

   $ 2,418     $ 997  

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

    

Depreciation and amortization

     883       604  

Amortization of core deposit intangibles

     142       —    

Accretion of loan discount and deposit premium, net

     (1,047     —    

Bargain purchase gain

     (891     —    

Reduction of loan loss provision

     (5     (187

Deferred income taxes

     1,154       590  

Net realized gains on securities

     (364     (97

Accretion of discount on securities, net of amortization of premiums

     602       496  

Deferred compensation

     (77     (2

Net realized (gain) loss on foreclosed assets

     37       (74

Life insurance income

     (97     —    

Changes in assets and liabilities:

    

Cash value of life insurance

     (382     (289

Accrued interest receivable

     100       34  

Other assets

     (209     (46

Accrued interest payable

     (147     (12

Other liabilities

     1,462       (26
  

 

 

   

 

 

 

Net cash provided by operating activities

     3,579       1,988  
  

 

 

   

 

 

 

Cash flows from investing activities

    

Activity in available for sale securities:

    

Purchases

     (17,881     (22,847

Sales

     55,115       24,275  

Maturities/calls/paydowns

     14,349       11,260  

Sales (purchases) of restricted equity securities

     1,131       (2

Net increase in loans

     (12,105     (19,446

Proceeds from the sale of loans

     —         100  

Proceeds from life insurance contracts

     321       —    

Proceeds from the sale of foreclosed assets

     326       864  

Purchases of property and equipment, net of sales

     (674     (279

Cash received in business combination

     11,698       —    
  

 

 

   

 

 

 

Net cash provided by (used in) investing activities

     52,280       (6,075
  

 

 

   

 

 

 

Cash flows from financing activities

    

Net increase (decrease) in deposits

     472       (2,260

Net decrease in borrowings

     (28,000     —    

Cash paid for fractional shares

     (5     —    

Dividends paid

     (473     (172
  

 

 

   

 

 

 

Net cash used in financing activities

     (28,006     (2,432
  

 

 

   

 

 

 

Net increase (decrease) in cash and cash equivalents

     27,853       (6,519

Cash and cash equivalents, beginning

     8,055       14,574  
  

 

 

   

 

 

 

Cash and cash equivalents, ending

   $ 35,908     $ 8,055  
  

 

 

   

 

 

 

See Notes to Consolidated Financial Statements

 

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Table of Contents

 

Consolidated Statements of Cash Flows

Years ended December 31, 2016 and 2015

 

 

 

Supplemental disclosure of cash flow information

    

Interest paid

   $ 1,840     $ 2,238  
     

 

 

   

 

 

 

Taxes paid

   $ 320     $ —    
     

 

 

   

 

 

 

Supplemental disclosure of noncash investing activities

    

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

   $ (458   $ 65  
     

 

 

   

 

 

 

Effect on equity of change in unfunded pension liability

   $ (172   $ (203
     

 

 

   

 

 

 

Transfers of loans to foreclosed properties

   $ 25     $ 541  
     

 

 

   

 

 

 

Business combinations

    

Assets acquired

   $ 253,135     $ —    

Liabilities assumed

     228,744       —    
     

 

 

   

 

 

 

Net assets

   $ 24,391     $ —    
     

 

 

   

 

 

 

Bargain purchase gain

   $ 891     $ —    
     

 

 

   

 

 

 

Stock issued to acquire Cardinal Bankshares Corp.

   $ 23,500     $ —    
     

 

 

   

 

 

 

See Notes to Consolidated Financial Statements

 

44


Table of Contents

 

Notes to Consolidated Financial Statements

 

 

Note 1. Organization and Summary of Significant Accounting Policies

Organization

Parkway Acquisition Corp. (“Parkway”) was incorporated as a Virginia corporation on November 2, 2015. Parkway was formed as a business combination shell 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 and Plan of Merger (the “merger agreement”), providing for the combination of the three companies. Terms of the merger agreement called for Grayson and Cardinal to merge with and into Parkway, with Parkway as the surviving corporation (the “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 merger was completed on July 1, 2016. Grayson is considered the acquiror and Cardinal is considered the acquiree in the transaction for accounting purposes.

Upon completion of the 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. 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 surrounding areas through seventeen full-service banking offices and one loan production office. Effective March 13, 2017, the Bank changed its name to Skyline National Bank. 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 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 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 merger.

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.

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.

 

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Table of Contents

 

Notes to Consolidated Financial Statements

 

 

 

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

 

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 collectibility 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.

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.

 

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Table of Contents

 

Notes to Consolidated Financial Statements

 

 

 

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

 

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.

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.

 

47


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 there of, 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 collectibility 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.

 

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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. Troubled debt restructured loans are maintained in nonaccrual status until they have been performing in accordance with modified terms for a period of at least six months.

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 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 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.

Core Deposit Intangible

Core deposit intangibles 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).

 

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Table of Contents

 

Notes to Consolidated Financial Statements

 

 

 

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

 

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.

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.

Comprehensive Income

Comprehensive income consists of net income and other comprehensive income (loss). Other comprehensive income 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, 2014

   $ (182    $ (405    $ (587

Other comprehensive income (loss) before reclassifications

     130        (203      (73

Amounts reclassified from accumulated other comprehensive income (loss)

     (64      —          (64
  

 

 

    

 

 

    

 

 

 

Balance December 31, 2015

     (116      (608      (724

Other comprehensive loss before reclassifications

     (218      (172      (390

Amounts reclassified from accumulated other comprehensive loss

     (240      —          (240
  

 

 

    

 

 

    

 

 

 

Balance December 31, 2016

   $ (574    $ (780    $ (1,354
  

 

 

    

 

 

    

 

 

 

 

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Table of Contents

 

Notes to Consolidated Financial Statements

 

 

 

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

 

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.

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 12. 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 loss 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 May 2014, the FASB issued guidance to change the recognition of revenue from contracts with customers. The core principle of the new guidance is that an entity should recognize revenue to reflect the transfer of goods and services to customers in an amount equal to the consideration the entity receives or expects to receive. The guidance will be effective for the Company for annual periods beginning after December 15, 2017, and interim periods within annual reporting periods beginning after December 15, 2018. The Company will apply the guidance using a full retrospective approach. The Company does not expect these amendments to have a material effect on its consolidated financial statements.

In April 2015, the FASB issued guidance which provides a practical expedient that permits the Company to measure defined benefit plan assets and obligations using the month-end that is closest to the Company’s fiscal year-end. The amendments will be effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2015, with early adoption permitted. The Company does not expect these amendments to have a material effect on its consolidated financial statements.

In August 2015, the FASB deferred the effective date of ASU 2014-09, Revenue from Contracts with Customers. As a result of the deferral, the guidance in ASU 2014-09 will be effective for the Company for reposting periods beginning after December 15, 2017. The Company will apply the guidance using a full retrospective approach. The Company does not expect these amendments to have a material effect on its consolidated financial statements.

In September 2015, the FASB amended the Business Combinations topic of the Accounting Standards Codification to simplify the accounting for adjustments made to provisional amounts recognized in a business combination by eliminating the requirement to retrospectively account for those adjustments. The amendments were effective for the Company on January 1, 2016 and did not have a material effect on its financial statements.

In November 2015, the FASB amended the Income Taxes topic of the Accounting Standards Codification to simplify the presentation of deferred income taxes by requiring that deferred tax liabilities and assets be classified as noncurrent in a classified statement of financial position. The amendments will be effective for financial statements issued for annual periods beginning after December 15, 2016, and interim periods within those annual periods, with early adoption permitted as of the beginning of an interim or annual reporting period. The Company will apply the guidance prospectively. The Company does not expect these amendments to have a material effect on its consolidated financial statements.

 

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Notes to Consolidated Financial Statements

 

 

 

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

 

Recent Accounting Pronouncements, continued

In January 2016, the FASB amended the Financial Instruments topic of the Accounting Standards Codification to address certain aspects of recognition, measurement, presentation, and disclosure of financial instruments. The amendments will be effective for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years. The Company will apply the guidance by means of a cumulative-effect adjustment to the balance sheet as of the beginning of the fiscal year of adoption. The amendments related to equity securities without readily determinable fair values will be applied prospectively to equity investments that exist as of the date of adoption of the amendments. The Company does not expect these amendments to have a material effect on its consolidated financial statements.

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. The Company is currently evaluating the effect that implementation of the new standard will have on its financial position, results of operations, and cash flows.

In March 2016, the FASB amended the Revenue from Contracts with Customers topic of the Accounting Standards Codification to clarify the implementation guidance on principal versus agent considerations and address how an entity should assess whether it is the principal or the agent in contracts that include three or more parties. The amendments will be effective for the Company for reporting periods beginning after December 15, 2017. The Company does not expect these amendments to have a material effect on its financial statements.

In March 2016, the FASB issued guidance to simplify several aspects of the accounting for share-based payment award transactions including the income tax consequences, the classification of awards as either equity or liabilities, and the classification on the statement of cash flows. Additionally, the guidance simplifies two areas specific to entities other than public business entities allowing them apply a practical expedient to estimate the expected term for all awards with performance or service conditions that have certain characteristics and also allowing them to make a one-time election to switch from measuring all liability-classified awards at fair value to measuring them at intrinsic value. The amendments will be effective for the Company for annual periods beginning after December 15, 2016 and interim periods within those annual periods. The Company does not expect these amendments to have a material effect on its financial statements.

In April 2016, the FASB amended the Revenue from Contracts with Customers topic of the Accounting Standards Codification to clarify guidance related to identifying performance obligations and accounting for licenses of intellectual property. The amendments will be effective for the Company for reporting periods beginning after December 15, 2017. The Company does not expect these amendments to have a material effect on its financial statements.

In May 2016, the FASB amended the Revenue from Contracts with Customers topic of the Accounting Standards Codification to clarify guidance related to collectability, noncash consideration, presentation of sales tax, and transition. The amendments will be effective for the Company for reporting periods beginning after December 15, 2017. The Company does not expect these amendments to have a material effect on its financial statements.

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. The Company is currently evaluating the effect that implementation of the new standard will have on its financial position, results of operations, and 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 August 2016, the FASB amended the Statement of Cash Flows topic of the Accounting Standards Codification to clarify how certain cash receipts and cash payments are presented and classified in the statement of cash flows. The amendments will be effective for the Company for fiscal years beginning after December 15, 2017 including interim periods within those fiscal years. The Company does not expect these amendments to have a material effect on its financial statements.

In October 2016, the FASB amended the Income Taxes topic of the Accounting Standards Codification to modify the accounting for intra-entity transfers of assets other than inventory. The amendments will be effective for the Company for fiscal years beginning after December 15, 2017 including 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 October 2016, the FASB amended the Consolidation topic of the Accounting Standards Codification to revise the consolidation guidance on how a reporting entity that is the single decision maker of a variable interest entity (VIE) should treat indirect interests in the entity held through related parties that are under common control with the reporting entity when determining whether it is the primary beneficiary of that VIE. The amendments will be effective for the Company for fiscal years beginning after December 15, 2016 including 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 November 2016, the FASB amended the Statement of Cash Flows topic of the Accounting Standards Codification to clarify how restricted cash is presented and classified in the statement of cash flows. The amendments will be effective for the Company for fiscal years beginning after December 15, 2017 including 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 2016, the FASB issued amendments to clarify the Accounting Standards Codification (ASC), correct unintended application of guidance, and make minor improvements to the ASC that are not expected to have a significant effect on current accounting practice or create a significant administrative cost to most entities. The amendments were effective upon issuance (December 14, 2016) for amendments that do not have transition guidance. Amendments that are subject to transition guidance will be effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2016. Early adoption is permitted. The Company does not expect these amendments to have a material effect on its financial statements.

In December 2016, the FASB issued technical corrections and improvements to the Revenue from Contracts with Customers Topic. These corrections make a limited number of revisions to several pieces of the revenue recognition standard issued in 2014. The effective date and transition requirements for the technical corrections will be effective for the Company for reporting periods beginning after December 15, 2017. The Company will apply the guidance using a full retrospective approach. 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.

 

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Table of Contents

 

Notes to Consolidated Financial Statements

 

 

 

Note 2. Business Combinations

On July 1, 2016, Parkway completed its merger with Grayson and Cardinal. Parkway had no material assets or liabilities and did not conduct any business prior to consummation of the merger except to perform its obligations under the merger agreement. As such, Grayson is considered the acquiring entity in this business combination for accounting purposes. Under the terms of the merger agreement, 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. There was no trading market and no market price for Parkway common stock on the date of the transaction. Parkway was quoted on the OTC Markets and began trading on August 31, 2016; however, Parkway is a new company and the stock is thinly traded. Grayson, as the accounting acquirer at the time of the merger, was also thinly traded and the limited number of shares traded prior to the acquisition were not considered indicative of trading value. Due to the limited trading history of Parkway and Grayson, the Company engaged a third party to determine the value of the transaction as well as the value of the consideration paid to Cardinal as a result of the transaction. The Company also 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.

The following table presents the Cardinal assets acquired and liabilities assumed as of July 1, 2016 as well as the related fair value adjustments and determination of purchase gain.

 

(dollars in thousands)    As Reported by
Cardinal
    Fair Value
Adjustments
    As Reported by
Parkway
 
Assets       

Cash and cash equivalents

   $ 11,698     $ —       $ 11,698  

Investment securities

     59,327       (322 )(a)      59,005  

Restricted equity securities

     1,308       —         1,308  

Loans

     164,044       (6,192 )(b)      157,852  

Allowance for loan losses

     (2,123     2,123 (c)      —    

Cash value of life insurance

     6,714       —         6,714  

Property and equipment

     5,384       1,039 (d)      6,423  

Intangible assets

     —       2,469 (e)      2,469  

Accrued interest receivable

     539       —         539  

Other assets

     2,450       4,677 (f)      7,127  
  

 

 

   

 

 

   

 

 

 

Total assets acquired

   $ 249,341     $ 3,794     $ 253,135  
  

 

 

   

 

 

   

 

 

 
Liabilities       

Deposits

   $ 218,671     $ 602 (g)    $ 219,273  

Borrowings

     8,000       —   (h)      8,000  

Accrued interest payable

     35       —         35  

Other liabilities

     1,289       147 (i)      1,436  
  

 

 

   

 

 

   

 

 

 

Total liabilities acquired

   $ 227,995     $ 749     $ 228,744  
  

 

 

   

 

 

   

 

 

 

Net assets acquired

         24,391  

Total consideration paid

         23,500  

Purchase gain

       $ 891  

 

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Table of Contents

 

Notes to Consolidated Financial Statements

 

 

 

Note 2. Business Combinations, continued

 

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 Cardinal’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 = 34%). Also recognizes partial reversal of Cardinal’s deferred tax asset valuation allowance.

 

  (g) Estimated fair value adjustment to time deposits based on the Company’s third party evaluation report on deposits assumed.

 

  (h) Cardinal’s borrowings were overnight borrowings and carried at fair value therefore no adjustment was required.

 

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

The merger was accounted for under the acquisition method of accounting. The assets and liabilities of Cardinal have been recorded at their estimated fair values and added to those of Grayson for periods following the merger date. Valuations of acquired Cardinal 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 Financial Accounting Standards Board Accounting Standards Codification (“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.

Due to the limited trading history of Parkway and Grayson, the Company engaged a third party to determine the value of the transaction as well as the value of the consideration paid to Cardinal as a result of the transaction. The determined value of consideration received by Cardinal, when compared to the fair value of the net assets acquired from Cardinal, resulted in a bargain purchase gain of $891 thousand. The determined value of consideration received by Cardinal represented a premium when compared to the market price of Parkway stock, which was not publicly traded on the date of the merger. The premium results from enhanced cash flows and a lower required rate of return which are expected to be realized by Parkway, as compared to Grayson or Cardinal on a standalone basis. The merger of Grayson and Cardinal is expected to increase loan revenues due to an increased legal lending limit and expanded market area. Fee income is also expected to increase due to the larger deposit population. Significant cost savings are expected to be realized, particularly in the areas of salaries and benefits, data processing fees, and professional fees.    A lower required rate of return is anticipated due to increased access to capital and an expected increase in liquidity of shares due to higher trading volumes.    

 

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Table of Contents

 

Notes to Consolidated Financial Statements

 

 

 

Note 2. Business Combinations, continued

 

The following table presents the assets and liabilities of Parkway and Grayson prior to the merger, the estimated fair value of Cardinal assets acquired and liabilities assumed, and the resulting estimated balance sheet of Parkway immediately following the merger on July 1, 2016.

 

(dollars in thousands)    Pre-Merger
Parkway
     Pre-Merger
Grayson
     Cardinal
Acquired
     Post-Merger
Parkway
 

Assets

           

Cash and cash equivalents

   $ —        $ 13,117      $ 11,698      $ 24,815  

Investment securities

     —          33,847        59,005        92,852  

Restricted equity securities

     —          971        1,308        2,279  

Loans

     —          244,800        157,852        402,652  

Allowance for loan losses

     —          (3,309      —          (3,309

Cash value of life insurance

     —          10,122        6,714        16,836  

Foreclosed assets

     —          95        —          95  

Property and equipment

     —          11,548        6,423        17,971  

Goodwill and other intangible assets

     —          —          2,469        2,469  

Accrued interest receivable

     —          1,253        539        1,792  

Other assets

     —          5,044        7,127        12,171  
  

 

 

    

 

 

    

 

 

    

 

 

 

Total assets

   $ —        $ 317,488      $ 253,135      $ 570,623  
  

 

 

    

 

 

    

 

 

    

 

 

 

Liabilities

           

Deposits

   $ —        $ 274,265      $ 219,273      $ 493,538  

Borrowings

     —          10,000        8,000        18,000  

Accrued interest payable

     —          96        35        131  

Other liabilities

     —          1,146        1,436        2,582  
  

 

 

    

 

 

    

 

 

    

 

 

 

Total liabilities

   $ —        $ 285,507      $ 228,744      $ 514,251  
  

 

 

    

 

 

    

 

 

    

 

 

 

Shareholders’ Equity

   $ —        $ 31,981      $ 24,391      $ 56,372  
  

 

 

    

 

 

    

 

 

    

 

 

 

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

The table below presents supplemental pro forma information as if the Cardinal acquisition had occurred at the beginning of the earliest period presented, which was January 1, 2015. 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 $1.5 million and $498 thousand are included in the Company’s consolidated statements of operations for years ended December 31, 2016 and 2015, respectively, and are not included in the pro forma statements below.

 

     Year Ended December 31,  
     2016      2015  
     (unaudited)      (unaudited)  

Net interest income

   $ 19,000      $ 18,448  

Net income (a)

   $ 2,620      $ 2,295  

Basic and diluted weighted average shares outstanding (b)

     5,021,376        5,021,376  

Basic and diluted earnings per common share

   $ 0.52      $ 0.46  

 

  (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 Cardinal acquisition as of the earliest reporting date.

 

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Table of Contents

 

Notes to Consolidated Financial Statements

 

 

 

Note 2. Business Combinations, continued

 

From the acquisition date of July 1, 2016 through December 31, 2016, Cardinal recorded actual net interest income of $3.5 million, non-interest income of $415 thousand, and net income of $133 thousand. These results do not include adjustments for amortization and accretion of fair value adjustments resulting from the application of purchase accounting guidance.

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 $4.6 million and $2.5 million for the periods including December 31, 2016 and 2015, 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
 

2016

           

Available for sale:

           

Government sponsored enterprises

   $ 2,046      $ 236      $ (73    $ 2,209  

Mortgage-backed securities

     36,021        4        (823      35,202  

Corporate securities

     3,061        —          (87      2,974  

State and municipal securities

     22,282        97        (224      22,155  
  

 

 

    

 

 

    

 

 

    

 

 

 
   $ 63,410      $ 337      $ (1,207    $ 62,540  
  

 

 

    

 

 

    

 

 

    

 

 

 

2015

           

Available for sale:

           

U.S. Treasury securities

   $ 1,534      $ —        $ (18    $ 1,516  

U.S. Government agency securities

     3        1        —          4  

Government sponsored enterprises

     15,327        83        (101      15,309  

Mortgage-backed securities

     13,595        11        (93      13,513  

Asset-backed securities

     1,989        —          —          1,989  

Corporate securities

     3,104        —          (130      2,974  

State and municipal securities

     20,673        176        (104      20,745  
  

 

 

    

 

 

    

 

 

    

 

 

 
   $ 56,225      $ 271      $ (446    $ 56,050  
  

 

 

    

 

 

    

 

 

    

 

 

 

 

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Table of Contents

 

Notes to Consolidated Financial Statements

 

 

 

Note 4. Investment Securities, continued

 

Restricted equity securities were $1.1 million and $972 thousand at December 31, 2016 and 2015, respectively. Restricted equity securities consist of investments in stock of the Federal Home Loan Bank of Atlanta (FHLB), Community Bankers Bank, 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 Community Bankers Bank 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, 2016 and 2015.

 

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

2016

               

Available for sale:

               

Government sponsored enterprises

   $ —        $